For more than a year, the Federal Reserve ignored numerous warning signals and continued to inject money into the economy. The result was the emergence of robust economic growth and a surge in demand, particularly in the labor market, that ushered in decades of inflation. But as the Fed belatedly hikes rates, the veil falls and with it the financial markets.
Oscar Wilde’s The Picture of Dorian Gray offers a striking parallel to our situation. The novel’s eponymous protagonist has a portrait that ages and decays while remaining young and vibrant. But his health is an illusion, while his portrait – hidden from view – contains the truth.
The Fed’s massive liquidity injections have created a mirage of economic health. Big nominal gains in corporate earnings, assets and even wages made the economy look healthy. Adjusted for the inflation created by too much money, however, these economic numbers are disappointing at best and negative at worst.
This inflation adjustment is the true picture of the economy, much like Dorian Gray’s portrait. It lays bare all the sins of the past. To prove it, in the first quarter of this year the economy grew at a robust annual rate of 6.5 percent in nominal terms, but actually contracted 1.4 percent when adjusted for inflation.
As reality sets in in the financial markets, investors continue their sell-off. Stocks continue to fall, with stocks down for most consecutive weeks since the Great Depression and posting their worst losses since the panic-induced sell-off at the start of the pandemic.
Inflation has robbed consumers of purchasing power, causing savings to be depleted, consumer debt to mount and future spending projections to fall precipitously. It turns out that corporate earnings won’t keep rising indefinitely now that the Fed’s sins have finally caught up with everyone.
Creating trillions of dollars out of thin air certainly gives the economy a temporary boost. However, easy money and cheap credit are creating an addiction with painful withdrawal symptoms that the nation is experiencing as markets are confronted with the true portrait of the economy. This only exacerbates the boom-bust cycle rather than smoothing it out.
Since the Fed can’t really create growth, let alone wealth, the best it can do is play the man behind the curtain and create the chimera of money-driven growth in place of the real McCoy. That’s exactly what we’ve seen over the last year and a half – what could be called the economics of Dorian Gray. In its errant attempt to prop up semblance of growth, the Fed has primed the real economy for disaster.
The Fed’s excuse for stoking this inflation over the past 18 months has been its “dual mandate” under which it aims to simultaneously maintain stable prices and the amorphous goal of full employment. Flooding the financial markets with liquidity for more than a year made for what appeared to be a resilient labor market and created such great demand for labor that vacancies hit a record high of 11.5 million and nominal wages rose rapidly.
But like other sectors of the economy, the real labor market is not as healthy as it appears. Prices are rising faster than wages, demonstrably making workers worse off today than they were 18 months ago.
And in creating prodigious amounts of money to support full employment, the Fed effectively served as the implicit funding arm of a Congress that ruthlessly evaded its tax obligations, relying on the hidden inflation tax to pay for trillions of dollars in unfunded spending.
For those who have previously sounded the alarm at this inflationary incubus, it is a hollow victory. It is no joy to see the fruits of an apolitical policy that impoverishes one’s fellow citizens. The reality, however, is that these effects have been hidden in a closed-door portrait for years.
EJ Antoni is a Research Fellow in Regional Economics at the Heritage Foundation’s Center for Data Analysis and a Senior Fellow at the Committee to Unleash Prosperity. Charles Beauchamp is a professor of finance at Mississippi College.
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