Over the past month, I have travelled within North America and Western Europe, met quite a few people, including senior bankers, and have been generally surprised by the feeling of ‘business as usual’. There is very little sense of impending doom or recession. Reasons given include:
Why do I believe this confidence is misplaced?
While the US Fed increases interest rates, the negative real interest rates of -7% means that monetary policy is still loose. The European Central Bank is not even making noises about QT, it has limited scope to raise interest rates due to the effects this would produce on the periphery, and monetary policy is even looser:
After stating that inflation was not a threat, then calling it “transitory”, Secretary Yellen admitted that she was wrong in her assessment of inflation (a welcome step), but went on to state: “I do not expect inflation to remain high, although I very much HOPE that it will be coming down now”. Since when is hope a strategy?
As explained in a previous article, I expect the Fed to tighten until something breaks (e.g. major market crash or credit markets freeze up, etc) and then to begin its fifth Quantitative Easing (QE) programme.
As Peter Schiff stated: “The most important mistake investors [and I might add: Central Banks] are making is thinking that a recession will solve the inflation problem. In reality, it will make it worse. When the Fed pivots and launches QE5 to stimulate the economy, the dollar will tank, accelerating the increase in consumer prices.”
As macro strategist Lyn Alden recently stated, there are two major supply-side factors redefining the world economy today:
Central Banks have no control on the above factors. Nor do they have control of coronavirus (COVID-19) and the Ukrainian war, which play further havoc with supply chains and price pressures. Whereas higher interests may dampen demand, so long as interest rates are negative in real terms, dampening of demand will be insufficient to quell inflation, especially as the aforementioned pressures on supply chains remain with us or even intensify.
Of course globally high debt levels (Government, corporate, individuals – for a grand total of over $350 trillion) add to global economic fragility, and less ability to tolerate higher interest rates.
This article is for educational purposes only and must not be construed as investment advice. Investors should obtain their own investment advice.
Les Nemethy is the CEO and founder of Euro-Phoenix Financial Advisors Ltd and a former official at the World Bank.