However confident the Fed is of recovery, there is growing evidence of a slide into outright deflation
Hurricane Harvey was such a distraction last week that Donald Trump forgot to tweet about his country’s return to 3% GDP growth. When the news came that US second-quarter GDP, when extrapolated over a year, showed the country growing at the fastest rate in the G7, he was busy flying down to Texas to support the relief effort.
Trump and his Treasury secretary Steve Mnuchin have promised to deliver 3%-plus growth and here was the first indication that the president’s arrival in the White House had made a difference. In a way, it is just as well he missed the opportunity to brag. The headline figures may look good, but a peek under the bonnet of the US economy makes for disturbing reading. In a report last week a senior City analyst, Albert Edwards, showed that the Trump effect is quite the opposite and much of the life has been sucked out of the American economic juggernaut in the last six months.
Edwards’s chosen measure of the economy’s lifeless state is inflation, which has tumbled since the beginning of the year. Not so much the headline inflation figure, but the measure of core inflation that strips out oil prices and other volatile elements.
Core inflation is considered a key indicator of an economy’s health. To the ranks of central bankers it reveals how much domestic pressure there is on prices from long-lasting factors such as wages, and not external shocks to prices that can disappear as fast as they emerge. Edwards argues that the slump in inflation knocks out the Federal Reserve’s arguments for a rate rise beyond the current 1% to 1.25% range currently in place.
This is an important consideration, when most of the world’s governments and central bankers have braced themselves for another round of interest rate rises from the Fed that could see a flight of cash from their banks to New York.
Without a rate rise, weaker nations can relax, safe in the knowledge that the flows of international capital will still come in their direction. Until recently Fed boss Janet Yellen was sticking to her view that there would be at least one more rate rise this year and another couple in 2018. Then she wobbled, as she admitted to Congress that the Fed had missed its 2% inflation target for the last five years and that core inflation stood at 1.4%.
Edwards says his preferred measure of core inflation shows it standing at 1.2% and on a downward trajectory. “If I were a Fed governor,” he said, “I would be pretty shocked/concerned/bemused at inflation developments this year. However confident the Fed is of a self-sustaining-recovery, there is growing evidence of a slide into outright deflation even ahead of the next recession which will likely unambiguously take us deep into deflationary territory.”
Edwards is one of many who believe the business cycle in the US, as elsewhere, is running out of steam and will soon go into recession. Japan is only growing, just like the eurozone, with huge amounts of central bank money injected each month. Britain has its outlook clouded by Brexit, but nevertheless, even the modest growth of the last six months would probably be zero or worse without the ultra-low interest rates on offer from the Bank of England.
Like many in the City, Edwards believes that the only option is to let the next US recession take its course without heavy Fed intervention, because to continue with ultra-low interest rates and quantitative easing is to store more trouble and invite an even bigger crash.
But as usual the debate in the City excludes the potential that governments have to support the economy with much-needed day-to-day spending and investment. Trump says that is exactly what he has in mind, but his reckless budget proposals look like being a rerun of the George W Bush tax cuts 15 years ago that favoured the rich and wrecked Bill Clinton’s efforts to balance the books.
To step in and allow the Fed to wind down its stimulus efforts, the US Treasury needs to raise more in tax. But not just any tax. One that targets those who are currently hoarding their winnings from the postwar boom. That puts baby boomers firmly in the frame along with their gains from property and pensions.
It is a global phenomena that this group have steadfastly refused to pay the tax needed to keep their governments and economies afloat. The Japanese government regularly runs 10% budget deficits and now has a debt-to-GDP level approaching 250% after the middle class switched to loaning its government funds rather than gifting a higher proportion of its income through tax.
The Germans hoard cash, which they then expect the rest of the world to borrow and pay interest on to keep them in a bountiful retirement. Britain and the US are among the countries where richer baby boomers vote to offload the problem to younger, lower-income groups, who must now borrow excessively just to make ends meet. Like it or not, low interest rates will be around for a decade or more unless older voters sanction their governments filling the void with taxpayer cash.
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