Senin, 23 Desember 2024

Double Secret Inflation

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Double Secret Inflation

by George Gilder and Richard Vigilante
12/23/2024

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Congress has made itself—and therefore voters—increasingly irrelevant to domestic policy by quietly offloading its real power to the administrative state.

On inflation of the dollar, both Congress and the White House have taken quite the opposite tack. They pretend that it's all up to the Fed, when the Fed is all but powerless on inflation.

Except (possibly) under the most extreme circumstances, monetary policy plays a trivial role in inflation. Fiscal policy—the most essential responsibility of Congress and fully retained to this day—overwhelmingly determines how much or how little dollars are valued.

In the nearby graph, the solid blue line is "sticky" Consumer Price Index (CPI) inflation. The broken green line is the "federal funds rate" — the overnight rate at which member banks lend to each other. That is the interest rate over which the Fed has the most influence, and by which it claims to control inflation, with the hearty agreement of essentially all politicians, the mainstream media, and even the conservative media.



As you can see, except perhaps for the few years either side of 1980, the correlation between the two is very light. To the extent causality can be teased out of the relationship, it appears that inflation causes the Fed rate to rise, rather than the Fed rate causing inflation to fall. This should come as no surprise: the Fed does raise the federal funds rate when inflation rises and then cuts it when inflation falls.

Except for that orchestrated correlation, from about 1983 onwards, the two lines appear to influence each other hardly at all. For almost 40 years, inflation gradually declines until settling out around 2%. By contrast, the green line jumps around quite a bit. In 2009, the federal funds rate hits zero and stays there, or near enough, for almost a decade. If that's not an inflationary policy, what is? Yet the inflation line hardly moves.

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What really happened? From the early 1980s through the pandemic, through six presidents with varying policies on various issues, one factor remained essentially unchanged. The Reagan era tax cuts (starting in 1978 with the capital gains tax reduction) remained mostly in place. The result was a dramatic increase in the real, after-tax return on investment.

Throughout the 1960s and 1970s, the combination of high taxes and high inflation meant that investors in U.S. stock markets lost about 2% (compounded annual return) a year.

From 1981, the year Reagan was inaugurated, through 2002 (so even including the Tech Wreck) the after tax, after inflation compound annual return on the S&P 500 was 7%, a 9% swing.

No other policy was so constant. It was this dramatic change in the real return on investment that drove the decline in inflation.

Investors represent the marginal demand for dollars. Consumers feel inflation's effects but can do little to offset them. Bread and milk do not become optional, though steak may give way to hamburger.

Investors have far more discretion. They won't want dollars if they cannot be profitably invested. Instead, they shun dollars—as they did in the 1970s — turning them into yachts and real estate and silly collectibles, and gold, the least fecund of all.

When investors — foreign or domestic — demand dollars, their value rises; when investors shun dollars, their value falls.

An added factor, as we saw brutally illustrated during the pandemic, is that when an economy becomes vastly less productive, there are fewer goods to buy. If the government at the same time spends like mad, there will be more dollars chasing fewer goods.

Taxing and spending, fiscal policy, is Congress's primary activity. Tax too much and productive investment and productivity decline; spend too much at the same time and prices must rise.

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What sticks out, however, is that just as fiscal policy dwarfs monetary policy in importance, on the fiscal side, tax policy dwarfs spending. Except briefly under Clinton, for all those 40 years of low and declining inflation, drunken sailors had nothing on Congress. Didn't matter; productive investment and economic growth kept dollars precious.

Only when pandemic lockdowns imposed effectively the most burdensome tax in U.S. history, and then Congress decided to pay all the shutdown workers for not working, did the combination reignite inflation.

Congress, the White House, and the Fed all want you to believe in the Fed's importance, the politicians to shift blame and the Fed governors because feeling important is fun.

But can you really believe that whether the Fed raises or lowers its target rate by a quarter point has any effect on anything?

The way to beat inflation is not to burn dollars but to get people to want more of them, as Reagan did. Restoring returns on capital boosted investment, improved the quality of capital allocation, strengthened both the economy and the dollar, and ushered in a multi-decade decline in inflation and interest rates.

If Trump does that, we will be okay.

Sincerely,
The Editors
George Gilder, Richard Vigilante, Steve Waite, and John Schroeter
Editors, Gilder's GuidepostsTechnology ReportTechnology Report Pro, Moonshots, and Private Reserve

About George Gilder:


George GilderGeorge Gilder is the most knowledgeable man in America when it comes to the future of technology and its impact on our lives.  He’s an established investor, bestselling author, and economist with an uncanny ability to foresee how new breakthroughs will play out, years in advance.  George and his team are the editors of Gilder Technology Report, Gilder Technology Report Pro, Moonshots and Private Reserve.
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