The three most influential economic minds of all time are, and few would dispute – Adam Smith, John Maynard Keynes, and Milton Friedman. In these times of rising inflation, the world needs a little bit more of Friedman. The Nobel Prize winner, best known for the theory of monetarism, would disagree with the Fed chair – Jay Powell’s view on inflation. Powell maintains that inflation is transitory, but the monetary theory of inflation suggests otherwise. It posits that elevated inflation could stay with us for a while.

Friedman’s dictum was that “Inflation can be produced only by a more rapid increase in the quantity of money than in output”. He called inflation a “hidden tax”. An increase in paycheck pushed one into a higher tax bracket while rising inflation meant that what he had left bought fewer goods and services. With the government having pumped in a tremendous amount of money to the point where unemployed no longer feel the need to get back to work, inflation has taken hold in everything from gasoline to food to staples.

The Fed originally predicted that inflation would be back to pre-covid levels by mid 2021. They have since recognized that it is taking longer and is now likely to come back down by mid 2022. We ask what if it doesn’t? What if the Fed needs several interest rate hikes next year to suppress runaway inflation? And what will be the impact on the stock market?

Future Wealth’s View

The people in the Fed, no doubt brilliant economists in their own right, appear to have circled around this theory that unemployment has to go back to normal levels before any action on interest rates is taken to stem inflation. But, even with higher than normal unemployment levels – sales at stores, restaurants and online shopping are at elevated levels going into holiday season. Commentary from companies in Q3 2021 earnings calls suggest that despite high prices, people are still flocking to department stores, appliance stores and going on vacations – not flinching paying the higher prices. 

Biden’s new $3.2 trillion spending bills will do little to reduce inflation, and instead, pump more money into the economy which would only continue to extend periods of high inflation. In these times, Friedman would argue that the best course of action would be to cut government spending, not increase it.

We believe the Fed could begin its tightening cycle i.e. interest rate hikes to control inflation – a lot sooner than the market expects. The market may not take it kindly but Milton Friedman would have his last laugh.