Dec. 14, 2021

The 2008 Cure For Inflation.

Many may have forgotten that fairly recently we faced a very similar bout of inflation.

It was just 13 years ago, in 2008. That inflation, as measured by the Producer Price Index soared to exactly the level it's at now: 6.6%.

A new President, Barak Obama was about to enter the White House. A President, incidentally, whose economic policies I consider to be essentially the same as his Vice President, the current occupant of the White House, Joe Biden.

The parallels between, 2007 the year before the crisis began, and today are remarkable. Like today, in the year before the Great Financial Crisis, real estate was roaring. With the price of the average home sky-rocking.

Financial assets were also performing well, with the Dow Jones Industrial Average cruising along in the 14,000 area. Then near all-time highs.

Now the key to understanding the economy of 2007, Just like the key to understanding today's economy, is that both are economies that are built on a literal mountain of debt. It is financial leverage that has built the tremendous asset appreciation that we've seen both back then and right now.

We tend to look at asset appreciation, the value of our house rising, or our portfolio as proof positive, that all is well. The economy must be performing well, after all my stocks are up, as is the price of my house.

And while appreciation certainly is a good thing. Excessive appreciation can show the excess returns due to leverage. Appreciation beyond what can be expected from core economic growth.

Sitting quietly in the corner, hardly noticed back then, was the purveyor of all of this financial leverage. The ultimate provider of easy money, and readily available loans, was none other than our own central banker: The Federal Reserve.

It was the Fed, after all, which open the monetary spigots. Providing the cash that banks would lend to future home buyers.

In the case of 2007, it turned out that many of those buyers would become unable to make the monthly payment on those home loans and mortgages. And that's how it all began to unravel.

By 2008 it became apparent that Main Street was in trouble. Homes had been purchased by buyers, who in ordinary times would not have qualified for those mortgages. The so-called sub-prime crisis had begun.

But Main Street wasn't alone in its over-leverage. Hedge funds, then all the rage on Wall Street were beginning to feel the squeeze, as the markets were not climbing fast enough to provide the funds needed for Hedge Funds to meet interest payments.

Sound like Evergrande yet? And yes, this leverage problem is a global issue right now?

Back in 2007, we saw two of Bear Stern's Hedge Funds fail. As they could not meet their own payments.

And so the ball began rolling downhill.

Inflation was about to come to a sudden, dramatic halt.

But not, I'm sure, how the Fed expected.

We hit the final straw. The one that broke the camel's back. And it all began to crash. The stock market crashed, home prices came back to earth with a resounding thud. And many financial institutions across the country, including some of the major banks, were on the verge of going out of business.

Interestingly, inflation, as measured by the Producer Price Index also came down with a might plop. Going from where we are now 6.6% to a MINUS 11.2% in that Fourth Quarter of 2008.

Now the good news, back in 2008 was that the Fed had several tools at its disposal. Tools that would help it provide the stimulus to get us out of this now deflationary spiral of late 2008.

First, they could lower interest rates. Back then the Fed Funds rate was over 5%. Lowering that rate would help stimulate the economy.

Second, the Fed's balance sheet was relatively low. At least as compared to today. And the Fed would use its own available credit to purchase treasury bonds. The so-called Quantitative Easing. The same QE that's being unwound now.

All of that points to today's problems.

If, as it did back in 2007, the Producer Price Index, is pointing to excessive inflation.

And if we are facing a potential slowing, or worse in the economy, as this writer believes.

Then, we have to recognize that the Federal Reserve's two principal tools in fighting a recession: lower interest rates and Quantitative Easing are both currently off the table.

We've done that already. There's nothing left.

So, in a few minutes, we'll get the latest reading on the Producer Price Index. In 2007, this was one of the first signs of a slowing economy.