Is the US heading for disaster?

24th May, 2021

Larry Summers may be an obscure economist to those of us on this side of the pond, but the former US Treasury secretary has captured the mood of the moment by accusing the Federal Reserve of ‘dangerous complacency’. Is he right?

Summers believes that the Fed is wrong in its assumption that inflation will simply snap back after the immediate recovery is has played out. He says the central bank has underestimated the risks to financial stability of its current policy of extremely low interest rates. He adds: “When, as I think is quite likely, there is a strong need to adjust policy, those adjustments will come as a surprise.” That “jolt” would do “real damage to financial stability, and may do real damage to the economy”.

The Fed Reserve is unmoved and continues to argue that inflation risks are transitory, fuelled by bottlenecks in supply chains, notably in areas such as semiconductors, plus a bounce from the resumption of economic activity.

The recent weakness in markets suggests that many investors share Summers’ fears. The majority of economic downturns have been precipitated by a sharp spike in interest rates necessitated by an over-heating of the economy. And much though the Federal Reserve could dismiss the vogue for cryptocurrencies and SPACs or retail investors’ new-found passion for markets, there is a ‘bubble’ feel to some of the trends currently out there in markets.

There is also the problem that the recent 4.2% inflation print appeared to be spread across multiple sectors – cars, clothing, food. US house prices have, so far, avoided the worst excesses, but more existing homes were sold in 2020 than in any year since 2006 and pressures appear to be building. More importantly, this is all happening before many stimulus cheques have been spent and before the government has started on its ambitious infrastructure projects.

Ultimately, however, it is wage inflation that tends to exercise policymakers most of all. Here, there appears to be few pressures. Those who still have jobs are grateful to have them and aren’t demanding pay rises just yet.

That said, it is clear that the Federal Reserve continues to fear stagflation more than it fears inflation. The shadow of Japan’s lost decades of growth weigh heavy on the minds of policymakers across the globe. The worry is that in avoiding ‘Japanification’ at all costs, they create an inflationary problem that is difficult to tame.

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This article was sourced from Adviser-Hub.co.uk.

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