SNAFU: Part 1
How did we get here? A lot has changed.
Since the last time I wrote, war has broken out in Europe, oil has risen to $130/barrel, and just this morning, Russia (Fuck Putin), the world’s largest exporter of wheat, has banned commodity exports. This is really bad, and rather than write about my thoughts in real time, I doom-scrolled for two days while the productive journalists at Bloomberg and the FT proclaim that stagflation is on the horizon:
Ukraine conflict raises the possibility of stagflation
War in the heart of Europe comes at an already difficult time for the global economy. The recovery from the coronavirus…
It doesn’t take a genius to surmise that this is bad for main street. Very bad. Anecdotally, our grocery bill has gone from $175 weekly roughly a year ago, to $220 now. And while we don’t exactly substitute our weekly purchases due to cost, I can say that the amount of taxable items (so, processed grocery items) we buy is usually less than 5% of the bill — we buy chiefly raw ingredients that require cooking from scratch. This is real goddam basic-goods inflation. I feed two adults 2–3 meals a day, and one 5-year old 2 meals a day (he gets lunch at school.) Gas in my neck of the woods spiked to $4.99/gal premium, from $3.95/gal about a month ago, but I go through a tank every 2–3 weeks so while not fatal, it sure is noticeable.
It doesn’t take much to figure out that this trendline of inflation is going to stress the average American consumer dramatically.
SNAFU part 1: How we got here
First, I’m going to plant my flag in the sand and say that the Fed fucked us; by us, dear reader, I mean the American Consumer (you are, after all, reading “The Main Street Economist.”)
The way out of this mess won’t be straightforward, because raising interest rates will have zero effect on the current cause of inflation, not in the way that keeping them low directly stoked inflation.
You’re thinking: “Main Street, you’re an idiot, your statements are contradictory.” And I may be, but hear me out:
Persistently low Fed funds rates are blamed (rightly) for causing asset inflation. After all, cheap loans for banks translate to cheap loans for businesses and consumers alike to lever up and, for example, plough money into the single-family housing market. Mortgage rates in January 2021 were an unheard of 2.65% for a 30-year fixed:
The money printer Fed spat out so much cash that prices in the real durable goods economy — stuff that people buy with cheap loans, rocketed skywards: housing is up >15% nationally y-o-y, cars & trucks are up 40% y-o-y for used cars and 12% for new cars, and equities valuation multiples reached nosebleed levels with the risk-free rate sitting at a paltry sub 2%.
This wasn’t the only cause though! The supply shock, due to logistical constraints secondary to the pandemic was lurking in the background, inflating the basket of goods that aren’t (necessarily) paid for with cheap loans: food (+7.0%,) energy (+40%,) apparel (+5%.)
The government (both 45 and 46) issued stimmy checks to consumers to weather this second type of inflation.
Throw it all together and we have 7.5% annualized inflation, across all goods!
And the Fed still has their foot on the pedal— it’s MARCH and we still haven’t raised yet; it’s coming this month, the Fed already ruined the housing market and other durable goods markets with artificially cheap loans. Now, thanks to war (Fuck Putin,) the supply shock situation is about to get way, way worse: energy prices are spiking in response to Russian oil embargoes and commodity prices are skyrocketing for everything from fertilizer to nickel.
“But Main Street, you just proclaimed this type of inflation isn’t the Fed’s fault, so how can you blame the Fed for fucking us?”
Well, I’m simple. I am a person (consumer,) with a household. We need a place to live, food to eat, consumer goods to buy, and transportation. A Fed funds rate of nothing led to cheap loans, enabling huge institutional players to speculate and lever up on all matters of asset markets: equities (S&P 500 +27%,) housing (Case-Schiller +17%), and made categories of previously sleepy low-return assets appealing to even the biggest of institutional investors.
Why the fuck does Blackstone* want a pile of single family homes?! You really think Steve Schwarzman is going to move into the 3/2 split ranch in the Tampa suburbs? NO! But he’ll rent it back to you at a cap rate of 9% with medium-term sub 2% commercial debt underwritten by a bank gorging themselves at the Fed window for zero percent. Those are eye-watering returns for a portfolio with baked-in tax advantages — ones that as a consumer, I can’t take advantage of (depreciation, 1031–exchanges, etc.)
So with all these institutional sharks circling the waters of the Fed-chummed SFH market, unless I, the little consumer, was born rich, or was rich enough to get in before the decade of stupid-low rates which called the sharks to the beach, I was effectively rendered unable to fix one of the largest household costs in the face of this war-stoked unrelenting inflation.
The Fed, effectively, stripped one of the only effective hedges for massive inflation out from the consumer budget — fixed cost shelter- with a fed funds rate of zero. Raising rates a shitty quarter-point at a time, even five times this year, won’t do anything to clear your already shark-infested beach, because institutional investors can still gorge on cheap medium-term debt!
QED: The Fed fucked us, and there’s no going back.
Stay tuned for SNAFU part 2, which is “WTF is the Fed to do?”
*n.b. These guys provided the seed capital for Invitation Homes, the largest single-family-home landlord in the country.