As so often, one of the last things I read before going to bed was my dear friend Alex Moffatt’s opening comment from J Palmer & Sons in Melbourne which he distributes around his Australian client base. In his opening lines, he wrote: “One can feel the expectation in the air ahead of the up-and-coming speech by the chairman of the US Federal Reserve at the Jackson Hole Symposium late on Friday night our time. Mind you I suspect he will toe the line and not provide anything new on which investors can hang their hats.” Moff’s observation is of course spot on but why, I wondered, all the fuss?
We pretty much know what Powell will say. Some time ago and just before one of Jay Powell’s many highly anticipated public addresses – it might even have been last year’s Jackson Hole speech, but I can’t remember – I decided as a bit of a joke to predict exactly what he was going to tell us. I was on the button although that revealed less about me and more about him. What it showed up, however, was the naïvety of the markets which had visibly been on tenterhooks when they should have known that Jackson Hole is not where the Chairman of the Federal Reserve System is going to offer up great revelations. Just known knowns. It’s August. The markets are thin. The grownups are on the beach. Is this the time and place to rattle everyone’s cage by indicating a shift in the prevailing monetary policy approach? Of course it’s not. Anodyne trumps. Job done.
If one is really interested in Jackson Hole, the hosting Kansas City Fed’s summary of what the aim of this year’s symposium is to be is surely of significantly more pertinence that what Powell will be repeating for the umpteenth time. Thus the introduction reads. “The 2024 event, which marks the symposium’s 47th year, will focus on the theme “Reassessing the Effectiveness and Transmission of Monetary Policy.” This year’s theme will explore lessons learned from the response of monetary policy to both the pandemic and the subsequent surge in inflation. The 2020s have witnessed some of the most forceful monetary policy actions on record. First, central banks worldwide adopted historically accommodative policy to offset the pandemic shock. Then, as inflation surged to multi-decade highs, monetary policymakers responded with one of the most rapid tightening cycles on record. Although outcomes have varied across economies, inflation has eased even as growth has remained surprisingly resilient. The resilience of growth through this period raises questions about the transmission of monetary policy and the lessons to be learned from this extraordinary episode”.
The key to the conundrum lies in the words: “inflation has eased even as growth has remained surprisingly resilient”. Yes, all the dire forecasts that suppressing inflation through the mechanism of monetary policy was bound to push the economy into recession have proven to be wrong. I too had agreed with Morris Sachs who was convinced that the Fed would tighten until it had pushed the economy into recession. This did not happen although, as recently as a few weeks ago, markets were panicking that the Fed was going to be doing too little too late in terms of easing from the currently supposedly lofty heights of its Fed Funds target rate of 5.00%-5.25% and that it was not about to make a mistake but that it had already made it.
In just 16 months between March 2022 and July 2023, and through 11 FOMC meetings, rates went from 0% to 5.00%. The fact that, despite rates having shot up so sharply, the economy did not fall off the cliff and now, a year after the last increase, still has not done so should have all monetary policy setters scratching their heads. This is not about whether the Fed could have or even has engineered a soft landing. There has been no landing at all, and it is not without reason that the assembled cabal of central bankers should be asking themselves whether their axiomatic assumption that detailed interest rate policy directly affects the economy is even right.
The tag line is of course that it takes time for changes in rates to feed into the economy but how long that takes and what the actual effect might be has never as such been measurable or defined and is therefore really no more than one big unsubstantiated guess.
Earlier this year, and while some highly overpaid idiots on Wall Street were still blithely predicting the Fed executing seven rate cuts before the end of 2024, I tried to step back and myself take a more holistic look at inflationary cycles. Some readers might recall the way at which I looked back at the great inflation of the late 1970s and into the early 1980s which was, at the time, famously met by Fed Chairman Paul Volker’s brutal hiking of rates. In 1981, the Funds rate averaged, repeat, averaged 16.4% having through the year ranged between 12% and 22%. It was not until 1991 that policy rates were last seen in double digits. The question I asked was whether inflation was brought under control by Volker’s ruthless monetary policy or whether there might have been an organic cycle at play. Please permit me to revisit.
The 1960s saw both the Vietnam War and the NASA moon programme. Both of them created jobs and incomes of significant magnitude without actually feeding consumable goods into the supply and demand cycle for the cash-rich workers to spend their money on. Inflation 1.0.1 teaches that inflation is generated by too much money chasing not enough goods. The base assumption is that if the Fed, or any of its friends and relations, constrain the amount of disposable household income by, for example, increasing the cost of servicing the mortgage and the car loan, then the excess in demand over supply will fall off and price pressures will diminish.
I tried to look at the matter from a different angle. Younger readers will not find it easy to relate to the pre-globalisation world when the vast bulk of what Americans or Brits or Germans consumed were manufactured in America, in Britain or in Germany, respectively. Economies were largely closed. China was between 1966 and 1976 by way of Mao’s Cultural Revolution at war with itself and at best we saw plastic pencil sharpeners or toys “Made in Hong Kong”. The era of cheap imported goods and therefore imported disinflation had not yet begun. So where did inflation go and why did it take so long to bring it under control?
My suggestion is that it was not brought under control; it did that by itself. Over time, excess production capacity that had previously been focused on providing Washington with arms for Vietnam and components for the space race were redirected towards filling household demand for everything from cars to dishwashers and eventually to computers and mobile phones. Capitalism is supposed to be about the efficient use of resources, both material and human, and capitalism resolved the imbalance that existed in the supply and demand equation. What happens to inflation once the gap closes? It comes down. Would it have done so without Volker’s over 20% interest rates? It’s certainly worth discussing. Would it have happened faster and less painfully? Also worth a thought.
What if, heavens forbid, Powell’s conclusion at this year’s symposium were to be that monetary policy neither transmits nor is effective? Of course it won’t be. Turkeys don’t vote for Christmas. Although we frequently argue that the global supply chain isn’t what it used to be, it is still very powerful and therefore the sort of supply and demand imbalances that occurred in the 60s, 70s and into the 80s are for the history books. It was the breakdown in global trade during Covid that laid the foundations for the ensuing rise in inflation and with its easing the force and velocity of price rises will fade. Central banks should forget trying to fight a fight they cannot win and should focus on managing the money stock.
My old friend Charlie Haswell, formerly Head of Public Policy for both RBS and HSBC and a man with a brain the size of a small African state, has long been arguing that it is not central banks but commercial banks that create money. He has for years been wandering from pillar to post trying to convince people of his observations. They listen, agree with him and then drop the ball. The received assumptions about the interplay between monetary authorities, monetary policy and their direct effects on the economic cycle are so deeply engrained that, to coin a phrase, the boat has become too big to rock. Maybe someone at Jackson Hole will have either the foresight or the temerity to question the direct effects of the current conduct of monetary policy but I doubt it. Maybe we will have to wait for the next big banking crisis to break out before the questions are properly asked.
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