... Let’s jump to Zoltan’s conclusion.
As a quick aside, when I was struggling with accounting classes in college, I’d go to my father for help. Dad was a CPA. He always took me to the conclusion first with the belief that if I understood where we are going, I’d be able to better see the pieces come together on our way to the conclusion. Kind of like the WAZE app on your phone, plug in the destination, look at the full map, and then press go and follow the turns step by step to get to your destination. So, let’s get to the conclusion, and see if we can find our way back to it.
With a hat tip to my old man, the following is Zoltan’s conclusion (bold emphasis mine):
- Zoltan believes inflation is going to be with us for some time.
- Figuring out where inflation goes from here is basically a matter of perspective: do you see inflation as cyclical (a messy re-opening after Covid, exacerbated by excessive stimulus) or structural (a messy transition to a multipolar world order, where two great powers are challenging the might and hegemony of the U.S.). If it’s the former, inflation has peaked. If it’s the latter, inflation has barely started, and could actually be understood as an outright instrument of war, for, as Lenin said, “the best way to destabilize the capitalist system [is] to debauch the currency.
- It’s time to think outside the box and to appreciate the pattern: the Fed went from transitory to not transitory; no hikes to hikes; hikes to a string of rate hikes; a string of 25 bps to a string of 50 bps; a string of 50 bps to a string of 75 bps; a string of 75 bps with forward guidance to the same without any comments…
- Bill Dudley and Larry Summers are having a Volcker moment in a “spot” sense, but they are not in charge, and they don’t have to navigate the political aspects of interest rate hikes. Jay Powell has too, and that is why he is moving slower. But moving he is, and he is quietly having his Volcker moment in a rolling, “forward” sense: look at the pattern above; listen to him when he says that “there will be pain”; listen to him when he says, “we’ll cut when inflation is dead” – we are paraphrasing Powell only on the last bit but are not exaggerating…
- This is not the growth-sensitive Fed of the post-Great Financial Crisis era.
- This is not the stocks-sensitive Fed of the post-Greenspan era.
- This is not the unipolar world order the Fed’s been operating in since WWII.
- This is a different ballgame…
- …and if you think that the peak of tightening is 3.5% because inflation peaked, and that cuts are coming next year because a recession is nigh and stocks are now at the cusp of a bear market (maybe not, because we need a recession, and lower asset prices are the path to a recession), you might be terribly wrong. Bill Dudley and Larry Summers are right about the direction of travel (more from here, not less), but Jay Powell sets the pace…
…because he is accountable to Congress; Dudley and Summers are not. But make no mistake about it: the risk of the Fed hiking to 5% or 6% is very real, and ditto the risk of rates cresting there despite economic and asset price pain. The market and the Fed’s Summary of Economic Projections (SEP) (perhaps the market, because of the Fed’s SEP) is telling us that we will curb the biggest outbreak of inflation in fifty years with a “hiking cycle,” where the peak of the “hiking cycle” next year corresponds to negative real interest rates… unless you think that inflation moderates to target, that is 2%, by next year. If that is true, I am going to re-take Economics 101.
- What could I be missing?
- Is Jay Powell a dark horse who is more political than serious about inflation? I do not think so.
- Once you go down the path of invoking Paul Volcker’s legacy, you can’t avoid making good on that promise: if you do, you damage the Fed’s reputation irreparably. The risks are such that Powell will try his very best to curb inflation, even at the cost of a “depression” and not getting reappointed…
- Between a deep recession and damaging the Fed’s reputation as an institution, a deep recession is the lesser of two evils. The former is public service, and the latter is a public disservice. The former is a central banker’s clear conscience, and the latter is a life-long burden.
- Whether Jay Powell will succeed in slaying inflation is not the question; in the context of economic war, we can doubt that. Rather, the question is whether he’ll try his best to slay it. There I have no doubts.
- In our next dispatch, we’ll start thinking about “what’s next”: if we are right about the nature of inflation and the need for an “L”-shaped path for the economy, how will we ever ramp up from the “_” part of the “L” without generating inflation? If the East holds the key to the supply side, and economic war means that the supply side is held back, the West will have to develop its own supply of things such that “L” becomes “L/.” And much like the current hiking cycle is not a cycle but a tightening campaign, that recovery won’t be a recovery driven by rate cuts but by fiscally funded industrial policy…
…which we will discuss in detail in our next dispatch.
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