The Federal Open Market Committee (FOMC) released its latest monetary policy statement on March 17, 2021.  As expected, the Fed will keep its target rate near zero, while continuing to add at least $120 billion per month to its balance sheet.

The FOMC statement says, “Inflation continues to run below 2 percent.”  Apparently the Committee members do not buy gasoline for their cars, and they don’t shop at the same grocery store as I do.

The Fed continues to maintain that, “With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”

They never exactly say how they will calculate the average.  Does this mean averaging inflation over the last 20 years?  Does it mean the last 2 years?  It sort of makes a big difference.

In Jerome Powell’s press conference, he continued to preach the 2% inflation mark.  He also said, “Beyond these base effects, we could also see upward pressure on prices if spending rebounds quickly as the economy continues to reopen…”  He added, “However, these one-time increases in prices are likely to have only transient effects on inflation.  The median inflation projection of FOMC participants is 2.4 percent this year and declines to 2 percent next year before moving back up by the end of 2023.”

Ever since the Fed announced it would target 2% inflation as an average, I suspected that it is just an excuse to run price inflation above 2%, even according to the government’s own statistics.

Powell is saying that we should expect price inflation above 2% this year before falling back. But why would price inflation push higher and then drop back to 2% or below?  Does this mean he expects a recession?  Does it mean that the Fed will tighten as compared to what it’s doing now?

According to Fed officials, we should expect the target federal funds rate to remain near zero for at least a couple of more years.  Maybe the Fed will slow down its purchases of assets, but there are no signs of that yet.

Looking back at 2008 to 2014

From 2008 to 2014, there were three rounds of quantitative easing (QE).  There was QE1, QE2, and QE3.  The Fed would inflate its balance sheet like crazy, then stop, and then start again.  It basically got away with it.  Sure, we all pay the price with misallocated resources and prices higher than they otherwise would have been.  But from the Fed’s perspective, they got away with it because we didn’t have a recession for 11 years, and price inflation remained relatively tame.

And when there was a sharp economic drop in March 2020, it could all be blamed on the virus. Of course, it was really state and local governments to blame for shutting down businesses.

We can’t overlook though that we may have been in for rough times anyway.  In 2019, the yield curve inverted, which is a classic sign of a coming recession.  In September 2019, the Fed had to step in when the repo rate spiked up.

So the virus and all of the hysteria was a convenient excuse for the Fed to massively inflate starting in March 2020.  It was also a good excuse for Congress to run even higher deficits than they were already running.  And it is largely the Fed funding these deficits.

I don’t see how we get out of this pleasantly.  There has been a massive buildup of debt, which was already a major problem. The interest rates are low now, but what happens when they go higher?  What happens when price inflation goes higher?  Does the Fed really believe that it can keep creating trillions of dollars out of thin air while keeping rates low, price inflation low, and the economy humming along?

I don’t think the Fed will get away with what it did from 2008 to 2020.  I think the chickens will come home to roost.

We are in a nearly everything bubble.  I think precious metals is one of the few things that isn’t in a giant bubble.

Real estate is likely in a bubble, but there is some justification for this, and it may not be as bad as 2008.  Stocks are in a massive bubble.  Bonds are in a massive bubble.  Crypto currencies are a bubble.  And now we have NFTs, which may be even a bigger joke than cyrpto currencies.  I’m just waiting for tulip bulbs to be in high demand.

All of these asset bubbles (although it’s hard to call cryptos and NFTs “assets”) could blow at any time.  The Fed will try to prop them up, since it was the Fed that inflated them all.

But what happens if price inflation, by the government’s own measures, hits 5 percent?  What if it hits 10 percent?

At some point, the Fed is going to have to choose between the dollar and funding the bubbles and massive deficits.  If history is any guide, the Fed will choose the dollar, just as it did in the late 1970s and early 1980s.

While I put the chances of something resembling hyperinflation higher than I would have a year ago, I would still give it less than a 5% chance.  The more likely scenario is that the Fed pulls back and we experience a depression for the ages.

We really don’t know what is going to happen.  This is why I recommend something resembling the permanent portfolio.  However, I do think chances are good that the Fed will scale back eventually.

I don’t know what that breaking point will be.  I don’t think the Fed will purposely go to 10% annual price inflation.  It could still happen if it loses control quickly.  But if we go beyond 5% price inflation, I would expect to see the Fed pull back in some way.

The Fed has been able to pull off this trick for a while, so it seems that it can go on forever. But the debt and bubbles are unsustainable.  Something has to give at some point.