Inflation and the Common Knowledge Game


Gasoline prices in California recently hit a record high of $4.69 for a gallon of regular.

US corporations are raising prices, sometimes [gasp!] at a faster rate than their costs are increasing.

As a result, ruling party politicians are losing their minds.


The highlight for me (or lowlight, I guess) was this Nov. 17 letter from the Biden White House to the Federal Trade Commission, calling for federal regulators to investigate whether oil and gas companies are engaging in “illegal conduct” by increasing their gross profit margin. I am not making this up.

Usually, prices at the pump correspond to movements in the price of unfinished gasoline, which is the main ingredient in the gas people buy at the gas station. But in the last month, the price of unfinished gasoline is down more than 5 percent while gas prices at the pump are up 3 percent in that same period. This unexplained large gap between the price of unfinished gasoline and the average price at the pump is well above the pre-pandemic average. Meanwhile, the largest oil and gas companies in America are generating significant profits off higher energy prices. The two largest oil and gas companies in the United States, as measured by market capitalization, are on track to nearly double their net income over 2019 – the last full year before the pandemic. They have announced plans to engage in billions of dollars of stock buybacks and dividends this year or next.

I do not accept hard-working Americans paying more for gas because of anti-competitive or otherwise potentially illegal conduct.

White House letter to Federal Trade Commission, Nov. 17, 2021

I, for one, welcome MiniPlenty’s forthcoming diktat on acceptable crack spreads. LOL.

So look, this is ridiculous stuff, almost as ridiculous as “temporarily” releasing 50 million barrels of oil from the Strategic Petroleum Reserves. But I get it. If I were an incumbent ruling party politician I’d be pretty miffed, too.

The US government has not just allowed but directed a dozen years of the most accommodating monetary policy conditions in literally the history of mankind, with a cost of capital that is effectively zero for large corporations.

The US government has not just allowed but directed the creation of a multi-trillion dollar infinity-pool of liquidity to prop up any hiccup in asset prices.

The US government has not just allowed but directed one of the largest transfers of wealth – again, literally in the history of mankind – to the managerial class.

One day we will recognize all of this as the defining Zeitgeist of the Obama/Trump years. One day. But not today.

And now you guys are raising prices more than your costs are going up? After all we’ve done for you? Seriously?

Like I say, I’d be miffed, too. Something, something, face-ripping leopards.

But this isn’t collusion or price fixing or “anti-competitive conduct” or any of the usual high-functioning sociopathic behaviors we’ve come to know and love from our titans of financialization industry. I mean, yes of course the vast majority of Chairman/CEOs (and ruling party politicians) are high-functioning sociopaths, but that’s not the determining factor here.

Why are US companies raising prices in unison?

Because it’s rational behavior in the Common Knowledge Game.

We’ve written about the Common Knowledge Game a lot, starting in the original “Manifesto”. Honestly, once you start looking for the Common Knowledge Game, you will see it everywhere.

Common knowledge is something that we all believe everyone else believes. 

The classic example of the Common Knowledge Game is the fable of The Emperor’s New Clothes. Everyone in the crowd possesses the same private information — the Emperor is walking around as naked as a jaybird. But no one’s behavior changes just because the private information is ubiquitous. Nor would behavior change just because a couple of people whisper their doubts to each other, creating pockets of public knowledge that the Emperor is naked. No, the only thing that changes behavior is when the little girl (what game theory would call a Missionary) announces the Emperor’s nudity loudly enough so that the entire crowd believes that everyone else in the crowd heard the news. That’s when behavior changes. That’s when behavior changes FAST.

Jay “it’s probably a good time to retire that word” Powell

For months now, Missionaries large and small have been saying that inflation is here and inflation is well-embedded. But when the most powerful Missionary in the world, Jay Powell, says that inflation is no longer “transitory” … well, now everyone knows that everyone knows that inflation is here to stay.

And when everyone knows that everyone knows that inflation is here to stay, ALL businesses can raise prices to maintain margins without fear of competitive pressure or customer pushback.

Narrative dynamics rule our world. Not fundamentals, whatever that means, but narrative dynamics. One on top of another. Endlessly. Recursively. It’s narrative dynamics all the way down. And the number one engine of narrative dynamics is the Common Knowledge Game. Understand that and you’ll understand the game of markets and politics and every other social interaction of crowds.

I wrote this almost exactly three years ago.

You don’t have to change your investment playbook for a Fed-created recession, a China-created credit freeze, or an Italy-created Euro crisis. You already know the deflationary playbook. It’s what you’ve been doing (or should have been doing) for the past ten years. Just keep doing THAT.

But if we enter an inflationary world, something that very few investors alive today have EVER experienced … well, everything you’ve been doing for the past ten years will be a mess. Your prayers to the great god of diversification, at least as that god is manifested today as the Holy Long Bond, will go unanswered. Your embrace of the cult of Vanguard, at least as that cult is expressed today as the worship of passive index funds, will give you pain rather than comfort. The very language that you use today to speak with other investors about core abstractions like Value and Growth will turn into gobbledygook.

Today’s common knowledge rejects this Fourth Horseman of inflationary regime change. But, but … demographics!, you hear. Don’t you understand that Demographics is Destiny™, that we are getting older and having fewer children, dooming us to the long gray slog? But, but … technology!, you hear. Don’t you understand that robots and AI are going to replace all us mere humans, creating a world where our bread and circuses just get cheaper and cheaper? Yeah, I understand. I hear these narratives and memes, too.

But that’s my point. We believe that we are in a deflationary world because we are TOLD that we are in a deflationary world. That’s the common knowledge. Everyone knows that everyone knows that inflation is dead and gone, that it’s a long gray slog going forward, forever and ever amen.

It’s hard to imagine when you’re immersed in it, but common knowledge can change.

That includes common knowledge of the fundamental inflationary/deflationary nature of our world.

I think it’s happening. I could be wrong. But that’s what I’m trying to imagine.

Things Fall Apart (Part 3)

The common knowledge of whether we are in an inflationary or deflationary world has now shifted. It will not shift back for years and years, because common knowledge is a stable, self-reinforcing phenomenon. Common knowledge is a barge, not a speed boat. Common knowledge is incredibly difficult to stop, much less turn around, but once it starts going the other way it will keep going.

At whatever point in time you think inflation will start to fade, you are being too optimistic.

Why? Because common knowledge. And here’s the kicker:

An inflationary world will cause enormous political and economic pain, but that pain will be different from the pain of a deflationary world.

This is the challenge of our economic lives for the next decade or more. How do we make sense of the differentness of an inflationary world? Will we have the imagination to conceive of the repercussions of that differentness and come up with the personal actions and social policies to address that differentness?

And will we have the courage to act.



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Comments

  1. “the only thing that changes behavior is when the little girl (what game theory would call a Missionary) announces the Emperor’s nudity loudly enough so that the entire crowd believes that everyone else in the crowd heard the news. That’s when behavior changes. That’s when behavior changes FAST.”

    Smacked me right between the eyes.

    Thanks, Ben.

  2. I’ll repost this from elsewhere but I’ll tweak it for this topic.

    Here’s how this works, and it’s pretty obvious to anyone paying attention:

    1. No, inflation isn’t real.
    2. Ok maybe inflation is real but it’s only going to hurt the wealthy.
    3. Akshually it’s a good thing that inflation is here, we never said it wasn’t, and frankly we think it’s pretty {insert undesirable ad hominem} that you’d even object in the first place because now poor people are making more money.
    4. (After some polling comes in) Oh shit, maybe inflation isn’t a good thing and maybe it doesn’t help the poor after all. Somebody :tm: needs to do something about this.

    The playbook is pretty standard and frankly it bores me that nobody has come up with anything more clever than this.

  3. Avatar for jrs jrs says:

    I was born in the early 80s, so as Ben implies I have no experience with inflation. Does anyone have a good read on exactly what the inflation playbook or common knowledge to protect oneself from inflation was the last time it happened in the 1970s?

    I did read John T Reed’s Protect Your Life Savings From Hyperinflation and Depression. Reed was a real estate investor in the 1970s and has done a lot of research on other inflationary periods throughout history. Reed has obvious political biases and he needs a good editor, but I basically learned 2 things about inflationary times from this book:

    1. The value of bonds will usually decrease. The value of stocks, surprisingly to me, will be variable. Sometimes they go up in inflationary times, sometimes down.

    2. The best way to protect myself and my family from ruin during inflation (and depression!) is to own everything we will ever need, today, or the means to produce it, as much as possible. Of course, this can be a very expensive strategy. Reed writes about how his father’s family owned a farm in West Virginia during the Great Depression and their life pretty much went on as usual since they were self-sufficient. But it was a hard life and Reed’s father hated it, moving to the city and eventually becoming an alcoholic.

    Do we agree that this was the common knowledge of the 1970s? Or is Reed’s perspective an outlier?

    I am also curious for Ben or someone else to unpack this quote specifically in the context of inflationary times:

    Your embrace of the cult of Vanguard, at least as that cult is expressed today as the worship of passive index funds, will give you pain rather than comfort.

    I am no longer a big fan of index funds (“but compared to what?”). But naively, I would think that owning index funds is riskier in deflationary times than inflationary. Since in deflationary times you know everything is correlated to move down together, no?

  4. I’ve read Powell’s speech from last week 3 or 4 times. Partly, because of the change in the way he talked about pandemic now contributing to inflation vs. deflationary in the past. Conveniently, now everyone this week believes omicron is weaker and the pandemic is effectively over, so supply chains will normalize in 2022.

    That has and continues to seem “too easy”, but I guess the next pivot point is trying to predict when everyone figures out we “are being too optimistic”.

    For some reason, all I can think about is Goldman reiterating Dalio for 2022, saying “Cash is trash”.

    Screenshot 2021-12-08 113756

  5. Avatar for bhunt bhunt says:

    Don’t have a view on John T Reed, @jrs , but I’ll try to unpack that quote about passive index funds.

    Your embrace of the cult of Vanguard, at least as that cult is expressed today as the worship of passive index funds, will give you pain rather than comfort.

    The basic idea here is that a) there’s not a Fed-supplied liquidity tide lifting all equity boats in a tightening cycle, and b) as we’re seeing in the tech sector today, there are a lot of losers and not just all-winners when the narrative barge changes course and starts moving in the other direction. Specifically, I think we’re looking at a prolonged period of multiple contraction for “story stocks”, which will hit the largest S&P 500 sector weighting - tech - the hardest.

    Bottom line - I think that there’s ‘space’ for stock-picking to work again as these tectonic plate narrative regimes shift, which is (relatively) bad for passive index funds and particularly bad as you’ll see real assets (as opposed to financial assets like an index fund) go up more sharply and with a big drum-beating narrative.

  6. Avatar for jrs jrs says:

    I think I understand. So your quote is contingent on (a) the Fed raising rates (etc) rather than letting the party continue. And your (b) boils down to that old quote about swimming naked when the tide goes out. So you’re not speaking of inflation in isolation, but rather as coupled to the government’s likely response to it.

    The Boglehead narrative is that active stock-picking does not work and has never worked. And to the extent that it does work, it is ultimately due to insider information in one way or another. The narrative is that multiple papers have been published showing eventual reversion to the mean for most or all active strategies studied, meaning the pickers just got lucky.

    That part of the narrative still rings true to me, although maybe it’s just a crutch for my own financial ignorance and laziness. (And if so, then I am one of millions of doctors and other non-financial professionals who are so fooled. And our Missionaries like Jim Dahle and William Bernstein are similarly fooled.)

    So, to perhaps unfairly frame this in the Boglehead way: Are you aware of any study or other evidence showing that any active strategy consistently made money, +/- before our current water became a thing?

    (Now that I write it out like this, I see that this question may be impossible to answer rigorously, as it seems common knowledge among active investors that soft insider information was much easier to get before the 1990s or so.)

  7. Avatar for Zenzei Zenzei says:

    Can I suggest a different avenue of inquisition to arrive at an understanding of how the Water may be changing?

    Personally, I am very interested in the idea that the game is not shifting between “active” and “passive” but between content and system. In other words, that what is happening is not really about the content in the system (the securities themselves) and strategies on how to play them, but about structural changes to the system itself; changes that are redefining the game.

    For example, Bogle argues that above a certain level of indexing the system equilibrium breaks down. I’ve seen estimates that it happens around 80% active. We are currently around 40% or so which suggests we are halfway there. If this view is correct, at what point in the run from 0-80% does the disequilibrium start to make itself felt? Is it linear decay? Exponential decay? Etc?

    And more interestingly, if the disequilibrium in the system pushes the market into a one-sided NGU regime - I wonder what happens to “reversion to the mean”? And if that breaks down - what happens to most of our conventional financial theory?

    Anyway - hopefully this helps you think differently about markets in a constructive way. :slight_smile:

  8. Great book to read as an investor. Not being a polyanna here btw, just being a shrewd clear eyes full hearts guy.

  9. It appears the “common knowledge” regarding inflation, has also made it to the White House. In my opinion, really stupid to try and get in front of this number with a presidential speech.

  10. Avatar for bhunt bhunt says:

    LOL. Completely agree, @Carl_Richards . I guess the print tomorrow is REALLY bad!

  11. My bias is deflationary, convinced mostly by the work of Lacy Hunt (any relation?) and his focus on the long term secular trends that are still in place today. I admit this article has been challenging to that perspective. I can see the shift happening and how it is likely to stick. But have there not been plenty of missionary’s shouting inflation post GFC? Surely what Ben wrote 3 years ago proved to be wrong given the situation then. Or is it that the current supply change issues (real or not) is the catalyst which was missing?

  12. Avatar for jrs jrs says:

    Thanks, this makes sense. I got this from Green’s video as well and it reaffirmed my decision to spend some of my spoils on LEAPS protective puts on my index funds. Would like a cheaper option but I’m no Spitznagel of course.

    I wonder which book Bogle discusses this in and whether he has any solutions. Seems there are subtleties to his original ideas which were forgotten in the mass market.

    If Ben’s theory is correct, and if you are also correct that it’s unknowable what happens next, then buying and holding real assets seems just as likely to win (at least in the personal context of avoiding ruin) as picking stocks based on those real assets. Of course, it’s not necessarily either/or if one has the resources.

    What is “one-sided NGU regime”? My Google returned nongonococcal urethritis, which I agree would not make for a fun market.

  13. Avatar for Zenzei Zenzei says:

    NGU = Number Go Up - a bitcoin culture reference.

  14. image

    Question for the pack from a caveman.

    CPI printed today at 6.7%
    PPI and unit labor costs are closer to 9-10%

    Will this mean higher inflation going forward?
    Is the difference being hedonically adjusted away?
    Are corporations eating the difference and earnings will slow?

    :man_shrugging:t2:

  15. Lots of great questions. I don’t presume to have all the answers. Sometimes they aren’t apparent until right before. But you are looking in the right places, and that gives you at least a chance for first mover advantage.

    You could also own the means to barter for

    … Or to barter for it. Or serve those in such a position. My grandparents seemed to do relatively well owning a meat locker and a dairy in a small farming community. The grain elevator owner did really well until a Co-op started.

    Obviously whatever the opposite is. The opposite is not shorting. The opposite is whatever benefits from a relative shift in capital / investment to the smaller end, maybe even away from public markets. Maybe buying a local, small strip mall instead of a major REIT will work. Or what about investing in, or serving small local businesses?

  16. I think the CPI is massaged more than the PPI.
    Shadowstats analysis (former Fed economist John Williams is the founder) posts that when using the 1990 methodology the CPI would be over 10 % !
    When using the 1980 methodology, it would be 15% !!!

    Recall that since 1980 the BLS changed the methodology for calculating CPI 5 times.
    Each time it lowered the #. Shocking I know.

    So no inferences can be taken from the differences between PPI, Labor Costs and CPI

  17. Avatar for Pat_W Pat_W says:

    I find it most helpful to look at the inflation numbers for particular categories of goods. Inflation in meats is quite high. It is also higher in housing and health care. Those are the major expenses for most families so a CPI that gives weight to the cost of electronic devices, which tend to get cheaper, is already a bit off the rails for my needs.

  18. Avatar for Zenzei Zenzei says:

    What’s fascinating about all of this is that the first note that brought me to ET was:

    Worth a re-read, particularly Ben’s tirade about the BLS…

  19. Indeed, a prized classic. The original intro of Neb Tnuh is awesome:

    For Neb, hell is other people who want to talk about markets or politics. It’s not that Neb is so certain that he has the answer for what’s going on, for why his Twitter feed is a dumpster fire, for why the markets seem like a bad joke and why politics seem like “Black Mirror” re-runs. No, Neb is positive that he doesn’t have an answer, that he’s definitely not in on the joke."

  20. I would submit to The Pack the following data from the most recent CPI release at BLS.gov for your analysis and observations.

    These are the most recent 12-month and 1-month changes in CPI - summarized at the indent-4 level. Black bars are the headline. Red is higher and blue is lower. (I’m happy to share the files for your own slicing.)

    At the risk of not falling in line with the cool kids, this would appear that inflation woes are due in large part to rising fuel costs and not necessarily a monetary policy error, per se. From these data, it seems fuel, cars, and items where shipping costs are most impactful to price are where most of the inflation lie.

    I would wonder if inflation is more a result of OPEC and the oil companies rather than a monetary policy mistake.

    I cannot be the only one coming to this conclusion. It would explain Biden’s November release of the strategic petroleum reserve. Of course, policymakers could never tell us what they are really thinking - you can’t handle the truth!

    I sense that this isn’t a monetary policy issue. It’s probably more than just a fuel issue, too. Supply chain and China fit in there somewhere.

    This puzzle will work itself out and the answer will seem obvious, after the fact. Today, I don’t know that Jay Powell and the Eccles Building gang are where the blame lies.

  21. But I can’t help but think the Fed has a seat in the back room. As such, watching the Fed presser- having some background in the performance arts, I’m able to get some use.

    If I had enough interest, and had a bored intern, I would have them go back for the last year of pressers and analyze reporter questions, and which answers Powell read from a prepared statement. It’s frankly amazing to me that with virtual meetings that he reads from the podium instead of a teleprompter. That one, I’m not sure if it’s a bad performance, or they don’t really care.

    Either way, I’m intellectually curious which journalists are leading roles in the theater. Not sure that it’s important enough to take the time myself, mostly because I trust ET to give me plenty of prediction into changes by the play narrators.

  22. I don’t see anything the Fed did yesterday that will slow down the rate of Increase in Inflation.

    They will continue to print money to fund gov’t spending programs (until April)
    They will keep extreme Negative Real rates at least throughout 2023 (based on their dot plots)
    They remain concerned about upsetting financial markets

    Nothing that changes the “Inflation is Here” new Common Knowledge
    Inflation simply gets increasingly embedded via the wage/price spiral that Ben has noted

    The Fed seems to be betting on “Hope” that Inflation will diminish
    “Hope” is not much of a strategy, but it does defer their own psychological “Pain”

  23. The BLS numbers are conveniently insulated from a large majority of current inflation.

    From 2008 - present, markets have had “Certainty” knowing the Federal Reserve has had their back.

    From March 2020 to present, markets have had “guarantees” with zero interest rates and zero risk of business failure.

    Trying to parse whether it’s zero interest rate policy, the first $4 trillion of QE from 2008-2020 or the 2nd $4 trillion of QE from March 2020 to present is a policy error, well, seems, I don’t know… Is there even a debate?

    Now, we are entering a period of “Uncertainty”, because every choice in an inflationary world has consequences. Want to remove QE, raise rates? Growth slows. Want to maintain current policy that it’s “transitory”? Risk hyperinflation, growth slows.

    With high-yield debt everywhere, markets won’t wait for Powell to discern winners/losers, which is what’s happening today. I have no doubt the Federal Reserve can stop inflation, but there will be consequences.

  24. At the risk of an “OK Boomer” response, I see the Narratives stretched to near breaking points. Yet, the Wall Street machine trots out the backtest to keep the hope up that all of the plates will keep spinning. A set of forces underpinned what the Bank Credit Analyst calls the Debt Supercycle the past 40 years. In no particular order:

    1. Real interest rates dropped from double digits to negative over 40 years.
    2. Nominal rates fell further as inflation also ebbed from high single digits to sub 2% (CPI).
    3. Debt replaced equity in capital structures as it got cheaper and cheaper.
    4. Leverage increased as asset prices became the bulwark for credit rather than cash flow.
    5. Credit creation became global and financed by all manner of non-bank entities.
    6. Valuation multiples expanded due to the math of lower rates, entities stuffed with capital that must deploy it, and the eventual loss of safe income derived from the asset class of bonds.
    7. Demand was pulled forward due to wealth effects and the availability of credit.
    8. The system is fragile during credit stress as the recessionary periods create “bank runs” that wipe out levered capital and dry up the credit needed to keep the system growing.
    9. Central banks are tasked with both easing and trying to provide backstops when financial conditions tighten.

    And, here we are.

    Inflation is BAD. Not only because Central Bank toolkits are bereft of strategies to neutralize it other than things that tighten financial conditions (higher interest rates, less credit creation). Inflation is also unpredictable in the ways it impacts business costs, revenues, margins, and free cash flow. It also undermines confidence when consumer incomes fail to keep pace with it.

    Inflation is really bad if Central Banks lose control of the Narrative. If they do, numbers 1-7 listed above all head in reverse. #8 recurs. Instead of #9 riding to the rescue by easing - the inflation in the system keeps them sidelined and in many cases actively tightening.

    If Inflation truly becomes persistent over the next few years it will not be easy to find investments that win. The most recent US experience with high inflation featured 10% plus bond yields and single digit P/E multiples that made financial asset valuation more resilient to higher inflation. As a thought experiment, value a real estate portfolio at an 8% cap rate instead of a 4% cap rate. With the type of leverage typical in those portfolios there is no equity left.

  25. Tomorrow, Primo Missionary J Powell is scheduled to speak at his Nomination hearing to Congress. In the past decade or two risk markets have typically rallied into a Fed Chair’s public speaking engagements, confident in the assumption that they would have soothing dovish statements .

    Now that Common Knowledge about Inflation is beginning to change, it’ll be instructive as to how the market acts before his commentary. I’m old enough to remember the market absolutely trembling before Fed Chief’s public statements, back in the ancient times when the Fed was fighting instead of encouraging Inflation.

    It will also be instructive the phrase-ology Powell uses. I don’t think it possible to thread the needle anymore but who would have thought the word “transitory” (when they applied it to Inflation) would have been so powerful ?

  26. Given the dramatic rally yesterday pm and over night , I can guess that there remains the sense that Fed chairmen are still there to support risk markets

    If Ben & Rusty are right that the Missionary is carrying a different tune, I would think there will be disappointment with the Powell’s comments

    And if Powell does re-emphasize the need to stop Inflation, what are the odds that Chuck Schumer (or another politician) will be saying “Get back to work Mr. Chairman” ?

  27. 7% YOY out this morning. The last time inflation was here was in 1982. Compare where interest rates were in 1982.

  28. Avatar for 010101 010101 says:

    The United Nations Food and Agricultural Organisation food price index is 28.1% higher across 2021 than in 2020.

  29. Remarkable how much trust and complacency there is out there.

  30. I thought Powell’s testimony indicated he was going to stay Firmly BEHIND the curve.
    “If we see Inflation, we will then raise rates” he said.
    That doesn’t work when Inflation is embedded (like now)

    Curious what other members of the Pack think

  31. This chart from Jeffrey Gundlach’s market charts call yesterday. From Minack Advisors. Fiscal policy filled in the gaps - underpinning inflation. The future course of fiscal stimulus will say much about the rate of inflation ahead.

  32. Interest rates below inflation levels will allow Gov’ts to erode the value of their high levels of outstanding debt without having to resort to overtly punitive taxation. The bigger the difference, the quicker it will go. I expect the CB’s will be constantly testing the wind for levels of disaffection and adjust their soothing verbal output accordingly.

  33. Right, that’s the Ray Dalio prescription for fixing things.
    As we discussed, I think this is a highly unfair one, unfair to the majority of Americans that bear the biggest brunt of Inflation.

    I don’t even think it’ll work because as Inflation rages (and without the discredited OER calculation by BLS at over 10% today) it will tear the country apart politically. That “strategy” takes years to play out, no way the Middle Class sits idly by and accepts this latest gov’t policy prescription.

  34. Disposable income GREW $2 trillion above trend in '20 and another $3 trillion in '21 while in the private sector income is still below trend.

  35. It is unfair but so is shoveling more money out the door than is brought in through taxation.

    I’ve no idea how people will react. While the times are different than post WWII, human behavior hasn’t changed. The “money illusion” is pretty powerful.

  36. Long existing commodity producers (especially food & energy). The lack of reinvestment in those sectors is a set up for violent repricing.

  37. I see the headline from Reuters declares without any evidence that inflation is close to peaking…I guess they haven’t spent much time looking at how rents lag housing prices.

  38. I can fix it ——for rents change the formula to just include NYC rent control units.

    image

  39. Tippy Top Analysts in the Eccles Building. Forecast Summary from Dec '20 attached. Since the print is small, Core PCE for 2021 was expected to be a range of 1.7-1.8%, this was a substantial uptick from the 1.6-1.8% in the prior forecast. November of '21 actual was 4.7%, December drops on 1/28

  40. This came out right around the time I was on a Zoom with one of our company’s PMs. It was him, me, and two other people in my office, so it was an intimate conversation. Small group settings allow for a lot more detail to be discussed. When I asked him how they were positioning their various long equity portfolios to account for inflation he assured me that the Fed’s target of 2% was not going to be “meaningfully overshot”. This is not a dumb guy who just lucked into his job. How in the world did he get it so wrong? How is it possible that a dumbass like me (and a ton of very sharp people in the Pack) saw this coming but the super smart guys who manage billions and the Fed officials who literally do this for a living missed it? Hell, even forecasting 1.8% and having it print at 2.1% wouldn’t have been that embarrassing. But to miss by so much is just…I genuinely don’t get how that’s possible.

  41. My guess is that the more people’s time is tied up with work, the less time they have for actual thinking and the more their thoughts are the product of whatever echo chamber they live in. That said, I’m very interested to hear what others on here who are closer to this think about this question.

  42. Many factors but I keep coming back to FISCAL POLICY. The Fed couldn’t, or at least didn’t, pencil in any of the Trump or Biden fiscal packages in the forecasts. When $3 trillion deficits in back to back years show up and the Fed balance sheet picks up the tab to hold the debt issued, Voila! Trillions in everyone’s pockets with service spending potential crimped due to Covid.

  43. How did PMs and the Fed miss it so badly ?

    1. They Rationalized, they wanted Inflation to not be a problem because that makes life so much harder for them.
    2. Fed economists are almost all trained in Neo-Keynesian/Monetary activist school.
      Academia doesn’t teach Austrian, doesn’t teach Friedman/Money Supply, doesn’t teach Classical economics.
    3. And Powell is a Lawyer, he counted on the economists to tell him what to do.
  44. Powell was very much aware of the economic law , I remember him distinctly saying that we needed to unlearn it. Last Feb —I was on a plane heading home from Pinehurst and I had my “ this time it’s different” moment I was watching his testimony for the Senate and was responding to a question from Kennedy (La).

    The hubris of that exchange was truly frightening.

  45. Avatar for 010101 010101 says:

    They look at a nation. It is their habit. Their philosophy is one of the many, not of themselves. They see a garden that is alive, vigorous, vibrant and burnished with the righteous fire that is America. They are ultimately correct. It is the power of this gospel, to convert a wayward public, to shepherd the US back into the fold. While He is in the chair He is the light of the world.

    Let’s face it, interest rates ain’t the flaming sword that guards the gates of Paradise
    (AKA cheap goods for the many and rising asset prices).

  46. That is Nobel class contortionism. Speechless.

  47. I don’t think Powell “missed it”, firmly believe he knew exactly what was coming, they were trying to buy time with “transitory”. The narrative now, and you could hear it in Powell’s testimony yesterday, this economy is plenty healthy enough to withstand rate hikes. Here is the money quote:

    Then there’s Bullard, with the narrative that rate hikes sooner will be more effective than later. Pretty hilarious when you think they could have at least started in 2021, but now he makes the statement.
    Screenshot 2022-01-12 220918

    I keep saying to myself “observe, don’t predict” , but sure feels like air is coming out of the balloon.

  48. Avatar for 010101 010101 says:


    Interest rate hikes did NOT strongly correlate with a reduction in aggregate broad money.
    This chart says the legend of Volker was narrative control.

    ‘Prices, thou shalt reduce’ sort of thing but without Charlton Heston.

  49. Most people are worker bees. Most are not curious. We all have our swimming lanes, but few are curious enough to take the time and learn outside of those lanes. Less so without an immediate financial incentive. What has worked before gets replayed over and over.
    I suggest the following: https://www.epsilontheory.com/too-clever-by-half/ I am positive that most of us here are coyotes.

  50. That observe don’t predict thing is just so damn difficult.

  51. That observe don’t predict thing is insanely difficult for this Y chromosome. It is my “alpha move”. It is my “bang my head against the wall and wonder why I have a headache”. And I still have those days. It’s worked miracles for my poker game, work in progress in trading. #ItsTheHandsYouDontPlay

  52. When do Fed officials ( and Wall Street economists) stop claiming that Inflation is a supply chain thing caused by COVID and will correct itself ( and bring Inflation down) over the 2nd Half of the year?

    Note, the Fed is still, today , going to print even more money to buy treasury bonds and MBS.

  53. Don’t hold your breath! They are bankers, supporting other bankers who always hew to an outlook that it is always a good time to invest. So, the forecasts have to support the story that the outlook is cheery. The only time it isn’t a good time to invest is when credit seizes up, stocks crash, and that forecast was so obviously wrong as to get them laughed out of the meeting. Then, they finally urge caution when investors should be going all in amongst the margin calls.

    BTW, every talking head was trying out the “Inflation is Peaking” narrative after the CPI print. Bullard squashed that and sent the 2 year screaming higher.

  54. “Where have you gone, Paul Volcker, our Nation turns it’s lonely eyes to you?
    Whoo, whoo, whoo”

    Shoot, I’ll take a half decent Missionary comment or two at this point

  55. Avatar for robh robh says:

    Today’s “Statement by President Biden on January Consumer Price Index Report” is pure gold.

    My two top economic priorities have been to create a growing economy with more good-paying jobs, and to lower the prices Americans have faced from the global problem of inflation related to the pandemic. We have seen historic success on the first priority, with the greatest year of job growth in history, Americans finding better jobs, better wages, and better benefits, along with the fastest economic growth in decades. On higher prices, we have been using every tool at our disposal

    While today’s report is elevated, forecasters continue to project inflation easing substantially by the end of 2022.

    And fortunately we saw positive real wage growth last month

    We separately saw good news with new unemployment claims continuing to decline. That’s a sign of the real progress we’ve made in getting Americans back to work over the last year.

    My administration will continue to be all hands on deck to win this fight.

    So they want to take a victory lap over full employment and significant wage growth, while simultaneously claiming to be doing everything they can to Whip Inflation Now while trying to pass some version of the highly deflationary** Build Back Better bill.

    ** Four out of five Nobel prize winning economists who write for the New York Times recommend Build Back Better to Whip Inflation.

  56. I don’t think that Missionary thing is working out too well for Biden

  57. What did your other long equity PM say? You know the one who, over the past decade, regularly expected increasing inflation with every new QE round followed by increasing interest rates. The one that tilted the portfolio towards energy, natural resources, consumer staples, value and away from growth for 10+ years. What did they say about inflation?

    Obviously @Desperate_Yuppie I know you get my snark. But maybe that’s how that PM missed it. The very reason for any excess alpha over the past decade might be the explanation for negative alpha going forward. Something to consider with choosing active equity managers.

  58. “You know the one who, over the past decade, regularly expected increasing inflation with every new QE round followed by increasing interest rates. The one that tilted the portfolio towards energy, natural resources, consumer staples, value and away from growth for 10+ years. What did they say about inflation?”

    I was one of those PMs, eventually sounding like a stuck record. Got tired of “being wrong for tooooo long” (amongst other things) so I retired. Hilariously, as soon as I retired the print started showing inflation.

  59. I love this answer so much, Aaron.

    There’s a gentleman on Twitter named Michael Kao (@UrbanKaoboy) who has dubbed the bigtime alpha managers of the last few years as the guys who hit the Liquidity Lottery. The Fed gave them an environment where it was almost impossible to lose money and they think they’re all geniuses because of it.

  60. “Liquidity lottery”. Beautiful, wish I thought of that!

  61. We missed the mark but to fix it we’re only going to do a 0.25% hike because there’s a war going on and we might get a recession from that so we are going to be proactive.
    UGH
    If I’m the Republican’s, I’m not voting for Powell (still chair pro tempore) and instead push to nominate “4 hikes by July” St. Louis Fed President James Bullard. They can crow about doing something about rates and inflation if the hikes work or crow about how Biden brought about recession if they sink the economy. Meanwhile, the Dems can complain about the Republicans only supporting another cis-white male to Fed chair while also trying to claim credit for doused inflation if the hikes work.

  62. Ok so I guess add a fifth step which is “Inflation is real but you shouldn’t care because things were good for a while before they got bad”. Seriously, these people can all kick rocks.

    https://www.bloomberg.com/opinion/articles/2022-06-22/inflation-ate-your-free-lunch-but-you-re-still-better-off?srnd=premium&sref=5dE0gZJ9

  63. Inflation is real , but hey look at much technology has advanced over the last 50 years.

  64. Avatar for bhunt bhunt says:

    It’s war or Weimar. Sorry, I don’t make the rules.

  65. As oversimplified as that article is, it does make the point that the epic misallocation of capital ushered in during the NIRP/ZIRP era of 2009-2021 did come with lower inflation. Investors chased business models that lost money to grow, relied heavily on minimum wage and even lower labor costs (those Uber drivers were not earning a real wage adjusted for the costs of fuel, insurance, and vehicle depreciation). and produced prices that incumbent businesses could not match without losing money. All of that was a deflationary illusion. Add in offshoring of jobs to geographies with lower standards of living and less concern for the environmental risks emanating from growth. These trends went on for so long that they were misconstrued as being sustainable. In the process, the reinvestment needed in the actual industries needed to grow with productivity lessened. Instead, hundreds of billions in capex was squandered on share buybacks that we will look back on in scorn in a deleveraging future. Successive administrations celebrated the anemic job growth this unhealthy mix produced and crossed their fingers it could somehow continue.

    This inflation is real. But, the tools the Fed brags about having to stop it are blunt and can’t fix the imbalances in transportation, food, and energy that tighter financial conditions don’t solve. So, instead they will remove credit and in the process destroy wealth, raise the cost of living further via less affordable housing and higher rents, and discourage job creation. Pretty cool tool that is. The Fed chasing the inflation genie with multiple causes with rate hikes will slow the economy enough to lower inflation - multiple prior Fed hiking cycles show this. But, the collateral damage will be lower stock, bond, housing and PE prices; along with higher costs to add the capacity needed in key industries that need investment to sustain growth. Add in that it doesn’t touch the supply chain, intellectual property, or national security issues of remaking global trade. How bad it gets depends on how much and for how long the tightening inverts the yield curve in an attempt to slay inflation. The bond market is already making a strong case that the 10 year will find flows related to risk-off the more the Fed flexes its politically necessary mission.

  66. All of that is true. But also…all of that was plain to see at the time and was discussed extensively. So why didn’t anyone who had something to lose by speaking up bother to speak up? I don’t recall seeing any of the hot VCs or money managers waving a torch yelling about what those conditions were going to lead to. None of the very important people who actually run the world–Larry Fink et al–were ringing alarm bells about how this will lead to worse living conditions in just a few short years. Either very smart people didn’t know better or they knew and just kept their mouths shut because nobody wanted to end the party. That leaves me with the belief that these folks are either stupid or they’re cowards. Perhaps that’s a lesson we can tuck away and save for the next bull cycle?

  67. Ben has spilled lots of digital ink describing these folks. I like your adjectives. There is also Ben’s raccoon. The online Thesaurus generates plenty of other colorful options like scalawag, scoundrel, reprobate, charlatan, swindler, miscreant, fraudster… the list is endless. There was a note that I cannot pull from memory about needing the eggs.

  68. I vote that they are Cowards

  69. Avatar for O.P.A O.P.A says:

    Ben has written surprisingly many articles about eggs. Was it perhaps: But We Need the Eggs - Epsilon Theory

  70. We all knew that this was not going to end well , but none of us knew how long the party would go on months ,years , maybe decades. It may not even be over yet! The FED may well still be increasing the balance sheet – I cant wait to see the action last week,

    The key will be what happens when it really does start to unravel , will the FED come in and rescue the system with an even bigger version of QE? One thing is for sure the longer it goes on the bigger the explosion at the end. The FED is also now losing money on its massive bond holdings , if rates move much higher they will also be losing money from operations. This is unchartered water, and
    I cant believe how cheap gold and silver remains.

  71. Avatar for Pat_W Pat_W says:

    The people on the Federal Reserve Board are folks whom we wish to think of as smart experts have taught economics at universities, done research, and/or worked in the government bureaucracy, Two have some limited experience in banking- Miki Bowman worked in her family"s small bank ($181 million, lol) for 7 years before becoming the Kansas Banking Commissioner. There is little to no experience in the free enterprise system unless you count “advising corporate clients on strategic challenges”.

    I am unimpressed.

  72. Avatar for AlexK AlexK says:

    I agree with jpclegg63 and Desperate-Yuppy but I feel they did not go far enough.

    Think outside the box of your experience, education, lifestyle etc.

    If “they” were cowards they would have left the field of play or been “disposed of”. If they were stupid they would not be there. Stupid people quickly get exposed.

    These people are still there (or the system is) so I would say it is a “mafia”, a “political mafia”. They know how to play the system and swindle the money for their purposes - after all, everything is money. Only one person can be president at a time, only one attorney general etc so position/status cannot be the ultimate “attractor”.

    The old brutal, aggressive, punky Mafia was there for all to see and at the time the whole world and the system accepted them. They actually had a well-known “in your face” code of honour! Eventually, they were dealt with to the point where they are usually below the radar.

    But the “political mafia”? Well, they are showing all the qualities of violence, self-preservation, illegality, money-grabbing etc without any code of honour! They couldn’t give a flying fig for “the people”.

    The worst part is that the above description applies to EVERY government and political class in the world right now! No exceptions. Left/right, West/East, Wealthy/Developing nations. It’s as if they have all got together and agreed on how to “screw the people”.

    All you have to do is stand “way” back and look at what is actually being done and the results.

    Ben often talks about these topics in his intelligent, well-spoken way. My thinking is way more basic than that. Just look at the world around you as it is. Are we thinking “they” will do the right thing “for the people”? Ineptitude doesn’t get close to explaining where we are. Surely, not every single person in the world’s politico-economic sphere is useless?

    Sometimes I feel we are trying to make excuses for “them” because our worldview is driven by a sense of fair play, hard work, ethical behaviour etc. “They” are not wired that way so let’s start saying it like it is.

    Well, that’s how my Friday is going - how is yours?

  73. More Obfuscation to wade through from our Wall Street friends. I went to check on the Atlanta Fed estimate of GDP after Q1 was revised to an even greater negative number this morning - (1.6%). And the revision lower was worse than the headline with inventory adding and consumption detracting. Here is the Atlanta Fed estimate evolving as the data drops during the quarter.

    Two main points Wall Street is still forecasting >3.0% GDP in Q2 when the stats that feed into the number are spitting out barely positive numbers for all of June. Second, the Earnings in the P/E Wall St touts are derived from this GDP estimate! So, consensus 2022 S&P EPS have not declined as the market has entered a bear market. With Reg FD, analysts are waiting to be guided by management in the upcoming Q2 reports/Q3 guidance. So, treat the $229 2022E with a huge dose of caution. EPS estimates are wrong at inflection points.

  74. One more “in the weeds” number in that revised Q1 GDP number that prompted posting this in the Inflation thread. Check out from Consumer Metrics what the Q1 GDP would have been if it was deflated by the actual CPI in Q1:

    For this estimate the BEA assumed an effective annualized deflator of 8.26%. During the same quarter the inflation recorded by the Bureau of Labor Statistics (BLS) in their CPI-U index was considerably higher at a recently unprecedented 11.27% rate. Under estimating inflation results in optimistic growth rates, and if the BEA’s nominal data was deflated using CPI-U inflation information the headline growth number would have been dramatically lower at -4.72%.

    We have to adjust our sense of reality to the inflation we are living through. Most of the nominal economic statistics we are seeing are hugely flattered by inflation. The real figures adjusted for inflation would show emerging contraction across many variables.

  75. A brief update to this chart from the Atlanta Fed GDP tracker:

    The forecasts are starting to fall, in conjunction with the data. And, the reaction in bonds, with the 2 year crashing back under 2.85% from the June peak of 3.45%, says unequivocal recession. It’s not that we won’t have inflation. The market is pricing an economic winter to go with the one in crypto if the Fed adheres to its forecast to push Fed funds north of 3.5%.

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