Large portion of inflation ‘has zero to do with the Fed,’ author says

Nomi Prins, author of “Permanent Distortion: How the Financial Markets Abandoned the Real Economy Forever,” joins Yahoo Finance Live to discuss how markets diverged from the real economy, Fed policy during the pandemic, and how to read economic and market signals.

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AKIKO FUJITA: Well, Fed vice chair Lael Brainard has indicated the central bank could soon slow its pace of rate hikes. In an interview with Bloomberg News, she said it will probably be appropriate soon to move to a slower pace of increases. Markets have been expecting a slowdown in December from the rapid pace of hikes this year. So what is the 20,000 feet view of the role central banks play in the financial system and the impact of policy on both the asset-based economy and the so-called real economy?

In her new book "Permanent Distortion," Nomi Prins suggests the world is divided into two very different economies, one that behaves according to the traditional views of money and economics and one that doesn't. And she joins me now. It's great to have you on today. Let's start with that thesis. Break it down for us further and how you see that playing out currently.

NOMI PRINS: Yeah, great. Thank you so much. So what I consider to be permanent distortion is that gap between how money is manufactured and flows into the financial asset markets-- stock markets, bond markets, housing market, and so forth-- and how it goes into the real economy.

So there's two elements to that. There's one that takes far less time to be manufactured by central banks and to purchase assets and to have that money leveraged into stock markets, lifting them, and right now, being something that is very much watched to see what happens next, if they'll continue to move up, if the Fed pivots. And the real economy, which takes a lot more time to soak up capital, and therefore, when it's created and goes into the markets, loses out.

And this permanent distortion has occurred because of the extra money that was fabricated by central banks in the wake of the pandemic, having started its path after the financial crisis of 2008.

AKIKO FUJITA: Well, I was going to say, we've been talking so much about the money that was flowing as a result of the stimulus put in the system during the pandemic, but you could certainly argue this happened-- you know, this began more than 10 years ago. I mean, can you elaborate a bit more on the distortion that's happening, and how that's creating that big divide?

NOMI PRINS: Yeah, so in the wake of the financial crisis of 2008, when the Fed, for example, blew its book or increased its book from $800 billion to $4 and 1/2 trillion over a period of three QEs, breaking rates to zero-- globally, interest rates were zero. So there was a lot of cheap money going into the markets and less so into the real economy.

As a result, what we saw was markets escalating by much more than they had before those sorts of policies were put into place and acted on. And the real economy basically dawdling around, and up 1%, down 1%, up 2%, and really hovering kind of on a flatline basis from the perspective of growth.

And we saw this occur throughout the period, really, through 2019, at which point the Fed had already increased rates a little bit and then started to decrease them in the middle of 2019 because bank liquidity, Wall Street liquidity, was starting to wane again. Then we get the pandemic, and the Fed creates about $4 and 1/2 to $5 trillion worth of money over just a six-month period, not a multi-year period. And that has the effect of turbo boosting the markets.

And on the flip side, that money doesn't go into the real economy. Markets can manufacture returns more quickly when they're going up than the real economy can, in terms of production manufacturing, wages, and just general Main Street health. And so that's what we've been seeing.

And even now that we've seen uncertainty come in because the Fed's raised rates by so much so quickly, going into this what I call stage one pivot period, which could happen as early as December, where the Fed, as Lael Brainard just said, sort of steps back on the increase size, we're going to see that lift in the markets and that wane in the real economy again.

AKIKO FUJITA: So picking up on that point, we have seen this accelerated tightening, if you want to call it that, it is sort of the Fed trying to steer the ship back in the other direction. Can you correct that distortion? I mean, I guess your book answers it, "Permanent Distortion." But to what extent can it be corrected with the Fed's policy right now?

NOMI PRINS: Yeah, so that's an excellent question because regardless of the fact that they are hiking rates in an accelerated manner to combat inflation, of which a large portion of inflation has zero to do with the Fed or any central bank-- it's energy related, geopolitically related, supply and demand related, food price related, rents hiking because housing prices had been so high, and now people are locked into rents and can't afford mortgages. All of these things are part of inflation the Fed's trying to both fight and also created.

On the flip side, though, they have a book of assets that's still just a little bit under the $9 trillion height that they had. They're like $8.7 trillion. The only way to really unwind the distortive impact of quantitative easing would be to sell off their book. Now, no one expects them to do that because doing so would literally crash all markets, kill liquidity, and create an economic and financial disaster, which is why the Fed is actually undershooting its plans to let those Treasury bonds roll off.

We've actually not seen as much roll off of their book as they had basically projected. And so that's one reason why I think this distortion is permanent because the markets know. The financial system knows that ultimately, there are trillions of dollars on offer as cushion, elevating their system and not going into the real economy. And the only way to, again, uncreate that is to sell them, and that's not going to happen.

AKIKO FUJITA: Thanks to Nomi Prins, author of "Permanent Distortion, How Financial Markets Abandoned the Real Economy Forever."