05 Aug Defiled Disinflation
“Predictions of a ‘soft landing’ and ‘Immaculate Disinflation’ are misguided.” – The Oracle
Headlines trumpeting a “soft landing” for America’s economy led TLR to renew a conversation with Apollo’s favorite, the Delphic Oracle who, during a 2022 interview with TLR, took a dim view of the Federal Reserve and its actions. That view is contrary to the rosy economic picture painted by Cassandra in her July 15th letter to TLR in which she predicted an era of Immaculate Disinflation when “the Fed’s ongoing actions will ensure that inflation indeed proves itself to have been transitory and that recessionary fears are overblown.”
The Oracle began our recent conversation by stating that “Cassandra is speaking gibberish in endorsing the mistaken adoption of Modern Monetary Theory by America’s Federal Reserve,” and then added the following:
“The Federal Reserve does not have God-like powers, Mr. Realist. Its limitations are apparent to anyone familiar with its history. Centuries of unsuccessful fiscal and monetary responses to economic reversals have furthered an understanding of what can and cannot be accomplished by Central Bankers – noting that today’s cycle does not differ materially from that of ancient Rome, 20th Century Germany, and any number of other nations that have experienced boom-and-bust periods.
As a consequence, interest rates will not be coming down in America for quite some time. Inconsistent, though persistent, price and cost increases will restrict the Fed from appreciably lowering rates. Recession, unfortunately, therefore is inevitable. The economic forces that have created inflationary pressures are not within Central Bankers’ control. They are the result of more than 2 decades of fiscal excess, accurately described in Fitch’s recent downgrade of America’s credit rating.
Excessive economic optimism is being generated by a media-driven message that paints America’s economy as invincible. Laissez les bons temps rouler! [Let the good times roll!] Americans are convinced that the current economic upswing is perpetual, that America will continue to enjoy economic growth, rising stock market prices and fading inflationary pressures, and that America’s ‘Goldilocks’ economy will continue for years to come. That is Cassandra’s prediction …, and it is fantasy. America’s economy is being propelled by debt financing powered by massive government subsidies and Quantitative Easing. The media has extolled the success of these expansionary policies. For example, a recent WSJ lead story was entitled ‘How the U.S. Economy is Sticking the Soft Landing’ and a recent Barron’s headline told investors to ‘Take it to the Bank: There Won’t Be a Recession This Year.’ These uplifting headlines have led to a bullish stock market consensus of 95%! – was there ever a clearer indication of excess?
Cracks abound. The yield curve is seriously inverted and has been since March 2022. Such an inversion presages a recession. Cassandra argues that ‘this time is different’ because the 2023 Federal Reserve seemingly has magical economic powers. History is to the contrary, replete with examples of Central Bank failures. Claims of Central Bank ‘soft landing’ abilities have consistently been proven wrong even during your brief lifetime, Mr. Realist, starting when the term ‘soft landing’ was first used in 1973 by an economist at the Department of the Treasury in predicting that America would avert recession and benefit from a rebounding stock market. Instead, the country suffered through a recession that saw unemployment peak at 9%, GDP decline by 3.2%, and the stock market suffer a 45% loss. Wrong indeed! Then, in late 2000 before the Dot-Com Crash, a column in the NYT praised the Fed for ‘Making a Soft Landing Even Softer.’ Wrong again! A subsequent prediction for a soft landing in January 2007 followed the same unfortunate pattern with the media assuring Americans that Fed Chairman Bernanke ‘has steered the U.S. economy to an apparent soft landing,’ a prediction that was followed several months later by assurances from the Federal Reserve Bank of Dallas that the U.S. would manage to shrug off the subprime mortgage crisis without a downturn. The Great Recession began shortly thereafter.
Today’s realities belie a ‘soft landing.’ Leading economic indicators have been falling for 15 consecutive months. They now are doing so at an accelerating pace. This at a time when the last vestiges of COVID stimulus are being exhausted, credit card debt is rising, and student loan repayments will resume, office abandonment will accelerate and commercial mortgage refinancings are rising. Moreover, those who believe that the banking crisis ended with Signature Bank, Silicon Valley Bank and First Republic Bank are sadly mistaken. Today’s high interest rates mean that all but the largest banks are stressed. They will continue to lose depositors and be threatened with insolvency. Jay Powell has admitted that the Fed’s economists see ‘a noticeable slowdown in growth starting later this year.’ He added, however, that ‘they are no longer forecasting a recession.’ That is excessively optimistic. The New York Fed’s yield curve model puts the odds of recession within the next 12 months at 97%. No recession? Don’t be ridiculous!
Inflation too is far from over. OPEC is determined to increase energy prices, with crude oil up by more than 15% since June and analysts looking for hefty increases in the second half of 2023. Further inflationary pressures from climate change and Russia’s campaign to crush Ukraine’s economy already have led to global food shortages. Add housing costs to that mixture. The Case-Shiller index of 20 cities shows a clear uptrend that foretells supply-induced housing price increases as far as the eye can see. Energy, food and shelter are the core measures of inflation. Wage pressures? They too will persist. And don’t be lulled into a false sense of security by June’s reported inflation rate of 3%. Expect a sizable inflation bounce in July measured against the July 2002 drop of -0.3%. Immaculate Disinflation is a fantasy.
With today’s higher interest costs, Federal deficits will increase. That will require the Treasury to issue additional debt in a self-reinforcing debt spiral that, in time, will require the Fed once again to print more money to buy more-and-more debt to pay higher-and-higher interest that will increase inflationary pressures, etc., etc. etc. With asset prices and financial leverage so clearly above trend, the Fed’s choices are stark: either inflate away the debt; or manage a 1930s-style deflationary wipe-out; or alternate QE and QT in a Modern Monetary Theory play-for-time. Whichever course the Fed takes will not end inflation or prevent recession. There will be no ‘soft landing.’”
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Finally (from a good friend)