“We’re gonna go big. GO BIG!”. Earlier this year, that was the political and economic mantra of Joe Biden and his Treasury Secretary and former Chairman of the Federal Reserve, Janet Yellen. Stung by the enduring legacy of the accusation that governments were almost entirely missing in action in the aftermath of the Global Financial Crisis more than a decade ago, when all the remedial economic heavy lifting was left to the central banks, Biden and Yellen were not going to suffer a similar slur in the wake of the pandemic: this time government would be leading from the front. They were not alone, of course; the very nature of the pandemic and the lockdowns to contain the virus’ spread created a contract between virtually all democratic governments and their electorates: “the quid pro quo of your locking us up to save our lives (or in the UK, the NHS) is you save our livelihoods too”.
But in Biden’s case, in an increasingly polarised yet still substantially conservative (with a small ‘c’) society, “GO BIG” has been diluted to “GO not-quite-so BIG”. Pushed by the ideological left-wing of his party, among others by Bernie Sanders and Alexandria Ocasio-Cortez (who at COP26 this week sampled Scotland’s ‘national drink’, Irn Bru, and, if not quite declaring it to be “made from girrderrs”, compared it favourably to ‘Puerto Rican kola champagne soda’; the mind boggles) to be bold and radical, nevertheless more conservative Democrats fearing spiralling debts and the inflationary effect of stoking the money supply rate, balked at the sums involved. Essentially, most programmes have been halved, and even then the remaining $1.7 trillion programme for social care and climate change investment has no sure path through the Senate.
6% US inflation an inconvenient reality…..
But now there is a much bigger issue. Inflation. This week’s US consumer price inflation data for October showed year-on-year price rises reaching 6.2%, the highest 12-monthly inflation rate since 1990. The Federal Reserve, whose job it is to control inflation, managing it to an “average of 2%” (question: an average measured over what period? How long is a piece of string?) has maintained throughout this year that the acceleration in inflation is a post-pandemic transitory phenomenon, don’t panic, move on. However, last week it was forced to concede the need to begin winding down net quantitative easing (QE) to zero by the middle of next year.
The White House clearly sees a more immediate risk and is flapping. We mentioned last week that notwithstanding the irony of making such exhortations during COP26, Biden had been frantically trying to persuade Saudi and OPEC to open the taps, to flood the international markets with surplus oil and to drive down the price of crude, relieving the pressure on downstream fuel prices to consumers. The Administration is now locked in talks with big business as how to un-clog supply chains and to minimise the inflationary pressures on Mainstreet. The difficulty is that events are moving faster than policymakers can react and many are beyond their local control (e.g. the world shortage of semiconductors is a major factor constraining new car production, the direct effect of which is that second-hand car prices in the US have leapt as much as 40% this year, indeed in some cases second-hand cars are more expensive than the list price of a new one), running the risk that inflationary pressures become enduring. It is not just consumer goods’ costs which are accelerating. A significant proportion of poorer US citizens’ household outgoings is accounted for by property rents: in many US cities, domestic rental rates are 20% up on a year ago which in turn pushes up wage expectations or raises social spending costs.
…revealing unhelpful divisions between the White House and the Fed
What is clear is that the White House and the Fed are coming at the same problem from very different perspectives. The Administration sees political red lights flashing, hears warning sirens booming. Biden’s presidency is already in trouble having only been in office for 10 months; his foreign policy is in disarray and his domestic reform agenda is a pale shadow of its aspirational self. Spiralling inflation with all its associated social and economic ramifications is the last thing Biden needs as a direct challenge to his economic competence. If inflation is not under control by next autumn, or at least the signposts are heading in the right direction that order has been restored, he faces a torrid time in the mid-term elections in exactly 12 months’ time; if he loses either the Senate (more likely) or the House (less likely but possible), then the remainder of his term faces endless horse-trading and compromise to get anything substantial done that requires the approval of Congress. The early warning signs are there: last week the Democrats lost two state governorships, Virginia and New York, one with a calamitous 10pt counter-swing.
The Fed, on the other hand, while trying to ensure markets do not become spooked by offering calm-sounding forward guidance, runs the risk that in being reluctant to respond, it simply gets left behind. It always hopes to be the solution; the risk today is that in losing the narrative it becomes part of the problem. Despite shrinking by 3.6% in 2020, in nominal terms the US economy had fully recovered its December 2019 value of $21.7 trillion by the end of the first quarter of this year. But the Fed too bought in to the GO BIG agenda continuing to pump liquidity into the economic system long after it was arguably necessary, all the time hoping that incipient inflationary pressures were not an issue. With Fed Funds (the base interest rate) effectively at zero and inflation at 6.2%, there is now a yawning chasm of a negative real interest rate. There is the debate, as we have discussed in previous columns, about what is the problem being addressed to which higher interest rates are the solution? Higher interest rates will not magically unload ships marooned in the Port of Los Angeles or procure Teamsters to pound the inter-state highways in their big trucks. This is a most unenviable position in which to have fallen.
Powell to be dumped?
None of which alters the perception that divisions are evident between the Administration and the Fed, with politicians at least allowing the inference if not making the accusation that the Fed is fast asleep at the wheel. That in turn becomes politically important because Jerome Powell, the current Fed Chairman who is by inclination a Republican and was appointed by Trump, comes to the end of his term in February. He might be seeking reappointment but speculation is rife about his future, who might replace him and whether in fact it makes any difference? The rotational composition of the Fed Board (only the Chairman of the Reserve Bank of New York, alongside the Fed Chairman, has a permanent seat) makes predicting future policy based on personalities little more than speculation in any time frame beyond the immediate future.
Nothing in life is certain, except death and taxes. But paradoxically markets dislike uncertainty and uncertainty is prevalent at present, particularly in the great inflation debate. There is an irony here: a year ago after the US went to the polls, the combination of the possibilities offered by the vaccines and Joe Biden’s extravagant expenditure plans and reforms gave rise to what was referred to in markets as the “reflation trade”. Explicit in “reflation” is inflation. When presented with the reality of inflation, the nerves start jingling and suddenly it isn’t quite so appealing after all!
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