For the first time in decades, central banks are tightening their monetary policy while governments continue to spend money as if nothing has changed.
Large enterprises are not harmed by the most recent rate increases as long as credit conditions are still lax. However, households and small enterprises are bearing the full weight of the financial squeeze.
The current level of mortgage rates in the US is the highest since 2008. According to Reuters, the average interest rate for a 30-year mortgage hit 6.02% last week.
A perfect storm of declining sales and increased finance costs hurts small enterprises. While retail sales rose 0.3% in August, the data for July was corrected to indicate a 0.4% decline in sales. In addition, after July’s numbers were negatively revised, core retail sales were unchanged in August. This indicates a sharp decline in sales in real terms. Since official retail sales aren’t inflation-adjusted, August’s 9.1% increase over the prior year was actually flat.
In order to combat inflation, the Federal Reserve has raised interest rates and moderated liquidity requirements, which continue to have an impact on consumers but have no appreciable effect on government expenditure.
Government expenditure continues despite the Federal Reserve’s excessive lag.
For seventeen months, inflation has exceeded the Federal Reserve’s target, and increased expenditure by the government only fuels the fire. Core inflation continues to rise.
When the money supply is completely absorbed by new government debt and public deficit spending is kept at record high levels, rate increases are insufficient. Because of this, yearly inflation is still at a three-decade high of 8.3%. Furthermore, core CPI, which strips out food and energy, rose to 6.3% in August. This month-over-month growth of 0.6% exceeded economists’ predictions by a factor of two.
According to analysts, inflation is decreasing and, based on consensus projections, will reach 4% or less in 2023. But if all goes according to plan, that means that in two years, consumers and businesses will see cumulative inflation of at least 12%.
Also keep in mind that since March, shipping rates and commodity prices have corrected, which brings us to these poor August numbers.
Because stocks and bonds are declining, market participants are pleading with central banks to change course. An investor base that has not seen tight monetary policies in more than ten years becomes more worried. Governments are also growing more concerned about rising public debt yields.
Governments like low rates because they profit from both, even if inflation surges.
A stagflation like to the 1970s is considerably more likely if central banks alter their approach and stop raising interest rates while governments implement so-called “anti-inflation measures” that entail increasing debt, expenditure, and currency creation.
There isn’t a magic bullet for inflation. It is quite simple to start and extremely challenging to stop. Governments will continue to introduce new aid initiatives that fuel inflationary pressures if they have a financial motive to grow their debt.
The notion of cost-push inflation is disproved by rising core inflation. The majority of goods and services would see flat or declining pricing if the amount of money remained constant. If there are not more currency units available, then costs do not increase uniformly.
Those who predict a decline in inflation are referring to the rate of price increases rather than a decrease in overall costs. Not that prices would decrease, but rather that the annual rate of price increases will slow down.
Because margins are shrinking and real incomes are declining, this new reality of enduringly high prices is difficult for businesses and families to accept.
The reality that households and small companies are getting poorer and the middle class is being destroyed is true whether you are bullish or bearish on the rate of change of prices.
Daniel Lacalle is one the most influential economists in the world. He is Chief Economist at Tressis SV, Fund Manager at Adriza International Opportunities, Member of the advisory board of the Rafael del Pino foundation, Commissioner of the Community of Madrid in London, President of Instituto Mises Hispano and Professor at IE Business School, London School of Economics, IEB and UNED. Mr. Lacalle has presented and given keynote speeches at the most prestigious forums globally including the Federal Reserve in Houston, the Heritage Foundation in Washington, London School of Economics, Funds Society Forum in Miami, World Economic Forum, Forecast Summit in Peru, Mining Show in Dubai, Our Crowd in Jerusalem, Nordea Investor Summit in Oslo, and many others. Mr Lacalle has more than 24 years of experience in the energy and finance sectors, including experience in North Africa, Latin America and the Middle East. He is currently a fund manager overseeing equities, bonds and commodities. He was voted Top 3 Generalist and Number 1 Pan-European Buyside Individual in Oil & Gas in Thomson Reuters’ Extel Survey in 2011, the leading survey among companies and financial institutions. He is also author of the best-selling books: “Life In The Financial Markets” (Wiley, 2014), translated to Portuguese and Spanish ; “The Energy World Is Flat” (Wiley, 2014, with Diego Parrilla), translated to Portuguese and Chinese ; “Escape from the Central Bank Trap” (2017, BEP), translated to Spanish. Mr Lacalle also contributes at CNBC, World Economic Forum, Epoch Times, Mises Institute, Hedgeye, Zero Hedge, Focus Economics, Seeking Alpha, El Español, The Commentator, and The Wall Street Journal. He holds a PhD in Economics, CIIA financial analyst title, with a post graduate degree in IESE and a master’s degree in economic investigation (UCV).