‘I think you need to buckle your seat belt because the next 3-5 months of CPI will probably be very bad, 7%, 8%, and 9%. Why? There are a handful of components that have completely run away. Number one, the biggest one, is rent. Rent works on a three-month lag. We’re going to reintroduce what the true owner’s equivalent rent is into CPI, so we can already forecast that CPI going up. Oil is at 105 bucks a barrel. The Russians are basically trying to break the banks of Europe by now by messing with their natural gas supplies.’ – Chamath Palihapitiya.
Despite the rapid interest rate hikes by the Federal Reserve. The U.S. economy is far from being out of the woods. In fact, several economists and macro investors have established that a recession is unavoidable at this point. In the most recent episode of the all-in podcast, Canadian venture capitalist and former senior executive at Facebook, Chamath Palihapitiya, serial entrepreneur and podcaster Jason Calacanis, and the rest of the crew discuss everything economic. Chamath, Calacanis, Sachs, and Freeburg extensively discuss the current state of the crypto and equity markets, especially what the next few months will look like with the rising prices and rapidly developing housing crisis in the United States. According to Chamath, the damage will be quite extensive because the Federal Reserve just does not have a great reputation for fixing things during such uncertain times. It is important to keep up with the markets and important indicators that might indicate the next direction of the economy.
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Where did the Fed go wrong with their mandate, if at all here? Because we do have maximum employment, we have out of control price stability.
I think we have to also be sensitive to the fact that the Fed operates on a certain class of data and that data in the 21st century is pretty pathetic. You can probably find this. But there was an article, I think it was in the New York Times, that really walked through how CPI is calculated, and it’s a bunch of people that work for the government that walk around with iPod’s building relationships with local businesses and all these random places all around the country and asking them to chit chat for 15 minutes and do these surveys. You would have thought that in 2023 or 2022, the government would have said to Visa, MasterCard, and American Express the payment rails, the banks and Stripe send me a feed in the following structured way.
So that I can actually have an absolute precise sense of inflation, because inflation really only occurs when a good or a service trades hands for money and you calculate what that thing traded for the day before and what it is trading for today. So you could get an absolutely precise sense of it. Instead, we do this random sampling thing and so humans, etc. So if you read this article, your takeaway will be, “Oh my god, this is very rickety” and it drives an enormous hammer that we use to try to manage the economy. That’s the first thing.
Russia is basically trying to break the banks of Europe by now by messing with their natural gas supplies. In fact, the German energy minister yesterday said that if that happens, it could be a contagion equivalent to Lehman Brothers with respect to energy. When you play all of these things out, what you have is unfortunately, rampant runaway costs that really have no mechanism to get back in check in the absence of some real governmental changes. Our policy on this Ukraine-Russia war, you know, how we intend to sort of work or cooperate or fights with China, all of these things have to be solved. So, in the absence of that, prices are going to continue to go up. So what does the Fed do? How does it throw away what little credibility it has left? When there’s 8-9% inflation, printing and saying, “We think we’re done for right now. You can’t do that”. So they will overcorrect. There is just going to be so much pressure on them to act all the time. I think it will lead to lower equity prices, and I think what David said astutely is that we’ve seen the first wave, but now it has to touch all these other areas.
For example, we have gotten totally drunk on debt as a country. One of the most obvious places where we’ve been serving alcohol far too late into the night is in the financing of all these private equity leverage buyouts. These are dangerous. These are sketchy companies that are sort of like, you know, teetering on insolvency at times where private equity comes in and levers up the balance sheet with debt. They price it right at the edge of what’s legally allowed or what’s financially possible, and then they go ahead and do it. But that’s all assuming the economy continues to grow, and so if all of a sudden you have some recessionary forces or prices go up and earnings don’t, you’ll have, you know, a contagion in the debt markets, or you could have a contagion in the commodity market. So we’re dealing with some really tough boundary conditions. I mean real estate.
Most Americans have most of their net worth tied up in real estate, and if we see a 30% correction in real estate. It could be a real problem, particularly with rising interest rates and an inability to refinance.
Chamath and David Sachs, an entrepreneur and investor in internet technology firms, also talk about the role of the Federal Reserve and President Joe Biden’s administration in the current economic woes. Sachs explains three key ways in which President Joe Biden helped speed up the economic decline, despite warnings from economists. He said that his actions would lead to nasty inflation and more financial burdens for the average American.
Well, the stock market, especially growth stocks, may have taken the majority of the carnage. But you’re right, there are other asset classes, and I think we’re going to see the carnage start to rotate into those. So you’re right, if you look at residential real estate now, the prices are at the highest they’ve been relative to median income since something like 2006 or 2007, before that sort of great real estate crash that precipitated the great recession of 2008.
So I think there are going to be more shoes to drop. I just want to build on Chamath’s point about root causes here. Milton Friedman once said that there’s nothing quite as permanent as a temporary government program. The temporary government program was quantitative easing. We had this great recession in 2008 that could have turned into a depression. In case of an emergency, they started this QE, which is basically the government intervening to buy bonds in the market. They had never done that before, and they loaded up their balance sheet. The crazy thing is that the program was still continuing until last year. Why? It was like on cruise control and so last year. So you go back to last year, when the Fed bought 54% of the government’s debt. Despite the fact that the economy was growing at like 5% GDP, that it was bouncing back really strongly from the COVID, and that you had the stock market at all-time highs. They were still intervening with this massive QE. And then when we got the surprise 5.1% inflation prints last summer, they didn’t stop QE till the end of Q1. So you’re right, they kept basically printing money and it’s still going on and that’s created massive distortions in the economy now.
So the Fed, I would say, is the number one culprit here. Jay Pal is the number one culprit, but the number two culprit is the Binder administration, and I think Binder did three things very early on in the first few months of his presidency to effectively tank his presidency.
Number one: he cancelled our energy independence on his first day in office, cancelling the Keystone pipeline and making it much harder to drill. And, of course, energy inflation is the number one factor in this sort of overall inflation. Number two, he pushed through that last 2 trillion of stimulus on straight party lines. The American Rescue Plan, after Larry Summers said economists in his own party said this is going to create inflation; don’t do it. And then the third thing is, and no one really talks about this, is that Biden could have used diplomacy in 2021 to basically find an off-ramp to this Ukrainian crisis before it turned into a full-fledged war.
And if you listen to the economist, the international development economist like Jeffrey Sachs, he basically says that Biden pulled his cabinet together and said, “Listen, should we negotiate and compromise with the Russians?” They all said no, and Biden handed down the order. We will not compromise with the Russians. So now we have this massive war in Ukraine. It’s fuelling food and energy inflation. It’s going to take his presidency and I don’t even think there was any debate about this.
We may not be negotiating against Russia. But we’re enabling them to print enormous surpluses, which I don’t know if you guys saw. But there was an article today that Janet Yellen is traveling around basically convincing folks to not include Russian Oil in a bunch of import bans. So, that these Russian Oil tankers can be insured. Why? So, they can sell this oil to places like China, India, etc. We push for all these sanctions. Europe gets on board and says, “We’re going to do it and we’re going to take the lumps.” Then we go around Europe and basically say, “Well, we kind of want to fight this proxy war.” But at the same time, we want to try to fix inflation. We didn’t mean to cause this, and it’s completely disorganized what’s happening.
Okay, as David Friedberg explains later on during the episode, the U.S. Federal Reserve is charged with maintaining liquidity in capital markets so businesses can grow and contribute to overall economic development. However, the process has to be sufficiently controlled to avoid inflation. That did not happen. Quantitative easing, a monetary policy strategy used by central banks where they purchase securities in an attempt to reduce interest rates and drive more lending to consumers and businesses, went on for far too long, even after there were serious indications of rising prices. The central bank did not deem it fit to properly examine other auctions that might have helped divert the crisis or at least spend it in their bid to save face and keep up the pretence that all was well. They drove us right into the middle of this record-setting economic disaster.
So the question is will the Federal Reserve realize the mistake just in the nick of time and somehow save the economy from plunging into a recession? Or will they continue to deny the obvious signs until we are right in the middle of one?
[This article is a transcription of a video made by Savvy Finance]
Original video: https://youtu.be/TIW6CQKkkJs]
