Inflation Watch: Beware The Ides Of March

President Biden has now had his $1.9 trillion stimulus package passed into law, and it will not be the last in the current fiscal year. Covid is not over and is sure to resurge with new variants next winter.

But even assuming that is not the case, we still have to contend with the aftermath of the pre-covid conditions, whereby banks had run out of balance sheet capacity combined with trade tariffs predominantly aimed at China. These conditions were a doppelganger for late-1929, and between 8 February and 20 March, the S&P500 index faithfully tracked a similar course to that of October 1929.

As far as possible, this article quantifies inflationary financing of government spending from March to September last year, and already sees evidence on the CBO’s own figures of that exceptional covid response being exceeded in the first half of the current fiscal year just ending. It points to something which no one has really foreseen, that the rate of monetary inflation has increased beyond the banking system’s capacity to accommodate it.

Even if the US manages to emerge from lockdowns in the coming months, the legacy of the turn in the credit cycle, trade tariffs, and supply chain disruption threatens a full-scale depression. There can be no doubt monetary inflation will accelerate, and we are beginning to see the consequences in rising bond yields.


It is nearly a year since the Fed on 23 March 2020 responded to stock market pressures and cut its funds rate to the zero bound and followed that three days later by increasing quantitative easing to $120bn every month. A further $300bn credit was to be directed at businesses, employers, and consumers. The Primary Market Corporate Credit Facility and the Secondary Market Corporate Credit Facility allowed the Fed to directly support corporate bond prices for large employers. And the Term Asset-Backed Securities Loan Facility would enable the issuance of asset-backed securities financing credit cards, student loans, and auto loans. Credit was to be made available to municipalities through two further programs.

And so on. Officially, the Fed was responding to the coronavirus in its role of ensuring market stability. Its emphasis on supporting businesses that otherwise would lay off employees reflected its mandate to target the highest level of employment consistent with its inflation mandate. Just in case the expansion of money led to a rise in consumer prices, last August the Fed changed the inflation target from 2% to an average of 2%, allowing itself the leeway not to change monetary policy if the target was breached.

Far more importantly, without the March stimulus the S&P500 was collapsing along with other non-fixed interest financial assets and commodity prices. If there is one thing that scares the living daylights out of the Fed, it is deflation. And that was what it suddenly faced.

A crisis in the repo market the previous September had alerted us to the inability of the banking system to further expand bank credit to support economic activity. Initially, investors paid little attention, but by early February 2020, the stock market began a sudden collapse, with the S&P losing 32% by the ides of March. For a central bank that believed in the wealth effect of rising stock prices it was vital to stave off a self-feeding 1929-style collapse in investor confidence. That was the existential threat at that time, and it had followed President Trump’s attempt to repatriate American manufacturing from China by way of imposing import tariffs on Chinese goods.

Essentially, financial and economic conditions were heading for a repeat of the Wall Street crash of 1929 which led into the 1930s depression. At that time, bank credit had expanded in the roaring twenties on top of Benjamin Strong’s monetary expansion, fuelling a stock market bubble of historic proportions. The trigger for its bursting was the Smoot Hawley Tariff Act, which was passed by the Senate in a debate between 23—29 October 1929. In the process, its scope was increased from the narrower damage limiting coverage expected in financial markets to an all-embracing tariff act, which added over 20% to the existing Fordney-McCumber tariffs of 1921.

It was that month that Wall Street crashed, with 24 October dubbed Black Thursday when the Dow lost 11% on the opening bell. The following week saw Black Monday and Black Tuesday as the falls continued.

In late-2019, the proportions of money and credit expansion relative to tariff impositions differed from 1929. The expansion of both money and credit was far larger, having accumulated over several credit cycles which were not permitted to wash out. Smoot-Hawley was global, while today’s trade tariffs were targeted mainly at the second-largest economy after the US and so less extensive. However, the combination was arguably at least as dangerous as that of late-1929.

It cannot be emphasized enough not to rely solely on empirical evidence, but from a theoretical stance to consider the economic destruction from tariffs, and then combine that with the cyclical collapse of bank credit. A moment’s thought about the consequences of such a combination and the subsequent mishandling of the consequences explains much of economic history between the early twenties and the run-up to the Second World War. And consequently, it behooves us to regard a similar combination in the run-up to today’s events equally seriously.

In February—March 2020 the sudden collapse of stock prices was eerily similar to the September—October 1929 crash both in scale and duration. A crucial difference is that in 1929 the stock market bubble was not deliberately inflated by monetary policies, being simply a side-effect of them. Today, the Fed openly admits to an objective of pumping the stock market through QE to create a wealth effect, necessary, in the opinion of policymakers, to retain confidence in the economy.

In 1929 there was an operational gold standard that meant the depression of economic activity led to falling prices. Today currencies are pure fiat, and the agreed policy is to expand their quantities to prevent prices from falling. It will not succeed in preventing a repeat depression, only serving to conceal it. A distinction must be made between the failed interventionist policies of both Hoover and Roosevelt, which hampered the markets’ adjustment and reallocation of all forms of capital, and the monetary effect. Under the gold standard there was a true reflection of the economic consequences of that fateful combination of collapsing credit and trade tariffs. Left alone, the depression would have lasted perhaps eighteen months or so, echoing the depression of 1920-21 — forgotten today, but equally deep.

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