Inflation continues to soar and the Fed continues to reinforce their agenda. Can the Fed effectively curb inflation? It’s not a question anyone can answer easily. We have historical precedence from the Volcker era but, the net result is certainly not comforting.
Was Paul Volcker a hero or a villain?
Depends on who you ask. According to many, he did what was necessary to curb inflation. And Jay Powell is known to be a big fan of Mr. Volcker. He even mentioned him in the Jackson Hole speech but, is he going to emulate his so-called idol?
Well, in a nutshell he broke the back of inflation by increasing rates to sky-high levels. This was the time of the late-70’s, early 80’s when the US suffered a wage-price spiral and inflation soared to over 14% at its peak.
The Fed had already started to increase rates and by 1981, the Fed rate had increased close to a whopping 20%. Inflation started to drop hitting 4% in late 1982. By the time he left office in Aug 1987, inflation was down to 3.4%. Sounds like a hero, right?
Not exactly.
The result of raising rates drastically was also breaking the US economy. And this is where he was deemed one of the worst villains in recent US history. Unemployed soared to 10.8% by 1982, the highest since the Great Depression and the US went into a deep recession. In fact, it was a double-dip recession.
[A double-dip recession occurs when an economy sees two periods of contraction, separated by a brief period of expansion.]
Volcker had a lot to say about inflation, for obvious reasons. And one interesting thing he said was around inflation psychology. When inflation starts to get embedded in people’s psychology, we’ve lost the first battle. Consumer’s start to anticipate future price increases and start spending sooner to beat inflation.
What does this do? This further increases prices and wages don’t keep up so people want cost of living adjustments. Higher wages means higher costs and higher prices. It’s a vicious spiral.
But, here’s the kicker. The most conducive environment for a wage-price spiral…. is full employment. Or rather, what we have now -when unemployment rates are very low. From a previous newsletter of mine:
It also presents a further economic conundrum. When unemployment is low, i.e., if the economy is near full employment, it creates a wage-price spiral. In theory, employees have the bargaining power to demand higher wages as there aren’t enough workers in the economy to fill vacancies. This in turn, can drive up costs and result in further inflation. It’s a vicious cycle and indeed a very plausible one, with the labor force participation rate still remaining low at 62.1%.
So what got me thinking about Volcker, inflation and the wage-price spiral?
This interesting indicator from Credit Suisse that I came across this morning. According to this, when the NAHB index falls, initial jobless claims start to rise sharply (with a 12-month lag). The NAHB started to meaningfully rollover towards the last quarter of 2021. If this is correct, we’re going to start to see a meaningful increase in jobless claims.
Add to that, news from around the market about pay increases. This is not just hardship allowance or temporary adjustments. These are actual wage increases. And if you don’t see that being done, then you see workers going on strike or threatening to do so. In the past week, we’ve seen
the threat of railroad workers going on strike
nurses organize one of the biggest strikes in the US
Amazon raising wages
the California FAST act which will implement higher minimum wages for quick service restaurant employees
Then, I looked up the Fed Wage Tracker - something I haven’t looked at in a some time. Here’s what I found:
The wage growth for both part-time and full-time has increased to the highest level since 1998. The story is the same whether you look at weekly or hourly pay.
And, people leaving employment to join new places are getting paid even more, which simply means that the cost to the employer continues to increase.
Truth be told, a wage-spiral has probably already started and this is the one thing that the Fed wanted to avoid. Unfortunately, the Fed, as with inflation, didn’t acknowledge this and the labor market being “strong” has been the party line this whole time.
We’re about to see things change. I don’t know if we see unemployment reach over 10% as it did in Volcker’s time but, it’s certainly going to increase. The US is already in a recession and rising unemployment will push it further into a recession. The Fed has no choice but to induce this recession. There is no soft landing in my opinion and the unemployment rate may just reach 6-7% before the Fed decides to reverse course.