“God does not play dice with the universe.”
- Albert Einstein
Maybe, but it appears that American presidents will play dice with the global economy.
As fourteen-hundred-dollar stimulus checks make their way out to Americans across these United States, U.S. President Joseph R. Biden Junior is about to embark on the biggest economic experiment since Nixon abandoned the gold standard in 1971.
America is defying pessimism that the pandemic has knocked the wind out of its sails.
Based on current plans, the U.S. Federal Reserve and the Treasury Department will pour some US$2.5 trillion into the banking system this year even while interest rates stay near zero.
If American policymakers were restrained in the aftermath of the 2008 financial crisis, they’ve clearly thrown off those restraints, with the probable result a bounce back in the U.S. and by extension global economy that was unthinkable just a year ago.
In January retail sales in America were already 7.4% higher as compared to a year earlier.
Stuck at home and with few places to spend their stimulus checks, Americans, who aren’t particularly frugal even in the worst times, stashed away some US$1.6 trillion in excess savings.
And if vaccines continue to go into American arms and new coronavirus variants can be avoided or defeated, there’s also a good chance that unemployment will fall below 5% by the end of the year.
Biden’s fiscal boost will also light up American appetite for global goods as the economy inhales imports.
And while Biden and friends will have a guaranteed place in history, the U.S. is now entering an unpredictable three-pronged economic experiment that marries unprecedented levels of fiscal stimulus, a more tolerant Fed that accepts overshoots of inflation targets, and huge pent-up savings which no one knows what Americans will use to do.
In no point in history has this trifecta of loose money, hot money and unspent money co-existed simultaneously and the danger for the rest of the world is that the U.S. economy turns white hot and overheats beyond its safe limits.
And it’s a risk that investors have already considered, as evidenced by the recent spike in benchmark U.S. 10-year Treasury yields, on expectations of higher inflation and eventually higher interest rates.
Because of America’s continued dominance in the global financial system, its monetary policy outlook spills over into other jurisdictions, as was seen when Australia’s central bank had to increase its bond purchases to prevent yields from running away, as had the European Central Bank.
The Fed has remained obstinate and held that it will keep rates low and continue to buy assets until the economy is much healthier, particularly unemployment, but has been vague on what those precise targets are.
Because how much unemployment is acceptable? Pre-pandemic levels? Or zero?
To make matters worse, the Fed is looking to bring in an amorphous “average inflation targeting” regime that was adopted last year, which says that inflation can exceed the Fed’s 2% targets in some years, as long as on the average it’s around 2%.
But how will anyone know what inflation will be in the years to come to make up this 2% average?
Is 10% this year ok if over the next five years inflation falls to 0%?
Fed Chairman Jerome Powell argues that even if inflation spikes, it’s likely to be temporary, because longer term inflation dynamics “don’t change on a dime.”
But we really don’t know that – no one expected Treasury yields to spike on a dime either, but they did.
Then again, no one expected a pandemic last year either (maybe Bill Gates), but it happened.
There are too many unknown unknowns to make a declaration that inflation is a non-starter.
Eventually if inflation gets out of hand and the Fed starts to see that it may not have a firm grip on things, it might have to jack up rates to get inflation down, tearing apart asset markets that might make things difficult for a government that is increasingly in hock over its head.
To be sure, Biden has to take the gamble if America wants to avoid the low-rate, low-inflation trap that has been the past decade in Japan and Europe, also known of as the “lost years.”
And massive fiscal response may become the new normal response to recessions, regardless of how they’re caused, but the bigger risk is the world’s largest economy will be left with soaring debts, an inflation problem it can’t cap, and a central bank whose credibility is being called into question.
When the dice is in your hands, the only thing you can do is roll them, so God help us all.