The latest CPI numbers came out for February 2021. The CPI for last month came in at 0.4%.  The more stable median CPI came in at 0.2%.

While 0.4% is a bit higher than typical for the last decade or so, it does not correlate well with the unprecedented rise in the Federal Reserve’s balance sheet. That is now over $7.5 trillion.

The U.S. stock market is at or near all-time highs.  The Dow has been hitting new highs, while the Nasdaq has retreated a little from its recent peak just above 14,000.

The boom in stocks seems heavily reliant on the Fed’s easy money and low interest rate policy. But if monetary inflation is giving us a stock bubble, then why isn’t consumer price inflation also exploding upwards?

There is no question that much of the newly created money is being used to bid up asset prices. This includes stocks, real estate, and even crypto currencies.  This does not get accounted for much in the CPI numbers.  Real estate will factor in a little, as one would expect rents to also go up.

I believe the CPI numbers are likely understated, but they are useful for looking at trends. I don’t think consumer prices in general are going up 10% or more as some have claimed, but it is probably higher than 2%.

If this all seems unsustainable, that’s because it is.  I think we are going to see a massive fall in stock prices at some point, but it can take a long while for a bubble to finally pop.

I have heard some argue with me that stocks won’t dramatically fall because the Fed will always be there to back them up.  I can’t completely discount this argument, although I do point out that stocks fell hard for 6 months in 2008/ 2009 before starting to climb again.

At some point, it should be expected that something has to give.  If stocks are that reliant on monetary inflation, then monetary inflation has to continue in order to prop up stocks.  It will either lead to significantly rising consumer prices, or it won’t be enough to keep the stock bubble propped up.

Jerome Powell, chair of the Fed, said that we could see a pickup in price inflation this year. Stocks fell after he said this, although it didn’t last that long.  But Powell has also said numerous times that the Fed is going to remain accommodative.

If we get to a point where price inflation is increasing and the Fed is forced to slow down its monetary inflation, then this could crash stocks.  Even if Powell announced that the Fed would reduce its asset purchases from $120 billion per month to $100 billion per month, we would likely see a market frenzy.

Of course, it will take more than 2% price inflation for this to happen.  The Fed changed its inflation target from 2% to averaging 2%.  So if we go to 3%, then it will be ok with Powell because it will be averaging out to 2% since inflation was below 2% previously according to its metrics.

Which Comes First?

Here is the big question.  What comes first? Will we see a significant pickup in price inflation, which then forces the Fed to tighten?  After the Fed tightens, (or in expectation of it), we would likely see a recession or depression of some sort.

Or will we see a major stock market crash and weakening economy (according to GDP statistics) that will lead to the Fed creating even more ridiculous amounts of money? This will likely lead to higher price inflation down the road, although this could take longer to happen.

Let’s put this in some numbers.  Which is more likely to happen first, if at all?  Will we see the Nasdaq fall below the 10,000 mark, or will we see annual consumer price inflation hit 5%?

I really think it could go either way at this point.  Assuming the Fed stays on autopilot for now, I slightly lean towards the Nasdaq going below 10,000 first.

If this happens, it will only encourage the Fed to create even more money out of thin air, which could lead to even worse price inflation down the road.

The Fed has had it relatively easy since 2008.  The central bank, with the dollar still acting as the world’s reserve currency, has managed to create massive amounts of money out of thin air without getting massive price inflation.

It is still very harmful, as prices are higher than they otherwise would have been, and it has caused a major misallocation of resources.  But from the Fed’s point of view, they have gotten away with it so far.

There are limits to almost everything, and this is no exception.  Sure, the Fed can start printing up a trillion dollars a month, but we are going to see massive depreciation of the dollar.

It is important to prepare for these scenarios.  While I do believe there is going to be a crash in stocks, I have no idea when and for how long it will last.

There is much greater certainty that the Fed is going to continue with its reckless policies, and we are going to see our money buy less and less as time goes on.

Even though I tend to think we will see a major fall in stocks before we see high price inflation, I am still bullish on gold.