A far greater pain beyond our borders
It's not time to talk about "turning the corner on inflation." Even when it is time in the United States, it will have likely come with substantial human cost around the world.
Source: Getty Images.
I respect Jay Powell for talking about the pain the Fed will cause:
While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
It had to be hard for him to publicly admit. Fed Chairs don’t ever go there; hiding behind the “softer labor market conditions” is more comfortable. Powell did not hide. Lowering inflation at home is necessary. But there’s more he did not say. It will also come with “far greater pain” outside our country.
The 75ers
Jackson Hole was tough talk. Until inflation comes down convincingly, the Fed will keep rates high, recession or not. When even the doves have talons out, it’s real. The Fed is data-driven, which is good, but it takes excruciatingly long to get future data.
The FOMC will decide on 50 or 75 basis points more in three weeks. Another soft-ish Consumer Price Index for core inflation, especially in services, gets you 50, not 75. But even 50 is a lot. The Fed has already blasted the federal funds rate from 0% to 2.25% in four months: 25 in March, 50 in May, 75 in June, and 75 in July. One must go back to the early 1980s to find a faster pace.
The ‘Man behind the Curtain’ saying the Fed is the inflation fighter knows it’s not true, especially not now. Our inflation will break, and it will take more victims than U.S. workers and small businesses. The global community will be one too.
Winter is coming
Our prices at the pump soared this year after Russian invaded Ukraine. Our electricity bills climbed. That’s hard for many Americans; for some, it’s very hard. Europe faces massively higher prices and even shortages. Europe basically imposed an embargo on themselves and is not caving as Russia cuts off more. Businesses and families there are making sacrifices, even in countries not as directly hurt by the energy shortages.
As prices skyrocket and shortages loom, big multinationals are, to an extent, putting people ahead of profits. For example, in Germany, large manufacturers, which are the engine of their economy, are substantially reducing the use of natural gas:
Right now, those cutbacks are ‘voluntary’, and many made them kicking and screaming. But it is happening. (Read Ben Moll’s thread for other examples.) More will be necessary, especially if the winter is a cold one. It is also worth noting that European governments expect the most from businesses and are trying to protect families from the blow with many different forms of relief. Imagine that.
What does all this mean for the European economy? A recession. Here’s a simple illustration: if a manufacturer uses less energy, it almost always manufactures less. If it has less to sell, then it makes less money. By the way, that’s not usually not good for the bottom line or meeting payroll. And it’s happening across sectors and regions. That’s a recession. The only question now is how severe a recession it will be.
Who benefits from Europe going into recession? We do. The United States, as the largest economy in the world, the largest producer of oil and natural gas, and with one of the strongest recoveries, should be able to weather the storm in Europe. Their hardship will sharply lower their demand and help bring our inflation down.
Germans are extremely fortunate that other European countries are not ‘getting even’ for the economic austerity they pushed, especially after the Great Financial Crisis and for electing Gerhard Schröder.
Humanity first. Europe is making sacrifices for democracy in Ukraine and the people of Ukraine, who are making the ultimate sacrifice now. One must go further back than the 1970s to see which lessons they learned.
Zero tolerance
Covid remains among us and is killing people every day. Leaders in China admit the danger. Yes, the Zero Covid policy in China with mass lockdowns has political motivations too, and it is causing hardships for people. It’s also saving lives in a country lacking an effective vaccine, with 1.4 billion people, and especially low vaccination rates among the elderly.
As with Europe, China’s government is pursuing policies that will necessarily harm their economy. They don’t need a recession. But they may get one. What they decided they need is to save lives from Covid unconditionally. The United States has repeatedly refused to make such sacrifices. But, hey, we get the new iPhone.
Yes, the lockdowns and production stoppages in China will reduce the available goods for us to buy. But remember, inflation comes down with more supply and/or less demand. We are not the only ones who buy electronics and cars. If demand in the European Union, the second-largest economy, China, the third-largest, and others slows dramatically, that’s less competition for goods and less inflation for us.
Now it’s not all good news for us. It could be too much for the U.S. economy to weather a severe recession in Europe and very slow growth in China without a recession here. But the United States is the largest economy and is more self-sufficient than most. Of course, anything is possible now.
Let them eat cake
Starvation. The war in Europe and the Fed fighting inflation have consequences for countries with no seats at the powerful table. That’s especially true for developing countries that import their food and, especially, those that have tied the currency to the U.S. dollar. That commitment to the dollar comes from years of ‘encouragement’ by foreign investors, multinationals, and policymakers in the United States.
The war in Ukraine—involving two of the world’s largest wheat exporters—sent grain prices through the roof. People who live in poor countries that could hardly afford food imports before the invasion of Ukraine are now in grave danger of starvation.
What does that have to do with fighting inflation in the United States? We are the world’s largest net exporter of food. And how is this our fault?
It’s the dollar.
With every increase in the federal funds rate, the U.S. dollar rises in value relative to other currencies. It has risen a lot this year. In addition to the cost of food imports, a strong dollar is crushing for poorer countries that must make their debt obligations in dollars. Inflation and shortages and debt and starvation.
We benefit. The stronger dollar pushes down our inflation. Imports are cheaper now for us from basically everywhere. Usually, the “pass-through” of import prices to the overall CPI is considered small. But import prices are falling markedly—both with the stronger dollar and easing supply chain disruptions—and will show up to some degree. Moreover, new research from the New York Fed by Mary Amiti, Sebastian Heise, Fatih Karahan, and Ayşegül Şahin suggests that the import price “pass-through” in the United States has been larger since the pandemic began.
Wrapping up
While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.
Tell that to the world.
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When the $ rises as fast as it has done over the past 12-months the history is clear: bad things happen--financial crisis, asset meltdowns, economic hardship and recession. Some call it the dollar wrecking ball--they are not wrong
Let’s cross our fingers that the higher interest rates and strong dollar don’t produce another “lost decade” like the’80s for emerging markets