Last week an economist said something to the effect that inflation is cancer and higher interest rates are chemotherapy. Higher interest rates are not good, but inflation is much worse, and it must be kept under control. Inflation is a serious threat to any economy. And controlling it is under the purview of our government–it is, perhaps, one of the primary and most crucial roles of our government—to protect private property rights. The question arises, though, why do we have inflation?
Well, it’s not like we haven’t seen this movie before—and as a country, we have understood it very well. As long ago as 1970, Milton Friedman (1912 – 2006), an American Economist—a Nobel prize-winning economist no less said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Too much money, too little output. Or simply, too much money chasing too few goods.In the current episode, we have had two things going on; first, supply chains were stressed by C-19—you cannot send everyone home and expect productivity to stay the same, and secondly, we had a phenomenal increase in the country’s money supply or M2.[i] On January 31, 2020 (just before the situation), the M2 sat around $15.41 trillion. Then two different Presidents (Symphony of Destruction squared) flooded the country with newly created cash, and as of January 31, 2023, it stood at $21.27 Trillion! An increase of $5.86 Trillion. (It had been worse, last March 2022, it stood at $21.74 Trillion.)[ii]
This is unprecedented. It is not unusual for the amount of money to grow slightly more than output (usually about 2%), but almost 40% is not sustainable. Another Friedman quote comes to mind, “What is unstainable will not be sustained.”
The hyper-increased money (read, deflated money), compounded by reduced productivity, was like watering 106 Spring Ave’s winter pansies with a high-pressure firehose. It’s created quite a mess. How much is $5.86 Trillion? For every one of the 335,942,003[iii] human beings living in the USA, it is, on average, an extra $17,443! Not earned but given! And in 2020 and much of 2021, consumers had very little to spend it on—too much money chasing too few goods. It’s hard to hide an extra $5,860,000,000,000 sloshing around when the consumer discretionary shelves were empty.
It is easy to criticize Presidents DJT, JRB, and the Fed. The Fed, to be charitable, believed the C-19 supply chain problems were the real issue, causing “transitory inflation.” In fact, they were hopelessly behind the monetarily induced inflationary curve. And the two Presidents—let’s just say they were distracted. It is well known that virtually any event during a presidential election year raises the drama. Anything and everything gets super-politicized. For the record and posterity, we now know what happens when a pandemic hits in the middle of a 50.3% to 46.8% presidential race—and it was not pretty for the economy.
Now that we’re in it, how do we get out? Mr. Powell (the Fed) is using one of the few tools he has—raising interest rates. He hopes this will reduce frenzied buying of everything in sight, gradually reducing demand. (Remember, life & money always boils down to a supply-and-demand curve.) Higher interest rates encourage frugality. People pay down debt and borrow less. This activity slowly reduces the M2. And true enough, it has fallen since that March high of $21.74 trillion to $21.27 trillion. That doesn’t look like much, but hey, $470 Billion is still $470 billion. And this trend is our friend. The recent banking issues are also helping here—misallocated capital is drying up. Silly or non-productive start-ups will find cheap money hard to come by.
A reduced money supply will negatively affect the markets. Expenses are rising—from the cost of capital, wages, and energy to increased regulatory costs all at the same time, corporations and consumers are (hopefully) reducing spending. Rest assured, good, high-quality companies can handle this—there’s plenty of money sitting on corporate balance sheets right now. But companies carrying too much debt, weak productivity, or products that are luxuries rather than essentials; for those companies, this will be a difficult road ahead. Indeed, they already traveled a much pot-holed highway in 2022. They are no doubt hopeful they can get through these last few miles.
Even for well-run, productive, and essential companies, we know their earnings will not be what they were in 2021 and 2022. This will be reflected in their share prices—and this is the long-term investor’s opportunity. A chance to buy good things cheap! Or at least cheaper.
As investors, we must stay invested and continue buying positions when possible. I’ve put a lot of investments on dividend reinvesting (In the S&P 500, dividends increased by 11% in 2022), so we automatically buy new shares of our single stock positions at pretty reasonable prices. In our fixed-income funds, monthly coupon (interest) payments are rising as their portfolios gather higher interest-paying bonds. In many cases, we’re plowing those payments back into the funds at some reasonable prices.
I’ve been around long enough to know we will look back on this period and wish we bought more. Corporate America is getting mean and lean and will become even more profitable as a result. Like the loser years of 2002 (-22%) or 2008 (-37%), the following years were very good for the survivors.
Besides, short-term gyrations of the markets should not concern a patient, disciplined, goal-focused, long-term investor. But writing this to you is like asking my wife to “please calm down” during a heated discussion. (I can safely report that the “just relax” tactic doesn’t work either—I’ll leave it at that.) Of course, I know it is worrisome when we’re in the middle of these pull-backs—trust me, I have the sleepless nights to prove it—but we will get through this, again. We hit years like these about every 4.3 years; the S&P 500 still averages about 10%.[iv] And if we don’t have a bank or two failing every so often, they’re not doing their jobs of helping entrepreneurs.
Thanks for reading, Marty
[i] https://www.investopedia.com/terms/m/m2.asp
[ii] https://ycharts.com/indicators/us_m2_money_supply
[iii] 2020 US Census. Census.gov
[iv] https://fm.cnbc.com/applications/cnbc.com/resources/editorialfiles/2023/02/25/2022ar.pdf
