336: We’ve Had High Inflation for YEARS and Didn’t Know it
Catch the full episode: https://www.wealthformula.com/podcast/336-weve-had-high-inflation-for-years-and-didnt-know-it/
Buck: Welcome back to the show, everyone today. My guest and Wealth Formula podcast is Edward Chancellor. Edward is a financial historian and journalist investment strategist and he’s also a columnist for Reuters Breakingviews and an occasional contributor to the Wall Street Journal Money Week and New York Review of Books and Financial Times. He has authored multiple books and the latest one and what we’ll be speaking about today is called The Price of Time The Real Story of Interest. Welcome to the show, Edward.
Edward: Pleased to be with you.
Buck: So, you know, this obviously this title on this concept is on everybody’s mind. But since you’re talking about sort of the real story behind this, I’ll take us back to the beginning of the mess that we’re currently in, as far as you wish. Historically so. And let us know how this all started.
Edward: Yeah, well, it’s it’s difficult to say where it’s all started. I would argue we. Interest rates peaked in the early 1980s and then they came down sharply as inflation fell away and probably the rot set in when the central banks, the Federal Reserve, started to realize it could use monetary policy to support the financial markets in times of difficulty. And the first time we saw that was when Alan Greenspan, newly installed as the Fed chairman in 1987, used the Federal Reserve’s capacity to supply liquidity to the markets to to to support the markets to the 87 stock market crash. Now, that crash was a relatively short lived event, and the Fed’s intervention was seen as, I suppose, a good thing.
But the trouble is, when central banks intervene to support markets, they start changing people’s risk preferences. The amount of risks that prepared to state. Because if you think the Fed has got your back when you buy a stock, you’re going to pay a bit more for it. And we saw that we go forward from 87 to 98, if you remember, in the late summer of of 1998, a hedge fund, very large, overleveraged hedge fund who had long term capital management with with really bets of roughly $200 billion on capital of I can’t quite remember, but let’s say around $5 billion so massively leveraged hedge fund that was toppling over. And at that moment, the Fed once again intervened to cut interest rates and the this the if you think back to the late 1990, this was the early period of the Internet. And there was a bit. Ostroff I just to put it mildly, in the US stock markets at the time. But after the Fed’s intervention, the Nasdaq index of technology stocks took off and we got this great, this great dot com bubble that that many of your listeners will still remember because probably those who are old enough lost money in it.
So then the dotcom bubble and the dotcom bubble was interesting from a historical perspective because in valuation terms it was by far the greatest stock market bubble that the US ever seen. So then the and you know, the in the late 1990s the Fed sort of jacked up interest rates when inflation was appeared to be returning and the dot com bubble burst as it as it might be expected to burst. So the next stage is the Federal Reserve then starts to worry, hey, the markets are collapsing. Perhaps, you know, we have deflation. There’s no evidence of deflation at time. So they cut interest rates, they get the Fed funds rate back to 1% in 2002, which was the lowest at the time, the lowest level since the Second World War. And this didn’t immediately revive the busted dot coms and tech companies. But, you know, you with your real estate background, knows what happened next is that you could borrow cheaply against real estate and on a decent stand. And combined with the fact that mortgages were being at the time, securitized, risky mortgages were bundled together and cut into different tranches. And it sort of increased the supply of mortgage credit. But fueled by these very low interest rates, the grade US real estate bubble took off. Now that bubble peaked in 2005 2006, and it took a couple of years for the for the year for that. So the aftermath of that first bubble to to really show how serious it was, namely with the collapse of Lehman Brothers in September 2008.
Now. So what did the Federal Reserve do then? Well, of course, they take interest rates down to zero, but that’s not quite enough. So they actually then started expanding their balance sheet, buying assets to bring buying mortgage securities and government bonds, to bring long term interest rates down and supply liquidity to the markets, but not just to supply liquidity to the markets.
They also deliberately wish to push up the value of financial assets and encourage people to take more risk. And they act in the belief that if people’s financial assets have increased and their wealth increased, they’ll start spending again. So now we’re in the period of the last decade and as you remember that decade, the constant expectation is that interest rates would rise and the central banks would stop printing money. But that never really happened. The Fed, Ben Bernanke, he was the chairman of the Fed at the time, the financial crisis. He left, I think, in 2014. And during the time Bernanke was there, the Fed never raised interest rates, never took it off its low base, and the Fed’s massively bloated balance sheet and never contracted. Then tentatively, the Fed started to raise rates.
If you remember any sort of trend from 2016 to 2018 by these tiny little increments and in 2018, stock market responded to the my mute raising of interest rates by going into bear market territory. And the Fed sort of was immediately back to printing more money again. And then finally we have the COVID lockdowns and the central banks gave not just the Fed but around the world growth rate.
And once again, interest rates cut to zero. And the Fed and central banks around the world print more money in the space of a few months than they printed in the 11 or 12 years since the global financial crisis. And now this will be this is definitely going to be in all your listeners recent memory, because we then had the final blast of the everything bubble US stock market rising to its its highest valuation in history with the exception of the last few months of the dot com bubble and then a plethora of other markets turning red on US housing you had within the stock markets, you had the the SPAC boom and special purpose acquisition companies. You knew which was sort of which was flipped into high tech ventures, a great bubble in electric vehicle companies. You remember Tesla was briefly valued at more than all US energy companies. In aggregate, you had crypto crypto craze, you know, not just Bitcoin’s, but you had the you had the you had a you had sort of spoof cryptos that were going up. You had Dogecoin and another Bitcoin that was a was a were a spoof of Dogecoin called Shiba Inu and so forth, you see. So you see basically, you know, up until really the end of last year, we had seen some of the frothy markets ever. And in my view the underpinning of these frothy markets was not just, you know, the psychology of investors or investor playing a, you know, a game of, you know, what we call greater fool.
I’ll buy this asset and sell it on to some sucker at a higher price. And I’ll play this game for as long as it can. I think that investors were misled into believing that interest rates would remain extremely low and that the low interest rates validated it extraordinarily high valuations.
Buck: So at that point, you know, I think it’s probably useful to sort of weave in the reason why those rates to stay low inflation and if you, if you would maybe just, you know, as you kind of, as you alluded to the last couple of decades, we’ve had plenty of money going into the system, right? Like lots of interventions, but we’ve never really had this problem with inflation. First of all, when not never, but in the last 20 years or so. First of all, what what in your mind changed? Is it is it sort of the queue to grab blow of the COVID? The lack of, I guess the, the problems with supply and then actually increase in demand because of essentially helicopter money.
Tell me what changed because what was the inflection point that turned an economy that was running on low interest rates and printing money for the last you know, certainly in the last 15 years to a significant inflationary problem.
Edward: Well, I mean, the two points you made I think are valid, but there is a really a sort of a perfect storm of factors. And I think even if one leaves aside what have happened during the COVID period, that the dynamics of the low inflation were were already coming unstuck beforehand. And I think it’s this is the way I see it is that the the globalization they the increasing trade between countries and in particular the entry of China and other former communist countries into the global trading system serve to depress the prices of traded goods.
And in particular, as you know US companies offshored a lot of their manufacturing in the beginning of this decade from, you know, from the US to China and other emerging markets. And what we see is that the price of trade in goods was declining as period and the Federal Reserve. And so what you could say is that and I think this accurate way of saying it is that inflation was no longer primarily or the drivers inflation were no longer primarily a domestic factors, but global factors. And I think you can see this in earlier periods of globalization, because globalization comes in way back in the late 19th century and then more recently. And as but but that that shifting globalization, you know, the rise of globalization even created a backlash that lots of blue collar workers lost their jobs, those, you know, reasonably well-paying pensions, supplying healthcare, providing jobs and were disgruntled.
And I think that explains to a large extent the popularity of the rise of populism and the popularity and election of Donald Trump in in 2016, then starts implying trade sanctions against China. So you already the you can already see that globalization is beginning to unravel and as globalization begins to unravel, then that dynamic for lower inflation that it provides ceases to be there. Now, as you then mentioned, then we get the pandemic. And with the pandemic, you get the interruption or of trade and broken supply chains and so on and so forth. But I think they were already fragile and beginning to snap.
Buck: Was there, I should ask, significant disruption in trade patterns? I know we had prior to the pandemic during the Trump administration, you mentioned some of the, you know, regulations put in place against China. But what you’re saying is that you feel like that was materially important for what we’re experiencing right now.
Edward: I think what I mean, you really see the global for the period of the global financial crisis was this sort of high point of globalization. And in the it really from that period onwards, global trade stops rising as the share of all of the economic activity and countries around the world start imposing sort of, you know, a closet head, hidden tariffs and making trade more restrictive. And I think this go back to the inflation problem. It’s interesting. You know, the central banks printed, as we said, you know, we used to have printing money, but obviously central banks don’t actually print money. They just buy assets and credit someone, you know, credit someone with some cash. And in there in the central banks account now, what’s interesting about quantitative easing as the name given to the central bank’s asset purchases at the time, the global financial crisis is it didn’t that money didn’t really enter into circulation in the economy.
It created it just looked let’s just say you work for a bank or you work for a fund manager. You own some treasury bonds or some mortgage securities. The Fed comes along, says, I’ll buy your your Treasury bonds and and use a short I’ll sell them to you. And the Fed says, okay, look, you’ve got this. Here’s the money. It’s in your account at the Fed. Well, you know, that doesn’t actually sort of push up the the price of icecream, does it? It just if what it does do is it pushes up the price of assets of securities on Wall Street. So the last decade we saw very little consumer price inflation. But as you know, we saw massive asset price inflation.
And really I think it’s fair enough to say that the last decade was the greatest period of asset price inflation in history. And the reason I can say that was some comfort is that the Federal Reserve actually makes print numbers for US household wealth and they have that data going back to the early 1950s. And what you see, if you look at the charts of the US, household wealth is a sort of rise. You know, they rose, they rose, they sunk to a very too low in the 1970s during the inflation and then in the time when interest rates were kept very high under Paul Volcker, a Federal Reserve in the early 1980s.
But in recent years they moved higher and higher and higher. And at the end, right. I mean, it seems so long ago now, but just at the end of last year, US household wealth was at an all time peak. It was I think roughly 250 percentage points of GDP above its long term average. So you can that that gives you a sense of how inflated things were. But when the but with the COVID lockdowns, because the governments, as you know, paid people to stay at home. Right. And watch Netflix and get home deliveries, a Deliveroo or whatever. Yeah. That money that actually that money did actually find its way into the economy at the time, as you said. Yes. When the supply when the supply chains were interrupted. So that that was, as I say, the perfect storm.
Buck: And just to just to add on to that, I mean, I think if you look back at the interventions as you’ve outlined already in and 2008 and some of the other, you know, minor crises times the Fed basically reacted and created these, you know, opportunities for for investors to basically get their, you know, to have their investments go up in value.
The major difference in my from what I see, the major difference of this intervention was it was truly what I guess Ben Bernanke called helicopter money. Right. We hadn’t seen that before, had we like pure money in the hands of consumers and to me, that answers a lot of the question of why we never saw significant consumer, you know, CPI increases. And and so I’m curious on that. Do you think that that was how big of an impact do you think that was to ultimately what we’re seeing now? I mean, obviously, there’s you know, there’s trade, you know, there’s there’s problems with supply chains and everything else. But I’m curious, on helicopter money was that the biggest issue?
Edward: Yeah, I mean, you could call it helicopter money. I mean, I remember a couple of years ago there was a lot of talk about this thing called modern monetary theory. Right? They were where the idea where it was sort of it had a brief vogue. The idea that, you know, the governments didn’t need to raise taxes. They could just spend money. They didn’t even need to issue bonds. So, yeah, there’s this sort of vogue for helicopter money and and the the quantitative easing money, as I say, stayed sort of, if you will, locked in the Wall Street safe, whereas this money went into people’s hands and boosted their spending. But don’t forget, it also produced a huge amount of asset price inflation.
And it was the S&P up something like 28% last year. So, you know, that was one of the great. Yes, yeah. But another way of thinking about inflation is just from a sort of monetarist perspective, which is tend to be neglected nowadays, but the which is the view that, you know, if you have a increase in the money supply abroad, money supply, bank accounts and so forth, money held in banks, then that feeds through to an inflation.
So if you had that, I think, you know, the US money supply in 2021, 22 was growing at an annualized rate of around 25%. And all all the great inflation, I mean, inflation’s an immensely complex subject, but all the great innovations of the past have been a monetary origin. It’s just the central bankers and the economists sort of become that, you know, monetarism fell out of favor.
And as these guys tend not read much financial history, they tend you know, they tended to ignore the inflation problem. But I mean, as you probably in a way, the man on the street sort of saw inflation coming and the rest of us I were suckered. It was in a way that tells you where to to to actually influencing events in the monetary policy world, the more blind you were to to what was actually happening.
Buck: Interesting. So let’s let’s kind of pivot a little bit and say, okay, well, that’s that’s where we are. What is your perspective on, you know, what happens with inflation over the next six months to a year? Obviously, there are some challenges there. We’ve got a, you know, a war in Europe, winter coming up, energy prices probably going up.
Where is this going? There’s a supply chain loosening up, help things out, do the rates increases, throw us into, you know, some kind of a recessionary thing where, you know, the inflation is going to have to necessarily, you know, die off at that point. What I’m curious what your take is in the trajectory.
Edward: Well, I wish I could give you a clear answer. As I say, inflation is is a complex phenomenon. And there are and when I talk about complexity, I’m talking about a system with feedback loops, which are, to a certain extent in the future is to a certain extent indeterminate. Now, I was mentioning to a second ago about the monetary monetarism or the monetarist now saying, you know, we have this wave of money supply growth and followed by a wave of inflation, but actually money supply growth in the US is coming down, has come down a lot and is now sort of average level and they say the monetary is new.
Some of them are saying the inflation problem is has really passed and the real problem now is that the central banks are risking over tightening and the worst in the argument I elaborate in the in my book is is is by drawing on the different functions the roles of interest. And we’ve talked a lot about how interest affects valuations but it also affects how money is capital is is invested.
It also affects the flow of capital around the world. And the argument my book in a nutshell is that the low rates and the expectations of low rates became embedded in the financial system. And we all had it. And presumably you had it. Most of your readers or listeners would have felt that these low interest rates were going to be around for a long time. So we made we take actions based on that. And one function of interest, definition of interest can, you know from your real estate background is the price of leverage.
Buck: So erodes debt. We’re happy about that part, right. Yeah. You know, I.
Edward: And you know so so as you know if you’ve taken on more debt, you’re going to be more sensitive to rising rates. Now, US households took on a lot of debt during the real estate bubble prior to the financial crisis. But in the last decade, the debt has really been largely accumulated by corporations and by private equity firms to leveraged buyouts, so forth. And the danger is that with, you know, with very small rates rises in interest when these companies and private equity come to refinance, they will be doing that. They knew that their deals went look so good. So you have the danger of a bad debts coming through and bad debts in financial terms, if there are enough of them, actually destroy money.
So then you move from inflation one day to deflation the next. But on the other hand, let’s just say this, the Federal Reserve was understood this risk and perhaps they do. If the Fed does nothing, then you’re going to say, okay, so it’s going to sit on its hands. I’m no get to I’m going to carry on bearing the cost of borrowing is way below inflation inflation is going to pay off my debt.
So you can see that the the Fed and this not just the Fed it’s true. Central banks around the world. You’re talking to me in England. The Bank of England is in a complete mess, too. They’re caught between a rock and a hard place. So all all the way I said, and this is not my own idea. But, you know, from friends, my investment friends of mine knew who was analyzing.
Edward: Problem is the question now is not so much inflation, but of inflation volatility of it rising, falling, rising, falling. And that is the thing we have to worry about going forward.
Buck: Interesting stuff. We live in interesting times. Edward, your your book, The Price of time, The Real Story of Interest. Assume this is available pretty much everywhere.
Edward: I have seen, say, Amazon and local booksellers.
Buck: That’s right. And then you also have a website: https://www.edwardchancellor.com. What kinds of things can we find there?
Edward: Well, you can find my articles I wrote. As you say, I write a column for Reuters Breakingviews, the financial Service, the Reuters. I’ve got sort of podcasts and views I put up there and I’ve got in talks I’ve given, and it is sort of less of the other books I publish, that sort of stuff.
Buck: Thank you very much for your time today. It’s been a real pleasure to get your perspective on what’s going on.
Edward: Great pleasure to be with you.
Buck: We’ll be right back.