Rickards: The Fed Must Have Inflation... "Failure Is Not an Option"

Authored by James Rickards via The Daily Reckoning,

The Fed says incessantly that “price stability” is part of their dual mandate and they are committed to maintaining the purchasing power of the dollar. But the Fed has a funny definition of price stability.

Common sense says price stability should be zero inflation and zero deflation. A dollar five years from now should have the same purchasing power as a dollar today. Of course, this purchasing power would be “on average,” since some items are always going up or down in price for reasons that have nothing to do with the Fed.

And how you construct the price index matters also. It’s an inexact science, but zero inflation seems like the right target. But the Fed target is 2%, not zero. If that sounds low, it’s not.

Inflation of 2% cuts the purchasing power of a dollar in half in 35 years and in half again in another 35 years. That means in an average lifetime of 70 years, 2% will cause the dollar to 75% of its purchasing power! Just 3% inflation will cut the purchasing power of a dollar by almost 90% in the same average lifetime.

So why does the Fed target 2% inflation instead of zero?

The reason is that if a recession hits, the Fed needs to cut interest rates to get the economy out of the recession. If rates and inflation are already zero, there’s nothing to cut and we could be stuck in recession indefinitely.

That was the situation from 2008–2015. The Fed has gradually been raising rates since then so they can cut them in the next recession.

But there’s a problem.

The Fed can raise rates all they want, but they can’t produce inflation. Inflation depends on consumer psychology. We have not had much consumer price inflation, but we have had huge asset price inflation. The “inflation” is not in consumer prices; it’s in asset prices. The printed money has to go somewhere. Instead of chasing goods, investors have been chasing yield.

In a recent article, Yale scholar Stephen Roach points out that between 2008 and 2017 the combined balance sheets of the central banks of the U.S., Japan and the eurozone expanded by $8.3 trillion, while nominal GDP in those same economies expanded $2.1 trillion.

What happens when you print $8.3 trillion in money and only get $2.1 trillion of growth? What happened to the extra $6.2 trillion of printed money?

The answer is that it went into assets. Stocks, bonds and real estate have all been pumped up by central bank money printing.

The Fed, first under Ben Bernanke and later under Janet Yellen — repeated Alan Greenspan’s blunder from 2005–06.

Greenspan left rates too low for too long and got a monstrous bubble in residential real estate that led the financial world to the brink of total collapse in 2008.

Bernanke and Yellen also left rates too low for too long. They should have started rate and balance sheet normalization in 2010 at the early stages of the current expansion when the economy could have borne it. They didn’t.

Bernanke and Yellen did not get a residential real estate bubble. Instead, they got an “everything bubble.” In the fullness of time, this will be viewed as the greatest blunder in the history of central banking.

The problem with asset prices is that they do not move in a smooth, linear way. Asset prices are prone to bubbles on the upside and panics on the downside. Small moves can cascade out of control (the technical name for this is “hypersynchronous”) and lead to a global liquidity crisis worse than 2008.

If the Fed raises rates without inflation, higher real rates can actually cause the recession and/or market crash the Fed is preparing to cure. The systemic dangers are clear. The world is moving toward a sovereign debt crisis because of too much debt and not enough growth.

Inflation would help diminish the real value of the debt, but central banks have obviously proved impotent at generating inflation. Now central banks face the prospect of recession and more deflation with few policy options to fight it.

So the Fed is now considering some radical ideas to get the inflation they desperately need.

One idea is to abandon the 2% inflation target and just let inflation go as high as necessary to change expectations and give the Fed some dry powder for the next recession. That means 3% or even 4% inflation could be coming sooner than the markets expect.

But the Fed should be careful what it asks for. Once inflation expectations develop, they can take on lives of their own. Once they take root, inflation will likely strike with a vengeance. Double-digit inflation could quickly follow.

Double-digit inflation is a non-linear development. What I mean by that is, inflation doesn’t go simply from two percent, three percent, four, five, six. What happens is it’s really hard to get it from two to three, which is ultimately what the Fed wants. But it can jump rapidly from there.

We could see a struggle to get from two to three percent, but then a quick bounce to six, and then a jump to nine or ten percent. The bottom line is, inflation can spin out of control very quickly.

So is double-digit inflation rate within the next five years in the future? It’s possible. Though I am not forecasting it. But if it happens, it would happen very quickly. So the Fed is playing with fire if it thinks it can overshoot its inflation targets without consequences.

Why is the Fed’s forecasts so consistently wrong?

There are many reasons for this horrible record, including the use of equilibrium models to describe a nonequilibrium complex dynamic system.

For years I’ve said that the Fed has defective economic models and the worst forecasting record of any major official institution (although the IMF gives the Fed a run for their money in terms of bad forecasts).

The facts back up my claim.

For eight years in a row, from 2009–2016, the Fed’s one-year forward forecast for annual economic growth was off by orders of magnitude. The Fed has failed to achieve self-sustaining growth anywhere near former trends, along with its failure to achieve its 2% inflation targets.

Perhaps the Fed’s biggest analytic and forecasting blunder is their reliance on the Phillips curve, which describes a purported inverse relationship between inflation and unemployment. The hypothesis is that as unemployment goes down, inflation goes up and vice versa. There is no evidence for this theory.

In the late 1960s we had low unemployment and rising inflation. In the late 1970s and early 1980s we had high unemployment and high inflation. Today we have low unemployment and low inflation. There is no correlation between employment and inflation at all.

The Fed has been pondering this lack of evidence. The Fed has concluded that they don’t really understand the relationship between employment and inflation. That’s a start. Maybe I can help.

The reason they don’t understand the relationship is because there is no relationship. Inflation is not catalyzed by employment or money supply. Inflation is a result of psychological expectations and the behavioral patterns of consumers acting on those expectations.

If people believe inflation is coming, they will act accordingly en masse, the velocity of money will increase and soon enough the inflation will arrive unless money supply has been severely constricted. That’s how you get the rapid inflation increases I described above.

It is only in the past two years that the Fed forecast has become more accurate, and that’s only because the Fed simply trimmed their forecast to the prevailing nine-year trend growth rate of just over 2%. Better late than never.

Meanwhile, the Fed is creating financial and economic headwinds with rate hikes and by reducing the money supply through its new program of quantitative tightening, or QT.

With the return of stock market uncertainty and the economy not much above stall speed, a severe stock market correction/and or recession is in the cards. I can’t say exactly when, but I’d say it’ll be sooner rather than later.

Got gold?


Cognitive Dissonance Wed, 03/07/2018 - 19:38 Permalink

I am getting seriously tired of Rick-tards. It's almost like he's a CIA hired (inverse) propaganda gun or something.

Must be just about time for another book publication. Yup, just checked. Nothing since 2016. He's usually good for one every year or two.

Jeffersonian Liberal veritas semper… Wed, 03/07/2018 - 20:25 Permalink

Who is this Rickards and why does she keep saying the same thing over and over and over again?


("She?" you ask. "You know Rickards is a man, right?" Yes, I do know. I've read two of his crappy books and he has no respect for the universal and generic male pronouns and throws the female pronoun in his writing just to pander to women and feminists. And that makes his writing a jolting, unflowing, pandering pain in the ass to read because the particular "she" thrown out there and attached to nothing stabs the attentive reader in the eye. So fuck you, Rickards. Fuck you and whatever group it is you are covering for.)

In reply to by veritas semper…

OverTheHedge laser Thu, 03/08/2018 - 01:58 Permalink

Because I am old, I can remember an "official" inflation rate of 25%. Something to consider. I also once paid a mortgage rate of just over 15% at one point. Seems otherworldly when compared to the 21st century.

These things have happened before, so they could happen again. The bubble collapse to cope with it would be monumental. If the vast majority of homeowners are struggling at 3%, what happens when their mortgage payments double? Or tripple? That's a really big asset transfer to the banks :-)

In reply to by laser

daveO OverTheHedge Thu, 03/08/2018 - 15:56 Permalink

Yea, you paid that when debt levels were far, far lower and debt demand was far greater, thanks to the Boomers just entering the work force. This time around will be different. It will be hyper-inflationary in nature, a dollar collapse. That's what Rikards is really hinting, as in "you think this is inflation, you ain't seen nothing yet". As long as the FED exists, there is no other option allowed.

In reply to by OverTheHedge

buzzsaw99 Wed, 03/07/2018 - 19:42 Permalink

Inflation is not catalyzed by employment or money supply. Inflation is a result of psychological expectations and the behavioral patterns of consumers acting on those expectations.

If people believe inflation is coming, they will act accordingly en masse, the velocity of money will increase...

i don't believe this.  who is it on here who keeps saying "niggas be broke"?  they aren't going to go buy two new $1K iphones or two new $60K pickups even if they do believe the price will double.

JibjeResearch Wed, 03/07/2018 - 19:45 Permalink

Inflation is easy to get.

When the PetroYuan is up/ running fully and when we have surplus trade, you will get a run away inflation until the Fed raises rate!

Hopefully the Fed acts on time to prevent a crash or high inflation.

Manipuflation Wed, 03/07/2018 - 20:00 Permalink

"Bernanke and Yellen did not get a residential real estate bubble. Instead, they got an “everything bubble.”"

Not in PM's.  I have a small 30 table local coin show(1 mile away) to attend on Sunday and have cash in my wallet.  9 AM start.  That means a cup of coffee, four beers and I'm there.

veritas semper… Wed, 03/07/2018 - 20:09 Permalink

Never mind that the Federal Reserve is Unconstitutional . Which it is.

But  I want to know where in the Federal Reserve mandate is specified that the Federal Reserve must create and manage inflation ?


east of eden Wed, 03/07/2018 - 20:12 Permalink

Of course the Fed wants inflation in consumer prices, BIG INFLATION, and Trump is in it with both hands and both feet. That's what these tariffs are supposed to do. 'Artificially' raise the price of consumer goods while giving the US Federal government a huge windfall in the form of multiple new 'taxes' that were not approved by Congress. Trump cares about the trade deficit because that is what will come back to haunt him. What he doesn't care about is the fiscal deficit, because that will be blamed on Congress, and he hates both parties in Congress equally, so, you could say that he is at least trying something, but, he is really just shuffling the chairs on the Titanic. As jobs fall away and more businesses close because they can't compete in the export market, then the rubber is going to meet the road. But hey, he will have successfully morphed the 'trade deficit' into a bigger fiscal deficit and will then blame Congress for it's profligacy.

I think that perhaps what the Fed Chair and Trump are forgetting is that it has taken 50 years to get rid of the inflationary mind set that people had in the late 70's and early 80's. If they stoke the inflation monster, then the outcome is far from certain. In fact, I can almost guarantee that once again, the 99% will lose, big time, while the 1% will gain more wealth.

There are an awful lot of 'unknown unknowns', in all this. For instance, as the fiscal deficit grows, rates will have to rise or the US dollar will devalue. Raising rates higher may be good for savers in the US but it will be bad for anyone holding variable rate debt denominated in US dollars. Have they considered what the economic impact of massive defaults around the world (including the US) is going to be? And the 'world' is currently your biggest supplier, so harming your suppliers may not be the best thing to do.

Whatever the outcome is in the US, it is an absolute windfall for commodity producing countries like Canada and Australia. Prices on basic materials are going to skyrocket. So thanks, Trump. Thanks very much, indeed.

Tip: Buy Russel Metals on the TSX. It just bottomed at a 52 week low, and if the history of how our primary timber producers went up like a rocket plays out in steel production as well, then it is almost a slam dunk, and you get it at a 30% discount.

It's by Design Wed, 03/07/2018 - 20:14 Permalink

The Federal Reserve is the biggest thief of the last century, and it continues today to rob the citizen of his wealth. Central Bankers confiscate our life’ Savings, and when government allows this, and profits from it, we are in serious need of change. Viva  la revolution 

MusicIsYou Wed, 03/07/2018 - 20:14 Permalink

You want to raise inflation to screw the littleless of these, even while you are blind to how small the richest are. I don't think so. Go back to the gold standard, and forgive debts.

JailBanksters Wed, 03/07/2018 - 20:23 Permalink

According to the Whiz Kids at the FED, you can easily combat inflation by printing more money.

Which incidentally is the same way to combat deflation by printing more money.

And only during the times of Interest Rates being in the Goldilocks Zone of 2% do you just print money.

MusicIsYou Wed, 03/07/2018 - 20:28 Permalink

Failure for the Fed had better be an option, because it's better to burn out than to fade away, and Yellowstone park is looking particularly unhappy.

InnVestuhrr Wed, 03/07/2018 - 20:34 Permalink

ZERO possibility of "runaway inflation" because the world is too severely over-populated, so labor costs will stay low, and much more likely that they go even lower and increasing levels of under-employment, un-employment, and poverty.

NO inflation for you !

Nelbev Thu, 03/08/2018 - 00:47 Permalink

The Fed has no choice but to allow inflation.  When inflation rises and treasury yields rise, the gargantuan refinacings to service the national debt will lead to a banana republic fiscal crisis.  They can not lower rates to let the Federal government again repeatedly refinance if markets say no due to inflation and other opportunities like arbitrage on commodity futures higher than treasury yields or banks seeing better opportunities for excess reserves, the QE low interest rat gig is up, the fed will keep the interest rate on excess reserves high enough chasing up not to let escape from being reserves at Fed as hope.  We will end just letting inflation rise lowering real debt of US gov to "solve" problem.  Chinese and Japan are going to own lots of toilet paper.  Sovereign defaults in some countries with IMF bailouts, whole world has same monetary policies, US just inflation.

ElTerco Thu, 03/08/2018 - 02:52 Permalink

"Why is the Fed’s forecasts so consistently wrong?

There are many reasons for this horrible record, including the use of equilibrium models to describe a nonequilibrium complex dynamic system."

Bingo. And this is why Economics is an unreliable science. All the models assume near-equilibrium conditions, which are often in force, but not enough to be classified as "usually". Animal spirits rule too often to be waved off as anomalous and ignorable.