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Barry Wood

Warning lights are flashing in the United States – petrol prices are up by more than 40 per cent, home prices are surging, the labour market is tight and supply disruptions are creating shortages. Inflation has risen to a 13-year high of 5.4 per cent. Unless the US Federal Reserve scales back monetary stimulus, the economy will move dangerously close to a treadmill of spiralling inflation.
To be clear, since the Covid-19 pandemic struck early last year, the Fed has done the right thing. It acted quickly in March last year to bring interest rates down, rolling out vast amounts of cash. These bold actions calmed financial markets and reassured an anxious public that a health emergency would not drive down living standards.
There is no overstating the danger that was faced. World Bank chief economist Carmen Reinhart looked at the worldwide shutdown and warned of a global depression. Fed chairman Jerome Powell called the pandemic the greatest shock to the economy “in living memory”.
The combination of generous government support, remote working and Covid-19 vaccines saved the day even as a new variant threatened the recovery that has taken hold.
But inflation is the new enemy at the gates and the Fed must act to fulfil its mandate of assuring price stability. The obvious first step is scaling back the US$120 billion monthly bond-buying programme that keeps interest rates very low.

Speaking in mid-October, former treasury secretary and long-time Democrat Larry Summers expressed “very considerable concern” at the ultra-lax monetary policy, surging house prices and exploding budget deficit. “We’re in more danger than we’ve been during my career of losing control of inflation,” said Summers.
It’s not only monetary stimulus that has fuelled excesses. Even without new infrastructure and social spending programmes, the government has put US$4 trillion of extra money into the economy in just 20 months. Like with monetary stimulus, fiscal stimulus – the 2020 Coronavirus Aid, Relief and Economic Security (CARES) Act, the 2021 American Rescue Plan – was useful, perhaps even essential.
But fiscal stimulus beyond the bipartisan infrastructure bill is unwise and dangerous. The federal budget is grossly out of whack with a deficit equal to 13 per cent of economic output, the second highest since World War II, exceeded only by a 15 per cent gap in the 2020 financial year. Put simply, the US cannot incur US$3 trillion annual budget deficits without undermining global confidence and the exchange value of the dollar.
As for monetary stimulus, naysayers should put aside their worry that the 2013 “taper tantrum” will be repeated. In that episode, then Fed chairman Ben Bernanke’s mere mention of scaling back an earlier round of bond buying triggered a sharp but temporary rise in interest rates and a stock market sell-off.
Forget 2013 ‘tantrum’ playbook as Fed prepares to tapers its bond buying
Equities lost 5.6 per cent over five weeks but then rebounded – and this is often overlooked – rising 19 per cent with the S&P 500 index ending the year with a 32 per cent gain.
Similarly, when the “taper tantrum” began, the yield on a 10-year Treasury was under 2 per cent. It rose to 3 per cent as tapering got under way in 2014 and then fell back to 2.4 per cent when bond buying stopped in October.
The stock market is currently on a tear with prices at record highs. Since the record low of the March 2009 great recession, the S&P 500 index is up by nearly 600 per cent. A modest health-restoring correction associated with an end to artificially low interest rates would be welcomed by many investors.

Jim Grant, the savvy publisher of Grant’s Interest Rate Monitor, rightly observes that we have the easiest monetary policy in a generation, one that fans the flames of an incipient enduring inflation. Few in Washington hold to the previous Fed maxim that above-trend inflation is transitory.
At its November 3 meeting, the Fed announced that it will start tapering its bond-buying programme. Global markets needed to hear the message that rates are heading higher and that the US is determined to forestall inflation as it moves to restore financial stability.
Summers has referred to the “toxic side effects” of quantitative easing not being recognised by policymakers. There is, he said, a “substantial risk that the amount of water being poured in vastly exceeds the size of the bathtub”.
Washington journalist Barry D. Wood has been writing about Fed policy for three decades


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A customer shops at Steve’s 9th Street Market in Brooklyn, New York, on May 12. Inflation has risen to a 13-year high of 5.4 per cent. Photo: Xinhua

The Wall Street Bull seen in Manhattan, New York, on January 16, 2019. Stock market prices are at record highs. Photo: Reuters

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The US Capitol building below an overcast sky in Washington on April 29. The government narrowly avoided a historic default after the Senate approved legislation to temporarily raise the debt limit. Photo: AFP

What do rising energy prices mean for inflation in China and the US?

A parking attendant gestures as he stands below power lines in Beijing on October 13. China’s post-pandemic economic rebound has relied heavily on energy-intensive industrial production and property construction, creating sizeable demand for electricity over the past year. Photo: AFP

A person shops for produce at a grocery store in Washington on August 12. Elevated inflation levels could be a small drag on domestic spending over the next 12 months. Photo: AFP

Opinion

Business


The Federal Reserve must act to ensure stable prices. Global markets need to hear that rates are heading higher and that the US is determined to forestall inflation as it moves to restore financial stability



Quantitative Easing

Bonds

Coronavirus US

Interest rates

Stocks

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)
