By Michael Every, chief strategist at Rabobank
ANCIENT ROME – OUTSIDE THE ‘VNEMPLOYMENT INSVRANCE’ OFFICE
COMICVS: Stand-up philosopher.
COMICVS: Stand-up philosopher. I coalesce the vapours of human experience into a viable and meaningful comprehension.
CLERK: Oh, a *BS* artist!
CLERK: Did you BS last week?
CLERK: Did you *try* to BS last week?
History is on my mind today. 96-year young Mel Brooks just released ‘The History of the World Part II’ to follow-up on 1981’s ‘The History of the World Part I’. The first wasn’t in the same league as his earlier films but still has the meme “It’s good to be the king!” (And, for Marjorie Taylor-Greene, “SEE – JEWS – IN – SPACE!”) It’s wonderful to still have Mel around regardless of what this new offering brings which, like the original, is apparently hit and miss: I liked the trailer joke where an early Christian threatens to cancel his subscription to Net-fish. We need people who remember the past, and who dare to laugh at it: we need less coalescing of the vapours of human experience. For example, the eight-part ‘Part II’ includes Stalin, played by Jack Black, as Reuters notes: ‘70 years after death, his polarizing legacy looms large’. That’s a line one would once only have imagined in a Brooks’ film, as with “Hitler, there was a painter! He could paint an entire apartment in one afternoon … two coats!”
It reflects how little we learn from, or laugh at, history that there are still debates about both the economic backdrop and what the Fed will do next, as we watch the paint dry ahead of Fed Chair Powell’s testifying to Congress, which the WSJ’s Timiraos suggests will be hawkish as economic data show the feared recession is ‘always six months away’. Indeed, even used car prices are soaring again.
It’s obvious that this is not the 1970s, both in that Mel Brooks is not making truly classic comedies, and that labor is in a far weaker position than capital, which is deflationary. However, it should be just as obvious that labor is earning better than it has for decades, as is Mel, and as we recently argued for the UK and Eurozone, alongside a similar US view that had already seen our Fed watcher Philip Marey flag risks of a 6% peak in Fed Funds, something which markets have now started to come round to. It’s ‘High Anxiety’ for those thinking yields will fall.
Moreover, few in markets, but some in central banks(?), are starting to grasp that the strength of capital can be inflationary too. One anecdote is higher mortgage rates being passed on by housing investors to renters: pay up or sleep in the streets. We called that ‘economic rent’ before it was rolled into capital when political-economy became more mathematical (and more dishonest) economics. Yes, that is eventually deflationary too –or feudal– but not for a long time if people borrow to keep a roof over their heads, which of course they will.
@IsabellaMWeber shows in more depth that high corporate concentration is triggering higher prices. US profit margins have reached levels not seen since post-WWII, when inflation last coincided with windfall profits, and firms which previously kept prices stable have now hiked them. Weber conceptualises this as a Lerner-type sellers’ inflation where even giant firms are price takers on commodity prices, but four principles of price-hike decisions then emerge:
- Firms tend to not lower prices to prevent price wars and raise prices to protect profit margins, if they expect other firms to do the same.
- Sector-wide shocks can create tacit agreements between firms to hike prices, since all firms protect their profit margins and know that the other firms pursue the same goal.
- Supply bottlenecks can grant temporary monopoly power which allows firms to hike prices to not only protect but increase profit margins.
- Firms navigate demand as a ‘portfolio of risks’ and prices as a social relation with retail partners and customers. Emergencies can create a pretext to legitimize price hikes.
In short, Covid, then war, triggered upstream inflation shocks, and some demand shocks; as these flowed through supply chains, firms raised prices to protect or amplify their margins; then workers fought to retain their spending power through higher wage growth. “It’s good the be the king.”
The implications for monetary policy are profound. Higher rates hurt workers already suffering from high inflation, and they can’t help firms suffering higher input costs. Indeed, if firms are able to pass higher input costs on, then higher debt servicing costs can be passed on too! On the other hand, lower rates are no solution if they mean higher commodity prices, then passed on, and higher asset prices, which are also inflationary (i.e., everyone quits work to flip condos or trade NFTs again). That’s something even the San Francisco Fed now realises. (“We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably.” Slow hand-clap!)
In other words, the economy is in a deeper structural mess than most realise. If (i) supply shocks are structural, and (ii) firms collectively raise prices, and (iii) even uncollective workers raise wage demands, then inflationary psychology will persist, at least until it is beaten out of two sectors, not one.
We just discussed (ii); part (iii) is being written; but part (i) is clear – the ‘return of history’ means ongoing supply shocks. Indeed, Singapore’s top diplomat just stressed the post-WW2 peace dividend which fuelled global economic growth is over, and “The rules-based world order, the focus on economic integration, liberal economics, free trade, all that was a formula for peace and prosperity and now the faith in those pillars has been shaken. It’s a flight to safety in a way.”
Or flight or fight, the latter inflationary. On which: Der Spiegel says Germany’s Rheinmetall is in talks about building a tank plant in Ukraine; Germany says there will be a future defence guarantee for Ukraine; the White House triggered the Defence Production Act to force US firms to build hypersonic missiles; House Speaker McCarthy will meet Taiwan’s president in California, not Taipei, for fear of China’s wrath; the Wall Street Journal argues ‘The US is not yet ready for the era of ‘Great Power Conflict’’, and needs to do vastly more on production; and China’s latest 7.2% increase in defence spending was matched by new centralised security agencies overseeing R&D, and promises of “forceful measures” to ensure it keeps moving up the value chain. Relatedly, if the White House is close to capital controls on Chinese tech due to national security concerns, yet Beijing is involved in all key value chains, how long until *all* US FDI into China is flagged as dangerous? The US is reportedly now focusing on biotech too, making that point.
Meanwhile, billionaire China investor Mark Mobius complains he can’t get his money out. How much history did he read before putting it in?
Even ‘vanilla’ supply-chain issues linger despite the drop in the Global Supply Chain Pressure Index (GSCPI). A great way for analysts to show they don’t understand complex logistical issues is for them to refer to the GSCPI as ‘proof’ that supply chains are ‘healing’. Try explaining that to those in the industry seeing the global tanker fleet shrink as they opt to ‘go dark’ and trade Russian energy. Or as the “Pentagon sees giant Chinese cargo cranes as possible spying tools.” This doesn’t mean ocean carrier rates are not falling – they are. However, ‘Shippers want stability and service, not rock-bottom freight rates’. Indeed, a procurement executive is quoted saying he had spot cargo moving at “below $1,000 per box”, and had been offered even lower rates, but doesn’t feel comfortable about it because, “At some stage, the rate is going to shoot right back up, there’s just no stability and we can’t budget.” That backdrop is not one where goods –or capital– flow, and inflation stays low, like before; that implies firms will keep acting to collectively raise prices; then workers will act up to try to keep up.
If US durable goods inflation drifts up to where it sat in an earlier phase of globalisation, it would average 4% y-o-y, not 2%. In which case, services inflation needs to come down much more, meaning far higher rates and far lower asset prices, or the inflation target will be repeatedly missed, or it may even have to be raised. Historic volatility lies ahead of us whichever way. (Indeed, despite 2023 market calls for a weaker US dollar, Bloomberg yesterday reported ‘World’s riskiest markets stumble into crisis with dollars scarce’, and Reuters noted ‘Chinese companies hang on to dollars, hedge to prepare for volatile yuan’.)
Of course, raising rates now more would be crazy given US drivers are fighting over expensive used cars and 15% of those who financed a new vehicle towards end-2022 are reportedly paying $1,000+ a month to do so. However, pausing rate hikes as a precursor to cutting rates again would be even stupider – indeed, the ECB’s Holzmann yesterday spoke of four more half-point hikes ahead(!)
Which is why, as I have repeatedly flagged, both logic and the history of the pre-1981 world show the only solution may be ‘rate hikes and QE’, i.e., some form of bifurcated monetary, fiscal, and industrial policy rather than a one-size all Fed easing or tightening. Some others are arguing for similar policy. If the San Fran Fed have woken up to the fact that lower rates don’t do any good, and higher rates may not either, than surely we can’t be too far away from seeing a new script for the first time in decades? Laugh at the idea if you want, but those who don’t learn from history are doomed to repeat it.
Powell will consider his own future position in it when he testifies today. Perhaps it isn’t always good to be the king.