Sunday , 3 July 2022

The Idea Of A “soft landing” Is Impossible – Here’s Why

The idea of a controlled explosion or a “soft landing” is impossible …[despite the Federal Reserve chairman’s contention that]  “a soft landing is really just getting back to 2 percent inflation while keeping the labor market strong…[yet, while] it’s quite challenging to accomplish that right now…nonetheless, we think there are pathways for us to get there.” [Here’s why.]

This version of the original article by Daniel Lacalle (mises.org) has been edited [ ] and abridged (…) to provide you with a faster and easier read. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.

The idea of a controlled explosion or a “soft landing” is impossible for the following 6 reasons:

  1. …The weak economic data:
    • While the headline unemployment rate appears robust, both the labor participation and employment rate…have been stagnant for almost a year…[and] real wages are down, as inflation completely eats away the nominal wage increase
    • The University of Michigan consumer confidence fell in early May fell to an eleven-year low…deep into recessionary territory…
  2. The…underestimation of the chain reaction impact of even allegedly small corrections in markets:
    • With global debt and U.S. margin debt at all-time highs, expectations of a controlled explosion where markets and the indebted sectors will absorb the rate hikes without a significant damage to the economy are simply too optimistic…
  3. …The Federal Reserve wants to curb inflation while at the same time the Federal government is unwilling to reduce spending:
    • Ultimately, inflation is reduced by cutting the amount of broad money in the economy, and if government spending remains the same, the efforts to reduce inflation will only come from obliterating the private sector through higher cost of debt and a collapse in consumption…
  4. The relative strength of the U.S. dollar is already creating enormous financial holes in the assets of a financial system that has built the largest carry trade against the dollar in decades:
    • We can see that markets have lost more than $7 trillion in capitalization in the year so far with a very modest move from the Federal Reserve…[and] the write downs are likely to be significant into the second half of 2022, leading to a credit crunch exacerbated by rate hikes.
  5. Central banks always underestimate how quickly the core capital of a financial institution can dissolve into inexistence:
    • Even the financial system itself is unable to really understand the complexity of the cross-asset impact of a widespread slump in extremely generous valuations throughout all kinds of assets and that is why stress tests always fail and financial institutions all over the world have abandoned the healthy process of provisioning expecting a lengthy and solid recovery.
  6. …The Federal Reserve hasn’t realized that the market is weaker than they anticipated, and liquidity is significantly lower than they calculated.
    • Borrowing costs globally are surging while the US dollar is strengthening, creating an enormous vacuum effect that can create significant negative effects on the real economy.

There is no easy solution. There is no possible painless normalization path. After a massive monetary binge there is no soft hangover. The only thing that the Federal Reserve should have learnt is that the enormous stimulus plans of 2020 created the worst outcome: stubbornly high core inflation with weakening economic growth. There are only two possibilities:

  1. To truly tackle inflation and risk a financial crisis led by the US dollar vacuum effect or
  2. to forget about inflation, make citizens poorer and maintain the so-called bubble of everything.

Neither is good but they wanted a decisive and unprecedented response to the pandemic lockdowns and created a decisive and unprecedented global financial risk. They thought money creation was not an issue and now the accumulated risk is so high it is hard to see how to tackle it.

One day someone may finally understand that supply shocks are addressed with supply-side policies, not with demand ones. Now it is too late. Powell will have to choose between the risk of a global financial meltdown or prolonged inflation.

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