Credit inflation: still alive | Looking for Alpha


Credit inflation. Is he still alive?

Well, in some areas of the financial markets, it looks like credit inflation is still high.

What is credit inflation?

I have defined credit inflation as an effort of the government to stimulate the economy, keeping consumer price inflation in check while the economy grows, however modestly.

The basic idea is that government policy continues to stimulate the economy, causing some consumer price inflation, while unemployment is kept low.

Many will recognize this description and say that it sounds a lot like the idea presented by the Phillips curve.

And, they would be right.

“Credit inflation” results from government efforts to stimulate the economy, but only in such a way that consumer price inflation is not excessive.

For example, the Federal Reserve has maintained a policy target of 2.0% consumer price inflation for some time.

And, they have done a very good job in this area over the last twenty years and they have managed to keep unemployment rates relatively low.

Unintended consequences

Like many other government policies, there are often unintended consequences attached to these policies.

One of the unintended consequences of this policy of credit inflation is that government stimulus measures have trickled down to asset prices rather than consumer prices.

In other words, rather than raising the price of food, or the price of clothing, or the price of energy, credit inflation leads to an increase in the price of gold, or the price of stocks, or house prices.

What seems to happen in the case of credit inflation is that the government stimulates the economy.

But, the essence of the credit inflation policy is that the government will continue to stimulate the economy over time so that consumer prices continue to rise by…say…2.0% per year.

Investors are learning that the government is going to stick with the stimulus package so that investors can rely on this stimulus package year after year.

Sounds like something you could bet on?

This is exactly what investors have started doing. They didn’t bet on consumer prices happening this year or next year and depending on random hits.

They bet on asset prices that can go up and up and up over the longer term. They have stopped betting so heavily on consumer prices which tend to rise due to shorter shocks.

Credit inflation came into play in the 1960s, following the efforts of the Kennedy and Johnson administrations.

President Nixon brought Republicans on board in 1968 as he claimed “We’re all Keynesians now!”

And as they say, the rest is history.

After Paul Volcker broke the back of consumer price inflation in 1980 and 1981, investors realized that consumer price inflation was just a short-term thing that the government stimulated and depressed over the business cycle.

Credit inflation saw the government “guarantee” lower levels of unemployment in the long term.

And investors bought into this “credit inflation”.

They have invested heavily in it.

In the 1990s, we had a lot of asset price inflation and asset price bubbles.

Again, in the 2000s, credit inflation did its job with low unemployment, low consumer price inflation, and high asset price inflation.

And, the period between the Great Recession and the 2020 recession was the “dream” outcome for those who support such a policy. Low unemployment, rising stock prices, rising property prices, prices of other assets are doing very well.

The rich did very, very well during this period.

Income and wealth inequality reached unprecedented levels during this period.

And then the pandemic hit.

Rachel Louise Ensign writes in the the wall street journal,

“Wealthier Americans have gotten even richer during the pandemic, taking advantage of the dual stock and housing booms that have driven up the value of their assets.”

Thank you Federal Reserve System.

Never before has the Federal Reserve pumped so much money into the economy in such a short time. She continued:

“Americans saved an additional $2.7 trillion from January 2020 to December 2021, according to Moody’s Analytics.”

“The top 10% had more than half of that money.”

Their cup overflows.

Today’s situation

The rich continue to assume that credit inflation will continue to be the way the US government does business.

Why not assume that?

The federal government has relied on credit inflation for the past 40 years or so to drive the economy forward.

The Federal Reserve may be raising interest rates and promising to reduce the size of its securities portfolio, but that will lead to market losses and economic hardship.

The Federal Reserve, the Federal Government, can’t bear the losses and the pain for long?


Well, writes Mrs. Ensign,

“Wealthy people increased their borrowing in the first half of the year despite rising rates and a stock market rout that hit the value of their portfolios.”

But, she continues,

“The wealth management units of Morgan Stanley and Bank of America Corp. reported double-digit loan growth in the second quarter.”

“The increase came from well-heeled clients who took out mortgages and asset-backed loans such as stock and bond portfolios…”

“The growth is another sign that American consumers — admittedly a wealthier subset — aren’t rushing in anticipation of a recession.”

“In earnings calls earlier this month, executives of America’s largest banks said their customers were spending at a healthy pace and tracking debt payments, all without emptying their bank accounts.”

“The wealthy are tapping into their equity-backed lines of credit to grab assets that seem cheap in today’s turbulent markets.”

And, oh yeah, the Fed isn’t really going to give up its penchant for credit inflation.

Oh, Hannah Mial also writes in the the wall street journal,

“Weak earnings reports don’t bother investors after a brutal year for stocks.”

Why should they discourage investors, especially wealthier investors who can afford to borrow even when the Fed tightens monetary policy.

But then the Fed won’t be doing this for very long and stock prices will rebound as the Federal Reserve returns to its roots of credit inflation.

At least, that seems to be what many wealthy investors think.

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