Soaring Inflation Hits Every American While The FED Keeps On Printing Money

Fiat Currency and It’s Inextricable Link To Soaring Inflation

There’s a common saying on Wall Street that the U.S. Federal Reserve writes the market letter. True enough, the Fed’s policies have a big impact on financial markets. But when you look at what this really means, another adage springs to mind:

“Money Makes The World Go Round”

Or in this case, to modify it slightly, money makes the market go up. The Fed’s power to influence the stock market comes from its virtually unlimited ability to inject printed paper money (fiat currency) into the economy. When the Fed signals that it is easing up on the brakes and stepping on the gas, it’s manna for investors. Other forms of stimulus that put money into the economy have the same effect.

This has held true pretty much forever, even during crises and periods that you might think would not be so responsive to the effects of money, such as a pandemic.

Soaring Inflation Hits Every American While The FED Keeps On Printing Money

Inflation Zooms Historically During Times Of Massive Government Funding

Since the current COVID-19 pandemic isn’t over, history is still being written. We won’t know the actual economic statistics until after the fact. Instead, let’s take a look back more than 100 years ago. The Spanish flu pandemic started in 1918, and a much smaller U.S. was slammed with a virus far more deadly than COVID-19, claiming the lives of more than 650,000 Americans and infecting about one-third of the U.S. population.

Nonetheless, the economy grew at a red-hot level of about 9% in 1918 and after a brief recession in late 1918/early 1919 grew strongly through 1919. In that era the massive injections of money into the economy came from the federal government financing our troops fighting World War I. The extraordinary level of war funding was enough to keep the economy going for about a year after the war ended in August 1918.

But before you conclude that money always can solve any problem facing the economy, realize that there was a catch. Inflation zoomed to probably the highest levels in U.S. history, averaging 15% or so during the several years of massive government funding.

What Goes Up, Must Come Down

In 1920 the economy totally ran out of gas and contracted, according to some estimates, by about 20%. When the prop for soaring inflation and faster-than-capacity growth was removed, the virtuous circle elevating nominal growth became a vicious circle weighing on nominal growth.

By no means are we relying on the experience of more than a century ago to tell us what will happen in 2021. But it does add an interesting and useful historical perspective to our analysis of how we see events unfolding this time around.

The events of 1918 are just the clincher in that they show that massive stimulus can generate substantial growth even in the midst of a major pandemic. They also show that stocks can rise during a pandemic: During 1917-19, according to what are considered the most reliable sources, stocks produced annualized total returns of about 15%.

Strong Economic Growth Will Lead To Inflation

So what is the outlook in today’s world? I believe that even a new variant of the coronavirus will not stop growth as tons of money continue to flow into the economy. And if we really get lucky this time, and there was no such luck with the virus in 1918, the new vaccines will be able to help keep COVID-19 in check.

Second, I expect that strong economic growth will lead to soaring inflation. Supply chains have been compromised both by geopolitical events, including precautions related to the pandemic, and by a lack of capital investment over the past several years. That means that higher demand will translate into higher prices. Worth mentioning is that even in the gold industry, where capital spending has not been declining, production has plateaued because the high-grade ore already has been mined.

One difference between today and the 1910s is that today’s war isn’t a hot one. It’s a rapidly expanding cold war with China, a country that along with the rest of Asia has performed remarkably better than the U.S. and other Western countries in managing the pandemic. But it still points to the need for a lot of spending because we are in a fight to maintain our standing in the world. We have our work cut out for us.

When inflation accelerates, high-multiple growth stocks tend to lag while value stocks tend to shine. These high-P/E stocks, especially technology stocks, have led the stock market’s march to record highs as inflation has been low, but the winds appear to be changing. Adjust accordingly.