Opinion – Helio Beltrão: Inflation changes the rules of the game

As you read this column this Wednesday morning (12), the US government releases accumulated inflation for 2021. It could exceed 7%, the highest rate in 40 years.

Here, inflation measured by the IPCA closed the year above 10%, or more than 2.5 times the stipulated target. Since the Tombini inflationary disaster (2015), the BC has been fulfilling its mandate to keep inflation within the IPCA range determined by the National Monetary Council.

Due to last year’s blowout —much more pronounced than in 2015—, the BC is obliged to send a public letter to the CMN justifying why it failed to fulfill its mandate: keeping inflation below the target tolerance ceiling of 5.25 %.

American inflation is more worrisome, not just because of the deterioration of Americans’ purchasing power. Inflation changes the rules of the game for the Fed and dollar monetary policy. This little-understood turn has important repercussions for the Stock Exchange, for the fixed-income securities markets and especially for emerging countries such as Brazil. I explain.

In the last 40 years, with every major stock market crash and every recession, the Fed has always set in motion the following recipe: bailing out the market and the economy, flooding the banks with newly created money.

The idea is that the money created out of thin air would be poured into the economy and cause an injection of morale and spending, supporting the stock market and interrupting the recession. In fact, on several occasions the new money encouraged the stock market and provoked short-term spending, but it did not abolish the economic cycle or inhibit financial crises. And since there is no magic in economics, there was a cost, albeit one that is invisible to the economically naked eye.

The alternative would have been to let the market adjust naturally. But the Fed is a sledgehammer and sees nails in everything.

This automatic bailout recipe became known as the “Fed put”, or “Fed insurance”, a kind of license to buy stocks and other assets without risk of loss. The “Fed put” began 40 years ago, with the enormous difficulties of Wall Street banks due to the Latin American debt crisis of 1982 and then with the failure of the seventh largest bank, Continental Illinois, in 1984.

The long history of bailouts has conditioned investors and banks to assume that in the next crisis the Fed will again bail out the stock market and the economy. But the novelty is that, unlike the other sledgehammers, there is now real inflation. Will the Fed return to being the savior of the country, pumping inflation into inflation by creating more money?

Today, the US stock market is bubbling with greed and euphoria in feedback. Part of the explanation has to do with Tina, Margaret Thatcher’s expression, “There Is No Alternative”. The iron lady was referring to the market economy, the best and only system that works. The analogy is that, as fixed income pays nothing, there seems to be no other option than to put it in the stock exchange’s “tub”.

However, if the Fed opts for the unequivocal fight against inflation and eventually indicates a path of normalization of interest rates (to levels above inflation), the stock market could plummet, and greed, become dread. Neither investors, nor banks, nor managers, nor other countries yearn for this alternative. Nor did they initially applaud when Paul Volcker rightly went after the dragon by raising interest rates in 1981, which led to the return of stability and decades of profits in the markets.

The Fed’s degree of freedom has disappeared. The so-called “free option” of non-inflationary (forehead?) injections has expired. The rules of the game have changed, and investors need to reread the playbook to avoid losses