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Uncomfortable economic truths


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Unlike many progressives, I worry a lot about debt. Public debt, private debt, personal debt — I don’t like any of it. You could maybe chalk it up to my Midwestern upbringing or being the child of immigrant parents. I like having cash on hand, and have always been willing to pay a return price to hold it. You never know when bad times are coming.

So I was particularly interested in a paper by economists Francesco Bianchi of Johns Hopkins and Leonardo Melosi of the Chicago Fed, that made a huge stir last week in Jackson Hole. The typically low key academic title, “Inflation as a Fiscal Limit,” belies the heat that it is generating in academic, policy and even financial media circles. The frightening upshot of the work is that it doesn’t matter what the Federal Reserve does right now in terms of hiking rates to try and get inflation under control. If monetary policy isn’t accompanied by appropriate fiscal policy (or to be more accurate, a “mutually consistent monetary and fiscal policy”), then stagflation will be the result.

For some people, that might sound like, “well, duh,” of course central bankers can’t do it all themselves. And indeed, it’s worth pointing out that Fed chairs since Ben Bernanke have been begging Congress to do its part in helping the US economic picture. Until recently, that’s been more about calling for investment. We’ve just come through an unprecedented period of easy money that would have been the perfect time to do cheap, public investment into education, infrastructure, clean energy — you know the story. Instead, we got Trump’s tax cuts and corporate share buybacks.

Now, rates are rising, which is a much tougher time to make investments, not just for political reasons, but because according to the paper, this is when you want to be reducing debt not adding to it. Let me pause here and give my huge caveat (which co-author Francesco Bianchi would agree with) — all fiscal spending isn’t created equal.

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Unfunded entitlements are one thing. But investments into the moonshot technology transition of our time — clean energy — paid for by taxes on corporations with higher profit margins than they’ve had in history? That’s fine. In fact, as Bianchi put it to me, “these types of investments could make a country’s economic position better over time,” by creating jobs and growth and tax receipts that bring down deficits. Indeed, Bianchi was understandably a bit concerned that by pointing out that debt matters when fighting inflation, he was at risk of being labelled a hard core Republican (he’s not).

The Biden administration obviously gets all this — witness the clean energy bill that just passed under the title the “Inflation Reduction Act.” But this idea that rate hikes and a deteriorating fiscal position aren’t a good mix dovetails with another uncomfortable truth — deglobalisation, climate change and the end of the neoliberal world may be fundamentally inflationary, at least in the short term.

Think about what it will take to build more regionalised industrial systems, resilient supply chains, and a new clean energy supply. All of it is necessary, in my view. It also involves spending, which is inflationary. And I’m not even getting into what our nascent move into a post-dollar world could add to this equation. It’s one thing to spend, spend, spend when the dollar is the reserve currency. It’s another to rack up debt (again, I’m taking unproductive debt, here) when that’s changing.

How will all this play out? I’ve written in the past about the possibility of a “dollar doomsday” scenario (see here for part II of that series) in which both currency and dollar assets fall. I don’t think we are headed there now, in part because the US is still the cleanest dirty shirt in the closet. All these trends I’ve just laid out will hit Europe even harder, and China feels riskier and even more opaque that it has always been, with the possibility that Xi Jinping could anoint himself ruler for life. So, the US is safe for a while. But both Republicans and Democrats need to start thinking hard about what the dovetailing of deglobalisation and rate hikes will mean — that’s a topic I tackle in my own column today.

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In the meantime, Ed, are you keeping more cash under the mattress these days? Or do the English do it differently?

  • My colleague Martin Wolf flagged an article for the FT editorial board on some frightening University of Chicago research showing that up to 20mn Americans believe political violence is justified. How do we counter this? By working with the other side, always, to make it clear that it’s totally OK to have diametrically different views, but it’s never OK to express them violently.

  • This New Yorker piece on the connections between refrigeration and economic growth is exactly the sort of thing I love to geek out on, but I do think the author should have taken on the challenging question of how air-conditioning itself poses climate risk even as it is totally necessary for creating more jobs in the hottest places on earth. Hmm . . . 

  • And everyone should read my colleague Jemima Kelly’s look at why intellectual humility is a rare and under-developed virtue. Do it especially if you think you know what the piece will say!

Edward Luce responds

Rana, if you literally mean cash then the answer is no. I almost never have cash on me since almost everything can be settled with plastic. With US inflation at these rates — and the UK’s rate forecast to go as high as 19 per cent this winter — it’s a particularly bad time to have lots of cash lying around. Might as well reap the upside of those rising interest rates. 

To be frank, though, I am still not sure I agree with the paradigm shift you’re sketching out. For sure, there is an element of deglobalisation taking place and that is worsening the supply chain problem, which is inflationary. I was intrigued to hear talk from Jackson Hole of a new age of volatility following 30 years of great moderation. That sounds disturbingly plausible and will challenge all walks of economic policymaking, fiscal and monetary. 

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Either way, I am feeling uncharacteristically humble in anticipating what will happen. We are living in a time when phrases such as “reversion to mean” and “all things being equal” sound increasingly fanciful. All of which is to say that all kinds of forecasting are going to get tougher and political risk will seep into everything. Will a coherent new paradigm replace the one that many people, including you, believe is vanishing? I think the future will be messier and less coherent than that, which isn’t a good thing. To paraphrase the journalist Lincoln Steffens, I haven’t seen the future so I don’t know if it works. 

Your feedback

And now a word from our Swampians . . .

In response to ‘The unanswered question of Mar-a-Lago: why did Trump do it?’:
“I am impressed that in Rana’s response, citing the words ‘id-driven man-child’, she managed to avoid the words ‘Boris’ and ‘Johnson’.” — David Gordon, North London, England

“The way a narcissistic, paranoid [person] became president of the United States has been possible in the context of the deep crisis the country is suffering. He is a crazy demagogue but product of several unhealthy and disruptive trends.” — Mariano Aguirre, Spain

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