Looking Through a Dark Glass - Old models rethought, New playing field

 

Photo by Barbara Platek

I have waited to write another blog on the economy because things have been slowing down a bit lately. Slowing down is a relative term of course. Financial news and gurus would like nothing better than to have massive activity or perceived activity to generate something to write about. It doesn’t matter what point they argue just that they can argue. I have found three articles discussing topics that I think may be interesting and possibly somewhat informative.

The first two articles are from the Financial Times and CNBC, written in mid and late December. I like them because someone is asking about how successful the various central banks have been in predicting and handling the most recent recession and interest rate crisis. They have not been particularly successful in either predicting or dealing with the crisis. The article is pretty good about pointing out a couple of good thoughts. However, the central banks only admit that they applied the wrong thinking to the problem. They now know where they went wrong (or so they say) and the problem won’t happen again. Don’t believe them. They haven’t got it right this time. We will continue to have crisis and they will continue to make the wrong corrections.

Central bankers are rethinking their approach to economic forecasting after their high-profile failures to spot the most recent inflationary outburst, as officials argue for greater candour with the markets about the uncertainties they are confronting. … “What we should have learned is that we cannot just rely only on textbook cases and pure models. We have to think with a broader horizon,” she said. (Christine Lagarde) (a)

The second article discusses the difficult nature of forecasting. If only the world were linear or bell curve shaped or predictable our models would have performed just fine. But because the world is unpredictable (who would have thought) we (the economists and central bankers) can’t be expected to be able to make accurate forecasts. So we will continue to use the old models with a few adjustments and expect the world to get in line and be linear or bell curve shaped. Because if it does conform to our view of the world then, of course, our models will get it right. Their models will not get it right, trust me on this.

Firstly, a “multi-polar world” and an “increasingly fragmented global order” are leading to the “end of hyper-globalization,” Little said. Secondly, fiscal policy will continue to be more active, fueled by shifting political priorities in the “age of populism”, environmental concerns and high levels in inequality.  Thirdly, economic policy is increasingly geared towards climate change and the transition to net zero carbon emissions. [More so in Europe but the Biden administration is determined to drag the US into the morass of massive spending, extreme regulation and ill-thought out initiatives.]

“Against this backdrop, we anticipate greater supply side volatility, structurally higher inflation and higher for longer interest rates.” Little said. “Meanwhile economic downturns are likely to become more frequent as higher inflation restricts the ability of central bands to stimulate economies.” (b)

 

New interest rate & inflation thinking

I like the below quoted Reuters article from early January. There is still a lot of sentiment that the Fed will be successful in a soft landing. You will notice that this discussion has been going on since early 2022 with an ever changing end date. The discussion of the recession, regardless if it crashes or is in fact a “soft landing” makes for good press so as long as it is never resolved there is good storytelling. Expect to see much discussion even after it is finally decided we are either in recession or had a soft landing

 “[A] well-known economist and former Fed official earlier this year argued the Fed has managed soft landings more often than is generally believed. But many investors and executives think the probability is low [for a soft landing at this point].

Investors are betting that the Fed could cut rates by as much as 1.5% by the end of 2024, but that would still leave policy rates at close to 4%, higher than where it has been for most of the past two decades. At that level, monetary policy will still be a drag on growth, as it would be above the so-called neutral rate at which the economy neither expands nor contracts.” (c)

What does this mean for you and me? More uncertainty and higher interest rates for quite some time and the likelihood of rollercoaster inflation and less inflation. For the last 30 years we have had it fairly nice. The central banks kept interest rates artificially low by pumping massive amount of money into world economies. We all benefited from cheap money. We are now, finally paying the price because the banks can’t kick the can down the road anymore. There was so much excess money (the central banks have actually been reducing their balance sheets some recently) that the whole world system began to collapse. That was when the world banks finally panicked and slowed the river of money. That is the catalyst for the current recession (starting in early 2022) and why it is still hanging on. Most previous recessions lasted from 4 to 10 months at the longest. We are still drying out from our massive, massive binge and it is being slowly done. So expect to see recession / inflation talk to continue (remember it makes for good press). See excerpts from the Reuters article below to see a pretty good discussion of what can and may very well happen and why.

“Interest rates underpin everything, from economic growth to the price of financial assets and how much it costs to borrow to buy a car or a house.

Higher rates make riskier assets, such as technology stocks and cryptocurrencies less attractive, as investors can earn a decent return without having to take on much risk.

With money harder to come by, riskier bets can fail and bubbles burst, leading to events such as the U.S. regional banking crisis last March. As businesses struggle, they retrench. People lose jobs and new ones get scarce.”

“While the Fed and other banks have been raising rates for well over a year, the world is yet to complete the transition from the time when money was free to a period when it no longer is. 2024 is likely to be the year when the effects of that transition manifest more clearly.

That means companies – and in some cases, entire countries -- will have to restructure their debt liabilities, as they can no longer afford to pay interest.

For consumers, while savings would yield more, higher borrowing costs will require an adjustment. Many U.S. adults have only known low interest rates for their 30-year mortgages, for example. They'd need to come to terms with rates that are more than twice as high and make the math work for their budgets.

Bottom line: investors' convictions will likely get tested, as everyone will have to figure out how to live with higher interest rates.” (c)

So, hang in there. Us old timers (me included and my generation) lived through this kind of uncertainty and massive upheaval in the 70’s and 80’s. We survived. We had to be more frugal and things cost more including anything that required borrowing or debt. Because the costs were higher we had to scale back on our expectations and it did impact our ability to spend and save. When we came out of that time period the world governments opened the money spigots to keep inflation low because they were so afraid of inflation that they would do anything to avoid it again. It appeared to work for 30+ years. Now it doesn’t work and you (the younger generations) are paying the price as are we. My generation went from tight money to loose money and we loved it. This younger generation is going from loose money to tight money and it is painful and will be so for a while. Good luck. Remember what is important and it isn’t easy money. It’s family, friends, neighbors and your spiritual wellbeing. Not what the world would have you believe.

Articles quoted:

‘(a) Financial Times, “Central banks rethink forecasting after failures on inflation”

Sam Fleming in London, Martin Arnold in Frankfurt and Colby Smith in Washington 

December 27 2023  https://www.ft.com/content/5d7851f3-ef7c-4599-8a5c-c34cecb83511

‘(b) CNBC ‘Bonds are back’ as markets enter a ‘new paradigm,’ says HSBC Asset Management

Published Thu, Dec 14 2023 2:45 am EST  https://www.cnbc.com/2023/12/14/bonds-are-back-as-markets-face-new-paradigm-hsbc-asset-management.html

‘(c) REUTERS, “For investors, 2024 is year of transition to a new economic order”, By Paritosh Bansal, January 2, 202410:07 am MST  https://www.reuters.com/markets/investors-2024-is-year-transition-new-economic-order-2024-01-02/