I have been writing this article since February 8, 2008.
The Great Recession started in December 2007.
So, I’ve been writing this post for a long time, and I wrote during the worst economic recession since the Great Depression and during the spread of the Covid-19 pandemic and accompanying recession.
I must admit that I am very pessimistic at the moment. How my current state of mind compares to prior situations is truly indefinable at this point in the evolution of the economic situation.
But, let’s say that right now, I’m quite pessimistic about the short-term future.
The underlying cause of this pessimism is inflation.
I lived through the inflation of the 1970s. In fact, when wages and prices were “frozen” by President Richard M. Nixon and the Cost of Living Council, I was there.
I was a keen observer of Fed Chairman Paul Volcker and his battle to beat inflation in the early 1980s as a professor of finance at the Wharton School at the University of Pennsylvania.
I led three bank turnarounds in the 1980s and again in the 1990s and discussed the consequences for organizations of paying for their behavior during periods of high inflation.
So, I have experienced the inflation environment before.
We pay for our sins
The first lesson I would say I learned from this experience is that we “pay” for our past actions.
In the 1960s and 1970s, the US government did a lot, both Democrats and Republicans, to bring the country to an inflationary base.
We paid for it and it was very annoying.
And, as I’ve written almost continuously for the past ten years or more, the US government created a new inflationary base in the 2010s as policymakers invented a new approach to generating economic stimuli: the stimulus tool. quantitative easing.
We didn’t get inflationary consumer price responses from quantitative easing, but we did get inflationary asset price responses like housing prices, stock prices, commodity prices, etc.
Then the spread of the Covid-19 pandemic took place and US policymakers responded with direct payments to those in need affected by the pandemic and a Federal Reserve quantitative easing program that drove the Fed outright buying about $120.0 billion a month in securities. and continue to do so for about sixteen months.
The Federal Reserve’s securities portfolio has grown from around $800 billion at the start of December 2007 to just over $8.3 trillion at the end of 2021.
And, the money created by the Federal Reserve has spread internationally.
Globalization may have diminished in some business activities, especially during Trump’s effort to “decouple” the United States from other countries, especially China.
But globalization has accelerated in the area of money and finance, especially as the world of money and finance has become more digital.
The world is full of dollars!
And, we are now paying for it.
The fight against inflation
Inflationary pressures began to change at the end of 2021 as economic and political conditions began to change around the world.
Supply factors stemming from the pandemic slowdown, energy issues stemming from political factors and, finally, the Russian invasion of Ukraine, created the conditions for consumer price increases to begin to spread again.
And, that’s where we are now.
Inflation in the United States and around the world has returned to levels not seen since the late 1970s and early 1980s.
in the United States, consumer prices increased by 8.8% in September 2022, while underlying inflation reached 6.6%, a four-year high.
The Federal Reserve is not in full combat gear. It has raised its key interest rate five times this year, raising the effective federal funds rate from 0.08% to its current level of 3.08%.
In addition, the Federal Reserve is also allowing its securities portfolio to shrink…$95.0 billion a month…to reduce the liquidity that remains in the banking system.
The portfolio has been reduced by approximately $190.0 billion since mid-March 2022.
Another factor: the US dollar
But, something else entered the picture.
With rising US interest rates, the value of the US dollar has risen dramatically.
For example, one euro now only costs around $0.97. And a pound is only around $1.13. At the beginning of March 2022, these currencies cost $1.10 and $1.33 respectively.
This rise in the value of the US dollar has put a lot of pressure on global financial markets and has particularly hurt emerging countries which have issued a large part of their debt in dollars.
This difficulty has increased as the synchronicity of the central banks of the main developed countries has turned into a common movement “unprecedented in the last five decades”.
The United States Federal Reserve System has the dominant reserve currency in the world, and it sniffs its nose, the rest of the world sneezes.
This only magnifies the problems everywhere else.
Andrew Duehren and Yuka Hayashi, writing in the Wall Street Journal, quote Kristalina Georgieva, Managing Director of the International Monetary Fund:
“The worst is yet to come.”
Then the two authors provide these data points: economies accounting for more than a third of global output will contract next year, while the world’s three largest economies – the United States, the European Union and China – will essentially stagnate.
Overall, the IMF predicts growth of 2.7% in 2023, compared to 3.2% this year.
United States? The IMF predicts growth of 1.0% next year, compared to 1.6% this year.
Much of the world is out of balance. Somehow, one way or another, the world will have to find a way out of this imbalance.
This will not be easy. It won’t be without pain.
And, getting out of many of these imbalanced positions will depend on what the monetary authorities, in particular the Federal Reserve, do.
And the situation seems to become less complicated.