Today’s popular outlooks are flawed. They ignore inflation cycle reality. The economy and the financial system still face more challenges – troubles made worse by the actions and inactions now being taken. They are based on flawed positive thinking.
Flaw #1 – Viewing the inflation cycle as a short-term event
The inflation cycle is one of those long-term problems that gain momentum if unpopular actions are not taken. Powell accurately said “pain” was necessary in his early comments. However, that view has evaporated along with the incorrect expectation that a “soft landing” in the economy is adequate for stopping an inflation cycle.
Unfortunately, the Fed’s tardy and overly slow inflation “fight” allowed this inflation cycle to become established. Worse, the Fed now has paused its interest rate raising, continues its overly slow reversal of its enormous money supply creation, and has added the false hope that those actions have created nirvana: Defeat of the inflation cycle with no recession.
Flaw #2 – Relying on short-term inflation measures
The focus on the latest 12-month inflation number dismisses the ugly ground upon which it stands. The presumption is that speed is the indicator to watch, not distance. To see reality, we need to keep the inflation cycle intact – from its birth in the easy money actions initiated in early 2020. The graph below shows the picture – of where this inflation cycle has taken us, compared to the Fed’s 2% annual goal.
So, what is clear is that inflation, the killer of a currency’s value, has risen dramatically in only three years (18%). Viewed in terms of the U.S. currency’s purchasing power, the dollar’s value has fallen 15% since 2020.
Flaw #3 – Disregarding active, accumulated damage
Wall Street is famous for focusing on the next six months and forgetting what came before. While that may be fine in untroubled times, it’s a flawed approach for an economy and financial system that is infected by an inflation cycle. That’s because the damage done remains active. Without rectifying or, at least, moderating that accumulated damage, the illness prevails.
This graph shows what rectifying this inflation cycle partially or wholly would require.
Importantly, the Fed (and Wall Street and the media) are acting like a 2% (or even a 3%) inflation rate from here is a successful win in the inflation fight. However, look at how those “low” rates compound the current damage to much higher accumulated amounts. They should be viewed as unacceptably high. Moreover, note that the current accumulated excess inflation (over the 2% trend line) would take five years of 0% inflation to get back to that 2% trend line.
The bottom line: History is repeating
Actually, it’s worse than history. The same and worse mistakes have been made and are being made compared to what happened in 1966’s mistaken “soft landing.” (For a full explanation of that period, see my article, “Fed Pivots Too Soon – What Now?“)
Therefore, the growing damage from this inflation cycle is here to stay until the Fed finally takes the unpopular actions required to offset and reverse it. When will that happen? Not soon enough.