This was an attention-grabbing week, by which it appeared that fairness buyers lastly and abruptly acquired the message that prime inflation is dangerous for the market; growing rates of interest are dangerous for the market; declining bid/supply liquidity is dangerous for the market; excessive power costs are dangerous for the market; world geopolitical unrest is dangerous for the market; and a powerful greenback is (finally) dangerous for the market. The final two days within the inventory market was a remarkably regular and orderly melting. Will it proceed? Effectively, none of these tendencies I simply talked about look as if they’re about to vary considerably, so the one query is whether or not the extraordinary widespread delusion returns.
The proximate trigger for the selloff appears to have been the hawkish speak from Fed audio system, together with the floating of the trial balloon early within the week about the potential of a 75bp tightening. By the top of Friday, Cleveland Fed President Mester was actively pouring chilly water on the notion that something so aggressive was out of the query, whereas nonetheless speaking when it comes to 50bps increments.
I admit that as of just a few months in the past, I didn’t suppose the Fed would hike charges greater than about 75bps in whole earlier than they misplaced their nerve. Alternatively, they’re about 500bps behind the curve, so coloration me stunned…however not impressed.
To make sure, I additionally thought the inventory market would have reacted earlier than this level. And I do suppose that it’s simpler to speak about how a lot you’re going to work out this summer season till it will get scorching. So we’ll see.
However, on to my actual matter as we speak: the annoying canard that “high prices are the cure for high prices,” which is a phrase so absurd on its face that the dialogue actually shouldn’t go a lot additional than that. The phrase implies that we will’t have inflation as a result of if now we have inflation, then costs will come down. It’s one purpose that individuals are anticipating used automotive costs to drop by as a lot as they beforehand rose – as a result of “no one can afford a car at those prices!”
The concept is that as costs rise, the sum of money in your pocket can’t purchase as many issues. Due to this fact, actual demand should endure as a result of increased costs imply that folks should purchase much less stuff. Ergo, inflation causes recessions (which is bizarre, as a result of we’re at all times informed how expansions trigger inflation – which implies that expansions should trigger recessions. Are you feeling a ‘down the rabbit hole’ sensation but?).
That is one other instance of a stock-flow fallacy. Or perhaps it’s a fallacy of composition. It’s a micro/macro mistake. The purpose is that it doesn’t work that manner.
The system can’t run out of cash. If costs go up 25%, it doesn’t imply that you may purchase 20% much less stuff. Effectively, maybe you should purchase 20% much less stuff, as we speak, till you run out of cash. However the one that bought you the automotive now has 25% extra money than he would have beforehand, had he bought the identical automotive earlier than. Possibly you’re out of cash, however he has 25% extra money. The cash doesn’t depart the system if you purchase one thing. It solely leaves your pockets. (The inventory market works precisely the identical manner, and nobody ever questions why inventory costs can’t preserve going up as a result of buyers are utilizing up all of their cash, proper?).
Now, if the whole sum of money within the system is similar as we speak because it was earlier than the 25% improve in costs, and the rate of alternate doesn’t change, then sure – that 25% value improve gained’t stick as a result of in mixture we will likely be spending the identical sum of money at increased costs, which implies we take house fewer items and companies. If however the sum of money within the system went up by 25%, then whole expenditures (if velocity is roughly fixed) would be the identical in unit phrases as earlier than. The system doesn’t grind to a halt and drive costs decrease. The system reaches equilibrium at costs which can be 25% increased. By the identical token, if there’s 40% extra money within the system, then these 25% value will increase gained’t be sufficient, there will likely be shortages, and costs will preserve rising.
This looks like an excellent level to recall that M2 cash because the finish of 2019 has risen 42%. Inform me once more why Used Automotive costs have to retrace a lot?
The actual query, to me, is why extra costs haven’t gone up 42%. My reply is that we’re nonetheless within the adjustment interval. It takes time for that cash to clean across the system, and it’s nonetheless on the rinse cycle.