Political analysis should follow this chain of events. First, there is the world view or philosophy of state leadership. The party or strong man in charge imposes his or her world view on his society. She takes the next step and creates a narrative, writes a story that is consumed by parts of society. There will be conflicting narratives promoted by factions, and via the political system, a winner will be determined. With political power in hand, the victorious faction will draft the policy or action plan that activates the narrative. And finally, to make sure that there is no confusion as to what is the prevailing narrative, it is codified in law for all to read or hear.
The Democratic and Republican parties have been vocal about their world views on inflation. The Republicans argue that Mr Biden’s spending under his American Rescue Plan is leading to high rates of inflation. The Republicans energize their argument by citing the last Consumer Price Index print which came in at 7% year-over-year for December 2021. This was up from the November 2021 print of 6.8%.
The Democrats rebut by arguing that spending under the American Rescue Plan will provide income supports that eventually lead to normal employment levels. Rather than increase consumer prices, the American Rescue Plan, along with the Build Back Better legislation sitting in the Senate, will ease long term prices. Americans have been facing high consumer prices in part due to clogged supply chains and Democrats have been arguing since last spring that this government investment will expand capacity and produce lower prices.
Traders should cut through the political banter and look at the data. Data from the U.S. Bureau of Economic Analysis shows that as a percentage of gross domestic product, federal government spending has held around 7% between 31 March 2021 and 31 December 2021. Actual dollar spending has declined during this period. First quarter 2021 spending was approximately $1,375.2 billion. Federal spending declined in the second quarter 2021 to $1,356.7 billion and fell further in the third quarter 2021 to $1,339.1 billion. During this period, the MarketWatch dollar index signaled dollar strength with the dollar going from 93.23 on 31March 2021 to 95.97 on 31 December 2021.
Along with the dollar strengthening over this period came inflation. Data for the U.S. Bureau of Labor Statistics shows that the Consumer Price Index went from 2.6% in March 2021 to 7.0% in December. Mr Biden could deflect Republican attacks by implying that inflationary pressures are a reflection of the growing money supply spurred on by asset purchases made by the central bank since March 2020. That would leave a few in Washington scratching their heads since the man who led the $120 billion a month purchase of Treasury and agency mortgage-backed securities, Jerome Powell, was nominated by Mr Biden for a second four-year term. In addition, Democratic leadership in the U.S. House and U.S. Senate have been singing Mr Powell’s praises for his interventionist policies.
Granted, the increase in M1 money supply has gone from $18,669.2 billion in March 2021 to $19,874.8 billion in November 2021 (latest figure available) making Mr Powell’s actions an easy target for the “too much money chasing too few goods” argument, but Mr Biden and in particular the progressives in the Congress will need Mr Powell’s cooperation to fund their Build Back Better agenda. The Fed is the Treasury’s underwriter and Progressives can ill afford politics that upset its banker.
The irony is that Mr Biden has showed no penchant to artfully deflect criticism from Republicans to the Fed for his handling of inflation. However, for the trader that is neither here or there. The question should be whether proposed fiscal policy will have an impact on the direction of foreign exchange rates and if so, in what direction.
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