E-piphany

I continue to get more and more disappointed in Powell as a Fed chairman. When he came in, as someone who was not an economist by training and therefore not (yet, as it turns out) captured by the economic orthodoxy, I was optimistic that he might be able to break the cycle of tragic decisions by the Federal Reserve. The Fed’s path has (along with errors in other central banks mirroring the Fed’s “leadership”) led to a series of bubbles and busts, with the busts not even being allowed to cleanse the system and so defer future bubbles. It has led to an overleveraged consumer, overleveraged business, and overleveraged public accounts, and this has in turn helped produce an exceptionally fragile financial economy.

The Fed has now embarked on a new easing program, as “insurance” and “risk management” against a future slowdown. Considering that it isn’t the Fed’s job to prevent business cycles, this represents enormous hubris – but that’s what happens when you take a bunch of people and put them in a really fancy building and tell them how smart they are.

For years, the Fed has been telegraphing their moves, so that the sort of Fed watching I used to do as a fixed-income strategist is almost moot. The amount of market volatility around the Fed’s rate cut today – or, really, around Powell’s ham-handed presser afterwards – is remarkable considering that the market got exactly what it expected, except for some mild adjustments to possible paths forward in the distant future. But let’s face it: relying on what the Chairman says today about what monetary policy might be next year (for the record, he said it is unlikely the Fed could hike rates again) is like relying on today’s weather forecast for next Tuesday. There is just so much other stuff that has yet to happen that you really shouldn’t put any weight at all on that future forecast. If you’re canceling next week’s picnic because the meteorologist today said it could rain next week, you haven’t been paying much attention to the efficacy of meteorological forecasts. Count that double for economists.

But for whatever reason, I found myself listening to part of the Q&A period and instead of continuing to scream at the television I thought I’d write down a couple of the things that annoyed me. But just a couple.

1. Powell said “Global disinflationary pressures persist.” This seems to be more of a slogan than analysis. Let’s take more than three seconds to examine it. Pray tell, what are these “disinflationary pressures?” Here are some popular candidates.

• Aging populations in developed countries – this certainly isn’t it. Aging populations are of course inflationary, not disinflationary. An aging population implies lower potential output, all else equal, and a leftward shift of the aggregate supply curve is plainly inflationary. To be sure, this isn’t economic orthodoxy, but the economic orthodoxy in this case (as in so many cases) is simply wrong.
• Trade – Globalization of trade has been the dominant disinflationary force for thirty years. Unfortunately, it seems to have run its course. There certainly doesn’t seem to be any sign that global trade is continuing to broaden and in fact it seems to be recently in reverse. At best, it is going nowhere fast after many years of being in fact a disinflationary force.
• Lower interest rates – It is plain to monetarists that lower interest rates cause lower inflation, since lower interest rates cause a decline in monetary velocity by increasing the demand for real cash balances (decreasing the prevalence of attractive substitutes). However, it also seems pretty plain that the Fed is not arguing this, both because they aren’t really monetarists any longer but more importantly because it this was their argument then it’s weirdly circular: “we’re lowering interest rates because of global disinflationary pressures, such as the fact that interest rates are going down.”
• Global debt overhang – this seems to be the only reasonable argument about a possible source of  global disinflationary pressures. A high level of private debt tends to be disinflationary because it increases the value of cash flow compared to profit. You can go broke realizing profits, if you don’t have enough cash flow to service your debt; this causes heavily-indebted companies to be more reluctant to risk market share by raising prices and causes heavily-indebted individuals to be more reluctant to risk continuous employment by asking for pay increases. On the other side, though, we know that heavy public debt loads have historically tended to be inflationary once they reach some difficult-to-define tipping point, because central authorities have increased incentives to let inflation run a bit hot to help grow out of obligations. But again, this is sort of circular as well since one reason that there is so much debt is because real interest rates are so low. And real interest rates are so low because central banks keep easing. So it would seem weird to be making the argument about too much debt causing disinflation and then lowering interest rates.

I don’t think he is thinking about the “AirBnB effect” (not real) or the “Amazon effect” (not real) or any of the various other postulated effects stemming from gee-whiz technology that never seems to hold up to actual scrutiny. In the end, I don’t think he really had anything in particular in mind. For the Fed, the fact that inflation hasn’t gone up means that there are disinflationary forces. Q.e.d.

Powell also noted: “If you look at the economy right now there’s no sector that’s booming and therefore might bust.”

Nope.

Sources: GuruFocus, Bloomberg, DOE, Enduring Investments.