- UK shows fiscal malfeasance can be even worse than monetary policy mistakes
- Focus shifts to Fed as high U.S. CPI affirms strong rate hike
- Political vacuum limits initiatives as U.S. absorbed in midterm elections
In the tug of war between monetary and fiscal policy, we can see from the experience in the U.K. that while high interest rates and recession may result from mistakes by central bankers, it takes a government to wreak real havoc.
The total implosion of Liz Truss’s government has already cost her short-lived finance minister, Kwasi Kwarteng, his job, and many are betting that Truss herself has only days or weeks left as prime minister, not months.
Kwarteng’s replacement, Jeremy Hunt, seems to be a safer pair of hands, but Bank of England Governor Andrew Bailey says that the ill-fated “mini-budget” will leave a legacy of higher inflation and higher interest rates even after Hunt has mostly reversed those policies.
Yield on the 30-year U.K. government bond (the one most affected by the accompanying pensions crisis) slipped back to 4.37% on Monday after Hunt took the U-turn on tax cuts and subsidies from its high near 4.9% on Friday, still well above the 3.3% before Truss became prime minister and the mini-budget was still a gleam in Kwarteng’s eye.
The U.K. is something of a sideshow at this point, however, as the focus of global investors shifts back to the US Federal Reserve. There, the news is going from bad to worse.
The U.S. consumer price index for September came in last week higher than expected at 8.2% and dampened any hope that the Fed might relent in its march to higher rates.
The minutes of the Sept. 20-21 meeting of the Federal Open Market Committee, released last week after the usual three-week delay, did not mince words:
“Many participants emphasized that the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.”
Policymakers intend to err on the side of caution. The thinking seems to be that even a painful recession now would be preferable to rising inflation and an even deeper downturn later.
Nonetheless, hedge funds and other normally savvy operators are betting on a pivot by Fed policymakers—pausing their hikes and then lowering rates next year as inflation cools. This won’t be at the next meeting on Nov. 1-2. Absent any demonstrable decline in measures of inflation, that pivot could be months away.
Most everyone expects is the Fed to hike its policy rate 75 basis points for the fourth time in a row next month, and some even expect a full percentage point rise. A similar rise may be in store for the mid-December meeting.
Speaking of governments wreaking havoc, U.S. officials are so focused on the midterm elections in just a few weeks’ time that President Joseph Biden has become the chief inflation and recession denier, despite all the evidence to the contrary. The Nov. 8 election, which could see a shift in control in both houses of Congress, is bad timing for the Democrats, but they had a chance to nip inflation in the bud last year and didn’t take it.
Former Treasury Secretary Larry Summers said last week that in the face of all the challenges to the global economy:
“I think the fire department is still in the station.”
He was referring primarily to the World Bank and the International Monetary Fund, both of which take their marching orders from the U.S., but his remarks could also embrace the Fed and the U.S. government itself.
“We’ve got the most complex, disparate, and cross-cutting set of challenges that I think I can remember in the 40 years I’ve been following this stuff,” Summers told an audience at the Institute of International Finance annual meeting on Friday.
The leadership vacuum is due not only to politicians’ preoccupation with the elections but also to the sad fact that we have a central banker, Janet Yellen, as the government official in charge of the world’s largest economy, and a politician, Christine Lagarde, in charge of the world’s second-most important central bank. Both are in well over their heads and not able to back any meaningful initiatives.
The political and financial crisis in the UK may be a harbinger of things to come on a global scale. As Summers said last week when he warned that the UK crisis could herald global tremors:
“And when you have tremors, you don’t always have earthquakes, but you probably should be thinking about earthquake protection.”