The Federal Reserve’s balance sheet has slowed down since its unprecedented rise from March to May 2020.  However, it is still rising, even if relatively slowly.

When you look back at the year 2020, there are a lot of incredible things to look at.  The hysteria over a virus is the most incredible thing, especially considering that the overall mortality in the U.S. for this year will not be all that different compared to previous years.

In regards to the reaction, I’m not sure what is more surprising – the fact that people so easily gave up their liberty to government, or the fact that many people have isolated themselves from friends and family.

It is still amazing what has happened in the last 9 months.  It is hard to believe that governors and mayors across the country were able to close down hundreds of thousands of private businesses just on their own word.

With all that has happened, it is easy to be distracted and not look at the many economic consequences.  For those who actually consider the economic costs of the shutdowns, we tend to focus on the unemployed and the many companies that have been put out of business, as well we should.

Still, even if all government lockdowns and restrictions ended tomorrow, we would feel the economic consequences for many years to come.

With all of the unprecedented things happening, it is easy to ignore the Fed’s balance sheet. It has now grown by over $3 trillion since the beginning of March.  We may be somewhat numb to it, given the massive expansion after the 2008 financial crisis, but it doesn’t mean it won’t significantly impact us.

While stocks started to crash in March and April, things reversed rather quickly after the Fed showed it would do whatever was necessary to bail out everyone.  We saw unemployment payments to people that exceeded the salary they had been previously earning, while most Americans received “stimulus” checks regardless of their employment situation.  The checks certainly did stimulate the stock market.

The Fed dropped its target federal funds rate to near zero, eliminated reserve requirements, and expanded its balance sheet by $3 trillion.  While that may be music to the ears of stock investors, it shouldn’t be music to the average middle class American who will eventually pay for all of this in the form of higher prices and a lower standard of living.

It’s quite amazing how bullish stock investors are.  Stocks were hitting all-time new highs when news was being announced of the possibility of effective vaccines.  I wouldn’t bet any money on these vaccines, as it could all go bad rather quickly if and when people start reporting bad side effects.  As with the government lockdowns, the vaccine cure is likely to be worse than the disease.

But even if these vaccines will provide the miracle cure to open up the economy again, these announcements of effective vaccines were coming at the same time that many cities and states were imposing stricter lockdowns.  So the stock bulls just shrug off the new lockdowns, but cheer the vaccine news.  The new lockdowns in places like California will put the final nail in the coffin of many small businesses, but that seems to be irrelevant to the bulls.

Price Inflation

Meanwhile, the latest numbers have come out for the Consumer Price Index (CPI).  The CPI rose 0.2% in November 2020, while the more stable median CPI came in at 0.1%.  The median CPI, year-over-year, is actually trending down a little.

I have to hand it to the Fed.  They have been able to get away with a lot without moving the overall price inflation numbers much.

The Fed’s massive monetary inflation is hurting us severely by allowing Congress to spend recklessly and by allowing a major misallocation of resources.  But since it isn’t showing up in the CPI, they are basically getting away with it.

One of the main problems with the CPI right now is that it doesn’t show us that necessities are tending to be more inflationary than more luxury items.  Governors and mayors determined what was essential, so it’s funny the Fed doesn’t discriminate on this basis as well.

If haircuts and pedicures are non-essential, then does it really matter if prices for these things have stayed flat or even gone down?  Prices may be really stable, or even down, for luxury services, for certain electronic items, and for rent in Manhattan.  But for most people, their basic necessities of food and medical care are going higher in price.  In most areas outside of some big cities, housing prices are also going up.

So while the CPI tells you that inflation is no problem, it seems to be a problem for many people when prices at the grocery store for some items are going up by 5% or 10% or more in the matter of months.

Since there is talk of more stimulus (bailouts) and almost no talk of worrying about deficits, we should expect the Fed to continue to expand its balance sheet in order to fund a good portion of the deficits.

It is hard to imagine that stocks can just keep going higher while the reported price inflation stays in check.  Something has to give. We are living in irrational times. The human race is completely irrational with regard to listening to the powers-that-be over a virus.  There also seems to be irrationality with regard to new stock market highs in the wake of economic devastation.

As Keynes said, the market can stay irrational longer than you can stay solvent.  So in that sense, it is hard to bet against the trend right now.

But there is a saying that when things can’t go on, they have a tendency to stop.  I don’t know what we’ll see first – a stock market crash or a spike in price inflation.  I am expecting one or the other.

In 2020, it would have been more profitable to invest in the Nasdaq than to invest in gold.  But past performance does not indicate future performance.  In these turbulent times, I’d rather stick with something more secure. When stocks eventually fall, I believe they will fall hard.