The precarious state of the global economy loomed large at this year’s New Orleans Investment Conference, and was a prominent topic for many of the annual event’s guest speakers and attendees.
At the economy panel, viewers were treated to a master class in economic theory courtesy of moderator Adrian Day and panelists James Grant, Mark Skousen and Brent Johnson. The discussion began with Day, Skousen and Grant agreeing that former US Federal Reserve Chair Ben Bernanke was not deserving of his portion of the 2022 Nobel prize in economic sciences.
“He did do some early work that was really valuable,” said Skousen, an economist and the editor of Forecasts and Strategies. However, he took issue with policy decisions seen later during Bernanke’s tenure.
“When it came to being an applied economist, I think he blundered repeatedly, especially failing to predict that there was any trouble at all,” he told the audience. “He knew of the subprime crisis, he knew of no-doc loan mortgages and the fraud that was going on, the violation of the prudent man rule — and yet he allowed it to take place.”
Bernanke’s role in the 2008 financial crisis, as well as his introduction of the controversial quantitative easing strategy, were Skousen’s main contention points for the former Fed head.
“He was the chief banking officer of the US,” he said. “That was a disgrace. He should have been fired. Any CEO that allowed the demise of their company like this would have been fired. And yet we’re giving him a Nobel prize. I think it was a major mistake.”
What will Powell and the Fed do next?
From there, the group connected today’s financial problems to the Fed’s long quantitative easing regime and the 180 degree turn it has made in the last 10 months in terms of interest rate hikes. Skousen referenced the “invisible hand” theory, a metaphor put forward by Adam Smith in the 1700s to describe the unseen forces that move the free market.
“If you look at the Adam Smith model … there are a number of principles that are very important. Live within your budget, keep taxes to a minimum to have sound (and) stable money,” he said. “When economics goes awry, when economists go awry, they’re not following the principles that were established by Adam Smith and other sound economists.”
Moderator Day pointed out that modern economic theory uses many formulas that older models don’t incorporate.
“That was Ben Bernanke. He speaks for that department of economics, when he said, ‘It takes the model to beat the model,’” said Grant, author and founder of Grant’s Interest Rate Observer.
He went on to note that the current school of thought used by macroeconomists and central bankers — the new Keynesian dynamic stochastic general equilibrium model — has resulted in the Fed ignoring the financial side of the economy.
To this, Skousen offered up the Austrian model, which focuses on yield curves as a better metric for gauging the economy.
“When you have a negative yield curve, you have had a recession almost every time,” he told conference-goers. “The negative yield curve is a very powerful way of predicting that we’re headed for trouble.”
For Johnson, CEO of Santiago Capital, the Fed’s next step has less to do with economic theory and more to do with curbing demand. “The whole point of raising interest rates is they want to crush demand, because they think that that will then crush inflation,” he said. “So the idea that the Fed is upset that the stock market is down is wrong. They want the stock market down. That’s their goal. They’re trying to engineer a soft landing.”
While former central bankers came under fire early on in the 45 minute discussion, Johnson acknowledged that current Chair Jerome Powell has been pretty honest about his economic goals this year.
“I’ve never heard a central banker speak more clearly than Powell has,” Johnson said. “He’s been very clear that, ‘I’m going to raise rates. Inflation has gotten out of control. If we let inflation go unchecked, that will do more damage than a recession.’”
Johnson believes job losses and wage pressures won’t be enough to get the Fed to switch its current path, although he does think there are factors that could lead to another about-face.
“The reason central bankers exist is to be the put option on the market. So if it gets bad enough, and the system itself comes into question, they will pivot. But I don’t think that they’re going to pivot until we get to that point,” Johnson said.
When and how the Fed moves away from tightening was the question of the hour and made for a lively debate.
Skousen said he is watching the emerging markets as a signal for when the Fed may reverse course.
“(Powell) is pushing the policy too tight, and as a result we’re going to see an emerging market debt crisis like we had in 1982, when Paul Volcker pulled back because of the dollar crisis,” he explained.
With the US dollar reaching a 20 year high in Q3, Skousen foresees trouble ahead. “The dollar is getting stronger, emerging market debt is all paying back in (US) dollars,” he said. “So when you start seeing these countries defaulting on their debt, that’s when Powell is going to throw in the towel. It hasn’t happened yet, but when it does, that’s going to be a great buying opportunity.”
The end of globalization
For his part, Johnson believes a crash in emerging markets won’t be enough to drive the Fed to change its stance. The CEO and financial manager doubled down on his earlier statement that Powell’s chief desire (in the current economy) is to crush inflation.
“While (Powell) may not be a genius, I think he’s smart enough to know that he cannot crush demand in the US without crushing demand externally first,” he said. “And I think that’s actually part of their calculation.”
Grant then quoted Austrian economist Ludwig von Mises’ theory that central banks give us inflation as policy and then deliver on it.
“He likened them to a kind of a demonic motorist behind the wheel that sees a pedestrian (and) runs over that pedestrian. That’s inflation,” Grant said. “And then having a look back in the rearview mirror notices the victim is still twitching, throws the car into reverse and performs quantitative tightening by backing up over them.”
The analogy brought laughs from the crowd.
Day then asked the panelists if and when consumer price inflation rates will come down. “I actually think that they’re going to start to come down,” Johnson answered. “But if they start to come down a little bit, he’s not going to stop.”
He went on to highlight what factors could drive the Fed to ease its strategy. “Now, if we get this crisis in the system itself — the credit markets seize up, the Treasury markets seize up — they will absolutely pivot again,” Johnson said. “That’s why they’re there. I just don’t think they’re going to do it to save Turkey, or do it to save Malaysia or Singapore.”
The US is the world’s largest reserve currency, making it the default payment method for most commodities. It is also widely used to pay national debts. As Grant pointed out, although the US dollar is the world’s currency, the Fed, which enacts policy and directives that impact the dollar, is a domestically focused institution.
“The trouble is you can’t have globalization as a concept when it’s convenient and deny it when it’s inconvenient,” Grant said. “So I think it’s one financial world to a great extent, as will be discovered.”
How high will interest rates go?
Causing other countries to default on their debt isn’t the only problem that a strong US dollar and rising interest rates present.
“We have a lot of problems … the national debt is now over US$31 trillion and it’s moving up pretty quickly,” Skousen said, blaming much of that on irresponsible monetary and fiscal policy. “There’s a real challenge here for the Fed, because if they keep raising rates like this you are going to face a fiscal crisis, because we’re talking billions and billions of dollars in interest debt.”
Concluding the robust economic overview, Johnson agreed with Grant and Skousen that the Keynesian philosophy of looking at money is going to cause a big disaster.
“It absolutely is,” he affirmed. “But I cannot figure out a scenario in which the rest of the world does well, and the US goes up to this big ball of flames.” Instead, he expects a situation that burns from the outside in.
“I think it starts on the periphery and it moves to the core,” Johnson said. “And for better or worse, we are the core. And just keep that in mind as you’re allocating your assets.”
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Securities Disclosure: I, Georgia Williams, hold no direct investment interest in any company mentioned in this article.
Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.
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