The Federal Reserve and USG Wrecked the Economy

I should have thrown more caution to the wind. I predicted the recesssion started in Q1, but I thought it would come from revisions, not on the first estimate.

BEA: Gross Domestic Product, First Quarter 2022 (Advance Estimate)

Real gross domestic product (GDP) decreased at an annual rate of 1.4 percent in the first quarter of 2022 (table 1), according to the "advance" estimate released by the Bureau of Economic Analysis.

Has the Recession Already Started?

As of April 5, 2022, the Atlanta Fed's model projects 0.9 percent GDP growth in Q1. Government economists don't have to be massively undercounting inflation for this to be a recession already. At an 8 percent CPI, it would only take a 12.5 percent error rate to wipe out all the growth. The nominal GDP climbs 9 percent and 8 percent of that is price increases, there is 1 percent real growth. If inflation is 9 percent, zero growth. If inflation is 10 percent, the real economy contracted 1 percent. I'm not making a call one way or another. I merely wish to point out that a small error wipes out small growth. That prices are experiencing volatility unseen in 50 years. That price, economic and geopolitical changes are happening faster than models can account for.

The BEA announcemnt shows this is exactly why the economy contracted:

Current‑dollar GDP increased 6.5 percent at an annual rate, or $379.9 billion, in the first quarter to a level of $24.38 trillion. In the fourth quarter, GDP increased 14.5 percent, or $800.5 billion (table 1 and table 3).

The price index for gross domestic purchases increased 7.8 percent in the first quarter, compared with an increase of 7.0 percent in the fourth quarter (table 4). The PCE price index increased 7.0 percent, compared with an increase of 6.4 percent. Excluding food and energy prices, the PCE price index increased 5.2 percent, compared with an increase of 5.0 percent.

Why is Inflation Bad?

Everyone focuses on prices during inflation, but prices under inflation are the least valuable. They are distorted by the inflation, but they do not capture the inflation properly. It's not like everything goes up in price by 5 percent. By creating price distortions in the economy, people chase after things rising faster in price. If food prices go up, what do they do? Hoard food. So the price goes up faster. Yet, there is actually no problem with the food supply. The move is a created by price distortions.

There are some real problems with food supplies, but the fact remains that inflation alone can cause food shortages. It destroys price signals that allow the trasmission of important economic information. This crisis is wholly the responsibility of the Federal Reserve, along with USG for both its spending and lockdown policies.

In The Price Illusion, I discussed Jeff Snider's work showing Japan's imports and exports are terrible once price is taken into account.

The stats out of Japan put a giant exclamation point on the price illusion caused by inflation. Exports rose 15 percent, imports 30 percent. Back out price effect and exports fell 2 percent, imports unchanged from a year ago. They're paying 30 percent more for the same volume of imports...now the tumbling yen makes perfect sense, right?

Way back in December, the odds of recession were high. All spikes in inflation produce recession, it's a 100-percent guaranteed signal: High CPI Screams Recession and Bear Market

Here's another similar chart, but with different variables: PPI minus CPI. Every spike like the one underway now (and this one is the biggest) produced a recession and major bear move in the stock market.

...People say the Fed is walking into a policy error. Their errors were already made when they pumped the market. The question, as always, is the one asked by Von Mises: will they voluntarily abandon the inflation or will they eventually destroy the currency system? Right now, the Federal Reserve is signaling voluntary abandonment. For however long that lasts, look out below. My expectation, my forecast, is that the Federal Reserve is going to wait longer than the bulls expect because it does not want to launch QE5 with the PPI still running hot. Whether that is in time or price, I cannot say. IF it takes longer, maybe crude at $50 is good enough for the Fed (an exmaple). If crude plummets to $40 by February, maybe they will reverse course much sooner. Either way, when Powell's "printer" is away, the bears will play.

Another important post was this one on the Restoration Hardware earnings call: Wall Street Ignores Margin Collapse Warning.

Here are profit margins with a regression line. Notice the surge following the pandemic. Inflation always looks like a boom at first. Corporations appear more profitable because inflation hits them first, in a good way. The first impact is rising demand. Every producer benefits because supply is constrained in the short-term.

Here is profit margin versus the S&P 500 Index:

The RH CEO tells us the benefit for the end stages of production is gone. Inflation is turning into a destroyer of value:

There's already evidence the recession may already be underway in the distribution stage.

ZH: Looming Freight Recession Sparks Plunge In Trucker Stocks, First Post-COVID Job-Losses

I didn't expect the recession would be visible yet, but it was. Most of Wall Street and economists, if they even predicted a recession, were saying much later this year or next year. I said Q1 2022. I was right.

Now you're going to hear calls for rate hikes or the Fed to slow down. Here's what you need to understand: the inflation caused the recession. If the Fed pauses, then lower your forecasts for the economy. The recession will get larger and deeper down the road. If the Fed instead signals this GDP report changes nothing (what they should do), then odds are a major recession could unfold. That would be a great buying opportunity in the markets. If instead the Fed does back off on their currency policy stance, markets could rally for a time, but as with the economy, the eventual low for stocks will be much lower than it would be if the Fed kills inflation now.