This week’s Courier Herald column:
If you’ve been watching the stock market lately, you probably are getting frustrated with the pattern. What became a game for many during the pandemic – with phrases such as “stocks only go up” and “buy the dip” heard as rallying cries – has transitioned back to some cruel realities. The last six months have seen broad declines in stocks, coupled with intermittent sharp pullbacks in bonds and cryptocurrencies.
You won’t find many officials at the Federal Reserve or in elected office say this out loud, but depressing asset values is a specific monetary goal at the moment. We continue to pay the price for printing trillions of dollars to stabilize the economy during the pandemic. With inflation well beyond initial projections, that money is being taken back more aggressively than was expected just months ago.
The inflation the Fed is combatting has both supply and demand components. We’re now quite familiar with supply constraints. China continues to lock down factories in response to Covid outbreaks. The war in Ukraine has roiled energy and food markets. Many of these supply shocks will get worse before they get better.
The Federal Reserve can’t do much about the supply side of the problem. They’re now actively trying to kill demand.
This will affect us in different ways, depending on where we sit on the income and wealth spectrum. This is where a reminder that economics is often referred to as “the dismal science” may be in order.
Inflation itself is already crimping demand from those with the least ability to pay up for higher food and energy prices. Quarterly earnings reports from retailers like Wal-Mart, Target, and even Amazon demonstrate that shoppers are delaying purchases for discretionary items and substituting cheaper goods where possible.
On the other end of the spectrum, much wealth was actually created during the Fed’s money printer blitz. A housing supply shortage decades in the making combined with historic low mortgage rates created huge amounts of home equity. Trillions of dollars in wealth were created with increasing stock prices as investors searched alternatives for returns in a zero interest rate environment.
The “wealth effect” is a real component of economic activity. When consumers see the value of their assets going up, they tend to spend more. When they see the same values declining, they tend to get more conservative and often postpone large and discretionary purchases.
This is one of the reasons you saw the Federal Reserve jump into action throughout the pandemic when there were large drops in the stock market. They were trying to keep demand – and the economic activity it generates – strong.
Now, they’re in the opposite mode. While the outward signs are that they are trying to keep the current decline somewhat orderly, they would be happy to see home values crest for a while, and they’re comfortable with stocks returning to prices that reflect historic price to earnings ratios.
The ripple effects are real, despite the knock on the phrase “trickle-down economics”. Companies are already shifting to a “hire any qualified person available” mode to a more conservative posture. With unlimited cash no longer available from equity markets, many tech companies in the startup phase are scaling back growth plans. More established companies like Amazon have hinted at reduced hiring. Netflix has announced layoffs.
As workers start to notice these changes, they too will likely get more conservative with their current spending and their future plans. Workers have been able to demand raises for the past couple of years as there have been significantly more jobs available than people to fill them. As hiring slows and jobs begin to disappear, today’s aggressive optimism about future raises will become a more defensive, “protect what we have” mindset.
This ultimately also reveals the limits of the Federal Reserve to fight these battles. Their tools are quite effective but also blunt and imprecise. The unintended consequences – on the way up and the way down – are many. And the timing from a policy change to it working its way into the real economy has a major lag time.
The Fed shouldn’t be fighting this battle alone, nor used as a scapegoat by elected officials that gleefully pumped the economy full of cash with fiscal policy well after it was clear the corner on the pandemic had been turned. There are supply issues that can be addressed via fiscal policy and regulation.
Those issues are hard and might require some current talking points to be discarded – angering political bases. After all, the Fed stands ready to take the blame, and too many politicians would rather take the easy road of the blame game rather than walking their voters through a pragmatic path to actual supply solutions.