Your Covid Dividend
This year, most wealthy families have had a windfall to their balance sheets. Rather than the usual ten-percent portfolio returns, many wealthy families have capital gains of 30, 40, 50 percent. This article explains the economics behind your gains this year, how inflation works, and why you should consider giving more than usual to others.
Your Covid Dividend is a Result of the Fed Trying to Create Enough Inflation
Money and monetary policy are more complex than most people realize. Some think that money-printing by the Fed will create run-away inflation. People talk about “Zimbabwe” and “the seventies,” fearing that double-digit inflation will return to the US and the developed world. That’s why gold is up 20 percent this year.
But does this make sense? Is gold really a hedge against inflation? How much inflation can we expect?
In this short essay, I will explain why the Fed should be creating inflation, why they haven’t yet printed enough money, why we won’t have much inflation, and how Fed policy impacts people who have assets.
What is deflation?
Deflation is when money buys more in the future than it does today. In that case, people hold money. Scott Sumner has shown that this is what caused the Great Depression. In the 1920s, dollars were pegged to gold, but everyone knew that the peg would be changed from $20.67/oz to something higher. So all the dollars stayed under mattresses as the economy tanked.
Finally, in 1934, Roosevelt raised the peg to $35/oz, a devaluation of more than 40 percent, ending the depression. While we can’t say the gold standard actually failed, what clearly failed was pegging the price of gold to dollars.
What is inflation?
Inflation is when money buys less over time. The more inflation, the more people would rather spend their money now than hold onto it. A rise in inflation increases the velocity of money. All things being equal, a bit of inflation creates more economic growth than very low or no inflation. Any monetary policy that encourages people to spend rather than hoard is called stimulative.
Does the Fed cause inflation on purpose?
Yes. Congress asks the Fed to stimulate the economy at a “Goldilocks” amount of inflation that isn’t too high or too low, but “just right.” At 2 percent, prices rise enough to encourage people to spend but not so much that people are worried or have to keep adjusting too often. Even though it’s their job to create 2 percent inflation, they rarely hit that target (the red line is the target):
Doesn’t inflation erode our savings?
If you keep cash under a mattress, yes. But most people don’t. Most people hold assets, like commodities, stocks, bonds, real estate, etc. And those prices always outpace inflation. In that case, inflation is your friend — it drives the value of your investments up faster than they would appreciate without the inflation. Even money held in a savings account usually keeps up with inflation, so no, inflation does not erode savings.
Doesn’t inflation make wages worth less?
It does not. This is called “the money illusion.” In this video, Don Budreaux explains that wages tend to outpace inflation, so people’s pay checks actually buy more over time, not less.
Coupled with technological advancement, wage-earners live a much higher standard of living than their counterparts of 50 or 100 years ago. Inflation plays a role by stimulating growth.
There’s government-driven inflation, and there’s also a natural rate of inflation. Is that true? It isn’t. I wrote that to see if you are paying attention. Milton Friedman said “Inflation is always and everywhere a monetary phenomenon.” If you have time, listen to him explain:
Isn’t too much inflation bad?
Yes. Long-term high inflation leads to many problems. It raises interest rates, it forces quick adjustments in prices, it discourages borrowing, and it makes everyone uncertain about the future. In some countries, run-away inflation destroys the economy. It’s memories of the 1970s and countries like Venezuela that cause people to be concerned about inflation in the US and Europe, but they needn’t be concerned.
How does the Fed create inflation?
As Milton Friedman explained, “inflation is always and everywhere a monetary phenomenon.” This is what Paul Volcker realized in the late 70s. He reduced high inflation by reversing the expansionary monetary policy of his predecessor. The Fed creates inflation by buying assets from banks. Banks receive new money (generally in their account with the Fed, called the reserve account), and the assets go onto the Fed’s balance sheet.
The Fed’s balance sheet is a special place. It contains money and assets that are not in circulation. The Fed manages its balance sheet only for the purpose of managing the economy. It really doesn’t matter what the value of the balance sheet is — it’s out of circulation.
When banks get new money, they can lend more, and that increases the overall supply of money, since banks create new money by lending against their reserves.
This directly affects prices. If the Fed doubled the amount of money in circulation, prices would double in short order. So when the Fed announces they are printing money, the value of everything increases.
But assets rise more than most prices in the everyday economy. Assets like real estate and stocks rise with the amount of money printed, whereas things like appliances and laptops go up only a small amount.
The Fed’s goal is 2 percent constant inflation. They recently announced they will do more to hit that target, so that if they undershoot one year, they will make up for it the next year with higher inflation (so they say — they have a long history of undershooting their inflation target).
Can inflation run away?
No. Just as the Fed injects money into the economy by buying assets, they can pull money out of the economy by selling them. So if the Fed saw inflation above target, they could easily reduce inflation to hit the target.
The Fed is completely in charge of inflation, and they are slowly realizing it’s not about interest rates. There is really no chance that the Fed will let inflation get above 4–5 percent (and only then to make up for very low inflation, like we have now). Their large balance sheet lets them dial in inflation to hit exactly the number they want.
What is a Covid dividend?
Families with assets like stocks and real-estate have received a special gift from the Fed this year. All but two of the 12 richest people have seen their net worth increase substantially this year:
Not all of this is money they earned. Much of it is a gift from the Fed. Without the Fed printing money, the stock market would be in a very different place. Not only is the Fed likely to print more, but they are very very unlikely to contract the money supply in the next decade. This gives wealthy families a huge dividend they can keep investing and using to build more wealth.
Does inflation help working people without assets?
Yes. Even though they don’t benefit from the asset-price increase, everyone benefits when the Fed hits its inflation target. Why? In today’s ultra-low inflation environment, inflation stimulates people to spend. This helps bring people back to work as soon as the health situation allows. Working people should be thankful the Fed is printing money.
Should we buy gold?
Gold is for people who don’t understand this, and there are many of them. They could easily push the price of gold higher, which is what happened back in April when the Fed announced their QE program:
There were fears that the Fed would create run-away inflation. There was much talk of Zimbabwe and Venezuela during the summer months. Finally, cooler heads prevailed and gold retreated. Gold has done well overall this year, but so have most other assets. The only people who were penalized were those holding large amounts of cash.
Smart people should not consider gold a hedge against high inflation, because there won’t be any high inflation. As always, a broad mix of assets is best for most of the portfolio, and an antifragile bar-bell portfolio is optimized to preserve capital yet perform well under volatile conditions.
What is the optimal monetary policy?
I’m glad you asked. The Fed isn’t very good at managing expectations. While printing money has the effect of stimulating the economy, the message is even more important. I’ve made a short ten-minute video to break down and explain the concepts of nominal GDP level targeting:
If this interests you, please see the resources at my Digital Money Book.
This year, think outside the box in your philanthropic activities. Come to the new Giordano Bruno web site to learn what I propose to do with a small part of your Covid dividend.
David Siegel is a serial entrepreneur in Washington, DC. He is the founder of the Pillar Project and 2030. He is the author of The Token Handbook, Open Stanford, The Culture Deck, Climate Curious, and The Nine Act Structure. He gives speeches to audiences around the world — see his speaker page if you would like him to speak at your next event. His full body of work is at dsiegel.com.