Financial markets investors worry that the US is on the brink of an economic downturn as central bankers in Jackson Hole reaffirmed their determination to raise interest rates to bring inflation under control. Steve Hanke, a professor of applied economics at Johns Hopkins University, said that he believes the US is heading for a “whopper” of a recession next year, but it’s not necessarily because of higher benchmark interest rates.
“We will have a recession because we’ve had five months of zero M2 growth–money supply growth, and the Fed isn’t even looking at it,” Hanke said in an interview with CNBC recently. “We’re going to have one whopper of a recession in 2023.”
M2 is a measure of the money supply that includes cash, checking and saving deposits, and shares in retail money mutual funds. Widely used as an indicator of the amount of currency in circulation, the M2 measure has stagnated since February 2022, following “an unprecedented growth of money supply” starting with the COVID-19 pandemic in February 2020. The problem is that if the US goes into a recession, it is only a matter of time before the slowdown turns into a global recession in general and the reality is that Pakistan cannot be an exception as we head into 2023.
Economic history tells us that there has never been sustained inflation in world history—that is inflation above 4 percent for about two years—that had not been the result of unprecedented growth of money supply, which we had starting with the COVID pandemic effectively from February 2020. This is precisely why the world is having inflation now, and this is why it is likely that it will continue through 2023 and probably go into 2024 as well.
Since what happens in the US is key to what is likely to follow in the international markets, there has been some serious work conducted in trying to assess how the events in the US will pan out in 2023 and beyond, both for the US and the world in general. According to the Yale Model developed by Professor Hanke, it predicted last year that US inflation would be somewhere between 6 percent and 9 percent in 2022. Hitting the bullseye with that model, now the model is estimating inflation at between 6 percent and 8 percent at the end of this year on a year-over-year basis, and 5 percent at the end of 2023 going into 2024.
However, ironically whereas analysts believe that the US inflation rate seems to be easing—with the Consumer Price Index increasing 8.5 percent from a year earlier, down from a 41-year high of 9.1 percent in June 2022, raising hopes that a surge in price level may have already peaked—Chairman Powell, on the other hand, is signalling (refer to his latest Jackson Hole speech) that the US central bank still plans to continue raising interest rates to return inflation to their 2 percent target, even if it results in “some pain” for US households and businesses.
The Fed is likely to push interest rates above 3.5 percent and hold them there until 2024. Now, this goes the directly opposite way to what the Yale model is predicting and this is why Professor Hanke was quick to declare that “The real problem we have here in the US is that the Chairman does not understand, even at this point, what the causes of inflation are and were. He’s still going on about supply-side glitches. He has failed to tell us that inflation is always caused by excess growth in the money supply, turning the printing presses on. And this is why inflation will remain high through 2024 because of ‘unprecedented growth’ in money supply since the pandemic.”
The underlying argument that Hanke is making here is that the US as the global economic leader should at this stage be more concerned about a slowdown or a recession rather than inflation. Not only does it have a responsibility to US businesses and to contain unemployment, but it also shoulders a larger moral global responsibility on the wellbeing of the global markets.
According to him, unless the Fed changes course now, the US and with it, the world could be heading towards a much deeper economic downturn in 2023, which could very well last unto 2024. In addition, a recent Morgan Stanley reports also pretty much predicts the same that if interest rates are not rationalised, it would take the US a “miracle” to avoid a recession.
The report argues why a recession is inevitable, as more and more lagged impacts of this major monetary tightening start to kick in—so far they all haven’t kicked in. It reminds us of the Paul Volcker approach to tightening.
Volcker served as the 12th chair of the Federal Reserve from 1979 to 1987. During his tenure, Volcker aggressively hiked interest rates and successfully wrung inflation out of the economy, but at a great cost—tipping the economy into two consecutive recessions with stock market crashes and high unemployment.
Today, it says that going back to the type of pain Paul Volcker had to impose on the US economy to ring out inflation is no longer an option because at the time his measures took the unemployment rate to above 10 percent. The food for thought in all this for us is that it seems that the mindset prevailing in our central bankers today may not be very different to that of Powell.
And this, without realising that the resultant unemployment from their monetary policies, especially at a time when the current floods have wrecked unprecedented damage, may simply not be a socially sustainable outcome.