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Friday's release of disappointing August payroll numbers should have been
a jarring wake-up call warning Wall Street that the economy has been treading
on thin ice. Instead the alarm clock was stuffed under the pillow and Wall
Street kept sleeping. The miss was so epic in fact (the 142,000 jobs created
was almost 40% below the consensus estimate) that the top analysts on Wall
Street did their best to tell us that it was all just a bad dream. Mark
Zandi of Moody's reacted on Squawk Box by saying "I don't believe this
data." The reliably optimistic Diane Swonk of Mesirow Financial told
Reuters the report "sure looks like a fluke, not a trend".
But the opinions of those that really matter, the central bankers in
charge of the global economy, are likely taking the report much more
seriously. Given that this is just the latest in a series of moribund data
releases, such as news today that U.S. mortgage applications have fallen to
the lowest levels in 14 years, caution is justified. Unfortunately very
little good comes from central bank activism. Recent statements from Fed
officials across the United States and recent actions from ECB president
Mario Draghi reveal their growing resolve to fight too low inflation, which
they believe is the biggest threat to recovery. There are many things that
are contributing to the global woes. But low prices are not high on the list.
Since the markets crashed in 2008, central banks around the world have
worked feverishly to push up the prices of financial assets and to keep
consumer prices rising steadily. They have done so in the official belief
that these outcomes are vital ingredients in the recipe for economic growth.
The theory is that steady inflation creates demand by inspiring consumers to
spend in advance of predictable price increases. (The flip side is that
falling prices "deflation," strangles demand by inspiring consumers
to defer spending). The benefits of inflation are supposed to be compounded
by rising stock and real estate prices, creating a wealth effect for the
owners of those assets which subsequently trickles down to the rest of the
economy. In other words, seed the economy with money and inflation and
watch it grow.
Thus far the banks have been successful in creating the bubbles and
keeping inflation positive, but growth has been a no show. The theory says
the growth is right around the corner, but like Godot it stubbornly fails to
show up. This has been a tough circle for many economists to square.
Two explanations have emerged to explain the failure. Either the model is
not functioning (and higher inflation and asset bubbles don't lead to growth)
or the stimulus efforts thus far, in the form of zero percent interest rates
and quantitative easing, have been too timid. So either the bankers must
devise a new plan, or double down on the existing plan. You should know where
this is going. The banks are about to go "all in" on inflation.
Despite their much ballyhooed "independence", central bankers
have proven that they operate hand in glove with government. They are also
subject to all the same political pressures and bureaucratic paralysis. There
is an unwritten law in government that when a program doesn't produce a
desired outcome, the conclusion is almost never that the program was flawed,
but that it was insufficient. Hence governments continually throw good money
after bad. The free market discipline of cutting losses simply does not exist
in government.
This is where we are with stimulus. Six years of zero percent interest
rates and trillions and trillions of new public debt have failed to restore
economic health, but our conclusion is that we just haven't given it enough
time or effort. My theory is a bit different. Maybe zero percent interest
rates and asset bubbles hinder rather than help a real recovery. Maybe they
resurrect the zombie of a failed model and prevent something viable and
lasting from gaining traction? This is a possibility that no one in power is
prepared to consider.
But what if they succeed in getting the inflation, but we never get the
growth? What if we are headed toward stagflation, a condition that in the
late 1970s gripped the U.S. more tightly than Boogie Fever? It may come as a
surprise to the new generation of economists, but high inflation and high
unemployment can coexist. In fact, the two were combined in the 70s and 80s
to produce "the Misery Index." But according to today's economic
thinking, the Index should not be possible. Inflation is supposed to cause
growth. If unemployment is high they say there is no demand to push up prices.
But it's the monetary expansion that pushes prices up, not the healthy job
market.
The tragedy is that if the policy fails to produce real growth, as I am
convinced it will, the price will be paid by those elements of society least
able to bear it, the poor and the old. Inflation and stagnation mean lost
purchasing power. The rich can mitigate the pain with a rising stock
portfolio and more modest vacation destinations. But they won't miss a meal.
Those subsisting on meager income will be hit the hardest.
Many economists are now trying to make the case that the United States had
hit on the right stimulus formula over the past few years and is now reaping
the benefit of our bold monetary experimentation. They continue the argument
by saying Europe and Japan were too timid to implement adequate stimulus and
are now desperately playing catch up. But this theory is false on a variety
of fronts. First off, the U.S. is not recovering but decelerating. Annualized
GDP in the first half of 2014 has come in at just a shade over one percent,
which is lower than all of 2013, which itself was lower than 2012. The
unemployment rate is down, but labor participation is at a 36-year
low, and wages are stagnant. We have added more than $5 trillion in new
public debt, but very little to show for it. We are not the model that other
countries should be following but a cautionary tale that should be avoided.
It is also spectacularly wrong to assume that the problems in Europe and
Japan can be solved by a little more inflation. Higher prices will just be a
heavier burden for European and Japanese consumers, not an elixir that
revitalizes their economies. The problems in Europe, Japan and the U.S. all
have to do with an oppressive environment for savings, investment, and
productivity that is created by artificially low interest rates, intractable
budget deficits, restrictive business regulation, antagonistic labor laws,
and high taxes. Since none of the governments of these countries have the
political will to tackle these problems head on, they simply hope that more
monetary magic will do the trick.
So as the Fed, the ECB, the Bank of Japan, and all the other banks that
follow suit, push all their chips into the pot and hope that a little more
inflation will save us from the abyss, we can wish them luck. It's going to
take a miracle.
Best Selling author Peter Schiff is the CEO and Chief Global
Strategist of Euro Pacific Capital. His podcasts are available on The Peter
Schiff Channel on Youtube
Catch Peter's latest thoughts on the U.S. and International markets
in the Euro Pacific Capital Summer 2014 Global Investor
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