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Category: Soap Box

Soapbox: In a hole

Jackson Hole, in the state of Wyoming, has the only US airport sitting entirely inside a national park. It was the first state in the country to allow...

26 August 2021

Gary Mead

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Jackson Hole, in the state of Wyoming, has the only US airport sitting entirely inside a national park. It was the first state in the country to allow women the right to vote, serve on juries, and hold public office – which is why Wyoming is also known as the ‘Equality State’.

But Jackson Hole is today probably better known for hosting an annual symposium of economists and central bankers, who normally deliver speeches and papers on such things as ‘Maintaining Stability in a Changing Financial System’ (in 2008), or this year on ‘Macroeconomic Policy in an Uneven Economy’. ‘Uneven economy’; a huge understatement today.

Few central bankers will be jetting into Jackson Hole airport for this year’s meeting, scheduled for Friday and Saturday this week, however. An uptick in US Covid-19 cases means that the event will now be virtual, says the symposium’s sponsor, the Federal Reserve Bank of Kansas City. The big dog of the proceedings is always the chairman of the US Federal Reserve, currently Jerome Powell. What he has to say on 27 August will be closely watched by financial markets around the globe.

Powell is sitting in a hole from which there is no easy escape. Rock-bottom interest rates in the US and quantitative easing by the US Fed (to the tune of $120 billion a month) and the vast stimulus programmes from US President Biden has meant there are trillions of extra Dollars sloshing around, which has helped push up prices of all kinds of assets – stocks, houses, cryptocurrencies… even Beanie Babies.

We all know why the Fed supervised the biggest explosion in money supply since at least the Second World War. It’s because it tries to steer between the Scylla and Charybdis of the economy – between ensuring ‘full employment’ and price stability.

Forty-four years after that dual-track policy was mandated by the US Congress it’s starting to look like trying to have your cake and eat it.

Too much cake

Too many contradictory cakes are causing Powell a touch of dyspepsia.
On the one hand he is confronting that fact that job vacancies in the US are not being filled; vacancies rose to more than 10 million in June, well above expectations. And while the unemployment rate fell in July by 0.5%, to 5.4%, 8.7 million people remain unemployed, far more than the pre-pandemic 5.7 million in February 2020. In the first quarter of 2021, the US economy bounced back faster than expected; but the 2nd quarter’s annualised rate of 6.5% growth was some 2% less than expected. For a variety of reasons, people are not flowing back to work as expected – or desired. Complicating matters are the various COVID variants, which is making a return to economic ‘normality’ very bumpy.

And prices are hardly stable. The US consumer price index (CPI) was at a 13-year high in July, the same as in June. US whole price inflation in July rose sharply for the sixth successive month to 7.8%. Maybe these will slow in coming months – and maybe they won’t. Jeremy Siegel, professor of finance at the Wharton School of Pennsylvania, said in May this year that he expects “over the next two, three years we could easily have 20% inflation” thanks to the expansion of money supply rising by almost 30% since the start of this year. “That money is going to find its way into spending and higher prices…The unprecedented monetary expansion, the unprecedented fiscal support… was first going to flow into the financial markets, into the stock market, and then once we’re reopening, and we’re right at that cusp, it was going to explode into inflation”.

But for every Siegel you can find a Powell, telling us the inflation is ‘transitory’.

Tapering in the spotlight

The US Fed has bought trillions of Dollar assets during the pandemic, equivalent to 18% of US Gross Domestic Product (GDP). Its total balance sheet is now more than $8 trillion.

This Quantitative Easing (QE) certainly helped the US economy weather the pandemic storm but has also distorted all markets; easier financial conditions have led to higher asset prices, booming stock prices (often disconnected to companies’ underlying positions), and less credit discipline. ‘Zombie’ companies – those with low earnings and high debts – have survived thanks to QE and subsequent low interest rates. The number of ultra-high net worth individuals (defined as those with investable assets worth more than $30 million) rose by 24% in 2020, the fastest rate of increase since 2003.

At Jackson Hole, Jerome Powell will be unable to be frank. He will shrug off the threats of inflation; he won’t be able to talk about the threat of a balance sheet recession; he will avoid talking about (except in very guarded terms) the most serious problem of all – how and when to bring to an end the massive QE programme.

But markets will turn sour whenever he signals that the Fed will start “tapering” its QE; volatility would rise as investors desperately shed risky assets and hunt for yield. Tapering QE and starting to raise interest rates would kill off what Ben Bernanke, a predecessor of Powell as Fed chairman, memorably called in 1996 the “irrational exuberance” of the markets. The US Dollar would strengthen, making US exports less competitive (and probably causing the Dollar/gold price to weaken) and would risk pushing the US into recession.

As the Financial Time’s John Plender has written: “The difficulty is that central banks cannot take away the punch bowl and raise [interest] rates without undermining weak balance sheets and taking a wrecking ball to the economy.

The temptation for policymakers is to muddle on and perpetuate the boom, bust and bailout cycle. That way ultimately lies the balance sheet recession — a downturn caused by debt burdens — to end all recessions”.

I expect Powell to do exactly what Plender suggests – muddle on and hope that things improve, that more Americans get vaccinated and start returning to work, and that the US economy starts growing again more solidly. He is likely to go down in history as “Mr Muddle On”. The merry-go-round must end – or spin off out of control.

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