Every economic recession in the entire postwar period has been precipitated by the efforts of the Federal Reserve Board to curb and reverse accelerating inflation in the US. Historically, the Fed has been behind the curve during every period of economic overheating because the Federal Open Market Committee has always followed rising interest rates instead of getting out in front of them.

As a result, in every instance, by the time monetary policy becomes restrictive the forces of inflation have become sufficiently entrenched so as to require an economic recession to break the momentum. Thus, the economy has never enjoyed a so-called soft landing.

Ironically, in the current situation, the FOMC claims that by “normalising” interest rates before inflation builds up a head of steam, it will ensure a long-running economic expansion.

Unfortunately, the FOMC’s focus on the currently low (3.7 per cent) rate of unemployment has left it oblivious to a number of forces that are not only suppressing inflation, but in addition are slowing the economy’s growth rate.

First of all, there is no such thing as wage push inflation. That is a totally fallacious concept. Inflation is always a monetary phenomenon, ie too much money chasing too few goods and services. Over the past year, broad money supply (M2) has expanded at a 3.8 per cent pace, well under the growth rate of nominal gross domestic product at 5 per cent-plus.

Together with the gradual shrinking of the Fed’s balance sheet, the increases in the federal funds rate and tepid loan demand have all contributed to what is a mild liquidity squeeze, hardly a backdrop for accelerating inflation. Also, inflation is being restrained by various structural factors, including globalisation, technological advances, intense competition by various disrupters, demographic factors and a strong dollar, the latter in part a function of a rising federal funds rate.

Moreover, the economy is already slowing, for example housing and autos. The Trump tariffs are raising input costs in some industries, which will either be absorbed by companies, thereby inhibiting their growth, or offset by raising taxes on consumers, neither of which can be constrained by a tighter monetary policy. An array of data from both the industrialised and emerging economies indicates that a global slowdown is under way. Of particular importance to the US is the pronounced slowdown in China.

It would seem that today’s FOMC members believe they have learnt from the Fed’s historical mistakes, but they are failing to understand that “this time it really is different”. If the Fed continues on its current rate-rising path in a desire to build up the weaponry with which to combat the next cyclical downturn, it will only hasten the downturn’s arrival.

Stefan D Abrams
Managing Member,
Bryden-Abrams Investment Management,
New York, NY, US

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