September 29, 2023 - October 5, 2023 The Sun Bay Paper Page 8 A Special Economic Opinion Piece Navigating Economic Risks: A Familiar Echo from 2007 In retrospect, the headlines of 2007 were marked by optimism, bolstered by predictions of a soft landing for the economy from institutions like the International Monetary Fund and the Federal Reserve. It was an era where rising imbalances were largely dismissed, partly because market participants and economists often viewed central banks as adept conductors, steering the economic vehicle. Interestingly, the current optimism about the U.S. economy echoes the sentiment of that bygone era. While some may argue that this time is distinct and will not lead to a crisis akin to 2008, they are correct in asserting that each crisis has its unique characteristics. However, a common counterargument when discussing the risks of a recession is the belief that the Federal Reserve will inject whatever liquidity is required, with quantitative easing regarded as the antidote to prevent a crisis. Yet, if the only remedy to avert a 2008-style contraction is monetary easing, then the peril of stagflation becomes even more pronounced. Thus, for those apprehensive about a recession, stagflation may be the more immediate concern. It has been emphasized previously that we find ourselves amid a private-sector recession camouflaged by unprecedented government spending. Recent Purchasing Managers Index (PMI) readings corroborate this view. S&P Global highlights that the “further loss of service sector momentum weighs on overall U.S. economic performance,” with manufacturing firms registering a decline in production and service sector firms experiencing their slowest rise in business activity in eight months. Additionally, U.S. consumer confidence dipped in August, reflecting a decline in the Conference Board consumer confidence index. More worrisome is the fact that the services sector and consumption have been buoyed by mounting debt levels. As of July 2023, the personal savings rate had fallen to 3.5 percent, well below the pre-pandemic average of 6.9 percent. Moreover, total credit card debt surpassed $1 trillion in the second quarter of 2023, marking a record total household debt of $17 trillion, as reported by the Federal Reserve Bank of New York. Despite elevated inflation levels, the U.S. government continues its prodigious spending, leading to an increased consumption of the currency it issues. Notably, Tim Congdon at the Institute of International Monetary Research has underscored the direct link between inflationary surges and broad money growth due to expanding government deficit spending. This perspective is corroborated by studies conducted by Claudio Borio at the Bank of International Settlements. Of concern is the staggering figure that threatens trust in the U.S. currency and the sustainability of public finances: the U.S. deficit totaled $2.474 trillion in the year leading up to July 2023. With nominal GDP during the same period at approximately $27 trillion, the deficit represented over 9 percent of GDP. The rise in debt levels is effectively propping up GDP in the United States. Simultaneously, inflation expectations remain high, the full impact of rate hikes has yet to materialize, and monetary aggregate declines indicate that the burden of monetary policy contraction falls squarely on the private sector. A burgeoning government deficit portends either higher taxes, increased inflation, or greater debt in the future. The belief in a soft landing persists largely because growing fiscal and debt imbalances have not substantially impacted the broader economy. While there may be validity in the notion that a recession is not imminent, the longer the delay in confronting an inevitable recession, the more severe its impact will be. Attempting to mask what would have been a reasonable technical recession after an enormous monetary and fiscal boost in 2020–21 may ultimately exacerbate the situation. Economic agents could be misled into thinking that rate hikes will have minimal impact and that credit supply will remain unaltered. Monetary aggregates have already started to rise well before the battle against inflation has concluded. Money supply growth has rebounded, and while rates have yet to increase, both core and headline inflation remain significantly above target. Furthermore, if the only factor preventing a 2008-style recession is further quantitative easing, then the recipe for stagflation is complete. Extensive liquidity injections aimed at sustaining markets may exacerbate the situation when coupled with persistently high government deficit spending. This is particularly concerning since the government appears reluctant to curtail expenditures. Unlike the previous instance, the economy's starting point is not deflation but escalating core and headline prices. The government must trim unnecessary spending and significantly reduce the deficit, while the Federal Reserve should tighten its balance sheet and resist the temptation to purchase long-dated treasuries from banks at the first sign of market concern. Additional government stimulus packages will merely compound an already low-growth, high-debt, and low-productivity economy. Monetary contraction should be targeted at reducing public sector imbalances rather than constricting the private sector. There can be no soft landing when the government's role in the economy expands, simultaneously squeezing and displacing the private sector. Warning signs are becoming increasingly apparent, and disregarding them would be a grave dereliction of responsibility. Copyright © August 15, 2023 SBP Media LLC and Sun Bay Paper All rights reserved. This newspaper or any portion thereof may not be reproduced or used in any manner whatsoever without the express written permission of the publisher.
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