Central banks’ excessive currency warnings are getting louder. This time, the insurgency came from America’s New Keynesian elite.
That’s the problem. It suggests that the Federal Reserve may be closer to a happier “policy axis” than the market thinks. By the time investors recognize the signs of any such Fed investment, there will be a major bear-trap rally in the assessed global stock markets – at least until The bulls are affected by the upcoming profit deflation.
Fed tightening rounds are often brutal for the rest of the world. This one is particularly aggressive. The broad dollar index is at epic highs, meaning slow torture for emerging and frontier markets with $4.2 trillion in debt in dollars. There is $13.4 trillion in foreign debt in dollars outside of US jurisdiction (BIS data) with no apparent lender. South Korea had to approach the Fed for dollar swap lines.
Borrowers are being hit by the double shock of both a higher dollar and a sharp rise in dollar lending rates. Some of this debt has to be transferred on the three-month loan market, with an increased risk premium for good measure.
Not only the Fed is rushing through jumbo increases by 75 points per meeting, it is also draining global dollar liquidity with $95 billion per month of quantitative tightening (QT). It has never done the two together before. And it doesn’t understand how QE/QT actually works, as Ben Bernanke’s confession, Nobel Prize winners as of yesterday.
Its model assumes that QT is slightly less than ambient noise. The San Francisco Fed said a $2.5 trillion drop in its balance sheet equates to a rate increase of just 50 points. Bond traders think the authors must be living on another planet.
Monetarists have been warning for months that The Fed model misunderstands the validity of QT. They were screaming from the rooftops that key measures of the money supply were collapsing on both sides of the Atlantic. They fear that the world will fall into a terrible slump unless central banks cool down soon.
It goes without saying that the policy establishment will never listen to the monetarists, who make their olympian (and unfair) platitudes funny. The New Keynesians worshiped the Dynamic Stochastic General Equilibrium model. But the facility will listen for their own type.
Maurice obsfeld, a former chief economist at the International Monetary Fund, said central banks are on a mission to salvage lost credibility. They are in danger of being exposed due to the fault of money was too loose eighteen months ago for the opposite mistake of too tight money today. “The danger now is that they have gone too far and pushed the world economy into an unnecessarily harsh contraction,” he said.
“Just as central banks misinterpret the factors driving inflation in 2021, they may be underestimating how quickly inflation could fall as their economies slow. By simultaneously moving in the same direction, they risk reinforcing each other’s policy effects without taking into account that feedback loop. The highly globalized nature of today’s world economy increases the risk,” he said.
The message was delivered Monday by Lael Brainard, the Fed’s vice president and chief intellectual, that synchronized tightening is “greater than the sum of its parts,” and that it increases the risk of blowback. into the US economy. it’s him. Similar warnings have been issued from the US Treasury Department.
Ben Bernanke flagged the dangers of a strong dollar and capital outflows from emerging markets yesterday. Without naming the UK gilding market, he said financial stress in the international system are building and posing a threat. “We really have to pay close attention,” he said.
Lael Brainard said that the lagging impact of past rate hikes is yet to be felt and the US economy may be slowing faster than expected. This change in tone is significant. If markets have yet to lower the Fed’s “final rate” for this cycle, they probably should.
Professor Obsfeld, now with Berkeley and the Peterson Institute, told me there was a conceptual error at the heart of central bank policy this year. They misunderstood the Phillips Curve – crudely, the trade-off between inflation and unemployment.
They assume that the curve is “flat” and so it will be subject to massive monetary penalties, severe recessions, and workforce purges to bring inflation back – once the god of inflation has been eliminated. cancel. But the curve may have stretched longer than they realized. In that case, the whole assumption about the underlying policy of the Fed and the European Central Bank is wrong.
He took special issue with comments by Isabel Schnabel, Germany’s member of the ECB’s executive board, who said that central banks must be tougher this cycle because they cannot control the level of projections. room in the global economy – the so-called global slack hypothesis.
“She is saying that everyone has to hit the brakes harder, and everyone does it at the same time. It is a non sequitur. Central banks should be less zealous,” he said.
Former Fed economist Claudia Sahm – known for the Sahm Rule, an early warning indicator for recessions – has run a campaign trying to stop her former Alma Mater from pushing the world. world into a crisis.
Importantly, the New Keynesian senior priest, economist Paul Krugman, has joined the critics in recent weeks. He focused on the Beveridge Curve, named after the British economist William Beveridge, the father of the welfare state.
This sets out the relationship between inflation and job supply (JOLTS in the US). Earlier this year, the number of vacancies for unfilled jobs reached a staggering 12 million, double the number of clear job seekers. This is high inflation according to the standard Beveridge rule.
But a miracle is starting to happen. The JOLTS figure plummeted in August and has fallen by almost two million since March. This suggests that the data has been distorted by the strange effects of Covid and that the inflationary impulse is rapidly fading. .
“Until recently, it seemed like restoring the pre-pandemic vacancy would really require something like a 5pc unemployment rate. In fact, more than 40pc of the excess vacancies have clearly disappeared over the past few months, with no significant increase in unemployment,” said Professor Krugman.
Five-year inflation expectations – as measured by the 5-year / 5-year forward rate – are actually lower today than they were at the 2018 peak. Wage growth was only modestly higher.
This is not the same as the Great Inflation of the 1970s. That episode built over a decade: this was a one-time price shock caused by Covid. Globalization and the China Effect are acting as counterweights to deflation. The world capital markets are integrated, digital and truly aging.
Fed Chairman Jay Powell famously wanted to be the Paul Volcker of our time, not the discredited Arthur Burns of the 1970s. Perhaps the risk that worries him more is the future of being Eugene Meyer, the money man. responsible for presiding over the collapse of the international financial system from 1930 to 1933.
It’s time to switch gears, Mr. Chairman.
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