I have written before about how the US Federal Reserve finds itself in a near-impossible position.
Overheating equity markets in America and around the world have combined with historically high rates of inflation and unemployment and low levels of labor force participation for the better part of a year.
The quandary, of course, for the central bank’s Chair Jerome Powell is walking the tightrope between social instability that may be generated by rising unemployment and the specter of rising inflation that could also place the fabric of American society at risk.
Powell, as head of an increasingly politicized Fed, is being forced to decide which of these two bad options will, perhaps literally, bring torches and pitchforks onto the streets first.
I have long speculated that raising rates — despite the incantations of the bank’s board of governors to the contrary — was unlikely and potentially dangerous in the face of already high unemployment and shaky markets.
The current US unemployment rate is 4 percent, though even Powell has noted that, for all intents and purposes, the actual “on the street” numbers are a good bit higher.
Compounding this, labor force participation hovers around 62 percent, which is about 6 percent below the highs of the 1990s and early 2000s.
This amounts to millions of people in America who are simply not working due to several factors, including pandemic-related job switching, caring for aging or sick relatives, general workforce dissatisfaction as real wages fall, and perhaps an understandable reevaluation of personal priorities in the face of lockdowns, mandates and illness.
Over the last year, the path has been difficult to navigate for any central bank. For the Fed, however, the situation has obviously become much worse in recent days.
With the Russian invasion of Ukraine, gold will — perhaps very shortly — reach $2,000 per ounce. Interest rates on US government securities, and therefore mortgages, seem to be disconnected from fundamentals and beyond schizophrenic.
The Fed has blamed “technical difficulties” for recent delayed Treasury and MBS purchases. Brent crude oil and WTI are now both hovering around $100 per barrel. And, amusingly, at least to me and economist Nouriel Roubini, Bitcoin has fallen dramatically in recent weeks.
None of these things described above bode well, but most are symptomatic of realities that have existed for a long while. One exception is the impact of the Russian-Ukrainian conflict that has shocked oil prices. This is something that is not a symptom of a shaky system, but a cause of that system transitioning from shaky to crumbling.
I warned back in September there was a substantial risk of recession and oil price decline should the Fed proceed with interest rate increases, and I stand by that assertion given the circumstances at the time.
Such action would have pricked the bubble of “post-pandemic optimism” and would have been very costly for energy markets. Now, of course, energy markets have become the very thing that has pricked this long inflating bubble.
With oil above $100 and uncertainty rising in Eastern Europe, the potential for stagflation, at least in the US, is almost certain when existing supply shocks are factored in. The question now is the extent of it and the degree to which the US central bank might exacerbate the problem.
As recently as a week or two ago, Fed governors were calling for a 50 basis point increase in rates. Should even half of that take place over the next month, I suspect the current equity market rout, of almost 12 percent over the last two months, will repeat itself with equal vigor.
Simultaneously, rising costs and likely exacerbated supply chain woes, along with fear-based falls in the consumption of available goods, will lift unemployment dramatically.
This has all been brewing for several months and recent calls to raise rates were simply encouraging the US central bank to engage in a policy error that would be costly in terms of welfare and the Fed’s credibility once it was ultimately forced to reverse said policy action.
The Fed and policy pundits now know that this cannot happen and that inflation is the order of the day along with a long painful recession.
To paraphrase Ernest Hemingway in his novel “The Sun Also Rises,” disaster usually takes place “gradually, then suddenly.” America has now transitioned from the former phase sharply toward the latter.
• John W. Salevurakis is an associate professor of economics at the American University in Cairo and an author.
