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New Inflation Numbers Mean the U.S. Economy Is Destined for ‘Hard Landing’

Joe Biden
US President Joe Biden. Image Credit: Creative Commons.

More inflation means more interest rate increases: Today’s disappointing consumer price numbers showing stubborn inflation that won’t dissipate. This now leaves the Federal Reserve with little option but to raise interest rates by another 75 basis points at its policy meeting next week. That heightens the chances of a hard economic landing by early next year.

Not only will the Fed’s continued hawkish monetary policy stance cause the US equity and housing market bubbles to burst. It will also compound a difficult economic situation abroad by further boosting the US dollar and by accelerating the pace of capital repatriation from emerging market economies.

More Inflation, More Problems

Prior to today’s inflation numbers, Fed Chair Jerome Powell cautioned markets that the Fed would stick to its hawkish monetary policy stance until it saw clear signs that it was regaining control over inflation. Today’s disappointing numbers give the Fed little reason to think inflation is nearly under control. Not only did headline inflation in August remains uncomfortably high at 8.3 percent, despite a sharp drop in gasoline prices. The so-called core inflation rate, which excludes gasoline and food prices, increased by 6.3 percent. That is three times as high as the Fed’s 2 percent inflation target.

One reason to fear that the Fed’s hawkish monetary policy stance will precipitate a hard US economic landing early next year is that it will severely damage the US equity and housing markets. This is not the least because the Fed is accompanying its aggressive interest rate hikes with an unprecedented pace of market liquidity withdrawal. Indeed, beginning this month, the Fed is now reducing the size of its balance sheet at the unprecedented pace of $95 billion a month. It does so by choosing not to roll over its maturing bond holdings.

Since the start of the year, the US equity and bond markets have lost around 20 percent in value. That has resulted in the evaporation of around $12 trillion, or around 50 percent of GDP, in US household wealth. Should the Fed’s further aggressive interest rate hikes and market liquidity withdrawal inflict additional financial market pain, that could constitute a meaningful headwind to consumer demand.

Even before any additional interest rate increases, there are now clear signs that the housing market is experiencing recession-like conditions. In response to an approximate doubling in the mortgage rate from 3 percent at the start of the year to almost 6 percent at present, mortgage applications have dropped by over 20 percent as housing has become ever less affordable. At the same time, new home sales have plummeted, housing starts have slumped, home prices are starting to decline, and builder confidence is plumbing new lows. As in the past, cooling in the housing market must be expected to have essential spillover effects on the rest of the economy.

Another reason to fear that the Fed’s aggressive monetary policy stance will lead to a hard US economic landing is that it is occurring in the context of an alarming deterioration in the world economic outlook.

Vladimir Putin has shut Europe off from Russian natural gas exports while the political situation in highly indebted Italy has taken a turn for the worse. That raises the prospect of a meaningful European economic recession and another round in the European sovereign debt crisis.

Meanwhile, the economic outlook for China and the emerging market economies has also deteriorated. China’s economy now shows every sign of stagnation as President Xi continues to lockdown major Chinese cities as part of his zero-tolerance Covid policy and as the country’s property sector bubble continues to deflate. At the same time, all too many emerging market economies are now headed towards recession as they struggle with falling exchange rates and with large-scale capital repatriation as a result of higher US interest rates.

It is against this background of strained financial markets, signs of a housing market recession, and a deteriorating world economic outlook that questions have to be raised about the Fed’s current hawkish monetary policy stance. It would seem that by withdrawing market liquidity at a very rapid rate at a time when the equity and bond markets are already on the back foot would seem to be inviting financial market stress. At the same time, continuing to raise interest rates in large increments will compound economic troubles abroad by causing further dollar strength and additional capital repatriation from the emerging market economies.

Inflation Problem

Image: Creative Commons.

In the period immediately ahead, the Fed would be well advised to pay very close attention to financial market conditions at home and economic and financial market developments abroad. It should stand ready to pivot to a less aggressive monetary policy stance as needed if it is to spare us from an unnecessarily hard economic landing.

Author Biography and Expertise: Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.

Written By

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

15 Comments

15 Comments

  1. Omega 13

    September 13, 2022 at 12:14 pm

    My advice? Embrace the suck. Prepare.

  2. David Chang

    September 13, 2022 at 12:37 pm

    God bless people in the world.

    AEI shall obey Ten Commandments with us, not worship democracy.

    War and inflation are consequences on rational choice theory. Because Ivy League think their political, economic, psychology, and sociology sciences model is perfect, no doubt, just like L. V. Kantorovich.

    So many people no longer think that reducing deficit is the duty.

    God bless America.

  3. Dr Scooter Van Neuter

    September 13, 2022 at 1:09 pm

    Wow, who would have possibly guessed that repeatedly printing billions of dollars backed by nothing would result in runaway inflation?
    Answer: Literally everyone.
    F****** idiots.

  4. David Chang

    September 13, 2022 at 2:35 pm

    God bless people in the world.

    Dr Scooter Van Neuter should obey Ten Commandments with us.

    Because democratic party make inflation with war, and make loss on foreign exchange with speculative money. It’s about socialism warfare which is promoting by democratic party and communist party. And this is the socialism action launched by the voter of democratic party to against East Asia countries many years ago, so East Asia countries claim that United States is empire.

    God bless America.

  5. Froike

    September 13, 2022 at 2:54 pm

    Thanks to our Vegetable in The WH and The Demonrat Politburo, it is predicted that the price of food and consumer goods will continue to rise. The Stock Market has become a Roller Coaster and our nation is headed for economic disaster
    Vote solid Red my friends. No, not every GOP Politician is trustworthy and competent, but there are no trustworthy/competent Demonrats!

  6. Ghost Tomahawk

    September 13, 2022 at 3:55 pm

    To stop inflation we have to destroy the economy?

    Thats stupid and these people need to be shot. Literally. This is the purposeful destruction of peoples lives and businesses for what? Bad economic policy.

    How about the federal govt STOP SPENDING MONEY. Thats what caused the problem. Knee jerk reactions to bad news that is caused by the govt is bad enough. Then we have a non govt entity whose only allegiance is to itself determining our fate. Great deal for them I guess. Our kleptocrats in office are immune from this because we pay for the gas, salaries and transportation to and from where ever they decide they want to put on our tab. They know when this is coming so they can pull money out of the market. “Savvy investing”.

  7. Error403

    September 13, 2022 at 4:28 pm

    Latest CPI figure is given as being slightly over 8% but actual number is higher with essential items like eggs and tofu well over 50%.

    But this won’t be happening at all if it wasn’t for the vote rigging in the Nov 2020 election and the rise of fascist democrat power in the white house. And the massive rearmament of violent forces of evil in europe.

  8. Fritz

    September 13, 2022 at 4:56 pm

    Since this inflation is a result of massive federal spending on top of crushing the energy sector, making it a supply side problem, how does increasing rates to squeeze demand help anything?

  9. Dr. Scooter Van Neuter

    September 13, 2022 at 5:07 pm

    Yeah, what a shocker that printing billions of dollars causes inflation. Joe should’ve asked Hunter – he would have told him this.

  10. TG

    September 13, 2022 at 5:49 pm

    OK I get that just printing money will of course dilute its value – but what we have here is more of a supply-shock. The government is jamming in more and more people, deliberately igniting a population explosion. At the same time, supply is being choked off. No amount of financial shenanigans can overcome physical reality.

    Most of the money printing that the government has done has been to subsidize the super-rich and big finance. This has created massive asset price inflation, but not immediately commodity inflation. Right now the main negative of that is that by letting companies borrow money at near zero percent interest, they are simply buying their stock back and giving themselves bonuses with borrowed money and not investing in new production. Also, not enforcing the laws against antitrust means that more and more industry is de-facto monopoly: why invest more money in production and cut your profits, when you can do nothing and let soaring profits roll in automatically? (An unregulated monopoly is basically Stalinist: it’s competition that spurs productivity, not private profit!!) Also government policies aimed at cutting off fossil fuels, etc.

    We are having inflation in necessities: food, fuel, transportation, housing. Things that are not necessities are actually having their prices slashed, as Target recently noticed. And necessities are not optional (duh). The fed will have to tighten a whole lot before people stop eating or having a place to sleep. I guess when we have widespread homelessness and REAL widespread hunger, that will tamp down demand enough to stop inflation. But is that really a solution, at least for you and me?

  11. Jack

    September 13, 2022 at 6:40 pm

    I remember when people were so relieved that Jimmy Carter was leaving the White House…..

    Same thing is going to happen to Joe soon…..

  12. David Chang

    September 14, 2022 at 6:44 am

    God bless people in the world.

    The question is not interest rate, and increase interest rate is not to prevent government deficit and inflation, because of the answer is Government Bond rate.

    But democratic party pursue the same socialism policies as Communist to restrict free market and delay the private petrochemical industry’s production planning. Moreover, all socialism parties increase the demand for oil with Russia-Ukraine socialism war, increasing domestic gasoline prices and leading to increase freight cost.

    When democratic party think that they can win elections by war, and advertise that they will resolve the socialism disputes between Russia and Ukraine, but forget about the huge amount of oil which our military need, they repeat the wrong policy of Vietnam socialism war.

    God bless America.

  13. Yrral

    September 14, 2022 at 1:04 pm

    Lots of American,do not have pot to piss in,and window too throw it out of, talking sending 10 of billion of more dollars,in lost cause in Ukraine

  14. Yrral

    September 14, 2022 at 2:47 pm

    While you American hellbent on being useful idiots for Ukraine,your economy is about to implode due to an impending Strike Google US Railroad Strike

  15. Yrral

    September 14, 2022 at 4:43 pm

    Make Sweden Great Again Nazis win election in Sweden Google Sweden Election

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