In recent times, President Biden and Congress, alongside the Federal Reserve, have inadvertently handed Americans a troubling gift: soaring inflation. The prices of essential goods and services have escalated dramatically, affecting everyday life.
The consumer price index (CPI) has surged by 6.8 percent over the past year, marking the steepest increase since June 1982. In reality, the CPI is rising at more than double the officially reported rate.
Can the Federal Reserve curb this rampant inflation without precipitating a severe recession?
Former U.S. Treasury Secretary Larry Summers expresses skepticism.
Summers, a prominent figure in economic circles, has long harbored ambitions of chairing the Federal Reserve, although his reputation may hinder that goal.
He is more fittingly seen as a fixture of Harvard’s academic elite, where he can opine on monetary policy from a comfortable distance. In his capacity as a paid contributor for Bloomberg, Summers’ insights are often disseminated with perfect timing.
For instance, in anticipation of the recent Federal Open Market Committee (FOMC) meeting, Bloomberg showcased Summers’ commentary. According to Bloomberg:
“Former U.S. Treasury Secretary Larry Summers said inflation has become entrenched, making it increasingly unlikely that the Federal Reserve can quell price surges without triggering a recession.
“Summers now estimates a 30 percent to 40 percent probability for a recession within the next two years. He also suggests the chances of a soft landing—where tighter monetary policy doesn’t significantly hinder economic growth—stand at 20 percent to 25 percent.”
The rationale behind these predictions remains unclear. In fact, we suspect the risk of recession is much higher, while the probability of a soft landing is effectively zero.
Our rough calculations suggest a 100 percent likelihood of a recession within the next two years and a 0 percent chance of achieving a soft landing.
Further exploration into the impending crash is warranted, but first, let’s establish some context.
The Legend of Casey Jones
Casey Jones, the engineer of Locomotive No. 382, had one clear directive: go fast and push the throttle hard. His penchant for speed resulted in multiple fines and suspensions over his career.
On April 30, 1900, Jones was meant to be off duty. Yet, he and his fireman, Sim Webb, were called to fill in for a crew that had fallen ill, causing a 75-minute delay on the Cannonball Express from Chicago to New Orleans.
Determined to make up lost time, Jones departed from the Memphis station at 12:50 am. His drive for speed led him to recover 55 minutes of the delay by the Grenada stop and an additional 15 minutes on the stretch to Winona.
He was nearly back on track by the time he entered Durant. However, new orders directed him to pull onto a siding at Goodman, Mississippi, to allow the No. 2 passenger train to pass before continuing on to Vaughan, just a short distance away. But all was not as it seemed.
As the train approached Vaughn, Jones’ world turned upside down.
“There’s a freight train on the siding,” he shouted to Webb.
Freight train crews were optimistic that the Cannonball Express could pass safely, but at the speed Jones was traveling, disaster was imminent. Unable to avert a collision, Jones made a last-ditch attempt to save his fireman.
“Jump, Sim, and save yourself!” he called, while he stayed behind to slow the train.
Though he succeeded in safeguarding his passengers, it cost him his life. His watch stopped at 3:52 am on April 30, 1900, and legend has it that he was found clinging to both the whistle cord and the brake lever.
The Solution to Inflation
In the aftermath of the FOMC meeting, Fed Chair Jay Powell attempted to strike a balance between inflation and economic stability, akin to Jones pulling the whistle and engaging the brakes. The Fed has been accelerating its monetary policy for too long, and Powell’s objective is to rein in inflation.
As reported by CNBC:
“The Federal Reserve made it clear on Wednesday that its ultra-easy monetary policy enacted during the COVID pandemic is nearing an end, resulting in aggressive actions to combat rising inflation.
“The central bank will be slowing monthly bond purchases to $60 billion starting in January, which is half the rate prior to the November taper—a marked reduction from what it had been purchasing in December. The Fed had previously reduced its purchases by $15 billion monthly in November and doubled that in December, with plans for further cuts in 2022.”
“Following this tapering phase, which is expected to conclude by late winter or early spring, interest rate hikes may soon follow.”
This approach appears promising. The Fed certainly has the capability to control inflation. But does Powell possess the resolve required to follow through?
We remain skeptical.
During the early 2000s, after the dot-com bubble burst and in the wake of Alan Greenspan’s policies, the Fed fretted over deflation. In a pivotal November 21, 2002, speech, former Fed Chairman Ben Bernanke illustrated a potential solution:
“The U.S. Government can produce as many dollars as it wishes at virtually no cost through its printing press—or its electronic equivalent. By increasing the dollar supply, or even by credibly threatening to do so, the government can decrease the dollar’s value in terms of goods, effectively raising prices.”
Bernanke’s remedy for deflation is inflation.
Back then, the Fed’s balance sheet was roughly $800 billion. Today, it exceeds $8.6 trillion. Consequently, inflation is now rampant.
Thus, tackling inflation necessitates a focus on deflation.
The Fed, however, detests deflation. It wreaks havoc on over-leveraged economies, leading to widespread bankruptcies and defaults. Additionally, it threatens governments reliant on money printing to meet their obligations.
The challenge for the Fed is to manage inflation without triggering a recession. After two decades of rampant money printing, both the economy and government have become dependent on it.
What happens if the Treasury issues debt without the Fed purchasing it? What occurs when interest rates rise significantly? What if the DOW plummets below 15,000?
Will the Fed reverse its strategy? Does it even matter?
Much like Casey Jones racing down the tracks, there seems no way to avert a catastrophic collision. We are on the brink of a remarkable upheaval. Inflation? Deflation? Expect a blend of both.
Brace yourself for the ride of a lifetime.
Sincerely,
MN Gordon
for Economic Prism
