It appears that the Federal Reserve chairman, Jerome Powell, is on the verge of cracking under pressure. In a recent interview, he said that the central bank does not need to wait until inflation hits its target of 2% to cut interest rates. He said the rate-setting committee just needs to see greater confidence that inflation will return to the 2% level.
That is quite a shift in rhetoric. He admits that if the Fed should wait until inflation gets all the way down to 2%, then it has probably waited too long. That is a given because of the lag effect of monetary tightening. It takes time for interest rates to work through the system.
Currently, the Fed fund rate is between 5.25% and 5.5%. Meanwhile, the inflation rate is 3%. So, in theory, the cost of money should be high enough to bear down on rising prices. And it does appear to be working, even if it is only happening in fits and starts.
However, it is often said that interest rates are a blunt and crude tool to control inflation. It is akin to using a sledgehammer to crack a nut. But if a sledgehammer is the best tool that the central bank has, then we will just have to live with it.
The thing to remember is that inflation is unavoidable. Milton Friedman once said that inflation is an old, old disease and we have thousands of years of experience of it. He believes that the only cure for inflation is to reduce the rate at which total spending is growing.
Question is how can spending be controlled when there is so much cash sloshing around the world. If we believe that inflation is the result of too much money chasing a limited supply of goods, then only when the excess cash is withdrawn can inflation be brought under control.
That won’t be easy. After all, how do central banks take away something that should never have been given in the first place? They can’t.
The upshot is that inflation may go away. But it will be back because of the weight of excess money. Investors should therefore continue to focus on businesses with pricing power.
The ability to raise prices when it is warranted should never be underestimated. It is how the fittest companies can survive the hard times and prosper when times are good.
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Disclosure: David Kuo does not own any of the shares mentioned.
