Cost of Capital. The Past, Present and Future? | Part 9

Back to the Future with Bidenflation

Modern Monetary Theory (MMT) is now dead, as Milton Friedman would have predicted.  Whether MMT was just a dumb idea or a Trojan Horse developed by progressives to actually create inflation is a topic for historians.  The energy policies of the US and Europe have also proved to be naïve in light of geopolitical realities.  The fallout is the inflation the Fed is trying to tame.

Policy Failures and Market Movements Driving Inflation

But the Fed’s job is made more difficult by the Administration’s various agenda priorities and actions taken to-date:

  • Energy Policy. Despite his protestations to the contrary, Biden has choked domestic energy  In addition to the pipeline and other regulatory hurdles, its overt hostility towards fossil fuels has throttled back the willingness of companies to spend the capital to develop new reservoirs.

Back in prehistory, when I worked on the World Oil Project at MIT, we believed that the soundest way to effect a transition to other energy sources was to tax the consumption of fossil fuels, not limit their production.  We now seem to have created a 1970s-like scenario where individual producing countries can once again have enough market power to significantly and unilaterally ramp up prices.

  • Free S**t. As many believe, the stimulus programs contributed to the inflationary surge.  As Milton Friedman maintained, the helicopter drop of money onto consumers would lead to the onset of inflation.  But it hasn’t stopped there.  In addition to the recent student loan forgiveness announcement, we hear cries from the Democratic base for universal income and all sorts of other goodies.  One pundit observed that we are now nearing our own version of “bread and circuses”.  We don’t think it will end well.


  • Other Collateral Damage. Accounting for housing costs in inflation data is weird because only rents (or subjective rent equivalents of ownership) are included, rather than house purchases.  But it is pretty clear that rents may continue to increase significantly even if real estate prices plateau.  Agricultural prices are poised to spike, in large part due to the Ukraine War’s adverse effects on wheat exports.  Climate issues (water, fires, etc.) may very well impair US agricultural production.  US budget deficits may soar due to a collapse in capital gains taxes due to recent capital markets volatility.  There is no shortage of other examples.

RELATED: PART 8 – COST OF CAPITAL | Three Potential Outcomes

The Fed’s Dual Mandate May Hamper Willingness to Fight Inflation

Looking at this mountain of inflationary stuff, it is hard for us bystanders to see how inflation can be snuffed out for a rate rise of a few hundred basis points.  Remember that Volcker had to raise rates to the 20% level to beat inflation over 40 years ago.  Despite the Fed’s adamant stance that it will raise rates until inflation is tamed, it is hard to envision that happening in this time of feckless governance.

And you don’t have to be Nostradamus to see this coming.  Interest rate increases have the potential to crater the whole housing sector – from the value of homes to the number of homes being built.  If the wheels start to come off of the housing sector, we would anticipate that the Fed would retreat from its aggressive rate posture in order to preserve jobs (the conflict inherent in the Fed’s dual mandate).  Avoiding a deep recession would then become the latest overall government priority.

Once that happens, we would be heavy bettors on stagflation being with us for a while.  Time to break out the platform shoes and Donna Summer 8-tracks.

Want to Discuss This Further?

This post and the accompanying exhibits were produced in-house by members of the Gordian team. Clients, potential clients and members of the media can book a call or meeting to learn more by contacting Leslie Glassman directly.

Commentary by Gordian Group CEO Henry Owsley