It should come as no surprise that the Dow Jones Industrial Average continues its meteoric rise past 36,000 — even with the Federal Reserve’s long-anticipated “tapering” (buying fewer bonds) starting later this month. After all, a balloon goes up when it gets inflated. But how much of this apparent growth is real, and how much is a meaningless illusion?
The Commerce Department’s report on third-quarter GDP sheds light on the subject. Economic growth was disappointing, increasing at a torpid 2.0% annualized rate, far below expectations. But the real devil is in the details.
Nominal GDP — that’s not adjusted for inflation — grew a blistering 7.8% in the third quarter, but real growth was just 2.0%. So, where did the other 5.8% go? Real GDP grew by just $96.5 billion in inflation-adjusted 2012 dollars — far below the widely reported nominal GDP, which is unhelpfully measured in current dollars, grew by $432.5 billion.
The Fed’s voracious appetite for government bonds has provided a continuous stream of liquidity infusions which in turn is fueling inflation, as the price of everything in the economy is bid higher by too many dollars chasing too few goods.
As a result, even if an asset price increased 7.8% at an annualized rate from the beginning of July through September, its real gains were still only 2.0%, with the other 5.8% lost to inflation. Of course, taxes are levied on nominal gains, not real gains, so you’ll be paying tax on the inflation too. That adds insult to injury since inflation is a tax from the start.
In the Census Bureau’s latest wholesale trade report, inventories rose 1.4%, and sales rose 1.1% in September from the month prior. But the producer price index, which approximates the changes in prices at the wholesale level, showed prices rising 0.5% from August to September. More than a third of inventory growth and almost half of sales growth for wholesalers in September was just inflation.
Likewise, the Census Bureau’s latest retail trade report showed more than half of the increase in retail sales and inventory growth in October was just inflation. Both retailers and wholesalers are making nominal profits by having goods sit in a warehouse for a month.
This is why corporate earnings reports should be thoroughly beating expectations right now. The market almost ought to expect blowout earnings because inflation — by almost any measure — is near its 30-year high, and earnings are priced nominally. Inflation increases the size of the bottom line simply because the dollar is losing purchasing power. Higher earnings numbers are not actually worth more because the dollar that measures them has shrunk in value.
These inflationary pressures are crushing consumers. While prices have been steadily increasing, real disposable personal income decreased 5.6% in the third quarter, and personal savings fell $300 billion. People are dipping into savings to pay their bills, which are getting more expensive every month because of inflation.
Another major point of concern is gross private domestic investment, or the amount invested in business. At first glance, it appeared to have grown by a healthy 11.7%, a sign of future economic growth. But that number, too, is an illusion. Of the $96.5 billion increase in real GDP, 97% was businesses stocking up on goods for resale, not pouring money into fixed investment such as capital goods. It seems businesses have been anticipating price increases and supply chain disruptions and stockpiled accordingly — not truly investing in growing their businesses.
This economic malaise — reminiscent of 1970’s stagflation — is the culmination of ill-advised fiscal and monetary policy. The expansion of welfare programs with the removal of work requirements have contributed to a shortage of labor, and vaccine mandates have made the situation worse. Meanwhile, the Fed continues keeping interest rates near zero, providing a river of cash to the market. That liquidity is turning into higher prices for everything — including stocks — as people’s appetite to borrow returns and the velocity of money increases.
The taper is too little too late. The real problem is, and always has been, creating money out of debt. The Fed has more than doubled its balance sheet from pre-pandemic levels while also removing the reserve requirement for banks and erasing the distinction between required reserves and excess reserves. Eliminating the reserve requirement was a move that many people missed because it happened in the early chaos of the pandemic. The Fed has now pulled backed this inflationary slingshot further than ever before, and they have begun to let go, launching stocks and all other prices to the moon.
The Department of Labor’s latest report on consumer prices is illustrative — October inflation was 6.2% over the previous 12 months, a 31-year high.
While your portfolio swells, so do all your bills. Nominally bigger numbers do not make you better off. In fact, they may be a sign that things are worse.
E. J. Antoni, Ph.D., is an economist at Texas Public Policy Foundation and a Visiting Fellow at Committee to Unleash Prosperity.
