🔔 The '22 Deflationary Bust

As you correctly said, no historical parallel is perfect. If you think of the 1970s we today live in a very different world. The structure of the labor market is massively different than what it used to be.

Our financial leverage addiction to asset prices is radically different to what it used to be.

If you think of technological innovation we really live in a world where technology is everything. When people say tech, I basically say, “what do you mean by tech?” Everything is tech.

The 70s and 60s were much more about inventiveness rather than, innovation.

We have very different demographics.

We have very different income and wealth inequalities which are closer to 1910s, 1920s Gilded age than they are are to the 1970s.

So there are no perfect parallels.

The way I prefer to look at it is to say there were three big shocks to the system.

One was in early 1920s. The other one was 1945-1948. And the third one was clearly the 1970s and what we're going through is just another one of those cycles, each one of those episodes have something to teach us.

And so to me, just looking at 1970s sort of ignoring the lessons of some of the prior periods, for example, clearly there was a massive spike of inflation around 1919, 1920, 1921.

That was the end of the Spanish Flu as well as the end of the Great War, WWI.

What you have then is a significant tightening of monetary &  fiscal policy occurred. And when that occurred in 1921, 1922, there was a massive deflationary bust.

CPI was negative more than 20% before it finally stabilized in 1923.

the Federal Reserve Bank of New York massively raised the discount rates as fiscal policy was brought back into under control

This episode was described by Milton Friedman, and many others. And the view was that if perhaps Federal Reserve of New York acted earlier rather than waiting for inflation to persist, maybe they wouldn't have had to tighten as much.

So there was, there is a debate clearly going on what you should have done, but the net outcome was more than 20% deflation in 1921, 1922

The unemployment rate is much lower (at 3.8%), and inflation is far above the Fed’s 2% target. To create sufficient economic slack to restrain inflation, the Fed will have to tighten enough to push the unemployment rate higher.

Which leads us to the key point: The Fed has never achieved a soft landing when it has had to push up unemployment significantly.

This is memorialized in the Sahm Rule, which holds that a recession is inevitable when the 3-month moving average of the unemployment rate increases by 0.5 percentage point or more.

Worse, full-blown recessions have always been accompanied by much larger increases: specifically, over the past 75 years, no less than 2 percentage points.

Yes, that's exactly what the yields are telling you. And when people say let's look at the short end or the long end that's incorrect.

You should always look at the long end because that's where businesses, the banks are expressing their view as to the trajectory of growth as to trajectory of inflation rates, what the equity rates they should have, you order to finance their balance sheets in order to carry on with their business.

You can also argue that the more we talk about the yield curve, the more the Federal Reserve will need to consider Operation Twist or in other words, some degree of yield curve control.

That's something that might be part of the discussion and debate as we go towards the end of 22.