You Still Owe The Fed $38.6 Trillion

Let’s start with a simple premise: The Fed now realizes that the massive windfall from the pandemic-era boom in property and stocks contributed to inflation.

Now let’s take it one step further. Knowing it can’t solve supply chain problems, drill for oil, produce natural gas, grow wheat or mediate a ceasefire in Ukraine, the Fed believes that taking back a portion of America’s accumulated wealth gains since Q2 2020 is among the most expedient ways to cool price pressures.

Now, finally, let’s assume that, given the scope of the inflation overshoot and the extent to which mismatches in the labor market have the potential to embed a wage-price spiral in the economy, the Fed wants to destroy all of the pandemic wealth gains in order to force people back into the labor force.

If all of that’s true, how much progress did the Fed make in Q1, when financial conditions tightened dramatically and stocks fell to the brink of a bear market? Well, not much, actually.

Household net worth fell by $544 billion in the first three months of 2022, Fed data out this week showed. That sounds like a lot until you consider that the accumulated wealth gain from Q2 2020 through Q4 2021 was $39.1 trillion (figure below).

For all the hand-wringing and headlines, Q1’s selloff on Wall Street simply didn’t matter all that much in the grand scheme of things.

To be sure, the stock drop wasn’t trivial. In fact, it wiped away the entirety of Q4’s gains — and then some.

The value of direct and indirect corporate equity holdings fell by almost $3 trillion from January through March (figure below).

That was more than a third of the pandemic drawdown. Still, the Fed would need to shave another $20 trillion off stocks to erase the surge they helped engineer.

Speaking of Fed-engineered bonanzas, the value of real estate rose a record $1.69 trillion over the first three months of 2022.

It was the sixth consecutive quarter during which property prices logged a gain of $1 trillion or more (figure below).

I’d note that home prices took a final leg higher in March and April, as buyers rushed to lock in rates and sellers to cash out at the top. If you round up, the value of real estate rose by $1.5 trillion in each of the last four quarters.

This is a familiar tale. Soaring stock and home prices minted countless American millionaires, even as the property boom put homeownership out of reach for countless millions of Americans.

It’s now painfully obvious that showering money on homeowners and stockholders compelled a meaningful number of people to consider exiting the labor force — some of them permanently.

At the same time, all that free money contributed to voracious demand for consumer goods, juxtaposed with a broken global supply chain.

Although it’s impossible to precisely quantify the Fed’s role in America’s inflation crisis, it’s not difficult to document the channel through which monetary largesse contributed. It wasn’t “money printing,” per se. The Fed didn’t send out checks totaling $40 trillion. Instead, they flooded the financial system with liquidity and binged on mortgage bonds, in what amounted to a Bernanke flex on steroids. The result is illustrated in the figure (above).

“If something indeed happened to the supply of labor post-pandemic (and some of that is wealth related), then to cool price pressures, maybe a pre-pandemic wealth level is appropriate indeed,” Zoltan Pozsar famously speculated in May. A few months previous, he wrote that,

If the young feeling Bitcoin-rich are less inclined to work and the old feeling mass affluent are eager to retire early, labor force participation drops to the detriment of real growth prospects. Maybe the path to slower services inflation — OER and all other services — is through lower asset prices. Volatility is the best policeman of risk appetite and risk assets. To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets — equities, credit and Bitcoin too.

In the same February note, Pozsar suggested that soon enough, “the Fed will incorporate some version of this thought process,” extreme though the prescription seemed at the time.

Ultimately, he was correct. If he was also correct last month to suggest that the entirety of the pandemic wealth gains need to go, you owe Jerome Powell another $38.57 trillion.