Fed efforts fail to fan inflation
Joel Dresang: Kyle, the Fed is unwinding an unprecedented attempt to stimulate the economy. They’ve pumped trillions of dollars into the economy. Normally, we’d expect that to increase inflation, but inflation’s not soaring.
Kyle Tetting: We’ve been talking about inflation for the better part of five years now with the idea that maybe at some point in time we’d see it. But the money the Fed’s been pumping in just hasn’t been going anywhere, so we haven’t seen inflation.
Joel: How is it supposed to work?
Kyle: Well, ultimately, what we would hope to happen is that as the Fed kind of injects that capital into the system, the banks who get that capital on their balance sheets loan it out. The corporations who have cash on their balance sheets from sales would maybe invest in people or invest in capital. And as a result, we’d see the economy grow from that cash really accelerating its way through the economy.
Joel: So the cash that the Fed has been pumping into the economy has just gotten stuck. Why is that?
Kyle: It’s really a function of this low-interest rate environment and what’s been a very slow growth period. For businesses, they just don’t see a lot of opportunities to invest that cash and then get any meaningful rate of return. And so in that environment, they’d much rather have the liquidity that cash provides.
The economics term for it is liquidity trap. And really what it refers to is this idea that as we are in a very low rate environment, what we call the lower zero bound for interest rates, the opportunity cost of lending out money just isn’t worth it – or of spending money just isn’t worth it. And so what we get is corporations and banks that just prefer to hold the cash.
Joel: Kyle, we heard Bob Landaas at our recent client seminar talk about the money sloshing around the world – how there’s an overcapacity for labor and for capital. How does that relate back to this liquidity situation?
Kyle: What we’ve seen is that there just isn’t any velocity to that cash, so as it sits on balance sheets, the inflation isn’t happening. And if you look globally, yeah, Bob has talked about – in a number of different ways – this global excess of labor, this global excess of capital. There just isn’t a lot of demand driving prices higher.
Joel: But with the Fed’s efforts, the economy is growing. It’s growing moderately. It seems to be picking up momentum. Is that going to be helping all of this?
Kyle: At some point in time, corporations just can’t sit on cash anymore. You know, they can only expand sales so much before they have to spend a little to get that next sale. So we should see inflation pick up a little more than it has. We should see that cash that the Fed injected start to accelerate its way through the economy. And that should be a really good thing because it should help drive future growth.
Joel: So what does that mean to investors right now?
Kyle: For investors, the big thing is that we’ve talked about: interest rates and earnings. If corporations are spending cash, that can be a little bit of a drain on the bottom line, but ultimately they’re spending cash to get those sales down the line. So they may be able to grow their earnings not just by cutting their costs, as they’ve done for so many years, but by actually growing their sales.
And then the other big thing about that is the interest rate side. And at some point in time, if growth really does continue to go the way it’s going, we’re going to see interest rates come up a little bit. And so that’s something that we watch but certainly not something we’re overly concerned about right now.
Kyle Tetting is research director at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
(initially posted Oct. 10, 2014)
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