On Friday this week, the chairman of the US Federal Reserve, Jerome Powell, will address his peers and would-be peers at this year’s economic symposium at Jackson Hole in Wyoming. Rarely have a central banker’s words been more eagerly awaited; rarely will they prove to be more disappointing. Powell needs to decide whether high inflation is ebbing away of its own accord, whether it needs ‘taming’ by higher interest rates – or whether it is now being caused by factors far beyond his or anyone’s control.
If Powell says US interest rates must go higher to combat inflation, now at an annualized 8.5%, the risk is that this makes a recession more odds-on. It is unthinkable that he will act with the determination of a predecessor, Paul Volcker, who got double-digit inflation in the 1980s “under control through the economic equivalent of chemotherapy: he engineered two massive, but brief, recessions, to slash spending and force inflation down. By the end of the 1980s, inflation was ebbing and the economy was booming”. Powell will be hyper-aware that the man who re-affirmed him in his job, President Biden, does not need a recession.
If Powell speaks mildly about inflation then the risk is that everyone relaxes and that wages and prices begin to chase each other, rather like a snake swallowing its tail, and inflation becomes firmly embedded.
At the back of Powell’s mind – of everyone’s mind – is the rapidly approaching date of the US mid-term elections. On Tuesday 8 November, all 435 seats in the House of Representatives and 35 of the 100 seats in the Senate are up for grabs. President Biden currently is disapproved of by more than 54% of the electorate. If Biden and his Democratic Party are to avoid becoming ‘lame ducks’ they need Powell to come up with some good news for the electorate – and fast.
Biden/the Democrats will not face a fresh Presidential election until the end of 2024, but if the Democrats lose their slim Congressional majority in November they will be unable to pass legislation – and Biden’s dream of being a second F.D. Roosevelt will burst.
In the UK, around 160,000 people – all the members of the governing Conservative Party – are about to choose the country’s next Prime Minister, following the resignation of Boris Johnson in early July. Whoever that person might be, they will lead the country for perhaps more than two years – the next general election is scheduled to be hold no later than 24 February 2025. These two years could be the most testing in decades, as a horrible level of inflation stimulates public sector worker pay demands that the government won’t be able to finance out of revenues.
Surging prices, and the success or failure to control them, will likely determine voter choices in both countries within two years. With inflation in both countries at a 40-year high, political leaders and their central bankers face huge difficulties. They desperately want to move on – if circumstances allow.
Adjusting the inflation target?
At Jackson Hole last year, Powell said that inflation was “likely to prove temporary”. At the time some of us gasped in shock – how could the policy of quantitative easing (which saw the central banks of the Eurozone, Japan, the UK and the US collectively expand their balance sheets by more than $11 trillion since the start of 2020) and the massive cash give-aways to keep economies on the road during Covid-19 translate into transitory price rises? “The stimulus payments which helped employers keep staff on also allowed consumers to shore up their savings”. US households on average have twice as much cash ready to hand as they did at the end of 2019; that’s playing its part in the inflation gallop. Powell and his peers either ignored or forgot Milton Freidman’s dictum that “inflation is always and everywhere a monetary phenomenon”, the result of governments expanding the money supply too enthusiastically.
We should remind ourselves of something that today looks absurd – the UK, the US, and the European Central Bank all aim to get inflation of around 2% a year. The Bank of England (BoE) now forecasts that inflation will peak above 13% in the final quarter of 2022, and still be above 9% in the third quarter of 2023. Little wonder that UK workers in all kinds of fields are now taking sporadic strike action. They watch their declining real (inflation-adjusted) wages rapidly decline while simultaneously noting that the likely cost of bailing-out the (failed) energy retailer Bulb may cost them more than £4 billion ($4.71 billion).
Independent analysts are forecasting still higher inflation for the UK – Citi has this week projected inflation will hit 18.6% in January 2023, the highest in almost 50 years. This could be worse – in Argentina expectations are that inflation will be higher than 90% over the course of this year, while in Turkey it is already 80%/year.
Powell is no Volcker: he will not raise US interest rates above the inflation level, there is too much at stake to risk a deeper recession. Rather he may well move the goalposts: instead of trying to pin annual inflation to around 2% we may have to get used to a fresh ‘target’, around 4%. Hitting that higher target would be easier.
Powell also must struggle to make sense of apparently contradictory information about US consumer behaviour. On one hand Americans are clearly anxious about the economy; “consumers are more gloomy now than they were during the worst of the Covid-19 pandemic, the global financial crisis or any other moment since…1952”. Yet while they are getting less for their Dollars “they are still spending them”. Halting high inflation will become more painful the longer it endures – and it’s going to last through 2023 for Brits.
Larry Summers, a former US Treasury Secretary, has said that “we need five years of unemployment above 5% to contain inflation… or one year of 10% unemployment”. Wages have recovered in the US since their calamitous Covid-19 drop. Unemployment levels are the lowest since 1969 in the US.
US real hourly wages by industry: % change since January 2020
Summers’ prescription to get inflation under control is harsh, but perhaps inflation’s appearance of slowing in the US (if not the UK or the European Union) is deceptive.
Europe is particularly vulnerable, with 40% of its natural gas and 25% of its crude oil coming from Russia last year. The International Energy Agency (IEA) said in July that the squeeze on energy supplies may have only just started and this is “affecting the entire world”. Russia has just ruled out any possibility of a diplomatic solution in its war with Ukraine; “the world has changed” Gennady Gatilov, Russia’s permanent representative to the United Nations in Geneva, told the Financial Times.
The management consultants McKinsey called their latest research into US consumer behaviour “The Great Uncertainty”. Powell faces his own ‘great uncertainty’ at Jackson Hole; British consumers are shortly going to face a great certainty, the certainty of energy bills rising even more. The US Dollar and Pound Sterling have lost around 80% of their purchasing power in the years since the last energy crisis, brought about by the oil export embargo of 1973, when gold then fetched around $106/ounce. Since then gold has risen by more than 1,500%. Gold is security; Glint its key.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.
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