Great inflation of the 70s was a fiscal phenomenon, not monetary: Barry Knapp

All right, so last night, San Francisco Fed President Mary Daley talked about the balancing act that the Fed has between the two pains, right? Inflation, the inability to afford things like food, for instance, or job, which obviously can be extraordinarily painful, although sometimes not working can pay more than working. Then she made a bold proclamation at the end. I want you to take a listen to this. I grew up in Baldwin, Missouri, in the 1970s, the last period of high inflation, and in my world, many people struggled. Inflation imposed a corrosive tax. It eroded earnings. It made it hard to pay bills. Now the Volcker disinflation remedied that. But the medicine was harsh. Looking back, that medicine seemed necessary. It reflected the conditions we had at the time. But I see the world today, and I know we are not in that world. The Federal Reserve has credibility that it didn't have back then. Businesses, household markets know that we will get the job done. All right, let's bring an Ironside macroeconomics managing partner, Barry Knapp. Barry, listen, I don't think the public has this kind of trust and the Fed that Daley believes they they have maybe business does. I want to know your thoughts. So you think there's this, oh, wow, don't worry about it. The Fed's going to glide us into a soft landing. I was at a National Association of Business Economics conference right before the pandemic kicked off, and we had that breakout session with the former staffer at the board and at New York Fed. And we started talking about the Volcker disinflation. And I asked him, what are you attributed to? And he said, oh, unequivocally, it's attributable to FED credibility to Volcker, and that's what solved the inflation problem. So I asked him, I said, you don't have any. You don't think it had anything to do with the deregulatory policy that started under Carter, carried on to Reagan, made the economy a lot more flexible or the globalization shock from China entering into the industrialized world? None of that. So when you're a Keynesian and you believe that the Fed is at the center of all this, she may very well believe her own words. But any of us have looked at that, you know, inflation, the great inflation objectively and understands that it was a fiscal phenomenon, not a monetary phenomenon. And this inflation was driven by fiscal policy as well. Would would view the Fed as not particularly credible in in as much as they think they have complete control over that portion of the economy, the whole inflationary influence impulse. So I know, I mean, listen, there was a there was a time for 1000 years where even the smartest people in the world thought the universe revolved around Earth. And if you had the nerve to say it didn't, it was hell to pay, right. So let's talk, let's update this now to where we are because the CBO just updated their federal deficit projections on, on, you know, of course, as a shared GDP much, much higher. Here's your June forecast, folks, higher than it was in the February 24th forecast, higher than it was in the January 2021 forecast. And you, you wrote about this and you kind of predicted this would happen. But what does it mean for markets, Barry? Well, I, I, I suppose on one level I agree with your prior guess that the probability of a recession is fairly low when government spending is 24% of GDP and we're running a 7% budget deficit. So no, going into a recession is a low probability outcome. It also implies higher inflation over time, which listen, for some parts of the equity market are is not a negative. If you have high up, you know, fixed operating costs and you have higher nominal growth, whether the growth comes from government spending in a price effect or not, you're OK. But in the long run, you know, this debt becomes unsustainable and the cost of it is inflation. So could the Fed end up easing in the face of this? Absolutely, as Bill Martin, the chairman of the Fed said back in the 60s, the Fed is independent within not of the government. There was a pretty good bond auction, Treasury auction today and bond yields. I'm going to show the audience. So we picked up here on the 10 year and they've been coming down here still above 4, still above 4%. Are you still in the secular bond bear market camp? I am unequivocally, but I would say that the the one thing that caused pauses in that secular bond bear market through the Fifties, 60s and 70s was a real deceleration of growth or a recession. And it looks like we're in one right now. There's a going to be a big debate about or there is a big debate about whether the labor market is deteriorating or not. The household survey, the rise in the unemployment rate, the data that the BLS gets from that IRS every quarter with a lag basis all makes it look like small business has been struggling. But and of course, we know retail sales have just deteriorated and as has jobless claims started to pick up. And even within the equity market, you were talking about this earlier, Charles. The only sectors that are really performing well and performing well from an earnings perspective are tech and communication services. I've called this earnings crunch time because this is the quarter. Last quarter we had 8% growth, but it was entirely attributable to those two sectors. This quarter, we're supposed to get nearly 8% growth from everything else. If it doesn't come through, we have a real growth scare. Honor. Yeah. And by the way, before I let's go, I will share with from your note that the discretionary industrial earnings revisions have come down really, really hard. Another red flag maybe ominous thing there. Hey, Barry, I wish we had more time. Always appreciate our conversations. Thank you very much. OK, Charles, I'll see you soon, man.