Prevailing economic theory is built upon three pillars: output, money and expectations. The people and groups that run economies want to increase economic output and strengthen their sovereign money against other currencies while managing expectations for the future to avoid economic downturns. There's not enough room in a column to dive into the gory details of all of these concepts, but let's zoom in on money, expectations and the entity responsible for those two in the U.S., the Federal Reserve, and tie it into recent inflation woes (and Bitcoin!).
The Fed has been given responsibility for monetary policy in the U.S. and aims to ensure "maximum employment, stable prices and moderate long-term interest rates." The Fed has three levers it can pull to achieve its goal: 1) open market operations (i.e. "print money"), 2) the discount rate (i.e. "interest rates") and 3) reserve requirements (i.e. "vault deposit rules"). Printing money (by buying bonds and "stuff") and changing interest rates (by changing the rate it charges banks to lend money overnight) are the main mechanisms we've seen the Fed employ in recent memory.
And, wow, does the Fed have its hands full right now.
"Stable prices'' is a goal for the Fed, and that has historically meant an arbitrary 2% target for inflation each year, meaning the Fed wants things to cost 2% more each year. Well, last week the consumer price index, a means to measure inflation, jumped to a four-decade high of 8.5% year-over-year in March. Basically, last year's $10 burrito is now $10.85. That is not a good thing. On top of that, year-over-year CPI metrics have exceeded 2% every month since March 2021. Inflation is clearly not transitory.
I'm not going to talk about how unprecedented money printing and near-zero interest rates might have led us here. Instead, I'm going to talk about what investors are doing to protect their portfolios.
In times of high inflation and economic uncertainty, investors go risk-off, and there's a "flight to quality." In practice, when sentiment flips risk-off, investors sell their risky tech stocks and buy something like bonds, or if they really fear inflation, something sound like gold.
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