How the Richest Americans Are Causing Inflation To Remain Elevated

And Why the Federal Reserve Should Not Hike Rates In Response

Inflation can be a controversial topic for many reasons. Human beings are particularly sensitive to the sensation of losing resources and money, mainly if it is for a reason that we can't alter with our own agency. Inflation is one infuriating risk that always draws the ire of economic populists on both sides of the political spectrum. You can work as hard as you possibly can and do everything right, and the purchasing power of your hard-earned dollar can still fall through no fault of your own.

Of course, since this is no fault of your own, the natural question is, who is to blame for robbing me of my dollar's value? The answer most people tend toward is the government. The Fundamental Attribution Error makes us prone to blame whoever is in power for inflation. Still, they are about as responsible for inflation as whether you choose to drink and drive tonight. While it is tempting to come up with a cohesive and tidy explanation for inflation like Monetarism does, the reality is that too many variables affect inflation for it to fit neatly into any theory.

It's always easy and tempting to blame the teacher and advocate recess (or tax cuts) forever instead of class, but America's wealthiest class is the culprit of inflation's current stickiness. Category by category, the only areas keeping inflation elevated are areas where the rich spend way more per capita than the rest of the population, and this persistent floor of demand unaffected by high rates keeps prices more elevated in these areas than they would otherwise be.

The government spending policies of the Biden administration may also contribute, but their effects will be felt far into the future. There are also indications that they are having pro-growth effects that will mitigate inflationary impact. The amount of investment the CHIPS Act attracts, for instance, is positive. Still, of course, there are risks that it could ultimately prove inflationary and misdirect capital if implementation fails.

But I see evidence that the greater culprit of inflation's stickiness is the massive wealth gap that has opened up since our economy's last major bout with inflation nearly half a century ago. It is a very different economy for many reasons, particularly the concentration of so much wealth in so few hands.

Many Americans feel inflation is higher than they normally would because of pro-corporate and pro-management policies advocated by both parties. However, the policies of Republicans have mostly resulted in workers receiving less than their economic fair share in wages, as you can see below. Hayek would refer to this as corporate socialism.

The wealth gap is not all negative; it is also likely contributing to the soft landing the economy has experienced since the extraordinary post-pandemic boom. Instead of everyone being unable to consume in unison, as when wealth was more equally distributed, the interminably deep pockets of the wealthy kept activity going. As I said in one of my five reasons to be positive about low volatility in the summer below:

The Concentration of Wealth Can Actually Aid in an Ordered Economic Slowdown, or Soft Landing: The excessive concentration of wealth can get a lot of people upset, and there's of course legitimate reason for that. It's a free country here in America, and we encourage dissent and spirited disagreement with each other through our hallowed and unshakeable liberal institutions. But a lot of the strength in the economy is because there is a group of US consumers, tending to be older in age, who basically have unlimited spending power, a willingness to use it, and are completely insensitive to rates for a variety of reasons. This is one positive aspect of how our economy has changed strictly in the context of its seeming effect of making the all correlations go to one panic sell-offs associated with economic slowdowns less likely. There are no economic slowdowns for America's rich, at least with the added benefit of the stock market at all-time highs and the corollary wealth effect.

Of course, you might have noticed that part of being human craves easy explanations in a highly complicated reality. Inflation is a topic where so many misconceptions and false beliefs pollute the discourse that I have found it genuinely difficult to have productive conversations with people about it. Again, it is an emotional topic for primates when our coconuts or bananas are being wrongfully taken from us. But even beyond the concentration of wealth the top 10% has acquired, their percentage of stock market ownership is even higher.

So, with the stock market at all-time highs, something called the wealth effect kicks in. Rich people feel more confident about spending than ever because they are overcome with joy whenever they log into their brokerage accounts. So when their snotty daughter asks for that $4,000 bag, they say sure, honey. This is why spending on luxury goods has maintained steadiness throughout the post-pandemic era. The rich are so rich now that they are insensitive to the Fed's primary monetary policy tool. The Fed may have a bazooka, but America's wealthiest 10% are a Tiger Tank that bazooka rounds bounce off of.

Indeed, it seems more likely that the fiscal side of the toolkit has been more effective. America's relatively more robust Keynesian response to the pandemic appears to have brought us the high economic growth necessary to escape the death clutches of a behavioral inflationary spiral, which is the exact scenario the Federal Reserve wants to avoid most. In other words, the robust transfer of government funds during an economic shutdown produced the growth needed to ameliorate the economic impact of high supply-chain-driven inflation and unprecedented cessation of economic activity.

As I said in an article about a recent CPI report, ideological fealty to monetarism is a key factor in why many appear to have hated this post-COVID economic expansion and resilience so much. It directly contradicts their ideological worldview.

And this is the rub. I detect a lot of resistance in bearish camps to admitting that the government intervention during the pandemic was a positive thing and that it has been largely responsible for the subsequent economic boom because of the ideological implications of that reality, not because of data. The data is clear, it appears that our relatively more robust Keynesian response to the pandemic brought us relatively stronger economic growth. That reality is a very hard thing to admit for large sections of Wall Street. -April Nonfarm Payrolls: Worse Than Expected News Is Good News, Chris Robb

One of the most pervasive false beliefs about inflation is that the Federal Reserve and the monetary supply primarily drive it. Milton Friedman and other Libertarian thinkers popularized this idea, and their disciples constantly use Paul Volcker's draconian policy action, raising rates to a level incomprehensible today, as proof of their crackpot theory, almost a quasi-anti-government religion.

While the constellation of ideas circulated in American right-wing political circles and Wall Street masquerades as an erudite ideology, it is much more a tribal grouping of ideas based on emotionality, not rationality. John K. Galbraith described it as a "search for a superior moral justification for selfishness." Confusion and rage are debilitating people's rationality, which can be seen in how they respond to economic surveys. A large plurality say they are doing OK economically, but they believe the national economy is doing horrible by a spread of 50 points.

While I strongly support Hayek's and Schumpeter's ideas of free markets and creative destruction, I find the modern manifestation of American Libertarianism to be essentially a lobby for corporate socialism, which leads to many false beliefs about the economy. As Adam Smith said, Labor is the original price paid, and corrupting that sacred contract can eat away at capitalism's efficiency.

Probably the most common target in the inflation blame game that inevitably develops when inflation rears its ugly head is the sitting government. Just ask Louis XVI; he and his wife lost their pretty heads because of inflation (in a nutshell). People can get quite ornery about it. Of course, the old forces of inflation were primarily driven by material scarcity, things like bad or good crops, or protectionist policy. Of course, in pre-industrial times, markets weren't free at all. So imagine getting your head sliced off merely because there was a bad harvest.

In modern times, we are quite precise in measuring inflation. The Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCE) are the two key macro readings for inflation that primarily absorb the attention of the Federal Reserve and market participants; of course, there are others. The changing nature of our digital economy means that we have a lot of "old-school" data sources like the CPI and the PCE with time-honored traditions but also with a lag that was more common in a bygone era. We now have more advanced and almost instant data sources to complement these traditional sources. The problem is that they have been diverging lately.

Diving Into Inflation Numbers

Firstly, let's dispell with some of the inflation drama. Many inflationistas insist inflation is at 40-year highs, and it has been very recently. Compared to pre-pandemic levels, Americans are paying much higher prices for many essential items. Economists tend to argue that inflation is coming down compared to twelve months ago. As esteemed economist Claudia Sahm puts it:

When Americans complain that prices are high, they are implicitly comparing prices now to those of 2021, when inflation took off. When economists point out that 'inflation' is lower, they are implicitly comparing prices now to 12 months ago. Both time frames are informative and prices rose in both periods, so both are inflation. -Claudia Sahm

We are now talking about the pathway for inflation based on it returning to the Fed's 2% target. I, like Claudia Sahm and many other economists, am of the opinion that supply chain disruptions primarily caused inflation and their untangling it will lead to disinflation. Many of the items driving inflation came down, and the ones currently keeping it above target are primarily areas where consumption by the rich is higher per capita than it is in other areas. Thus, the rich are driving inflation, and there is very little the Fed can do to mitigate it with its primary policy tool of raising rates.

I have been covering inflation numbers for the entire post-COVID cycle for either my former employer, Fundstrat, or Seeking Alpha. We'll give a brief history for the 99.9% of you who don't pay close attention to inflation numbers. Inflation spiked to levels not seen since the 1970s and 1980s due to COVID-19. While some argued this was the result of government spending during the pandemic, others argued it had more to do with the supply chain and demand disruptions associated with the biggest economic curve ball the world has ever swung at, and frankly, the most serious economic risk of modern times.

The Jobs Numbers Support The Rich Driving Economic Activity and Sticky Spending in Key Inflation Areas As Well

For many months, job numbers were coming in way hotter than expected. This led many to speculate that the Federal Reserve would have to cut in order to slow a heating economy that seemed increasingly at risk of a wage-price spiral. A lot of this was hindsight bias, in my opinion, though. The strength in the jobs market showed the same reality we discussed above: that consumption activity is primarily driven by the rich, given the prodigious portion of total wealth under their control.

Like the strength in certain areas of the CPI and PCE numbers was driven by the asymmetric per capita consumption of the wealthiest Americans in areas like Housing, Hotel Rooms, Airline Tickets, and Cars/Car Insurance, a lot of the employment strength occurred in areas servicing the conspicuous post-COVID consumption of America's wealthiest citizens. Part of this is generational, as you can see above. As Ed Yardeni points out, the Baby Boomers are the wealthiest generation in history, and many of their proclivities in terms of spending are exactly where inflation remains stickiest.

• Cars/Car Insurance
• (Expensive) Houses
• Eating out
• Services
• Hotels
• Airline Tickets/Travel

For example, when a white-hot jobs report in September 2023 came in at 336,000 non-farm payrolls gained on expectations of 170,000, the bulk of that activity was driven by hiring in Hospitality and leisure, specifically restaurants and bars. This was while the average American pulled back on spending at restaurants and bars, but the exceptionally rich Americans kept the demand going anyway. Enough to cause a hiring bonanza.

Why the Fed Shouldn't Hike If The Spending of the Wealthy Keeps Inflation Elevated

Basically, the Fed would be bashing the economy to try to get the ultra-wealthy to stop traveling and buying second homes and nice cars at the expense of the rest of the economy's activity. This doesn't seem like a wise move, and Powell seems to know this. The initial causes of inflation were supply chain disruptions, and the Fed was less than correct about their transitory nature. But two wrongs don't make a right.

Bashing the economy to maintain some ideological consistency with Milton Friedman's warped perception of how the money supply affects inflation could be one of the worst policy errors the Federal Reserve could commit. The economy is much more anesthetized against higher rates than it was during the Great Inflation, and I think the OER calculation for housing that is keeping inflation so elevated will soon catch up with the leading data sources on shelter prices. Once rent collapses, the inflationistas and Monetarists will be in a very uncomfortable position, ideologically speaking.