Fed, Biden Risk Credibility Crisis With Inflation Cliffhanger

“Prices surging,” declared alarmist chyrons on Saturday morning news shows in the US.

If it’s inflation expectations we’re concerned about, it probably doesn’t help that Americans are now starting their weekends bombarded with news about rapidly rising prices for everything from gas to food.

That’s not to say cable news should purposefully bury the story. It’s just to state the obvious: Inflation can become self-fulfilling through the expectations channel.

If you wake up to your favorite news anchor telling you prices are rising at the fastest pace since Desert Storm, you might be frightened into buying the 48 gallons of milk you need for this month right now, because by Monday, they’ll surely be more expensive. If enough people do the same, milk will be more expensive by Monday, seemingly validating your initial concerns.

You can conjure any number of alarming visuals. The figure (above, from BofA) includes some helpful annotations.

The bank’s Michael Hartnett noted that US CPI is running at an 8% annualized rate, the most in 40 years. “Next comes the wages surge,” he wrote, citing small businesses’ compensation plans.

In the latest NFIB survey, a net 44% reported raising compensation, the highest in almost 50 years of data (figure below).

A net 32% expect to raise pay over the next three months. That too was a record high.

“Raising compensation is the main resource available for owners to retain their current employees and compete for new talent,” the report said.

Government data out Friday showed a record 4.4 million Americans quit in September (figure below).

The quit rate sat at a record high headed into last month.

Although it still seems likely that consumer price growth will eventually cool, some version of a wage-price spiral looks like a foregone conclusion.

Plainly, employers are having an extremely difficult time raising wages enough to retain workers or hire new employees. Despite record readings on gauges of planned and actual compensation changes, almost half of all owners surveyed by the NFIB said they were unable to fill openings. “The number of unfilled job openings far exceeds the 48-year historical average of 22%,” the survey said.

Although wages and salaries rose at the fastest pace on record in the third quarter, and despite surging average hourly earnings in some sectors (according to nonfarm payrolls), the general sense is that wages need to increase dramatically in order to convince workers their buying power won’t be eroded. The more media coverage dedicated to inflation, the more pronounced that dynamic is likely to be.

The figure (below) is simple enough. Prices for beef, milk and gas are all at multi-year highs.

Excluding the anomalous surge during the spring of 2020 when the industry was upended by the onset of the pandemic, beef prices have never been higher. Or at least not on the BLS’s average price gauge.

The problem for The White House is straightforward. Consumer confidence is deteriorating fairly rapidly as expectations for real incomes fall in the face of rising prices.

It doesn’t help that average gas prices are $4 in three states, a situation that hasn’t occurred since oil prices were nearly $150 a barrel. Everyday people will understandably come to the conclusion that something is amiss considering crude isn’t anywhere near $150 today. Fairly or not, the blame will surely fall on the Biden administration (where “the buck stops”).

When it comes to the Fed, I’d argue that from the general public’s perspective, it’s not a matter of assigning blame for rising prices. Rather, it’s a matter of credibility vis-à-vis public declarations by Fed officials that policymakers have the tools to arrest inflation.

The public doesn’t understand much about the mechanics of monetary policy, but they do have some vague conception of the Fed’s inflation mandate. In the eyes of market participants, Jerome Powell will take some of the blame for creating the conditions for surging prices, both by being too slow to remove accommodation and by sticking with average-inflation targeting. In the court of public opinion, though, Powell be indicted not for causing inflation, but for failing to arrest it.

Critics in market circles spent a decade lampooning the Fed for creating asset price inflation while failing miserably when it came to effectuating real economic outcomes. Now, the same critics insist that the very same policies which didn’t work to create real world inflation for a dozen years, are the proximate cause of rising prices for goods and services, even as that’s plainly not the case (it’s a supply-side problem).

The public doesn’t care about that debate. If you think they do, go drive your Porsche into Section 8, knock on some random doors and ask who wants to talk about quantitative easing and its effect on milk prices. When you finally make it back to your gated community later that evening (in an Uber, because you’ll “lose” the Porsche somewhere along the way), let me know how your day went.

To the extent regular people care about the Fed’s role, it’s because, at some point, they saw Powell quoted saying i) the Fed “accept[s] accountability for inflation,” ii) conceding that “the level of inflation that we have right now is not at all consistent with price stability,” iii) promising the Fed has the “tools” to combat it and iv) ultimately pledging that under no circumstances would the Fed permit high inflation to “become a permanent feature of life” in America.

But during the same press conference (after the November FOMC meeting), Powell also admitted that the Fed has virtually no capacity to relieve supply chain frictions or resolve labor market tensions. Together, those frictions and tensions are the proximate cause of surging prices.

So, in fact, the Fed doesn’t have the “tools” it needs. And what continually vexes me is that, almost without exception, the people arguing for a Volcker-style response are people who wouldn’t be affected by the ensuing recession.

“The Fed, in my opinion, hasn’t done a thing right since Paul Volcker,” Jeremy Grantham said this week. It’s easy to suggest (tacitly or otherwise) that the Fed should engineer across-the-board demand destruction when you’re a billionaire.

Incidentally, the linked Bloomberg article flatly noted that GMO’s flagship Benchmark-Free Allocation Fund “has returned 2.2% this year.” That’s “just” 23.5% less than the S&P 500. (Good thing it’s “benchmark-free.”)

Still, critics are right about at least one thing. Powell now has a credibility problem. Both with markets and with the public. The public credibility deficit is more important.

The US economy is on the brink of a wage-price spiral and virtually everyone now agrees that the supply chain issues pushing up input prices aren’t going to be resolved in the very near-term. Absent some policy pivot that convinces workers the cost of living isn’t going to keep rising rapidly, regular people will demand higher wages.

As BofA’s Hartnett suggested, inflation is on the brink of “becom[ing] embedded.”

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