“The descent is always more sudden than the rise; A punctured balloon will not deflate properly.”— John Kenneth Galbraith
In July 2022 I traveled to London and Normandy, France with my family. The important purpose of the trip was to satisfy in Normandy my father-in-law, who had all the time dreamed of visiting the places where the tide was turning in World War II. I didn’t realize our trip would have a lot relevance to today’s economic conditions.
On September 21, 2022, the Federal Reserve intensified its attack on inflation with the third consecutive 75 basis point rate of interest hike. The Fed also warned that further monetary tightening was imminent and would last no less than next yr.
Threading the needle on Threadneedle Street
The Fed is in a difficult position: it must prepare the general public for the economic problems ahead, but without creating panic. The reality, nevertheless, is that a recession is now virtually inevitable. Why? Because the Fed can only use blunt policy tools to reverse extreme economic conditions. This makes it extremely difficult to attain a soft landing. The last two comparable events, the tightening cycles of 1920 and 1979 to 1981, each triggered severe economic contractions.
During our visit to London my son and I visited Threadneedle Street and the Bank of England Museum, where we played the inflation game. The goal is to balance a steel ball in the middle of an air tube marked with a 2% inflation mark. The player – or an annoying dad – then presses an “economic shock” button, which shakes the tube, releasing the ball and sending it either to the far right, representing inflation, or to the far left, representing deflation. My son struggled to get the ball back heading in the right direction and overshot the goal several times before settling back right down to 2%.
Image courtesy of Mark J. Higgins, CFA, CFP®
The inflation game is an ideal metaphor for the Fed’s predicament for the reason that COVID-19 pandemic began in March 2020. First, the large economic shock caused the ball to slip to the left. The Fed and federal government responded by flooding the economy with liquidity to stave off extreme deflation and a possible depression. Then in 2022, after excessive stimulus moved the ball too far to the appropriate, leading to high inflation, the Fed modified course. It will almost definitely overshoot the goal again, just in the opposite direction, before it may possibly achieve a return to the comfortable 2 percent goal.
The human cost of the Great Depression
This tightening of monetary policy could have consequences – the ball has simply strayed too removed from center. This will result in economic stress in the shape of declining asset values, job losses and general fear of the long run. That does not imply the Fed is taking its responsibilities flippantly. The Fed’s leadership knows that its policies will cause short-term pain, but additionally knows that the long-term consequences of policy mistakes – or inaction – are far more serious.
This brings us to the second stop of our trip: Normandy, France. It is not any coincidence that the Second World War broke out lower than ten years after the beginning of the Great Depression. In 1929, the Nazi Party was on the snapping point. The German economy was recovering from the devastating hyperinflation of the early Nineteen Twenties and recent optimism was spreading. In the 1928 elections, the Nazis won only 12 of the 491 seats within the Reichstag. But then got here the worldwide economic crisis. Millions of Germans became unemployed and the economic decline looked as if it would don’t have any end. In the September 1930 elections, the Nazis won 107 of 577 seats and started the dissolution of the Weimar Republic.
The experiences of the Thirties and Nineteen Forties are price remembering. When central bankers flood the market with liquidity to stop a Great Depression-level event, their primary goal will not be to support stock prices but to avoid wasting lives. Would the Second World War and all its horrors have existed without the Great Depression? Probably not. Could similar catastrophes have occurred in 2020 – or 2008 – if central bankers and government policymakers all over the world had didn’t stop the panic? It’s a definite possibility.
The misery of great inflation
The Great Inflation dislocations of the late Sixties to early Nineteen Eighties caused similar disadvantages within the United States. This is reflected within the Misery Index, which adds the inflation rate and the unemployment rate. During the worst years of the Great Inflation, Misery Index readings were almost as bad as they were in the course of the Great Depression. The average misery index at the height of the Great Inflation from 1968 to 1982 was 13.6%, in comparison with 16.3% within the Thirties.
The US Misery Index, 1929 to 2021*
*The official Misery Index begins in 1948. The pre-1948 unemployment and inflation data used to calculate the Misery Index are based on a unique methodology. Nevertheless, the final trend is more likely to point the way in which.
History shows that economic suffering results in popular discontent, which in turn results in unrest and violence. This occurred amid the good inflation of the late Sixties and Nineteen Seventies within the United States. In fact, the misery of the Great Inflation was much more insidious than that of the Great Depression. An economic collapse can easily be understood as a source of suffering. The paralyzing fear brought on by constant price spikes is harder to know. It took Paul Volcker’s foresight and courage to temporarily increase the pain with a purpose to curb inflation in the long run.
Sympathy for the Fed
The Fed and other officials are easy to criticize, but I imagine they take their responsibilities seriously and understand that their decisions impact the lives of tens of millions of individuals. Their quick motion in response to the pandemic prevented the U.S. economy from sliding into one other Great Depression. Their current efforts are geared toward countering a repeat of the Great Inflation. Neither the Great Depression nor Great Inflation is an event that anyone would love to repeat.
There will undoubtedly be more problems in the approaching yr before the U.S. economy returns to normal. And even if that is so, recent challenges will arise. I’m keeping my fingers crossed that the Fed will someway thread the needle and engineer a soft landing. But if it fails, it isn’t due to personality flaws or skilled incompetence. The reason for that is that the duty is nearly unattainable. Instead of blaming the Fed for the pain we’re more likely to experience within the near future, we want to maintain our eye on the ball and do not forget that returning inflation to the two percent goal is our most vital priority.
If you enjoyed this post, do not forget to subscribe.
Image courtesy of Library of Congress Prints and Photographs Division/ Original drawing by Edmund S. Valtman.
