Plain English with Derek Thompson - Everybody Was Wrong About Inflation

Episode Date: January 14, 2022

Okay, almost everybody. The Biden administration was wrong. Many critics of the Biden administration were also wrong. The Federal Reserve was wrong. Investors were wrong. Banks were wrong. And Bitcoin investors weren't exactly right, either. How did everybody miss the most important economic story of the year? Derek breaks down the highest inflation rate in 40 years and welcomes back his economic roundtable guests, the finance podcasters Michael Batnick and Ben Carlson.  Host: Derek Thompson Guests: Michael Batnick & Ben Carlson  Producer: Devon Manze Learn more about your ad choices. Visit podcastchoices.com/adchoices

The press box is here to catch you up on the latest media stories. Hosted by Brian Curtis and David Shoemaker, these guys have the insight on the biggest stories you care about. Check out the press box on Spotify or wherever you get your podcasts. Today I want to talk about inflation. So this week, the government reported that inflation hit 7%. That's the highest rate since 1982. Core inflation, which excludes food and energy,

since those prices are a little bit bouncy, was 5.5%. That's the highest rate since 1991. So depending on how you look at it, we're either dealing with the highest inflation rate in 40 years or the highest inflation rate in 30 years. I'd say that's a pretty big deal. And this is a case where a lot of very, very smart people got it very, very wrong. So the government got it wrong. Last March, the Federal Reserve was projecting inflation in 2021 to hold around 2% or 3%.

Nope. Investors got it wrong. If you look at several measures of investor expectations of inflation in the last year, they mostly seem to be expecting inflation to come out around 2 to 3%. Nope. The banks got it wrong. Most of the big banks published these fancy analyst notes where you get a bunch of big economic brains to predict the future.

And one summary of bank predictions that I found for inflation had an average of, just wait for it, two or three percent. Wrong, wrong, wrong. But even the government's critics weren't exactly right. There were a lot of Republicans and even some non-Republicans, like famous economist Larry Summers, who spoke out against the Biden administration last summer and said that, you shouldn't send these $1,000 checks to all these people because it's going to land us in a stagflationary environment like the 1960s. The stagflation being the portmanteau of stagnation and inflation, which is a phenomenon that we saw in the late 1960s, early 1970s.

Well, Summers and these other critics of the administration, they were right about inflation, but they weren't right globally. They were wrong about the stag part. They were wrong about the stagnation. The U.S. economy isn't stagnating at all. Americans are spending money like crazy. So those prognosticators didn't give us an accurate snapshot of the future as they saw it either. And finally, the Bitcoin Bros got it wrong. A lot of people in the crypto community have been predicting that the U.S. government was leading the world into this hyperinflationary environment and that the best investment you could make to ride out the wave was to buy Bitcoin. So let's roll back the tape. Say you had

$1,000 to invest in March or April of 2021, and everyone is making all these predictions and you think, okay, should I put my money in the stock market? Or should I bet on inflation, put my money where my mouth is, and put it in Bitcoin. Use it like an inflation hedge, like digital gold. Well, if you put your $1,000 on Bitcoin in March or April 2021, you would be down $200 to $300 today. Meanwhile, if you put your money in the SP 500, not just any particularly intelligent basket of stocks, just dumb, blind corporate America, here take my cash, I'm putting a thousand bucks in the SP 500, my friend, you would be up more than $200. So in the last nine months, the market has beaten Bitcoin by 40 percentage points.

This is not an argument that the Bitcoin maxis have won. This is a strange world in which everybody seems to be a little bit wrong. And I want to be clear, like, this is not an argument against Bitcoin. If you bought Bitcoin in March 2020 or something, I think you're up something like 800%. But the point is as a matter of correctness about the path of inflation in the last nine months. There's nothing about the price of Bitcoin that suggests that this group was especially right. So in conclusion, basically everybody was wrong about inflation. Here's what I want to know.

Why were we wrong? And what happens now? I'm Derek Thompson. This is plain English. We are back with our economic roundtable. That means Michael Battenek and Ben Carlson are here to break down inflation news. Michael is the Director of Research for Ritholt's Wealth Management. Ben is the director of institutional asset management.

They co-host the wonderful Animal Spirits podcast. Okay, guys, so here is the news. US inflation hit its fastest pace in nearly four decades last year. The consumer price index, that's what the government uses to measure what consumers typically buy, rose 7% in December, fastest rate of any month since 1982. And yet, big picture, important to point out, this is happening in a broader economy that is kind of booming in unemployment is very low. Spending is very high. The stock market had a blockbuster year. So first question for each of you, what is the single most important thing

about the latest inflation report? Michael, you go first. It is broad-based. Unfortunately, there's not just one thing that we could point to. 90% of the total CPI subcomponents are rising faster than the Fed's target rate of 2%. I know we're going to get into meat later. because I've got takes there. But as an example, energy prices are up 30% gasly in the national average a year ago, which was quite low. So to be fair, it was quite low, was $2.35. It's $3.30 today. Commodity prices. It's everywhere. Copper is at an all-time high. Use car trucks and price, used car trucks, used car trucks, used car and trucks, prices are still going up like crazy. 37%. My lease just came off. And instead of buying a new car or leasing a new car, I buy a new car,

bought my old one because economically it just made sense to do that. And here's the thing that I think is most important to pay attention to. All of these things that we were potentially talking about as being transitory, like the used cars and trucks, they're going to come back down. But the sticky thing that never reverses are wages. So the Atlanta Fed has this three-month average of the median wage growth. And that was four and a half percent, which is the highest level since 2002. And that's great, especially the biggest people on the bottom are finally getting to

participate in the economic expansion, but when you compare that with 7% inflation, it's not so good. And then the last thing on this topic is that over the last few years, inflation has been very moderate, and it's been primarily in services. But now it's primarily, or I shouldn't say primarily, we're seeing goods inflation, which is very rare. And the silver lining there is it tells me that goods inflation is hopefully one of the things that will moderate and eventually go away. So basically your big takeaway is when you look at stuff inflation, because experience inflation, services is not particularly high, but in stuff inflation, it would be lovely if we could say, oh, this is just about used cars. This is just about the price of bacon, but it's the price of jewelry

and it's the price of commodities. It's so many different things. So much stuff, suits. So much different stuff is seeing unusual inflation. Who is the suit anymore in the pandemic? I don't know why I said suits. I think part of it, like, you said it's the highest inflation rate in 40 years. I think big around numbers really psychologically impact people. Like, it's 7%. That's so big. Like, if Wilts Chamberlain scored 99 instead of 100, no one would remember it, right? But he has a sign with 100. I think there's a huge psychological component to inflation. And I think seeing this number on the news every single day beating people's heads, just beating people over the head with it, is going to have a psychological component on how people spend their money potentially. And I think it's hard to

think in real terms for people. So if we have 8% economic growth, but 7% inflation, people are going to think that's way, way worse than having 3% economic growth than 2% inflation, even though it's the same thing, basically, right? So I think we haven't dealt with this in 40 years. The majority of people, especially the three of us sitting here, have never had to deal with the situation. There's really only been two secular inflation spikes in our history, like the 1940s and the 1970s. There are some boomers who still remember the 70s. But this is a, a totally different time frame. So I think the fact that we've just never experienced this, I think psychologically how people react to it is going to be fascinating because I really don't

know. It was so broad base that they added an extra week to the NFL. That's right. Yeah, even the schedule is seeing hyperinflation in ways that's screwing with all of us. It definitely screwed with my fantasy team, that's for sure. So I, I'm glad you guys started there. I want to have a bit of media reckoning and economist reckoning. I want to know how so many people got 2021 inflation wrong. Because if you look at the teams that started a forum at the beginning of last year, almost every single team missed this badly. So first off, there was-

Guilty. And we're all going to give our own confessions. Our own Catholic confessions are coming soon. But there was team we won't have any inflation in 2021. Okay, they were obviously wrong. Then there was team transitory. That team, this is going to happen for three or four months. but by the end of 2021, we're going to be back at two, three, three and a half percent inflation.

Well, I think it's time to say that they were clearly wrong. There were critics of the administration, critics of the Fed, like maybe most prominently economist Larry Summers, who predicted the imminence of possible stagflation, the combination of inflation with stagnant growth. Well, he got inflation, right? But he also got stagnant growth wrong, because we're kind of booming in terms of spending in addition to inflation. Then, finally, you have like the Bitcoin Maxis, who's.

said, you know, I'm all in on Bitcoin because I think inflation is going to happen. But if you look at the price of Bitcoin over the last four years, over the last year, Bitcoin is not doing nearly as well as the S&P 500. So financially speaking, their bet on how inflation might cash out for them has also been disproven. Why, Michael, back to you, why was everybody or almost everybody so wrong about 2021 inflation, what did we miss? First of all, we're always wrong. Everybody's always wrong about predicting the future course of where the economy is going to go because it's unpredictable, just in its very nature.

But I think inflation is especially unpredictable. But I think there's two things to be very concrete of things that we underestimated. One, I don't think it was interest rates because we've been in a low interest rate world for the last decade and we've had pretty much no inflation. It was we, I think we underestimated the impact of fiscal stimulus. People love to trash the Fed. It was Treasury and the government that was sending money that really, in my opinion, juiced inflation.

The other thing that we severely underestimated was how difficult it was to turn the economy back on. We shut it off for 16 months, however long it was. And then the idea that we could just turn the supply chain back on, it didn't quite work that way. So I think that this is more – I know this is a cop – I do think it is a supply chain issue. Obviously, demand is there, which is great, but I still think supplies behind. This is a good time to admit that I got it wrong as well. I thought inflation might be three or

four percent. I didn't make a specific prediction, but I did not think that we were going to see six or seven percent inflation in 2021. Michael, to your point, you go back to March of last year. Biden signs the American Rescue Plan. Americans get their $1,400 stimulus checks, and they say, I want furniture, I want a new car, I want electronics for my home. I want, and and the U.S. can't import enough furniture, cars, and electronics fast enough. Demand outraces supply, and it gives us specific inflation in this category called durable goods, which I think of as just stuff. Another thing I want to put on the table, though, which was a legit surprise, is the Delta wave.

Delta swept through Asia, and we saw lockdowns in southern China and other factory hubs, and that's screwed with supply chains as well. In the U.S., it kept older workers on the sidelines. They were afraid of getting sick by going back to work. It kept working moms and dads at home. All these early retirees and working mom and dads pulling themselves out of the labor force, I think is contributed to the labor shortage that we see. And the labor shortage that we see is also, I think, pushing up prices.

Ben, how do you see this cash out? Why do you think we got it wrong here? Well, to put some color on that demand, so U.S. retail sales over the last 20 years pre-pendemic was up like 4% per year. since the pandemic, and this includes an 18% correction at retail sales in the first few months of the pandemic, it's up 13% per year. So we are spending so much money right now. But I also think I'm willing to let people move the goalposts a little bit because this wasn't an economic cycle. You couldn't look at a textbook and understand what's happening here. This is crazy. This is more like

a war, but it's different because we didn't, like, you know when a war is ending, right? We don't know when this is going to end. And I think the fact that COVID was so prolonged, we sent out the checks. And I think the fact that it kept going, I think the people that were saying transitory might have been right if COVID would have been taken care of right when we had the vaccine rollout, right? But it's still going now and now we've got the worst wave ever. So I think this is just the weirdest economic environment we've ever seen. And the crazy thing is, if you look back to the pre-pandemic trend of economic growth, like GDP, we're basically back on trend. So people like Larry Summers who said, we're going to run hot. We're running hot compared to a crappy year in 2020,

but compared to before, we're back to where we were. So we had this huge dip. We had the worst economic GDP contraction on a quarterly basis ever, even worse than the Great Depression. And we've made that back up, and now we're back to where we were, basically. And just explain that a little bit, what you mean by that. When you say, we're back to where we were,

you mean that nominal gross domestic product, like the size of the economy is back at the trend line that we expected it to be in 2021 before there was any pandemic. Is that correct? Yeah, so following historical trade, GDP doesn't move all that much. The stock market is all over the place. GDP rarely moves. Even in 2008, the economy was down like, I don't know,

three or four percent when the stock market fell 50, right? So GDP doesn't move all that much. So if you follow a long-term trend line of where it was going, we're basically back to, yeah, where it was going before we had the dip and then the comeback. And real GDP is at an all-time high after inflation. Yes, even accounting for inflation. So the whole thing about people missing how high inflation was going to be and how long it would last. I think that is all pandemic-related.

I'm willing to give most people a pass. I also think everyone these days is a macro tourist. So everyone has an idea. The crypto people who made all their money in tech, they think, I'm smart. I made a ton of money. I know what's going to happen to the economy now. And everyone does. And I think inflation is just really, really difficult to predict.

There's no model in any techs that can tell you this is going to cause inflation if we just pulled these one or two levers. We really don't know most of the time. So for example, as somebody who is on Whole 30, I'm on a no-carb diet. I'm a meat and veggies guy. I'm feeling it, Derek. I am feeling the meatflation. You're feeling the meatflation.

You look at meat prices right now. I mean, it sucks for you. Beef and veal up 17.6%. Uncooked beef, uncooked ground beef, that's 11%. Uncooked beef roast. I don't know if you're beef roast guy. That's 21%. Big time.

Bacon, 17%. Interestingly, butter, cheese, and tea are the only food products I can find that are seeing falling inflation. My wife, huge into tea, big into cheese, big into butter, she is keeping this family afloat. If it was just for me, we'd be bankrupt because I'm out there buying all the steaks and the bacon. I'm bankrupt in this family, but she's buying all the stuff where prices are falling. But in all seriousness, you're exactly right.

I think this is definitely a bizarre, a bizarre moment. I can hear like two different arguments on Delta. One is that Delta created more inflation, but the other is that maybe Delta is actually holding back inflation. Maybe there's Americans that really want to spend a lot of money on services on restaurants, on vacations, but they're keeping that money in their pockets. And so in a weird way, the rising variance might be holding inflation down more than they're pushing it up. Ben or Michael, how would you tease apart that argument? Do you, like, do you come down strongly once out of the other? I just booked a flight yesterday to Miami for February. Guess how much a one-way ticket is? I'll tell you.

$92 bucks. Jesus. So that shocked the heck out of me. I guess people aren't flying right now. But here's where I think one impact of the virus that we haven't spoken about, again, getting back to the wages, is that people rethought how they were going to go back to work. And in order to get them to go back to their jobs that some people weren't happy with, they said, I'm not doing that for $11 an hour.

There's no chance in a heck. So I think that had a huge impact on the wage story, which is ultimately going to be what drives potential sustained inflation, in my opinion. I do think, Derek, to your point, if supply could meet demand right now, I think things could be a lot worse. I think growth could probably be higher, too, so that that relationship might be similar on a relative basis. But if we were allowing supply to go, I think we could have that like roaring 20s boom we've

been hoping for and talking about if we could have those two meet. Now, obviously, it's going to be hard to have them meet perfectly and find this equilibrium. But I do think that's a possibility. Like, if we could just figure out how to get this and like, be a little patient with this and let the supply stuff come back online and see what happens as opposed to, no, no, no, we've got to shut it down now, slow demand, and let's cut it off right now. I don't see how that's helpful to anyone. I want to talk specifically about meat inflation. Prices are up, as I said, 17% for bacon, 22% for veal. This is a case where a lot

of democratic politicians have stepped into the fray and said, we're blaming companies for inflation, not the macroeconomic conditions, not these big picture things like pandemic, supply demand, no, we are blaming companies. And Senator Elizabeth Warren caused us to stir when she came out against the meat processing companies. And I want your reaction to what she said. So I'm quoting from her tweet, quote, families are rightly upset that the price of meat has gone through the roof. Who's to blame? Meatpacking monopolies that are using inflation as a cover to raise prices and make record profits. The four largest meat processing companies are jacking up beef prices to fatten their profit margins while consumers are left

with higher prices. End quote. And the White House has picked up on this theme. Jen Saki, the press secretary, tweeted this, quote, four big companies control 50% of meat processing. These middlemen use their position to overcharge grocery stores and ultimately companies, end quote. Ben, do they have a case? Are the meat processing companies, aren't the meat processing monopolies to blame for Michael's impoverished state as he's on the Whole 30 diet? I honestly think they're on the right track, but the fact that they're narrowing their search to meat processor seems bizarre to me. Because you could argue that corporate America has taken advantage of higher prices. So people in corporate America are complaining, we have this,

labor shortage and we're having to pay people more and we have higher input prices and the supply chain is all messed up. But profit margins for S&P 500 companies, that's all the biggest companies in the stock market, have never been higher. There's as high as they've ever been. They've been rising over the past year. So companies are making more in profit and keeping more now than they ever had, even with these higher costs they're having to deal with. So you could say, yes, corporate America. And I understand taking corporate America to task, I'm not sure going at the meat processes, So we're dealing with these problems of, I'm sure they've had tons of COVID outbreaks at their plants, right? They're dealing with higher fuel costs.

Commodity prices are higher, way higher over the past year. So I understand wanting to go off the big, bad corporations, but going after this meat packer specifically, I'm not sure this one really hits to me. Michael, what do you think? So Tyson and Hormel, which are two of the biggest meat company, publicly traded companies, their margins are close to all-time highs. But their net margins are like in the single digits. So they're not like absolutely killing people. And I think people were like sort of rolling their eyes at the meat processing company. But when she went after grocery stores, Elizabeth Warren, which she did, that's what people

like, okay, wait a minute, wait a minute, wait a minute, grocery stores are the lowest margin business possible. Kroger's net margins is 0.75%. They're not gouging the customers. So I think maybe they're right about corporate America to Ben's point, but they're pointing the fingers of the wrong places. So one of the things that's responsible for this is underlying inflation. Cattle futures, for example, are as high as they've been since 2016.

If you want to blame anybody, blame the cows. So I think she's right. Like you guys said, that there is obviously a lot of consolidation in meat processing. There's a lot of consolidation across the economy. I have two specific objections to her case, and you guys have partly covered both of them. One, meat inflation is a little bit unusual, but it's not that unusual. Meat inflation is the same as used cars, energy, furniture, oranges, peanut butter. We're just seeing a lot of different price categories at 40-year highs.

Number two, animals need food to eat before we eat them. That's how it works, circle of life. Food prices are going up. So animals cost more to raise, which means they cost more to eat. And I was wondering, you know, what do animals eat? They eat a lot of grains. You would need grain inflation to be a raw. around the highest it's been in maybe 50 years to partly explain the price of meat.

So I looked it up. And it turns out that the producer price index for grains, that is what farmers are paying for grains to feed their animals, is in fact the highest it's been in 50 years. So again, I don't want to suggest here that like corporate consolidation is a fantasy. It's very, very real. But if we're trying to understand the rising price of meat, the rising price of grains in order to feed the animals that become our meat is a pretty important clue. And to your point, when she starts going after the grocery stores that have profit margins between like 0.5% to 1.5%. I start to wonder whether the good argument for antitrust regulation is being marshaled in the least possibly useful way. Yeah, I'm sympathetic to her case.

But when she says things like this, it makes me want to hop off. And so, again, to point the fingers in the wrong faces, we might have spoken about this last time, but housing prices stock. So DR Hordid, for example, it's the biggest home builder in America. Their margins are at all-time highs, even though lumber prices have gone up so much. But when lumber prices crashed, they were asked by an analyst on the calls. Lumber prices came down. You raised home prices as a result of lumber going up. Now it came back down.

Are you going to lower prices? And they said, no, we're going to take it to margin, which they have. So they are taking advantage of the situation. And guess what? That's sort of their job. But so it does stink. I have one actually. I have a macro question for you guys, because you understand.

this space better than I do. But I'm thinking, you know, bacon's top of mind. Let's just say I run a bacon store and I've got a couple employees that I pay in my bacon store and I obviously have to buy the pig meat to start. If I'm in a high inflation environment, inflation's going up for wages for the people that I employ and inflation is going up for the pigs, wouldn't I start to raise prices even a little bit more than I have to to keep up with yesterday's profit margin in anticipation of the fact that I'm in a high inflationary environment

in which all of the prices surrounding my business are rising at the same time. Like, I guess to make it one sentence, is it rational, does it seem rational for some companies to purposefully try to increase their profit margins in high inflationary environments as a protective measure, not as a matter of greed, but as a matter of worrying that next quarter's

prices just might be at a point where today's prices that you're charging consumers won't pay for it. Does that make any sense? Well, this is the psychological component of inflation. The same with consumers, right? So consumers might want to buy, and this is why I think if that eventually trickles down to consumers and inflation stays here for long enough, this is where you throw the models out the window and go, oh no, this is having an impact on consumer. The problem is right now, consumers are still spending so much that we're giving the corporations a break here

and letting them raise prices as much as they want because we have so much money. The consumer balance sheet has never looked as good as it has today. And takeaway that, it's never looked as good as it has coming out of a recession as it does today. Because interest rates are so low and people got money and people paid down credit card debt and short up their finances. So the fact that the consumer is still spending

gives them leeway to do this. but I understand your point that it's psychological and you're planning ahead and what if it gets worse? And that's the point where if that trickles down to the consumer and that changes their spending habits, then maybe inflation stays here for a little longer

than we even anticipate because maybe people start buying sooner because they think, well, prices are going to be higher in the future. I should buy now. We haven't seen that happen yet, but it's possible. People really hate inflation because even though their wages have gone up,

those are usually one-time boosts, whereas you see prices going up every week and I think that this is largely responsible for President Biden's discerable, disapproval rating. Rating ratings are at all-time lows for him, and I think a lot of this is consumer prices. Yeah, I'm glad that you walk this back into politics, because that's where I want to move on to, is the Federal Reserve, where, look, I think a lot of the debate over inflation cashes out as what should the Federal Reserve do about it? So I want you guys to help me with a kind of, you know,

econ 101 here. Ben, what is the Federal Reserve? What is its job, and what are its tools? Right. The Fed is essentially the lender of last resort. Before the Fed existed in 1913, we were on the gold standard, and there was really no backstop to the U.S. economy. And so I did some data for one of my books I wrote. From like the 1850s to the 1930s, essentially through the Great Depression, the U.S. economy experienced a recession or depression once every four years. And the average contraction in GDP was like 23%. So this is before the Fed, you know, before the Fed really sunk his teeth and a new one was doing. Since then, we have won roughly every seven years. And we had the two longest economic expansions in history since 1990 alone. And so the Fed, I think, is a huge reason for this. They effectively acted this lender of rest resort for the banking system so we don't have like runs on the bank. So in 2008, that could have turned into, I think that was closer to going into depression than even the corona crisis because the financial system was teetering on the brink. And the Fed stepped in and said, we're going to back all these credits, all these people who can't pay the debts that they took out. We're going to back them up. We're going to make sure the credit

system continues to flow so people can borrow money and the economy can continue to chug along. And the Fed really has this dual mandate and it's two things. One is they want employment to be strong and two is they want price stability. So you can say in this last 18 months or so, they've done a really good job on one of those dual mandates. Unemployment rate has gone from 14.7% to 3.9% in 21 months. And then not so great on the price stability because prices are all over the place and they're going higher. The problem is their instruments for this stuff are pretty blunt. Like, they control short-term interest rates, and they can buy bonds, which is what they can do, kind of mess with the credit markets and change the rate that people to borrow

with. And they can do this by basically the push of a button. The problem is, it's not like the Fed can send out money to people or take it back from them, right? The Fed is effectively, we're borrowing money from ourselves when the Fed creates a bond, right? They're borrowing from the Treasury. The Treasury is borrowing from the Fed. It's just money coming out of thin air that really effectively just changes interest rates. It's the government, as Michael mentioned, through fiscal policy is the way to get money to households. So it's not the Fed. When people say the Fed is printing money, they're not really printing money by giving it to households. That's why we didn't see any inflation coming out of 08 because the Fed was doing things in the banking system, not the real economy by giving people

money. So the Fed controls interest rates. So by raising interest rates, the Fed can impact consumers because maybe mortgage rates go up, maybe credit card rates go up and they go up. So they can have an impact there. But they're not effectively changing like the money supply that people see in their bank account and their checking account. They're just playing with interest rates. And so, unfortunately, yeah, raising interest rates could help things now, but the Fed is not going to be able to help the supply chain unless they just completely slow demand. They can't make the supply chain stuff any better just by raising or lowering interest rates. Fantastic summary, fantastic history. So Federal Reserve, basically the king of monetary policy, they've got a handful of tools. Number one,

they can change interest rates. Number two, they can buy bonds. They can buy assets and through that process sort of create money in the system by buying the asset and then giving a bank money that is essentially coded up, printed up, so to speak. And then number three, you suggested this, but I just want to put a point on it. The Federal Reserve has a tool called talking. The Federal Reserve can say, we are never going to raise interest rates ever again. Like Jerome Powell has the the ability, the chief of the Fed, has the ability to say this, and that is going to have an effect. It's going to make people think that inflation is going to be, sorry, that interest rates are going to be low forever, and they're going to change the way they, you know, go about getting loans

or buying houses. On the other hand, Jerome Powell can say, I am going to raise, or I am interested in raising interest rates 57 times in 2022. And that's going to have a very big psychological effect on people who are interested in, let's say, buying a house. If you want to buy a house next year, if you're looking for a house right now, she's, we're in 2022, if you're interested in buying a house this year, and the Federal Reserve is like, we're going to raise interest rates several dozen times in the next 12 months, you're like, holy crap, I need to buy this house now. Lock in my interest rate because it's going to go from like three to 10 percent in the next 12 months. So I just want to be clear that just by talking, just by talking, the Federal Reserve can wield power.

Michael, speaking of the power that the Federal Reserve wields, what is the Fed saying it's going to do in the next 12 months right now? Yeah, so for the audience listening that doesn't know Jerome Powell, he is the head of the Federal Reserve. He sort of think of him like David Stern or for the NBA, or Adam Silver for the NBA in terms of the power that he holds. So what is the Fed saying they're going to do? What is the market think they're going to do? And what are they doing today? Okay, today they are still in crisis mode. If you knew nothing and you just saw what the Fed was doing, we have interest rates at zero, right?

So money is free. We are still pumping money or liquidity into the system. They are still, even after reducing their purchases, they are still buying $40 billion a month of treasuries. And again, to Ben's point, this is a banking thing. It's left pocket, right pocket, but it's liquidity. And it certainly has a big impact on asset prices. And they're still buying $20 billion of month of mortgage-backed securities. Does the housing market really need accommodative policies when real rates are negative?

So all of these sort of things, I think a lot of people take issue with. They think that the Fed is increasing income inequality or wealth inequality because all the rich people hold all of the assets, which is certainly a part of it. So I think current monetary policy, and it's easy to be an armature quarterback. I don't think that they have bad intentions here. I think that current policy is inappropriate, given where we are. in the recovery. So that's where we are and where we were. So why do you tee up the next one? Yeah, if current policy isn't appropriate, Michael, what is appropriate? I mean, tell me, you know, you, Jerome calls you this afternoon. What should I do? Walk me through it.

Like, in as clear as possible language, like, I don't, don't go all the way into nerdery. But like, you can go tiptoe a little bit into nerdery. What should the Federal Reserve do right now? I think we should slow down and you could say even stop injecting liquidity into the system. stop buying $40 billion worth of treasuries a month. That's number one. Number two, let's begin to normalize interest rates. Let's stop acting as if we are in an economic crisis today. And when I say normalize, stop with the free money.

I don't think we need to jack up rates to kill demand. I don't think demand is so hot that we need to stop it. I think demand is a good thing. We've had pretty subpar nominal GDP growth for the last decade. There's nothing wrong with running a little bit high. and having four, five, six, seven percent GDP growth. But I think that we just need to get off of the crisis levels that we're at and just start to get back to normal.

And just before I get to Ben, connect the dots for me a little bit. If the Fed stops buying treasuries, if the Fed raises interest rates a little bit, what's the next thing that will happen? What's the next domino that falls based on that decision? and how does it trickle out into the broader economy? Because I think one thing that is confusing about the Federal Reserve for a lot of people is that, like, average people

have no direct relationship to the Federal Reserve, right? The Federal Reserve is not printing money and then dropping it out of the helicopter and the dollar bill floats into my pocket. The Federal Reserve is changing interest rates and orchestrating monetary policy in a way that through the falling of interconnected dominoes cashes out in economic conditions,

labor conditions, wage growth. So from a domino falling standpoint, what happens after Jerome Powell does what you're asking him to do? Everything is based on interest rates. It's the lifeblood of the economy. It's the cost of money. It is integral to our lives, even if nobody directly interacts with the Fed on a daily basis. So, for example, everything is based off of what is the overnight rate that the Fed is conducted between itself and the banks that it's lending to and borrowing from. So if there's a spread between mortgage rates and overnight rates, if that's at zero, that's going to keep mortgage rates pretty low. If those rates start to creep up, the cost of money is going to start to increase. So that is going to impact the real economy.

Now, it also has a big impact on the stock market potentially. Ben, Fed share, Jerome Powell, had a really interesting statement. I think this was earlier today on Thursday or might have been late Wednesday. day. He said, quote, to get the very strong labor market we want with high participation, it is going to take a long expansion. And to get a long expansion, we are going to need price stability. Ben, you seem to speak a bit of Fed ease. You are fluent in Powellese. What is Jerome Powell saying here? What is he saying, do you think, about to get a long expansion, we're going to need price stability? He's basically saying we have the teeter totter.

I said already they have their dual mandate. They've done well on the employment front. The inflation is much higher. So they need to figure out how to have that teeter totter come back into balance a little bit more. And so I think he's saying we're going to have to do something to try to rein in inflation. And if that means raising interest rates to one or two percent, we're going to have to do that. Even if that means the stock market goes down and maybe housing prices slow a little bit and mortgage rates come up. He's saying we're going to have to take some of that medicine now so we can continue to have this.

And I don't want to have to go and create a recession. but I want to maybe things just take a breather for a little bit. Things have been so hot and heavy for 18 months or whatever that things have been going well, housing prices are up 20%. And the stock market is up 100% off the bottom. Like, maybe we can slow down a little bit with that stuff. And if I raise rates and we stop our bond purchases and we have to take a pause, I think that's what he's saying.

If we can try to rein in inflation a little bit, then maybe we can balance that out a little more and not cause a recession and have people get out of their jobs again and have an unemployment vehicle back up. But I think he's trying to thread the needle here between, having people go back to work and having wages rise, with also bringing price control back into place, which we haven't had for a while. Last question, guys, inflation 2020.

I'm not going to ask you to make any predictions because I think as we've established, any effort to make a strong and clear predictions about inflation is an exercise and futility. But give me a framework that you have, something to look out for in the next month or two, about the direction of inflation for 2022. because honestly, you know, obviously this matters for people's lives.

It matters for businesses. It matters for families. It matters a lot for politics. If inflation is 7% in October of 2022, Democrats are going to get smashed. Like, Republicans are going to run up the largest midterm election win, maybe in modern history. I guess that's a strong prediction.

So give me some, give me a framework for how to navigate the data of the next few months, what are you looking for? And Michael, we'll start with you. Sure. I think the most outrageous outlier that we're seeing is used cars and trucks. And I'm going to use that as my barometer for some semblance of returning to normalcy. So if we continue to see the rates that were increasing on, I really think that's unlikely. I'm going to start to get very nervous. I don't know if that's the right gauge, but that's what I'm going to be looking at. Ben, what are you looking at? I do think I try not to use too much econ speak here, but like the second derivative is basically, yes, inflation is still accelerating, but is it accelerating at a lower level?

So I think we actually finally saw that this month, where month over month inflation was 0.6% in November, but in December was 0.5%. So it's still going up, but it's doing so at a lower rate. So I think if we can see that acceleration probably still happen, at least for the first five or six months of the year, it's probably going to remain high because we're coming out these low base rates. But I think if we can see that rate of change start to slow and not go up as much as it has in the past, I think that is a potential light at the end of the tunnel where we're finally seeing it ease a little bit. Can I just make one more comment that I think is very important

here? Absolutely. We're talking about what happened as a result of a confluence of events, of government intervention, fiscal, monetary, COVID, the whole deal. I think it's a miracle that we're talking about an overheating economy, given where we were just two years ago. And this is so much better than the alternative. And I'm not saying that everybody did everything perfectly, obviously, but this is so much better than the alternative of literally a global depression if we did nothing.

And that's what would have happened. So I'd much rather face these issues of inflation and rising prices and rising wages than the alternative. I'm glad you said that because that's where I want to land. You know, I don't want to carry water for the administration here. I don't want to pretend that inflation is no big deal. It's a big deal that inflation is rising faster than wages. That is a big deal.

It means that in real terms, a lot of households are getting or feeling poorer depending on how they spend their money, right? Like households that got a one-off raise, got that annual raise six, seven months ago, and are living the Michael Battenick diet on buying a lot of bacon and pork and veal are absolutely feeling poorer than they did the month before they got their wage. That is a reason to be frustrated with the federal government. It's a reason to be frustrated with Biden, and it's a reason to be frustrated, just, period. At the same time, we have to think about the parallel universe in which we did not pass these stimulus bills,

in which we did not send checks to Americans, in which the Federal Reserve and Jerome Powell were not accommodative in their monetary policy and basically let the economy bottom out. having unemployment under 4% given where we were 18 months ago or 20 months ago is a, it's a minor miracle. And so we are seeing historic, scary inflation in the context of that minor miracle. And we don't have to say that it's all good or all bad. We can just say there's good stuff and bad stuff, and there's a parallel universe that we could be living in, in which it's all bad. Guys, thank you so, so much for talking to me again and walking me through this complex stuff. I really appreciate it, and I'll have you back on very, very soon.

Thanks, Eric. Thanks, Derek. This is a lot of fun. Plain English with Derek Thompson. It's produced by Devin Manzi. If you like what you hear, please follow, rate, and review us. New episode drops on Tuesday. Have a great weekend.