Hard Landing Ahead
Birds in the trees. Green, green grass. Wisteria cascading over the doorway. We’re glad to be back in our Irish cottage.
But stalking the emerald isle is the same menace that dogs the rest of the world. The Irish Times reports: ‘Irish inflation soared to 6.9% in March, EU says’:
‘Annual inflation in Ireland soared to 6.9 per cent in March, according to Eurostat, the statistical office of the European Union. The EU inflation measure differs slightly from the CSO’s consumer price index, but the two track each other very closely
‘By way of comparison, Eurostat’s estimate for Irish inflation was 5.7 per cent in February, and just 0.1 per cent in March 2021.’
All over the planet, prices are rising. Because all over the world, central banks followed the same recipe and baked the same cake. Lots of sugary free money. Loads of leavening. And each time investors began to feel sick — 2008, 2020 — they dumped in more Jim Beam and methamphetamine.
Ireland uses the euro. And euroland inflation is running at 7.5%…not far beyond dollarland inflation above 8%. In Turkey, inflation has reached 67%.
All over the world, too — except Japan — central banks say they’ve taken the pledge: no more inflationary monetary policies.
Last week, the Fed announced a rate increase of 50 basis points (0.5%).
The Australian central bank raised its key rate last week as well. The Russian central bank lends at 17%. And, naturally, Argentina is ahead of the curve…with a 60% lending rate.
So far, the European Central Bank has dragged its feet. But it, too, is expected to go on the wagon, with a ‘tightening cycle’, soon.
Does this signal the end of inflation? Have central bankers learned their lesson…thrown out the old Keynesian cookbook…and with their right hands solemnly laid on a copy of Ludwig von Mises’ opus, Human Action, vowed never again to do anything so stupid?
The Fed’s 0.5% rate increase brings the Fed Funds rate to a real level of around MINUS 7.5%. Even with yesterday’s rise, the ‘risk-free’ 10-year Treasury bond yields MINUS 5% or so. Can you really rescue a man from drowning at the bottom of a pool by pulling him up a few inches? Can you really stop inflation when you’re lending money at negative interest rates? Not likely.
Investors realised immediately that the Fed was only pretending to be ‘hawkish’. From Barron’s:
‘The stock market ripped higher Wednesday afternoon after the Federal Reserve delivered on its plan to fight inflation. The central bank hiked interest rates by a half-percentage point and started reducing the size of its balance sheet, which has ballooned during the pandemic.
‘The Dow Jones Industrial Average gained 932 points, or 2.8%, after the announcement. The S&P 500 rose 3%, while the Nasdaq Composite added 3.2%.
‘[Bond yields] dropped after the Fed signaled it wasn’t about to become even more aggressive in tightening monetary policy. The 2-year yield fell to 2.64% Wednesday afternoon, and the 10-year yield dropped to 2.92%.’
But what now? Is the inflation threat history? Is pilot Jerome Powell bringing the US economy in for a landing so soft the passengers don’t even know they’re back on the ground?
It would be one for the record books.
Meanwhile, back on Earth…
The problem is a familiar one — the wrong metaphor. A skilful pilot can pull back on the throttle, adjust his wings, raise the nose slightly…and set a plane down softly, even in a storm.
But no amount of mechanical skill keeps a man from getting what he’s got coming. The best weatherman on Earth can’t stop the wintry winds. And when the PhDs at the Fed go out for lunch, the waiter still brings the bill, no matter what their ‘dynamic stochastic’ models tell them.
The US economy has US$88 trillion in debt. The Fed turned the interest rate knob into negative territory; people took advantage of the opportunity to borrow at below-inflation rates.
And now, down on Earth…where the Fed says it intends to land…even a modest increase in interest rates could have catastrophic results. Just three percentage points, for example, would add more than US$1 trillion in interest charges for the federal government alone…and US$2.5 trillion more in total interest costs to the economy as a whole, an amount equal to nearly 100% of all US corporate profits.
Where would that money come from?
What would stocks and bonds be worth then?
And how about houses? Imagine mortgage rates at 10%. How many people could refinance their homes? How many houses would suddenly be on the market? What will happen to house prices — where most families hold most of their wealth — when mortgage rates are back to ‘normal’?
And what about all that inflation already ‘in the pipeline’? Energy, raw materials, rare metals — sooner or later, the ‘inputs’ must be passed along to final consumers. How can the Fed prevent it? What dial do they turn? What lever do they pull?
We don’t know, but if Jerome Powell can pull this off, maybe he can broker a peace deal in the Ukraine, so that the two sides walk away with no hard feelings?
And maybe he can walk across the Potomac…and receive his Nobel Prize from God Himself?
For The Daily Reckoning Australia