Inflation: Does a Big Shock Await Us?
Inflation: Does a Big Shock Await Us?
The US government is pumping money and credit into the economy on a mindblowing scale equated with a war-time splurge. The excuse is that it needs to counter the damage done by the pandemic, but the Biden administration views it as an opportunity to pour money into its favoured interests – voters, welfare, public services.
The recovery package it has already forced through Congress was for $1.9 trillion. It’s asking for $3-4 trillion more. Olivier Blanchard, former chief economist of the IMF, says that federal discretionary and automatic fiscal support for the economy amounted to 12.6 per cent of GDP last year and is planned to be another 12.8 per cent this year.
According to his estimates, that is three times as big as the US output gap – the shortfall of actual from potential output due to the pandemic. Reality is that the pandemic has provided an excuse for what politicians like most – spending taxpayers’ money, or simply printing the stuff, without worrying about consequences.
The central bank, the Federal Reserve, is happy to facilitate the process, keeping interest rates ultra-low and continuing to pump $120 billion into bonds every month.
It’s ignoring evidence of a strong economic recovery – economists are raising their expectations to as much as 7 per cent growth for this year. “Signs of market froth are multiplying in an ‘everything rally,’” says the highly respected commentator Mohamed El-Erian. More companies are warning about rising input costs. Employment cost growth is at its highest quarterly rate since 2006.
Economic policy is shifting towards favouring consumer spending. “The resulting surge in demand is coming when companies are dealing with supply chain bottlenecks, higher commodity prices, industrial concentration, pervasive inventory shortfalls and in some cases labour issues. Chip shortages have already shut down some production facilities.”
The looming threat of inflation
Things are looking like a bubble. That could well end with an explosion in inflation. Will it?
The Fed predicts that the coming rise in inflation won’t be serious; that consumer prices will only rise moderately, to an annual rate not much above 2 per cent; that it can be tamed by moderate braking measures when required; and that it’s still far too early to think of tapping the brakes.
Most economists seem to agree, but not all. Larry Summers, the former US Treasury secretary, has warned that there is a risk of a big jump in inflation and the Fed could delay tightening up.
He hasn’t said so, but my view is that the thinking of central bankers has become dominated by fear of deflation; they will almost certainly be unwilling to risk that their actions torpedo economic growth, infuriating the politicians; and that pushing up interest rates could trigger a corporate debt default crisis.
The Fed’s replacement of its traditional “forecast-based” policy framework with the new “outcome-based” approach means the world’s most powerful central bank is committed to having to wait for months of rising inflation before responding, instead of acting in anticipation of an emerging problem, as I have always expected central banks to do.
Summers warns that exploding inflation and late/reluctant tightening up could produce a financial crisis and a deep recession before 2024. {That could well mean Trump’s return to power).
Latest news is that the US economy is already showing higher inflation. The Consumer Price Index soared in April to an annual rate of 4.2 per cent. The month-on-month rise was the sharpest since September 1981. Markets reacted by pushing up inflation expectations, taking the five-year breakeven rate on ten-year Treasury bonds to 2.75 per cent, the highest since May 2006.
Markets are hoping that the US Federal Reserve will continue to delude itself that inflation isn’t going to be a problem, ignore the evidence, and keep interest rates at zero for another year. Perhaps they’ll be right. But if opinion shifts it could come without much warning and deliver a very nasty shock. Michael Levitt suggests in The Credit Strategist that the danger level would be a 2½ per cent on ten-year Treasury bonds. They’re now about 1.7 per cent.
Another surprising piece of American news is that growth in employment is slowing down despite economic recovery. After an increase of 776,000 jobs in March the figure for April was only 266,000. That is despite rising complaints by employers that they can’t get workers. The proportion of job openings in small businesses that couldn’t be filled has risen to a record 44 per cent.
President Joe Biden is obsessed with jobs — claiming his policies are a good thing because they’re creating them. But latest news proves he’s often wrong.
An estimated 42 per cent of unemployed Americans are currently getting more in welfare benefits than they would be in work. There are still some eight million who lost their jobs because of the pandemic who are still out of jobs.
Steve Rattner, who served in the Obama administration, says: “With enhanced benefits, workers… can now make more on unemployment than they did at their jobs.” He compares benefits of $11.23 an hour in Pennsylvania to the minimum wage of $7.25 for a 40-hour working week. Those with jobs such as pre-school teachers, hotel clerks, dishwashers, do better to stay at home and collect their benefits.
Some federal welfare benefits are due to expire in September and many Republican-governed states have announced they will opt out of the federal enhanced unemployment handouts of $300 a week as early as next month.
However the additional welfare programmes introduced during the pandemic are going to be extremely difficult politically for governments everywhere to unwind. Once people get a taste of higher incomes for doing nothing, they are going to protest loudly at the withdrawal of handouts.
Inflation: Does a Big Shock Await Us? taken from our ‘On Target Newsletter’ issue no 267