Today, The Wall Street Journal published my op-ed titled “How the Fed Rigs the Bond Market.” Themes include:
High inflation should no longer be surprising, nor should it be labeled “transitory.” Its existence should prompt serious reflection on policy decisions and spur action to avoid a financial crisis.
The big issue is financial stability.
– The U.S. Treasury bond market has been rigged and manipulated since the Federal Reserve’s second quantitative-easing program began in 2010. The consequence of this blurred line between Fed and Treasury responsibilities—”monetizing the debt”—is inflation.
– Sales by the infamous “bond vigilantes” used to serve as a warning of inflationary policies. The signal has been muted.
The op-ed offers specific actions for Congress, Treasury, and the Fed to defuse imbalances and gradually restore market dynamics to the determination of bond yields.
This morning, Bloomberg’s John Authors said it well “We have October’s inflation numbers, and they were bad. Indeed, they were worse than the worst fears, with U.S. CPI exceeding the highest estimates provided by economists to Bloomberg. When you go below the surface, they’re even more troubling than they look.”
Macro and financial market analysis often includes a bit of guesswork. However, there are certain mathematical forces of nature in markets, economics, and debt management that are frequently ignored. Money, the government’s budget constraint, and the resulting seigniorage tax are among them.
Under the leadership of Professor William A. Barnett, the Center for Financial Stability (CFS) has provided many tools for investors and officials to reduce the probability of errors in making meaningful decisions.
Here are a few to help frame the new debate around what John Authors suggests is “how long it will last.”
With inflation in excess of 5% in each of the last 5 months, two measures would have been helpful for the Fed and investors in prior months. To be sure, they should influence Fed and investor decisions going forward.
Center for Financial Stability (CFS) Divisia M4-,
Global inflation diffusion indexes that analyze price and expectation signals in 49 countries.
CFS Director of Advances in Monetary and Financial Measurement (AMFM) Professor William A. Barnett delivered the keynote lecture “Is the BREXIT Bifurcation Causing Chaos in the United Kingdom?”
Bill’s remarks explore:
Why is Brexit changing economic risk without a source of external shocks?
Mathematical properties of chaos with relevance to BREXIT and U.S. monetary policy.
Why chaos is not necessarily bad. It is normal in nature (weather, climate, etc.) and is relevant to science and economics. Chaos contains useful information.
The United Kingdom and United States economies have undergone significant structural and policy changes in the past decades rendering chaotic dynamics more relevant.
Meaningful policy implications stem from the existence of Shilnikov Chaos.
Shilnikov chaos, produced by interest rate feedback policy with sticky prices, explains the downward drift of interest rates over the past 20 years.
Interest rate feedback policy rules need to be augmented by simultaneous use of a second policy instrument focused on the long run to avoid unintentional downward drift of interest rates to their lower bound.
Today my letter in the Financial Times (FT) responds to Howard Marks’ “Investors must not bet too much on macro forecasts.” Marks offers a superb road map for navigating future inflation twists and turns.
However, he misses how macro rules of nature can often be measured – helping investors and public officials better achieve their respective goals.
Monetary measurements represent simply one meaningful mapping.
Across the board higher consumer price inflation in the United States removes any ambiguity or doubt regarding the existence of price pressures beyond transitory or base effects.
Overall consumer prices increased by 5.4% on the year ending in June. Core inflation increased by 4.5% over the same period. In fact, in the last 4 months, both overall and core inflation exceeded market expectations and increased relative to the previous month’s release.
The phenomenon also extends well beyond simply the United States. It is global.
A diffusion index of every inflation release relative to the prior release for 49 countries shows an upward impulse since the beginning of the year. More pointedly, a diffusion index of reported inflation relative to expectations for the same complex of countries illustrates how actual inflation has been exceeding expected inflation especially since May 2021. (see Figures 1 and 2… www.CenterforFinancialStability.org/amfm/studies/Global_inflation_071421.pdf)
The Center for Financial Stability (CFS) has been clear about risks and financial stability implications. Our first email on April 22, 2020 noted how the initial impulse in the signal from CFS broad money would be a period of disinflation followed by inflation.
CFS broad money growth slowed to 12.1% on a year-over-year basis in the latest reading for April down from 23.8% in March.
The initial response might be to assume that the large expansion of money is reaching an end. This would be a mistake. The “base effect” elevating monetary growth on a year-over-year basis began to end in March 2021 and fully finished in April 2021. A few issues include:
CFS Divisia monetary growth of 12.0% in April dwarfs average growth of 5.6% since 1967 (DM4- excluding Treasury bills).
A high frequency reading of CFS monetary data stretching back over 54 years portrays a radically different perspective regarding the performance of broad money and its implications for inflation. It highlights how broad money growth and inflation risks are actually beginning to accelerate (chart available on request).
On April 22, 2020, we were early and clear in our email message “CFS Money Growth Soars to double digits.” The initial impulse embedded in the signal from CFS broad money would be a period of disinflation followed by inflation.
Going forward, inflation will likely continue its upward ascent and stretch beyond the Fed’s comfort zone.
The present global macro backdrop for investors and officials is one of the most challenging and complex in decades. We look forward to any comments you might have.
Bloomberg terminal users can access our monetary and financial statistics by any of the four options:
1) ALLX DIVM 2) ECST T DIVMM4IY 3) ECST –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’ 4) ECST S US MONEY SUPPLY –> From source list on left, select ‘Center for Financial Stability’
Investors and the public are right to worry about inflation. Yet, measures to predict the impact of Fed policies on inflation, the economy, and financial stability are of deteriorating quality and being disregarded.
Market participants and especially officials must recognize that quantities of money matter now more than ever. Gyrations of the Fed’s balance sheet are at heights not witnessed in over 100 years.
Here, the Fed is moving in the opposite direction of its Congressional mandate (Section 2A) by increasing the money supply far in excess of long-run growth.
Since 2012, the Center for Financial Stability (CFS) has offered the public alternative monetary measures – pioneered by Professor William A. Barnett.
From this work, we now know that measuring activity in the financial system better predicts both inflation as well as financial instability risks.