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Fuel for Inflation
For financial markets, September 2022 was one of the worst on record. A nonstop bear market has been created by a decline in stock prices in excess of 20 percent, just as national output declines for the second straight quarter. These indicators point to a continuing recession. Inflation pressures have, as of now, brought the thirty-year fixed-rate mortgage to a 6.7 percent rate, up 1.5 percentage points in the past six weeks and double what it was in January 2022. The Federal Reserve has instituted a series of sharp rate increases to tame the inflation. But this remedy, even if justified, will drive down stock prices in the short run and, by raising the cost of capital, could well further dampen economic activity. Wages have risen in nominal terms, but well below the rate of inflation.
We are now past the point where any government response to monetary issues can reverse this downward trend. Instead, what is necessary is a hard look at the wide array of social and business policies that have led to the current malaise.
Recall for these purposes that the basic definition of inflation is too many dollars chasing too few goods. The rate of inflation does not depend solely on monetary issues within the Fed’s domain—it also depends on changes in the stock of goods and services. Sensible economic policies that aid growth will thus tend to curb inflation even with bad or capricious decisions by the Fed. But conversely, foolish economic and regulatory decisions will compound the problem by shrinking the economic pie in area after area; a key tenet of progressive thinking harbors the sorry illusion that if the Fed does its job, governments and businesses—often backed by government power—are free to pursue all sorts of collateral ends, most of which are counterproductive.
Thus, in the financial sector, one of the most powerful recent social movements is the rise of ESG: environmental, social, and corporate-governance changes that are intended to undo supposed mischief resulting from the Friedman doctrine, which in 1970 posited that the sole function of the corporation is to produce gains for its shareholders so long as the firm operates within the legal boundaries set by the positive law, be they wise or foolish. A common criticism of this narrow focus is that it fails to include, as has been urged by Oliver Hart and Luigi Zingales, a wide range of critical social values. There is no doubt that shareholders as a group care about more than their bottom line. However, it is a sheer leap of faith to assume that all these collateral causes an ESG model attempts to incorporate into shareholder decision making line up with some progressive creed. Just as some shareholders champion gun control, others work tirelessly to promote broader Second Amendment gun rights. No corporation can satisfy both sets of demands simultaneously, which strengthens the Friedman position by making it clear that independent decisions by individual shareholders will reduce the number of conflicts of interest that arise when ESG becomes corporate policy.
In short, it is sensible to allow shareholders to maintain different values and have them reflected in their private donations rather than let the corporation impose a set of uniform values upon shareholders.
It is in fact impossible to be a faithful fiduciary to the multiple groups of stakeholders—shareholders, employees, suppliers, customers, and the public at large—whose interests commonly conflict. Under the Friedman model, each group has its own trustees who can better serve each respective constituency (whose members have more uniform views) than a corporation pushing an ESG-based agenda.
The illusion that all groups are owed fiduciary duties means in practice that none gets any reliable protection, which in turn allows for the emergence of strong external norms that are routinely baked into ESG. On the employment front, for example, ESG commonly requires that firms take steps to engage in diversity, equity, and inclusion. In the abstract, this initiative sounds good in its ostensible commitment to hiring from all sorts of identity groups and a supposed tolerance for differences of opinion. However, it could lead to quotas or other questionable policies when mandated by the SEC. ESG can also create other adverse consequences, including higher fees for ESG funds, which then must be audited to ensure compliance with government statutes and regulations. Yet if they do comply, the level of firm diversification is reduced such that, as one study from Derek Horstmeyer concludes, “the average ESG investor may be taking on more small-cap risk, interest-rate and inflation risk, and single-stock risk than an investor in a standard all-equity fund.”
Indeed, these ESG obligations could conceal serious conflicts of interest. For instance, BlackRock, a stalwart defender of ESG, used its voting rights as Exxon’s second-largest shareholder to reduce oil and gas production, without disclosing that Exxon’s abandoned fields could well be acquired by PetroChina, a firm in which Blackrock also has a sizable stake. It is therefore no surprise that some nineteen red-state attorneys general sent a strongly worded letter to Larry Fink, BlackRock’s CEO, reminding him that the traditional duties to state pension funds of loyalty and care are in breach by Fink’s policy.
At the center of this issue is the hotly disputed topic of climate change and the steps that should be taken to control it. The SEC has already spoken independently about this issue with the creation of its Climate and ESG Task Force, whose purpose is to ferret out mistakes in the disclosure statements of various firms on climate risk. Behind this ill-conceived initiative lies the assumption that the mandated SEC disclosures will have any material impact on business of which shareholders ought to know. If it passes legal challenges, compliance costs to firms of these disclosures will prove enormous and duplicative, and will surely deter banks and other financial institutions from investing in or lending to the fossil fuel industry. Sadly, it is no easy matter to ramp up wind and solar substitutes for fossil fuels, as Mario Loyola of the Competitive Enterprise Institute notes. Not only is an archaic and balky permitting process sure to delay the installation of new solar and wind facilities, but there is also substantial local opposition to the installation of transmission lines that must accompany the construction of new energy-generating operations, leading to chronic shortages and huge productivity losses.
The fundamental constraints still apply, no matter how hard California Governor Newsom, President Biden, and multiple lobbyists in Washington attempt to hasten the introduction of electric cars. These cars have to be charged somewhere and at some time, and yet for years to come intermittent sources like sun and wind will not be sufficient to supply the electrical grid. That point was driven home in the recent heat wave in which Newson, even as he sang the praises of electric vehicles, also had to declare a state of emergency in which he implored individuals not to charge those electric cars until the heat subsided. The blow is hardly softened by demands that thermometers be set above 78 degrees, lights be turned off, and appliances remain idle during the peak load period in summer between 4 p.m. and 9 p.m.
All these policies generate profound inflationary pressures as the price for natural gas and other fossil fuels soars in the United States, Britain, and Continental Europe, just as the respective regulators slow-walk the addition of new fossil fuel supplies that are needed now, not five years from now, to solve the shortages. There are incorrigible pro-renewables analysts who “see the current crunch as good reason to speed up the shift off fossil fuels, not slow it down, with unsteady supplies and unpredictable prices lining up as one more reason to get the transition done.” But the source of this instability is not any sudden inability of fossil fuels to supply steady and reliable energy on demand, as they have always done. Instead, it comes from administrative and regulatory tangles, including the planned disruption of pipelines and tanker construction. The correct solution is to: (1) remove the regulatory inhibitions; (2) beef up the production of these fuels, which will lower energy costs today; (3) reduce the inflationary pressures that high energy costs bring; and (4) stabilize foreign relations in order to reduce the impact that Russian leader Vladimir Putin can cause by withholding, and perhaps destroying, energy supplies needed everywhere else.
There is, of course, every need to reduce pollution from fossil fuels, just as the same imperative applies to renewables, the latter of which receive both cash subsidies and blanket exemptions from safety regulations, and face liability for their pollution damage. But the extreme approach that involves shutting down the most efficient sources of fossil fuels (which become more efficient over time) in order to expand the footprint of wind and solar will cause fierce inflationary pressures. Such pressures will compound the new inefficiencies that hound finance, banking, and employment. Altering the money supply won’t stop this hemorrhaging, but sensible regulatory policies might.
© 2022 by the Board of Trustees of Leland Stanford Junior University.
Published in Economics, Law
Dear Mr. Epstein – your post is outstanding and may fall on deaf ears. However, should be read by all. This ESG system was cooked up by WEF and Klaus Schwab, and originally resulted out of the CCP system – a communistic-totalitarian control that no one can meet, or not meet. Even the head of Toyota said we cannot meet all vehicles as electric by 2030.
It’s a system to result in failure and the elimination of capitalism and free markets, i.e. freedom and democracy. What can we do?? We need solutions.
I was OK with the progressives “death wish” until I realized it was my death for which they were wishing.
Yep, all part of the plan of Biden’s War on Energy. By my estimate the real economy will shrink by 25% during Biden’s 4 year term. It is going to get worse before it gets better.
Richard:
“Recall for these purposes that the basic definition of inflation is too many dollars chasing too few goods. The rate of inflation does not depend solely on monetary issues within the Fed’s domain—it also depends on changes in the stock of goods and services. Sensible economic policies that aid growth will thus tend to curb inflation even with bad or capricious decisions by the Fed. But conversely, foolish economic and regulatory decisions will compound the problem by shrinking the economic pie in area after area; a key tenet of progressive thinking harbors the sorry illusion that if the Fed does its job, governments and businesses—often backed by government power—are free to pursue all sorts of collateral ends, most of which are counterproductive.”
Exactly right.
There are two sources for inflation: a money supply that is rising too fast causing a demand for money and supply side factors that create scarcity for goods and materials that cause inflation.
In 2020 and 2021 the FED printed a whopping six trillion dollars causing a tsunami cascade of too many dollars chasing too few goods which caused a lot of the inflation in late 2021 and early 2022. That said however the money supply has been negative since february and now most of the interest rate sensitive elements of the economy are actually in deflationary mode: total full time jobs have shrunk by hundreds of thousands jobs, consumer sentiment is the worse ever measured, Home prices are cratering, builders no longer want to build, imports measured by container traffic is down like 30%, retailers are cutting way back on inventory for sale etc.
On the supply side, gas prices are the highest ever, natural gas are also very high here but in Europe they are roughly 7 times what they are here, fertilizer prices and supply have tanked the agricultural sector so while prices are very high now, however this winter and spring due to other supply factors like droughts etc, food prices are expected to skyrocket. There is a world wide food and energy crisis now . Health care costs are way up- allegedly 24% over last year and housing costs driven by higher mortgage interest ( 22% of home portages are variable rate and most commercial apartment loans are indexed ) are also a factor. As Richard said these inflation sources are driven almost entirely by government policies and actions.
But there are even worse problems on the horizon. Little reported by our now heavy censored and Progressive narrative driven press coverage is the fact that the British bond market collapsed last week forcing the British Central bank to again print money in a big hurry. This enormous financial disaster was caused greatly by margin calls by the British pension funds. Analysts here are worried Credit Suisse is close to a “Lehman moment” causing similar margin call problems here. The long and short of it is that the current FED rate hikes policy may ultimately destroy our economy very soon.
Richard:
At the center of this issue is the hotly disputed topic of climate change and the steps that should be taken to control it. The SEC has already spoken independently about this issue with the creation of its Climate and ESG Task Force, whose purpose is to ferret out mistakes in the disclosure statements of various firms on climate risk. Behind this ill-conceived initiative lies the assumption that the mandated SEC disclosures will have any material impact on business of which shareholders ought to know. If it passes legal challenges, compliance costs to firms of these disclosures will prove enormous and duplicative, and will surely deter banks and other financial institutions from investing in or lending to the fossil fuel industry.
To really look at this issue one must step back from the intricacies of finance to look at the real and nasty effect of what the FED’s huge Quantitative Easing money print since 2009 did to the economy over the last 13 years.
To grasp this issue one has to first understand:
A. The Federal Reserve normally digitally prints a certain amount of money each year so that the amount of money per person can keep up with population growth.
B. In the past when the FED increases the money supply the banks normally would increase lending across much of the entire economy.
The Quantitative Easing money printing starting in 2009 was on a scale far exceeding that any sound economy had tried in modern times. Normally such a huge money print would destroy that country’s currency. The only reason that the FED could print so much money without destroying the dollar’s value is because for similar reasons the European Central Bank, the Bank of Japan and the Chinese Central bank printed money on a similar scale so all the major rival currencies were devalued at the same time.
But with Quantitative Easing the FED chose a different course from the past where contrary to normal point A behavior the FED printed in quantities far exceeding any historical easing and secondly through our evolving Financialization of the economy, this huge money print only really was given to huge Corporate, Hedge Fund and Banking concerns at almost zero interest ( 0.25%) giving these concerns an enormous competitive advantage against smaller concerns in the marketplace. This QE scheme thus led to an enormous and illegal multi, multi- Trillion dollar transfer of wealth from the lower 90% of the population to the 1%.
So according to some financial analysts the ten largest corporations/ banks all now sit on a cash horde of over a trillion dollars each. These hordes have funded a takeover of the economy and our political system. To make matters worse, for whatever reason, these same corporations have decided to go fully woke which is driving the Woke/ESG takeover of nearly everything. But at the bottom of it all is the FED which has become the Financial arm/Financier of the Woke Takeover.
Actually Fed rate hikes are designed to lower inflation and nominal long-term interest rates, which should help the leveraged financial institutions. The downside is that makes the dollar stronger, which hurts the value of debt denominated in Pounds, Euros,… if the other central banks don’t raise their short-term rates.
Actually Fed rate hikes are designed to lower inflation and nominal long-term interest rates,
Perhaps Don you didn’t understand what Richard wrote. FED rate hikes do little to lower inflation caused by supply chain disruptions and scarcity of goods, services and materials.
Excerpted from Matthew Pieperburg at Zerohedge in “The Fed’s Strong Dollar Policy: a Recipe for Systemic Implosion..”
“From Main Street USA to the village corners and central banks of Europe, Japan and elsewhere, the Fed’s strong USD policy is backfiring—big time. Just ask the Brits…
Having spent years creating the inflation (QE1 to unlimited QE, Repo bailouts, massive money supply expansion, and an historical wealth transfer from an inflated, Fed-driven stock market), the Fed will be cleaning up its own inflation mess on the backs of the U.S. working class and its other global “allies” while blaming the CPI inflation on Putin, Covid and climate change.
How’s that for rigged to fail?
But that’s just the beginning, and it’s not just about the USA.”
Engineering a Recession Powell Can’t Control
By raising rates into what we all know is a recession, Powell, who delusionaly pretends to be Volcker re-born, wants to solve the inflation he helped create by engineering a demand-crippling recession which he thinks he can control, but can’t and won’t.
And this will be the mother of all recessions, as there is an historical and concomitant debt (and hence currency) crisis in every corner of the globe ($300T+) as well as every corner of the nation ($90T+), from the toxic corporate bond market and over-strapped households to a grotesquely bloated ($30T+) government debt market.
Keep It (Horribly) Simple
It’s all horribly simple, in fact.
If debt is the everywhere-driver of the economy and markets, then any significant increase in the cost of that debt will destroy every corner of that economy and those markets, from zombie enterprises to negative yielding US Treasuries.
Powell’s hawkish stance will lead to anything but a “contained recession,” which the Fed will be no less effective “containing” as they were in “containing” their so-called “transitory inflation.”
Rising rates will cripple nearly every asset but the artificially inflated USD until all savings are gone, most citizens are hand-out dependent, and most markets and currencies are on their knees.
At that point, Uncle Sam will either default on the IOU’s (Treasury bonds) which no one will want, or the Fed will pivot to more mouse-click money to buy/support his debt addiction, following the recent example in the UK.
And since the US is too arrogant to fail/default (TAF), the Fed’s only stupid choice left among a long history of stupid, will be a gold-boosting QE pivot.
continued
Yes, An Inevitable Pivot
So, again, when will Powell pivot?
After the pain, politics and panics have reached levels the US and global economy and markets haven’t seen since the FDR era, Powell will throw in the towel and pivot.
In the interim, the US (as well as global) middle class can thank Greenspan, Bernanke, Yellen and Powell for all the pain ahead, as it is the direct (and I mean direct) result of years of unprecedented drunken free money and bloated debt, the hangover for which is going to be a record-breaking B!c7%…
A Treasury Market on the Cliff’s Edge
Investors are forgetting that not only is Hawkish Powell raising rates into a debt bubble, he’s slowly tightening the Fed’s balance sheet, which just means dumping more Treasury supply into a demand-less sovereign bond market.
And this supply stream means bonds will fall even further and hence their yields (and interest rates) will keep rising, thereby by adding massive insult to an already fatally injured credit/debt market.
I feel that when UST’s start to tank en masse, Powell’s fantasy of being the next Volcker will end and the pivot toward money printing will be fast and furious—sending precious metals to record highs.
But until then, buckle up.
Powell’s Master Dollar Plan—Foreign Suckers
For now, Powell’s plan is to let rates, yields and hence the dollar rise, in the hopes that the Greenback will be the only place left for global investors (suckers) to hide, which is where they are indeed beginning to hide.
Powell’s Strong Dollar Policy is Backfiring
In short, Powell’s strong USD policy, like the West’s sanctions against Putin, are openly backfiring as America’s “allies” bend under the oppressive ripple effects and weight of an artificially strong USD—and all of this as the EU heads into a winter with less energy from the East.
Then again, the Fed is always at least two to three steps behind its own learning curve.
As a political rather than independent bank, they can only rely on words and distortions rather than math and honesty when speaking to a public which they have mis-served since the day of their official (and Wall-Street-leaning) birth in December of 1913.
These converging currency, debt and energy patterns look like the weather map of a perfect storm.
In short, foreign currencies, suffocating under the weight of Powell’s strong USD, will continue to tank as global bond markets continue to dry up and hence implode.
Unless the Fed reverses course on its strong USD policy (and pivots to more QE/Mouse-click “magic”), global markets face a legitimate risk of systemic collapse.
But then again, more mouse-click money just means a currency crisis. Again: Pick your poison.
80% of the right was perfectly fine with all of this. I call it structural Neo Keynesianism. They get imbued in it and they think it’s all normal as things go up. Then they get frustrated when it goes awry in their personal life or with politics. Inflationism is not the friend of the right.
It’s hard to Like your comment, but everyone should be interested in what is happening across the board to the financial sector…
https://www.cnbc.com/2022/10/06/britains-shadow-banking-system-is-raising-serious-concerns-after-bond-market-storm.html
This ignores globalization. The largest company (Apple) has global revenue, so the correct GDP to look at is not US GDP, but global GDP. Is NYSE total market cap out of whack with global GDP?