(The following is an excerpt from our most recently published client newsletter.)

A dominant theme that we will be watching closely in 2025 is that of Reflation. In prior blog posts, emails, videos, etc. we have tried to shine a light on the fact that inflationary cycles tend to follow a fairly consistent pattern in history. While I am certainly not the first, I’ve often referred to this as the “3-Act Play”. 

• Act I: Generally speaking, inflation is triggered  by central bank/treasury/governmental policy error leading to an unnatural, non-market driven, spike in money supply. This leads to more money chasing the same amount, or less, goods and services. As such we have the seeds for inflation. 

• Act II: As inflation begins to permeate through the economy, the central bank recklessly swoops in to “save the day” by tightening monetary policy, usually spurring a recession due to the sentiment shift caused by their hasty action. And of course after a few pulls of the lever, they proclaim victory and announce the “All Clear” taking credit for solving a problem of their own creation. It’s a lot like the way a fishing buddy might push you off the dock, then throw you a life raft, and afterwards he tells everyone he saved your life. 

• Act III: After a thorough round of self-congratulations, the central bank then evaluates the economic pain they inflicted while cosplaying as Superman. This is where they then hastily cut rates and attempt to stimulate the economy in order to prevent the recession from turning into a depression. Unsurprisingly, the central bank is gobsmacked to find inflation resurfaces and because their overly-accommodative whipsaw restriction and stimulation never had a chance to percolate through the economy. This time, however, they are already dealing with recessionary or recently recessionary economic conditions and sentiment, so their ability to be restrictive is curtailed. Thus the second wave of inflation soars. Resolution only comes when the natural market is allowed to progress through the often painful but necessary stages of an economic cycle. 

In modern history, we can reflect on the “Great Gold Grab of 1933”, when FDR ordered the seizure of the private gold holdings of the American people by issuing Executive Order 6102. Yes, that actually happened! (Read more about this here). Less than 10 years later, the US officially entered WWII and the inflation cycle began. Although Americans had their gold unconstitutionally confiscated, at least at that time, the US dollar was still backed by gold, preventing the treasury’s ability to print ad-infinitum. They did, however, have new stores of gold recently taken from American citizens. This allowed them to print excess dollars. They then sold war bonds to un assuming, yet patriotic Americans, completing the money creation cycle. The adjusted monetary base nearly doubled from 1942 to 1945. It should come as no surprise that inflation took hold just as it does every time we see an inorganic increase in the money supply. We can then see the 3-Act performance play out, finally concluding after roughly 15 years in 1955 (See chart below).  

Another prime example of the play and its three acts took place between 1972 and 1987. I will spare dragging Federal Reserve Chair, Arthur Burns, name through the mud as this has been done plenty over the past 40 years. It should be noted though, Arthur Burns was far from the sole culprit behind the events in the 70’s and 80’s. President Richard Nixon's decision to officially end the gold standard for the US dollar, thereby transitioning the dollar to a fiat currency, remains in history as one of the most detrimental economic decisions carried out by any US president. Once again, we saw a situation in which abhorrent policy errors led to an inorganic expansion of the money supply (again, for the sake of funding a war) that in turn spawned one of the most destructive inflationary cycles in history. In fact this particular period was so impactful that it led economists to have to create a new term for an economic condition that was previously thought to be impossible. Due to the confluence of events between 1972 and 1982, the United States economy, not only experienced double digit inflation, but simultaneously experienced an extreme rise in unemployment. Prior to this event, economist almost unanimously agreed that it would be impossible to have hyperinflation and a stagnant job market. Once proven wrong, they were forced to coin the term “Stagflation”, now a common term in our modern day parlance.

These are just two examples of a pattern we can see repeated throughout history. Another extreme example is that of the Weimar republic ushered in by Rudolf Havenstein, the disgraced president of the Reichsbank. 

If history can teach us anything, there is a high likelihood this pattern will once again repeat. If so, it is very likely we are in the second act, somewhere toward the end of intermission, eagerly anticipating the curtain to rise for the start of the third act. This does not inherently mean that we will see recessionary economic conditions, but it is possible. We are currently seeing that inflationary markets do not always lead to recessionary conditions, but in all likelihood, before inflation rates are subdued in a meaningful way for an extended period of time, it is likely that we will need to see some economic contraction. This may come as a result of the incoming administration’s economic decisions, only time will tell. Regardless, we believe that rate hiking is far more probable than rate cutting in 2025.

Please keep in mind, recessions are a statistical and economy-wide phenomena. Recessions do not impact individuals in the same way broad statistical metrics don't impact individuals. Just because a person has a 1 in 15,000 chance of being struck by lightning, does not mean YOU have that probability. If you are careful not to be outside during electrical storms and you choose to live in a location with a low prevalence of heavy storms, the statistics change drastically. Your own circumstances and your ability to adapt and adjust to market conditions will define your success or failure, regardless of whether we are navigating a recessionary economy or expansionary economy. This is where a well designed and prudent financial plan, focusing on the variables within your control will ensure you are able to successfully navigate the variables you cannot control.