It’s not news that the latest inflation data are disastrous.  Even if they won’t last, as Mr. Powell again assured Congress, it sure is hard to see how the combination of pressures detailed in the inflation data lead to ta rate even close to the FOMC’s median projection for 2022 of 2.6 percent.  This means that real rates will remain negative throughout 2022 and well into 2023.  Indeed, given that the FOMC’s median projection for the near-term fed funds rate never gets above 2.1 percent, even the Fed has tacitly conceded that negative real rates may well be  prolonged absent either divine intervention or another devilishly-deep recession.  In June of last year, I predicted that U.S. inflation would not prove transitory and forecast the political impact finally understood at the highest levels of the Biden White House.  Much is also now being written about the inequality impact I described last year, but little is said about the sum total impact of these sorry facts of life on the financial system.  These may also prove anything but transitory.

The first financial-system impact of high inflation and slow growth for anything but the S&P is both political and structural.  With his back increasingly pushed to the wall by inflation’s toxic equality impact, Mr. Biden defended himself against the latest CPI numbers by arguing that many of them are due to monopolistic price controls best cured by rapid antitrust initiatives such as the one already launched against the meat industry.

Other than an oblique reference by Sen. Warren, tough talk about high prices hasn’t yet turned to finance, but prices are upper-most in at least one financial regulator’s mind.  CFPB Director Chopra targeted what he called “exploitative” pricing when he promised to reform overdraft fees, also arguing that big banks have undue market power by virtue of their control over the cost of mortgages and credit cards and the return consumers receive on savings accounts.  Given the vital importance of all of these products and the obvious animus the Biden Administration has to big-bank consolidation, it’s likely that pricing will prove at least as critical a deal-decider as the usual measures of market concentration.

If policy-makers fail to understand the complexity of deposit and loan pricing, especially when judging the regulated-banking sector, then they might concur with Mr. Chopra and short-circuit all but the smallest bank M&A.  However, if they do so on what are likely to be mistaken premises, then merger policy will make it even harder for regulated banks to achieve the economies of scope and scale essential to curbing the real direct and — vital — indirect price-setters:  tech-platform companies.

The second structural impact of continuing high inflation also requires an understanding of how many deposit, lending, and payment services are quickly zooming outside the regulatory perimeter.  Paul Volcker radically raised interest rates in the 1980s to curb inflation, reducing the real cost of holding deposits at a bank.  Now, with inflation at seven percent and savings rates at 0.06 percent, the real return to the average depositor is -6.94 percent.

In the 1980s, depositors largely had to grimace and bear it; the only competitors to bank deposits then were money-market funds, which grew exponentially at the time but were still only a partial deposit substitute.  Now, MMFs and open-end funds are viewed by large investors as cash-equivalent, a perception validated by the Fed’s rescue of the sector in 2008 and again in 2020.  The SEC’s  reform proposals may dim a bit of the cash-equivalent luster of prime institutional funds, but the sector is a powerful alternative.  Indeed, because of capital pressures, even banks are refusing deposits and sending them over the transom to MMFs in their asset-management divisions.

And, if you can’t afford or don’t want investment funds, there’s always cryptoassets.  As I noted in another op-ed last fall, the fact that minority households disproportionately invest in cryptoassets speaks not only to their distrust of established financial institutions, but also to a desperate search for ways to put small dollars to better use at a time when every cent counts.

An era of negative real rates and market choices has thus turned depositors into investors or speculators and who can blame them.  However, this transformation cuts the vital cord that ensures through-the-cycle financial intermediation and, thereby, stable growth founded on capital formation.  The Fed’s recent financial-stability report and  FSOC’s annual summation   fail to factor inflation  into their assessment of a financial system founded on asset prices born of the yield-chasing driven in turn by negative real rates.  Indeed, not only is little said, but less appears likely to be done.

This sows dangerous seeds not only for financial stability, but also macroeconomic growth and economic equality.  If you don’t like the political consequences of inflation now, just wait.