It was a particularly gloomy September, but when sentiment turns this sour, it starts to feel overdone. Investors are asking, when will it ever end? First Covid, and now this?
As the weather turns chilly, I’ve been thinking back to my (long ago) figure skating days. One of the most basic elementary moves on the ice is called a change of edge. You begin to trace a circle with one edge of a double blade, and then while on the same foot shift to the other edge to trace a new circle in the opposite direction. At the moment of the change of edge, the skater is straight and motionless-it’s all about balance. Has the global economy reached that moment? The risk of course is that we don’t head in a new direction, but take a nasty fall.
Since we all know the reasons behind the current pessimism, what are the possible events that could turn things around?
- Something breaks, and the Fed sees that it has gone too far and slows or reverses course. A chorus of economists including Paul Krugman and Claudia Sahm have warned against the speed if not the direction of their response. Their basic argument is that inflation was not caused by monetary policy, and therefore cannot be eradicated through interest rates. A pivot in my view is a highly like event.
The question is, how soon? Jay Powell might be attempting to emulate Paul Volcker, but in today’s environment of interdependent financial systems and much higher overall debt post-pandemic, a Volker-like response is unwise if not catastrophic, and could trigger a global financial crisis. Focusing on US price levels and employment in this instance of inflation is misguided; Covid has tainted these lagging indicators. Money supply however, has leveled off in 2022 signaling a possible economic slowdown.
- Data is revised or is suddenly more favorable and the Fed puts on the brakes. Again, this will happen sooner or later, the question is merely when, and why.
- Politics wins. People and enterprises have already been through so much because of Covid that it is hard for bureaucrats to ask them to go through another round of hardship. This is what is happening in Europe with energy prices, while the Fed is hoping to create higher unemployment in the US. Political opposition is going to swell dramatically this winter. As Robert Madsen, my colleague at Hale Strategic has said, the desire for a return to normalcy and the status quo is a powerful force. Underlining this point, seventeen US states have already put inflation support policies in place, which are simulative.
- China roars back. It is now the slowest growing economy in Asia, but once it is unshackled by the end of Covid quarantines and its 5-year political cycle, Chinese economic growth could rebound. Other Asian economies are already in full recovery mode according to a new report by the IMF. As a a result of the Asian Financial Crisis, most have healthy forex reserves. Major assumption: China will be able to handle its current debt as well as currency issues and restructuring of its property sector. Based on past performance, there is more than a 50/50 chance this scenario will play out. Hong Kong will remove all restrictions for international travelers this month. More will follow.
- The war in Ukraine ends and Europe revives. This scenario gives me the most hesitation. A year ago I would have thought this war was totally impossible. But it will end eventually, and will be followed by a Marshall Plan, preferably led this time by Germany rather than the United States. A rebound in economic growth will occur.
My conclusion is that I don’t believe that the Federal Reserve will be able to continue at its current pace, and that a pivot might happen a lot faster than is expected. Markets were more buoyant on Monday, but we have become inurred to volatility so I don’t think this one-day uptick supports my thesis- yet. My point is that we should be prepared not only for negative outcomes, but for positive surprises.
Skaters use the momentum of edges to launch either a jump or a spin. Hopefully the world will land a perfect jump rather than enter a death spiral.
Japan, ever the exception and a monetary tightening holdout, has been left out of this letter, but here too the prospects for revival are good. EconVue will be hosting a panel discussion on the Japanese economy later this month with Richard Katz, John Greenwood and others, TBA.
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Monetary Policy & Inflation
September 29, 2022 / New York Times
OP-ED
Is the Fed Breaking Too Hard?
Paul Krugman
Do we know for sure that the Fed is braking too hard? No. The current economic situation is full of uncertainty, and any policy decision involves making trade-offs among various risks. What we can say is that the risk that the Fed is moving too slowly to contain inflation has declined, while the risk that high interest rates will cause severe economic damage has gone up — a lot.
September 30, 2022 / Federal Reserve
SPEECH
Global Financial Stability Considerations for Monetary Policy in a High-Inflation Environment
Vice Chair Lael Brainard at “Financial Stability Considerations for Monetary Policy,” a research conference organized by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, New York, New York
September 27, 2022 / Financial Times
OPINION
Central banks have prepared a recipe for monetary overkill and liquidity crises
John Plender
While bankers are keen not to repeat 1970s mistakes, the financial environment and debt burdens are different now.
September 7, 2022 / Financial Times
OPINION
Letter: A low and stable expansion in the money supply is the key
Tim Congdon
Low and stable, but always positive, growth of the quantity of money is the ideal.
September 11, 2022 / Brookings Institute
ARTICLE
5 key takeaways on inflation from the August CPI report
Chris Miller
Headline inflation is better, but core is concerning.
September 21, 2022 / CNBC
ARTICLE
Mike Winters
Hard for the Fed to compete with this.
Global Views
September 20, 2022 / Peterson Institute for International Economics
VIDEO
Speech by Counselor to the US Treasury Secretary Brent Neiman
Cross-border debt, sovereign debt restructuring, and recent challenges for the global financial infrastructure.
September 12, 2022 / Cato Institute
BOOK FORUM
The Story of Population Growth, Innovation, and Human Flourishing on an Infinitely Bountiful Planet
September 2022 / KPMG
Anton Ruddenklau
The optimism that permeated the fintech market at the end of 2021 quickly transformed into concerns about a potential recession in H1’22 as uncertainties related to the Russia Ukraine conflict, ongoing supply chain challenges, and rising inflation and interest rates took their toll on public and private companies alike.
September 5, 2022 / Caixin Global
Local Government Overreach Is Undermining China’s Economic Recovery
Recently, China’s State Council undertook its ninth accountability inspection, exposing multiple influential cases, including a widely publicized one in which local authorities in Yulin, Shaanxi province, fined a grocer 66,000 yuan ($9,564) for selling 2.5 kilograms (5.5 pounds) of substandard celery.
September 4, 2022 / Daniel Lacalle Blog
Europe’s Energy Crisis Was Created by Political Interventionism
An energy policy that bans investment in some technologies based on ideological views and ignores security of supply is doomed to a strepitous failure.
September 28, 2022 / Financial Times
Bank of England launches £65bn move to calm markets
Chris Giles, Emma Dunkley, George Parker, Owen Walker, Peter Foster, Josephine Cumbo, Jim Pickard and Harriet Agnew
They will all crumble sooner than you think.
