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Category: Soap Box

Soapbox: Pass the poisoned chalice

By this time next week, we should know who will be the next chair of the world's leading central bank, the US Federal Reserve....

18 November 2021

Gary Mead

By this time next week, we should know who will be the next chair of the world’s leading central bank, the US Federal Reserve. President Joe Biden said this week in response to a reporter’s question: “Yes, as my grandfather would say, with the grace of God and the goodwill of the neighbors, you’re gonna hear that in about four days”. Will he re-appoint Republican Jerome Powell, who was given the job by President Donald Trump, or will he elevate Fed Governor (and Democratic Party supporter) Lael Brainard to the post?

These two are the front-runners; there is hardly a dollar bill between them in terms of their views on monetary policy. Both have recently been ‘interviewed’ by Biden. Powell, ‘Jay’ to his friends, has been on the Fed board since 2012. Brainard has sat on the Fed board since 2014. Her husband is President Biden’s top adviser on Asia. Powell is the bookies’ odds-on favorite. He took the chair in February 2018, replacing Janet Yellen, who is now Biden’s Treasury secretary. Powell’s term as chair expires in February. By previous standards Biden should have made an announcement by now: Powell was nominated by Trump on 2 November 2017; Janet Yellen was nominated by President Barack Obama on 9 October 2013; Ben Bernanke was nominated by President George W. Bush on 25 October 2005 and re-nominated on 25 August 2009.

Whoever it is will be passed a poisoned chalice. They will inherit an inflation rate running at an annualised 6.2%, the highest in a generation, and threatening to become entrenched. Non-official sources, such as Shadow Statistics, which uses the methodology in place in 1980, suggest that inflation is closer to 14%. High inflation is souring American in consumers’ views. For Biden, the choice of Fed chair is not purely economic; he faces critically important mid-term elections in 2022 and he will want someone who might improve his chances at the ballot box. That will mean the person most likely to be able to steer a course towards greater price stability. It could mean ‘better the devil you know’ – Jerome Powell.

In a conventional world – which is not where we are today – such high inflation ought to dictate a rise in interest rates. The US benchmark interest rate, the federal funds rate, was lowered to 0% in March 2020. In its November statement, the Federal Open Market Committee (FOMC), which sets rates, said it intends to keep the benchmark rate at current rock-bottom levels until inflation averages 2% over the long term. The Fed expects inflation to increase by 3.7% this year as the economy recovers, then drop to 2.2% in 2022. That looks a remote possibility right now.

Mary Daly, president of the San Francisco Fed who also sits on the FOMC, is just one influential voice against interest rate increases. She believes that higher rates now would slow the economy just when it will start to motor, in about a year’s time. The US economy is still some 4.2 million jobs short of the total level of payroll employment before the COVID-19 pandemic. Fed officials are keeping a loose monetary policy for fear the nascent economic recovery will hit the buffers.

Inflation is a global problem

The poisoned chalice for Powell, Brainard, Biden or indeed officials from other countries is that what has seemed transitory might become more permanent. If the inflation is down to supply-chain bottlenecks, there’s bad news for the ‘transitory’ adherents: ocean freight rates, what we pay for goods being shipped, may take more than two years to return to ‘normal’ levels according to those in the industry. And almost 60% of British companies are planning to raise their prices to recover rising supply-chain costs and wages, according to a just published, thrice-yearly outlook by Accenture and IHS Markit.

In the UK, the consumer price index (CPI) in October jumped to an annualised 4.2%, against 3.1% the previous month, and the fastest pace since November 2011. That’s more than double the 2% target set by the Bank of England. Moreover that CPI reading feels inaccurate to many people; the UK cost of electricity, gas and other fuels rose by 23%. The average house price in the UK went up in September by an annualised 11.8%, to a record high of £270,000. In the Eurozone, inflation in October rose at the fastest pace for 13 years.

The curse of inflation is not simply that things cost more. Inflation divides societies. Inflation which becomes uncontrolled breeds anarchy. The poisoned chalice spills its contents.

A monetary phenomenon

The US economist Milton Friedman would not be surprised at where we are today. He once said “inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”. The generous financial supports from governments everywhere during the Covid-19 pandemic are now starting to be felt. In September 2021 money supply growth in the US, i.e. basic M1 currency plus demand deposits, was almost double what it was prior to the pandemic. As economies start to get back on their feet, this money supply explosion has led to some crazy things, such as a stock valuation of would-be electric vehicle maker, Rivian, of $105 billion, zooming past that of Volkswagen, despite Rivian having almost no revenue. Loose money has encouraged greater risk taking and intensified the hunt for yield; it’s also one reason why cryptocurrencies have been so strong. People are generally flush with cash, and they want to spend it, and hope to make a quick buck with it.

Tick the boxes

Yet there are political obstacles to the simple reinstatement of Powell.

For one thing he is, for Democrats and some Republicans, tarnished by having been appointed by Donald Trump. Senator Elizabeth Warren, one of “the nation’s leading progressive voices” according to her website , a forceful Democrat, wants to impose a ‘soak-the-rich’ tax on “fortunes worth over $50 million to generate $2.75 trillion in revenue over ten years – enough to pay for universal child care, student debt relief, and a down payment on a Green New Deal”. Warren called Powell “a dangerous man to head up the Fed” in September and said that she would oppose his re-nomination. She thinks Powell in dangerous because he isn’t tough enough on banking regulation – Warren is still fighting the last war, that of 2008, rather than preparing for the next. Warren’s side of the Democratic Party favours Brainard; she also wants to see tighter bank regulation. But banks and their misdemeanours are not hot button topics right now.

Who will be better?

As gold owners and users, it probably doesn’t matter to us who sits in the Fed chair. Our mild preference should probably be for Brainard, as she is likely to be marginally more dovish when it comes to raising interest rates; she will hold off raising them for as long as possible. Pushing up US interest rates would make the US Dollar relatively stronger and thus damage the gold price.

But Powell, who seems to have the backing of Janet Yellen, has also been remarkably dovish in his handling of monetary policy. In July he told Congress that he didn’t want to raise interest rates “prematurely… One way or the other, we are not going to be going into a period of high inflation for a long period of time, because of course we have tools to address that. But we don’t want to use them in a way that is unnecessary or that interrupts the rebound of the economy”.

Fed officials have already pulled back on one leg of their ultra-easy policy, slowing the large-scale bond purchases they’ve been making for more than a year and a half to keep borrowing costs low and financial markets functioning smoothly. Those same markets are increasingly betting that the next step – rate increases – will kick off by the middle of next year.

Biden has a lot on his plate right now; he will be 79 on 20 November, an age when most people are thinking of pruning flowers rather than pruning a deficit. In December, he has to navigate through an evenly-split Congress, an increase to the limit on the federal debt (now $29 trillion or £15.57 trillion) and also hopes to persuade Congress to approve a $1.75 trillion (£1.30 trillion) spend on expanding the social safety net and climate change issues.

Biden has his own poisoned chalice; should he choose the continuity candidate (Powell) or reward his party faithful and select Brainard? For gold holders and users of gold as an alternative to fiat money it probably makes little difference. What will matter is the moment the Fed starts to push up interest rates. But neither Powell nor Brainard will think about pushing up rates until mid-2022 at the earliest. Which means that crazy stock valuations, higher house prices, more cryptocurrency gains, are likely. Biden probably needs a Fed chair (and will find it easier to get Congressional approval for) a candidate who at least tries to look hawkish; so Powell should be a shoo-in.

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