As Jonathan Garner, Morgan Stanley’s chief emerging markets strategist, wrote recently – the recession debate is over, apparently we’re already there and more difficult times await us.
However, I’m not sure there was any substantive debate at all. For any good economics student, the reasons for the current situation and the general future trend are quite clear and consistent with the fundamentals of economics. So we can also be sure that everything was all the more clear to the managers of the FED.
For the last two years Mr. Powell has been assuring us, first that there would be no inflation, then, when inflation came, that it was transitory, and finally, after two consecutive quarters of GDP decline, that there was no recession.
It’s hard to call it all a “debate” because the FED and other central banks were simply trying to give the markets “signals” that if anyone believed in, now they don’t believe in at all. The only thing managers and economists believe now is hard data: macroeconomic indicators and the actual response of the monetary regulator, coupled with government decisions. This is what economic agents are basing their expectations and preferences on today, effectively ignoring the verbal interventions of regulators – and rightly so! It is hard to trust the soothing words of someone who calls black white, knowing that it really is black and being sure that you know it too.
Once again, I will not elaborate on the reasons for the state of the economy we have today. For nearly three years, in fact since the beginning of the Covid-19 pandemic, I, like many of my colleagues, have been saying in detail and in a variety of ways, essentially the following: huge increases in liquidity and hypertrophied social spending are bound to lead to big inflation and recession, among other extremely negative socio-political consequences in the longer term. Lockdowns, production and logistical imbalances, and labor market distortions have led to supply chain disruptions and labor supply problems that have only exacerbated the problems, not caused them at all!
But governments and monetary authorities have been quick to turn things upside down and assign broken supply chains as the root cause of actual stagflation – rising inflation and a recessionary economy. A perfect way to write off the inevitable externalities of an unprecedented expansion of the state’s distributional mandate and de facto etatism as force majeure! Geopolitical instability in Eastern Europe has also become another “convenient” factor to explain the inflationary pressures. However, all of this is the natural, expected and natural behavior of any populist government, with elites who have felt the sweetness of uncontrolled budgetary redistribution.
So what is today’s reality and what might it be tomorrow? The reality is grim and there is no light tomorrow. What the FED and the government call a strong labor market, and what in fact is an absolutely pernicious disequilibrium in today’s economy, is a consequence of the very insane monetary expansion and social spending that is now fueling inflation, along with still and incomplete supply chains, and geopolitical turbulence in commodity markets. Consequently, consumer confidence and business sentiment are at extremely low levels, causing a reduction in production and a primitivization of consumption, and in general sharply narrowing planning horizons. And now, as was already evident two years ago, regulators are faced with an obvious gigantic problem: How to stop inflation and not kill the economy?
Solving this problem inevitably forces governments and monetary authorities to choose between two evils. And the authorities choose to extinguish inflation as the main existential political threat.
This choice is rational and correct, but it is coming from the other, wrong end. Maintaining the stability of the rate of price growth and its adequacy to the growth of production and the consumption it provides is the main task of the financial regulator in a free market economy. A regulator designed to respond to changes in the balance of supply and demand and to provide the financial system with the amount of liquidity that the economy needs at a particular stage of the market cycle for an effective horizontal exchange of goods. Once again: the role of the regulator is to respond at a particular stage of the market cycle, not to preemptively engage in cyclical smoothing or directly create a toxic economic incubator – something the authorities in the US and other advanced economies have been doing for the past 20 years .
Now, the FED and the authorities simply have to contend with their own Frankenstein. Two-plus decades of distorting the market economy with economic expansionism, the political elites are forced to put out the fire with gasoline, as I have said many times. Intense inflation for today’s government is not a threat to balanced economic growth, because balanced organic growth was out of the question for the last two decades, the economy existed virtually on public money. Now it is a political threat, it is the main reason for possible social discontent and, accordingly, stability for the political elites.
On the one hand, inflation reduces the purchasing power of voters, and intense inflation reduces it intensively. On the other hand, inflation is a depressing factor for production, which leads to its reduction, economic stagnation and a decrease in the volume of the employed labor force. And this triggers social discontent on the other side.
What is most important for an expansionist state, pumping consumerism into its economy for decades and buying selective loyalty with populism: supporting the economy, that is, “supply,” or appeasing the population, that is, “demand”? The first is long, painful, and, most importantly, not popular right now, i.e., politically unprofitable. The second is much easier, more familiar and, most importantly, politically advantageous today and in the short term of tomorrow.
As a result, having realized the threats and alternatives, the government is going for a monetary tightening in an attempt to preserve the purchasing power of voters and hoping to compensate for the recession by another expansion of government spending and government order.
The UK is now trying to take a different, difficult but correct path, where the Conservative Party, like Margaret Thatcher in the early 80’s, has taken a completely unpopular decision today – to raise rates and lower taxes, with a compensatory increase in the national debt at the same time. Of course, as I said, this is a painful and difficult process, just like any “withdrawal” after years of acute drug or alcohol addiction. As the great Friedrich von Hayek used to say, the party will end someday…
But if the state has to engage in direct redistribution or, as they call it, “help” to economic agents, it should be primarily producers, not consumers! Otherwise, the state is giving away the fish instead of helping to find the rod.
By helping the “supply side,” the state rectifies economic processes and gives them the impetus for subsequent organic growth, when consumer capacity and growth in demand match the productive capacity and growth rate of production. As the state emerges from a deep crisis, it will be able to reduce public debt by reducing the budget deficit.
This is the trajectory that developed countries took in the 1980s and 1990s. In the early 1980’s, against the backdrop of the Great Depression of the 1970’s, the painful but correct decisions of Thatcher, Reagan, and Kohl to reduce social spending and taxes, combined with tighter interest rates and higher government debt, enabled advanced economies to emerge from the “awful 70’s. And it is precisely the consequences of the major world economies taking the path of healthy growth that made possible an era of the “golden 90s,” with stable inflation, economic growth and dramatic technological development, restrained government spending and deficit-free budgets amid falling national debts.
Today, however, nowhere in the world is this true except for Great Britain. On the contrary, in the U.S. President Biden’s administration has raised government spending to exorbitant levels, increased taxes on “rich income” and corporate profits and enshrined in the Inflation Reduction Act. And it is important for the Administration and other Western economies’ governments to maintain voter loyalty without tough decisions – populism rules the ball. Asset value problems in pension funds, insurers, banks and foundations will be solved by ad hoc bailouts. The consequences of the absolutely inevitable and already occurring economic downturn will be compensated by the state order, partial nationalization and subsidies to inefficient agents, which governments have been doing for more than two decades. The state order will include, by the way, expanded production of military products, given the geopolitical threats posed by aggressive or simply active authoritarian regimes, which have emerged and strengthened not without the participation of a conciliatory and “pragmatic” policy of global cooperation of developed countries with resource autocracies, including, primarily, Russia and China.
I am far from making made-up correlations, but many nuances of the current economic and socio-political state today are very reminiscent of the economic and political international situation in the 1930s. This applies to total Keynesianism and state expansionism in the economic policies of the leading developed economies, primarily the U.S., and the growing activity of authoritarian regimes and their aggressive “chiefs,” and the conciliatory policy vector of Western governments in cooperation with these autocracies in the status quo mode, and the quality of “leaders” of already developed countries themselves.
They say that hard and difficult times produce strong leaders, capable of painful but necessary decisions and able to convince people that they are right. Nobody seems to have any doubts about “times” today. There is a problem with strong leaders. And the problem is not just that there are none in developed countries today.
The main problem is that there are “strong” leaders in those very active autocracies…. But that is a different conversation.