We’ve been working through the trading doldrums here the first two weeks of August. In the U.S., we aren’t exactly like the French, who take off the month of August, though even in hot markets like the late 1990s, it was clear that many were on break. And while difficult to back up with actual data, it does seem that a long-term trend has developed toward less and less decision-making in late summer. So what better time than now to grab a cold iced tea and talk policy?
One thing that must be weighing on investors is the upcoming national elections. It’s three months away and despite daily updates from the pollsters, we think it far too early to place any large bets on the outcome. Many of the intended policies described by the two major party candidates stand in direct opposition to each other. Trade, tax policy, spending, and so on. This leaves long-term decisions about asset allocation and specific investment tactics without key inputs for evaluation.
Still, the equity markets continue to drift slowly upward. The S&P’s total return with dividends stands at +8.14% as of August 17.1 Commodity prices are generally higher, with some significantly higher than earlier in the year. Higher commodity prices, of course, are part of the inflation definition. Despite this, the release by the Bureau of Labor Statistics shows no change in prices in July and only a 0.8% total increase in prices over the past 12 months.
Inflation is one of the key indicators used by the Federal Reserve Open Market Committee to decide when and by how much to raise rates. In contrast to the above figures, some Fed members (per Fed minutes released on August 17) have suggested that the inflation target of 2% is nearly reached and that the rest of the economy is recovering strongly. Thus, they would vote for a rate increase in September, or surely by December. Others on the committee were less convinced. We’ll have to wait and see.
Are Current Monetary Policies Backward?
We are on record multiple times saying that the market does a much better job of setting rates than a committee of twelve—or the “fatal conceit” as coined by some economists. We are also on record noting that Japan has been using various forms of quantitative easing and zero interest rate policies for over 20 years without success.
Also, and as we discussed last month, state money is not a large enough proportion of total money to make the inflation water flow up hill. Bank money has actually declined over the past eight years, leaving monetarists to remind us all that inflation “is always and everywhere a monetary phenomenon.” Not much growth in money, therefore not much inflation.
But maybe we have it all backwards.
Recently, we read with interest an article from the Federal Reserve Bank of Saint Louis.2 In the article, they wrote about the work of Irving Fisher, an early 20th century economist. Among his many theories, the one that struck us most strongly was his position that low rates create low inflation. This, of course, flies in the face of current thinking, as we generally expect that a global zero or negative rate environment will increase inflation.
In short, neo-Fisherites suggest that instead of holding rates low worldwide, central banks should instead raise target rates. By doing so, and perhaps even significantly, this would lay the foundation for higher inflation.
In economics, however, it’s nearly impossible to test such a theory without removing the old and replacing it with the new. No double blind test in the marketplace. And I don’t expect to see the Fed changing to accommodate this approach any time soon, but I am encouraged to see new ideas come out of the organization. So, for now, I’ll stick with the market, but if given a policy choice, I’m voting for Fisher.
The Bottom Line, For Now
Under current policies, we feel that rates, inflation, and growth are likely to remain low for much longer than any of us can imagine. We aren’t doing the math just yet on what might result post-election. For now, we’ll simply continue to observe the proposals and handicap the potential options.