Why is Inflation So Soft While We Are at Full-Employment?
In 1977, Congress amended the Federal Reserve Act, directing the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
Known as the duel mandate, the Fed is guided by the mandate to keep unemployment rate at a maximum and inflation at a minimum. This concept has an internal conflict in that at full employment, pressure on wages increase and inflation tends to increase.
As Jewish people will ask at next week’s Seder, So why is this night different than other nights? Why is inflation not increasing as the Phillips Curve predicts? The Phillips Curve predicts that the lower the unemployment rate, the higher wage pressure should get the higher the inflation rate will be.
Figure 1: U.S. inflation (CPI) and unemployment rates in the 1960s
In the 1960s, the average age of the population in North America was in the early 20s thanks to the post WWII baby boom. The economy was growing, unions were strong and growing, and so too were wages. The more real income people have the more they will likely spend it. But one key variable on how you spend your money is life stage. You make a different decision about saving and spending when you’re the 25 year old version of yourself and life expectancy was about 65 than when you are 65 and life expectancy is over 90.
The vast majority of people participate in economic growth through the wages they receive for their labour rather than through investment income. That is primarily the top third of people. In the past 4 decades, the vast majority of real (after inflation) income gains has come from investments, which tends to help the top half way more than the bottom half. All the economic policies (QE, Fiscal deficits) we employ are designed to boost the stock market and while that is working, it’s masking the median experience with the average. This link is essential reading. Though I do not agree with all his recommendations on how to fix some of these issues.
The Harvard Business review had an article a few years ago highlighting many issues around wage growth contributing to this dynamic. It includes lack of post secondary education, weaker unions, robotics and lack of an inflation adjusted minimum wage.
This is the main reason Donald Trump is President. The average person is getting left behind. The President has had a recent tweet storm around why interest rates need to fall so that the economy can keep growing. He is WRONG!
He is trying to put in place an economy to bring back manufacturing jobs, but that just will not happen though his trade policies. They are increasing cost of goods through tariffs and slowing the global economy. Falling interest rates will not fix any of the issues keeping inflation and growth down, it will only contribute to it.
We will not see any real inflation pressures until labour’s share of income increases. In other words, the older we live, the more money we need to save for retirement, the longer it needs to last, the more we need to save, the less we have to spend now. Therefore, inflation will not be a major problem for decades to come.
The big US corporate tax cut will not work either because the vast majority of that has gone to share buybacks and not wage gains (though there were some to be sure). The only thing that will work to boost inflation is for people to have more money to spend and be willing to spend it at higher prices rather than waiting for a sale.
The knock on effect of all of this is that for investors, bonds will have a negative real return for decades to come and make it very difficult to generate growth in your saving on a real basis (after inflation). We do not need the tariff kind of inflation pressures, we need the average worker to earn more of a real yield if you want to fix the weak global economy that has only grown in recent years due to debt and leverage. The accumulation of debt is another big headwind to growth that I will talk a bit more about in the coming weeks.
Come out to one of our remaining Berman’s Call events and learn how to take advantage of active asset allocation. The fixed-income part of your portfolio is going to be a huge problem in the decades to come for most people.
Learn to Sleep at Night in a Bear Market
The previous Investor’s Guide to Thriving tour wrapped up on December 1st 2018. Aptly named “How Long Can a Bull Market Run?” we may have received our answer. The market printed the worst December since the Great Depression – bringing most of the major indices officially into bear market (-20%+) territory. Markets have rebounded in January as they always do after steep declines, but we are likely in the early phases of a bear market where average corrections are closer to 30% and extreme corrections are more than 50%. If this is case, we haven’t seen the last of market volatility and a downward pattern of lower highs and lower lows. Many people are surprised at this phase because it can take some time for the fallout to move from Wall Street to Main Street – showing up as a recession. Job markets are relative robust still and Central Banks are still talking about raising rates. Markets are forward looking and generally anticipate economic downturns, so even as rates continue to rise, employment appears to be strong, and many companies are still posting record earnings – you should be paying attention to the growing cracks in the system.
Larry will take the audience on a more detailed tour of past bear markets to see what we can learn about how this next one might compare. Will it be a gentle panda or a deadly grizzly? Can we hope for a soft landing due to aggressive government policy? How would we recognize a market bottom – when the next major bull market might begin? Why not go to cash or put all your money into a GIC right now? There are many questions to ask – and while (spoiler alert) we don’t have a crystal ball to give you the definitive answers, Larry can show you how to navigate a bear market so that you will use it as an opportunity rather than something to fear. Using some of his favorite indicators and techniques, you will learn how to use a tactical approach to trading, and strategic asset allocation (including the use of gold, real assets, and other non-equity vehicles), to help keep your portfolio within your emotional comfort zone – while avoiding costly emotional mistakes. Success in difficult markets is both a science and an art, so Larry will also discuss the psychological aspect of managing portfolios under stressful conditions.
You will take away from this live presentation a timely perspective on how to approach your investments in 2019 and beyond – along with actionable ideas to help strengthen your portfolio, and even a few tools and resources to use at home.
Click here to register for free and as always we ask for volunteer donations to one of our two favourite charities. Children’s cancer research at the Sick Kids Hospital and Alzheimer’s and dementia research at the Baycrest Hospital.