Mark It Zero

by: The Heisenberg

- Friday was a wild ride, and it continued after the closing bell on Wall Street.

- Investors are now left to ponder both the short- and longer-term consequences of the latest Fed and trade drama.

- Here are some thoughts on what happens next both for markets and for policy.

After the closing bell sounded on the fourth consecutive week of losses for the S&P, President Trump responded to China's retaliatory tariffs.
The tariff rate on the $250 billion in Chinese goods which were taxed at 10% from September 24, 2018, and from 25% after the White House abandoned the Buenos Aires truce in May, will be taxed at 30% starting on October 1. Additionally, the tariff rate on the $300 billion in Chinese goods which were set to be taxed from September 1 and December 15 (Trump delayed duties on some items in an effort to avoid hurting US consumers ahead of the holiday shopping season) will be 15% instead of 10%.
Delaying the announcement until after the close on Wall Street was clearly an effort to avoid triggering further losses. The S&P fell more than 2.5% on the final day of the week.
The worst, second-worst and third-worst days of 2019 for US equities have all come in August.
Here's an updated version of the annotated August chart which documents all of the relevant twists and turns.
If you, like everyone else, are wondering what comes next, the first thing you'll want to watch in the new week is the yuan. China on Saturday "strongly objected" to Trump's Friday afternoon tariff hike, and the yuan was already on the back foot following the President's tweets.
You can expect the offshore yuan to test its all-time low of 7.14. The daily fix will be scrutinized for signs that Beijing is either trying to calm things down, or send another message Washington's way.
Obviously, any indication that Beijing is willing to let the currency absorb more of the tariff pressure would ostensibly be bearish for risk assets, but it's worth noting that last week brought the first ever revamped loan prime rate print (the "new" LPR), which marked the culmination of China's efforts to reform their two-track interest rate system.
Long story short, on the 20th of each month, China will publish the rate (there's a one-year tenor and five-year), which is set based on submissions from banks, which quote the new LPR in basis points on top of the medium-term lending facility ("MLF" for short). So, mathematically, cutting MLF rates will bring down LPR, all else equal. The point: Beijing may well cut open market operation rates soon thereby tipping a lower LPR in late September, and that option could substitute for weaker yuan fixes.
From a bigger picture perspective, what happened on Friday increases the odds that the Fed will ultimately cut rates to zero (or close).
As documented here, Jerome Powell's Jackson Hole speech was replete with references to the darkening global growth outlook and to geopolitical turmoil. On top of that, Powell alluded to the flatter Phillips curve, a nod to the purported safety of running the labor market (and the economy more generally) hot without risking a dangerous spike in inflation. The Fed chair also said, quote, "a lower r* combined with low inflation means that interest rates will run, on average, significantly closer to their effective lower bound." That's pretty explicit in terms of validating bets for a lower short-rate.
What you want to keep in mind here is that the longer the US economy holds up in the face of a deteriorating global backdrop, the bigger the risk of importing disinflation due to a persistently stronger dollar. I've talked about this in these pages before, but it's even more relevant after Friday.

One of the reasons the market is pricing in sharply lower rates in the US is arguably that some believe the Fed will have to cut aggressively even if there's not a recession, because if they don't, the imported disinflation from a strong dollar will eventually cause a downturn anyway. The whole thing has a certain deterministic feel to it, which President Trump seems to have picked up on.
The trade war is exacerbating the situation by imperiling the global growth outlook, thereby compelling foreign central banks to cut rates and lean ever more dovish. Meanwhile, the US economy is still hanging in there, having run out ahead in 2018 thanks in part to the tax cuts and fiscal stimulus. It's hard for the Fed to justify aggressive rate cuts when the US consumer is still spending, the labor market is still healthy and the jury is still out on whether the manufacturing sector is going to roll over in earnest or not. So, you're left with both an economic and a monetary policy divergence, with the former feeding into the latter and the trade war exacerbating both.
Clearly, the trade tensions have now worsened, which sets the stage for more lackluster data abroad, more accommodation from foreign central banks and, all else equal, a stronger dollar, which risks imported disinflation.
So, why did the dollar dip on Friday? Well, because President Trump's tweets were seen as materially raising the odds of outright, active FX intervention by Steve Mnuchin's Treasury. To be clear, Treasury doesn't have very much ammunition in that regard. The Exchange Stabilization Fund is small in absolute terms and tiny compared to the FX market. Here are the technical details of how Mnuchin can effectively marshal the entire $94 billion in the ESF (from a Barclays note):

The ESF’s actual intervention power is often understated, but even at its maximum extent, it remains tiny relative to the ‘very, very large, liquid markets’ of FX, in the words of Mr. Mnuchin.

While the ESF’s dollar holdings total only $22.6 billion, it has the ability to issue ‘SDR Certificates’ equal in value to its SDR allocations to the Federal Reserve in exchange for USD.

Additionally, it can ‘warehouse’ its euro and yen holdings with the Fed through an FX swap, but requires Fed FOMC authorization to do so. The outstanding FOMC authorization for warehousing currently stands at $5 billion, but in the past the FOMC has authorized as much as $20 billion. However, even assuming warehousing of all the ESF’s euro and yen assets, its $94.6 billion in total assets would represent just 2% of average daily FX transactions involving USD.

The Fed would be compelled to match that. In other words, the Fed, in keeping with historical precedent, would likely double Mnuchin's firepower to roughly $180 billion. Some on the FOMC would doubtlessly dissent against any such move. After all, there were two dissents last month on a 25 bps rate cut, so one can only imagine what the reaction would be if Powell came to his colleagues with a tacit mandate from Mnuchin to conjure up $90 billion for the purposes of helping the White House drive down the dollar. But, in theory anyway, Powell has unlimited ammunition. Here's Barclays one more time:
Were the FOMC fully on board with an effort to depress the exchange value of the dollar, because the Fed has the ability to create dollars by fiat, it could sell unlimited quantities. This would almost certainly require complete politicization of the Fed — a rising concern of market participants following the nominations of Stephen Moore and Herman Cain as Governors — but even then would not be the most likely outcome. As noted before, President Trump appears to see too-tight Fed policy as the primary source of excess USD strength, hence easing monetary policy would be a more straightforward action from a politicized Fed (and one that would attract less Congressional scrutiny).
The point in all of this isn't to suggest that unilateral intervention would be successful. It almost surely wouldn't. Historically, interventions were coordinated affairs, but nobody is going to coordinate with Trump in an effort to undercut their own exports by helping push down the dollar in the face of tariffs. Rather, the point is to say that on days like Friday when the President's pronouncements come across as particularly irritated and thereby foreboding, it stokes concerns about the volatility which would invariably accompany an intervention, and those concerns manifested themselves in the dollar falling against G-10 peers.
As alluded to in the latter passage from Barclays, the far more likely scenario when it comes to the dollar "problem" is that the Fed ultimately cuts rates to the effective lower bound.
Powell's speech provided a series of justifications for starting down that road, although clearly, President Trump did not read between the lines or bother trying to decipher the nuance.
Deutsche Bank's Stuart Sparks summed the situation up in a note out Friday afternoon. Here is a brief passage from the executive summary:
Powell enumerated slower global growth, trade policy uncertainty, and muted inflation as key risk factors for the policy formation process, noted the effects of a flat Phillips curve, and reiterated previous Fed comments that “a lower r* combined with low inflation means that interest rates will run, on average, significantly closer to their effective lower bound”. Taken together, these can be seen as validating market pricing for aggressive further Fed easing. China's announcement of additional tariffs on US imports, and President Trump’s response, have provided a catalyst for still more aggressive Fed pricing, and Powell’s statement can be seen as establishing the basis for an ultimate move to zero policy rates.
Assuming the dollar doesn't suddenly roll over and sustain a drop (unlikely barring an abrupt deterioration in the US economic data or concrete signs that Mnuchin is set to intervene), the Fed will find itself forced to cut rates further and faster, or risk a disinflationary FX shock that would further undermine the central bank's ability to fulfill its price mandate.
Of course, the Fed can wait and hope that the environment shifts. A sudden inflection for the better in the data abroad, a series of dour data points on the home front or, potentially, a lasting trade truce that helps stabilize the global growth outlook thereby removing some of the pressure for the FOMC's counterparts abroad to ease, could potentially take some of the pressure off when it comes to dollar strength.

But waiting around risks falling even further behind and having to catch up by rapidly cutting rates, something Deutsche's Sparks underscores in his exposition on the subject.
Ultimately, it's hard to see how the Fed doesn't end up back near zero one way or another.
The worry is that all of this competitive easing (i.e., the "race to the bottom") will come to naught, as the tit-for-tat rate cuts and monetary accommodation offset each other in the FX space, while further distorting fixed income markets along the way, leaving everyone with negative rates and no ammunition to deploy in the event of another acute economic crisis.
And with that, I'll leave you with one final chart (this one from BofA) which shows that, to quote the bank, "a quarter of the world, in GDP terms, is now subject to negative central bank rates and a fifth of the world is now living with negative 10-year yields."


The euro must prepare for future shocks

Monetary policy is not enough on its own — fiscal co-ordination is essential

Laurence Boone

Eurozone finance ministers at the Eurogroup Finance Ministers' meeting in Brussels last December © EPA

For the past year, the OECD has been warning about the accumulation of risks and uncertainty that undermines investment and the world economic outlook. Its 2019 global growth projections fell from 3.7 per cent in September 2018 to 3.2 per cent in the latest forecast in May, well below the growth rates seen over the past three decades.

The summer is providing little respite amid heightened trade tensions, the possibility of a no-deal Brexit and renewed market volatility. Brexit alone illustrates the magnitude of these risks: if the UK were to start trading with the EU on World Trade Organization rules, gross domestic product in the remaining EU27 area would contract by around three-quarters of 1 per cent over a few years, with steeper declines in some countries and individual sectors.

In such a challenging environment, Europe will be in a stronger position if further progress is made on economic management across the bloc.

Speakers at the European Central Bank’s annual conference earlier this summer reviewed the first 20 years of the euro, judging it against benchmarks for outcomes, institutions and policymaking. The consensus view was that outcomes, in terms of the convergence of living standards, have been uneven. However, the eurozone has been strengthening its institutions and policy toolbox. Looking back in this way can help disentangle policy mistakes from institutional constraints. And it will make it easier to build political support for joint action across the eurozone in the future.

On the monetary side, the ECB has been impressive and continues to fight stubbornly low inflation. It was instrumental in lifting the eurozone out of the financial and sovereign debt crises, and fulfilled its role of lender of last resort, providing liquidity to banks.

Yet the central bank was not as quick to react to the slowdown in activity at the same time. It did not initiate quantitative easing, on top of larger liquidity support and negative interest rates, until March 2015. Why did it take so long for the ECB to start quantitative easing when growth was anaemic, inflation falling and other central banks had already increased their balance sheets? The US Federal Reserve, for example, started QE on a large scale five years earlier.

There were institutional reasons for the delay. It took time to forge a consensus amid legal uncertainty. And there were entrenched opposing views in the ECB’s governing council. There were also concerns about the asymmetry of the central bank’s mandate to ensure price stability.

Mario Draghi, the president of the ECB, addressed the question of asymmetry at a press conference in July, insisting that there was “no question” of accepting permanently lower inflation rates. But a firmer consensus on the governing council and policy support from the eurogroup of EU finance ministers, while respecting the independence of the ECB, would permit a swifter response to new developments.

It is on fiscal policy that support from the eurogroup will be most crucial. After a large synchronised stimulus in 2009, the fiscal stance reversed quickly. Tightening started much too early, while the output gap in the eurozone was still widening.

Adjustment measures were decided at the country level, ignoring cross-border spillovers. Since then, rules have been reformed but the lack of co-ordination remains.

Fiscal co-ordination is challenging and spillovers are difficult to measure. But there is little doubt that cross-border fiscal effects are significant in an integrated currency area such as the eurozone. In addition, political incentives are weak. Some member countries have been reluctant to respect the fiscal rules, while others have neglected the EU’s macroeconomic imbalance procedure. The combined effect has been to undermine incentives to co-ordinate policy.

However, looming threats to growth in the eurozone should encourage member states to put their differences aside and formalise greater fiscal co-ordination. This would boost confidence in the ability of the eurozone to deal with shocks and assume some of the burden currently borne by monetary policy.

External shocks could be caused by a no-deal Brexit (the likelihood of which is growing), or escalating trade and currency tensions. They would call for a co-ordinated fiscal response, parallel with monetary accommodation. The OECD’s estimates of the impact of these shocks show that individual countries will struggle to absorb them without such a package.

Over its first two decades, the euro has proved to be impressively resilient. The next few years will bring further tests. But they will also be an opportunity to improve the single currency’s governance structures, allowing the eurozone to make a more positive contribution to global economic and financial stability.

The writer is chief economist at the OECD

Locating Equality

For years, wealth and income inequalities have been rising within industrialized countries, kicking off a broader debate about technology and globalization. But at the heart of the issue is a fundamental good that has been driving social and economic inequality for centuries: real estate.

Harold James


MUNICH – Inequality is the leading political and economic issue of the current era, yet debates about it have long suffered from a degree of imprecision. For example, the standard measure of inequality, the Gini coefficient, reduces a country’s entire income distribution to a single number between zero and one, and is thus highly abstract.

Similarly, while inequality is rising in many parts of the world, there is no simple correlation between that trend and social discontent or unrest. France is much less unequal than the United States, and yet it has similar or even greater levels of social polarization.

Today’s inequality debate effectively began in 2013 with the publication of French economist Thomas Piketty’s Capital in the Twenty-First Century, which found that the rate of return on capital tends to outpace the rate of growth, thereby causing inequality to increase over time. Specifically, appreciating real-estate values seem to be a fundamental driver of rising inequality. But here, too, one encounters a degree of imprecision. Real estate, after all, is not a homogenous good, because its value famously depends on “location, location, location.” There are elegant castles and palaces that now cost less than small apartments in major cities.

Wealth stirs the most controversy where it is most tangible, such as when physical spaces become status goods: the corner office is desirable precisely because others cannot have it. More broadly, as major cities have become magnets for a global elite, they have become increasingly unaffordable for office workers, policemen, teachers, nurses, and the like. While the latter must endure long, tiresome commutes, elites use global cities as they see fit, often hopping around from place to place. Large swaths of Paris and London are eerily shuttered at night. Manhattan now has nearly a quarter-million vacant apartments.

Whenever violence and revolution have consumed unequal societies, real estate has been a focus of discontent. In the later years of the Western Roman Empire, vast estates catered solely to an aristocratic elite. In a famous homily from this period, St. Ambrose of Milan, reflecting on the Old Testament story of Naboth’s vineyard, decries elites for making “every effort to drive the poor person out from his little plot and turn the needy out from the boundaries of his ancestral fields.”

Likewise, the French social historian Marc Ferro has demonstrated that many urban Russians were driven to the Bolsheviks in 1917 not out of ideological zeal, but because the old regime and the new constitutional parties had proved incapable of providing food and housing. Over the course of World War I, Petrograd had developed an enormous munitions industry, manned by peasant labor conscripted in the countryside and brought to the newly expanded factories. But production planners had neglected the question of where these workers would be housed, and in 1917, the worker committees (soviets) offered an answer: apartments would be confiscated from the aristocrats and bourgeoisie.

A similar pattern played out in other cities where rapid, unplanned wartime industrialization had occurred (Budapest, Munich, Turin). Today’s equivalents are the centers of the new economy, such as Silicon Valley and its high-tech imitators in Europe and Asia. These cities have produced many jobs, but they have utterly failed to accommodate the people who actually live there. As a result, even middle-class professionals are living in cars, vans, and trailers.

And this malaise is not limited to the global cities themselves. Support for Brexit in southeastern England owes something to the perception that London and its immediate surroundings have become unaffordable as a result of too much immigration, international financial activity, and tourism – in short, globalization.

Needless to say, the political response to the real-estate problem has so far been inadequate, even counterproductive. Some large European cities are introducing rent controls, despite the poor track record of such policies. When New York tried similar measures in the twentieth century, the open market dried up, and property was hoarded or traded at a premium on the black market. When the UK rolled out a fiscal subsidy for first-time homebuyers, home prices rose accordingly, offsetting any potential benefit.

Removing tax privileges – as the US did recently by imposing a $10,000 cap on the state- and local-tax deduction – is a slightly better approach. But it will not solve the fundamental problem of supply. Not surprisingly radical, even Bolshevik-style, proposals are making a reappearance. A popular initiative in Berlin, for example, would socialize the holdings of large-scale real-estate owners (those managing more than 3,000 apartments).

The obvious solution to the supply problem, of course, is to build more housing. But new construction can conflict with environmental protections and a city’s architectural heritage, and is often opposed by existing property owners, who do not want the value of their own property to fall.

Sometimes, new construction can create alternative urban magnets, such as when the Spanish city of Bilbao was transformed by the addition of a Frank Gehry-designed Guggenheim Museum. But many declining industrial cities have already tried this solution, and only a few have succeeded. Those that have failed are still run down, and now have the added burden of maintaining new arts infrastructure.

Eventually, the cities and urban areas that are driving the bulk of new wealth creation will provoke a counter-movement. If they price out or otherwise exclude those who earn less, they will have sacrificed the openness that made them attractive in the first place. So, if they want to survive and thrive in today’s egalitarian political climate, they will need to come up with bold solutions.

During a previous period of urban-based dynamism, in the early sixteenth century, rich merchant families built low-rent housing that was then allocated to the poor. One such project, the Fuggerei complex in Augsburg, Germany, still provides low-rent social housing to this day.

If enough such housing cannot be supplied, might a lottery allocation of public accommodation help to stem the encroaching homogeneity of today’s global cities? It is certainly worth a try.

Harold James is Professor of History and International Affairs at Princeton University and a senior fellow at the Center for International Governance Innovation. A specialist on German economic history and on globalization, he is a co-author of the new book The Euro and The Battle of Ideas, and the author of The Creation and Destruction of Value: The Globalization Cycle, Krupp: A History of the Legendary German Firm, and Making the European Monetary Union.

How Hong Kong Can Save Itself

Maintaining the city’s position as a global financial powerhouse requires a resolution to the political stalemate and an economic overhaul

By Nathaniel Taplin

Hong Kong is the most free economy in the world—in theory. In reality, most residents struggle to get by, and have little say in their political or economic future. Photo: isaac lawrence/Agence France-Presse/Getty Images 

Hong Kong is in the midst of its worst political violence since the semiautonomous city’s handover to China in 1997. Defusing the crisis—and maintaining its status as a global financial powerhouse and conduit for capital into China—requires urgent action not only on grievances including police accountability and stalled electoral reforms but also on deep, festering problems with the city’s economic model.

That means curbing the power of Hong Kong’s property tycoons and monopolies, finding a government-revenue model that doesn’t depend on sky-high property prices, and spending far more state resources immediately on public housing and public assistance. By some measures, Hong Kong is already among the most unequal societies in the world.

Most of Hong Kong’s most urgent economic problems relate to land. Median income growth has been modest over the past decade, but residential property prices nearly doubled in real terms from 2010 to 2018, according to the Bank for International Settlements. That far outpaces increases even in other notoriously bubbly markets such as Canada, where prices are up about 40%. Hong Kongers live in tinier apartments and pay more for them than nearly anywhere else.

Part of the issue is Hong Kong’s hilly geography, which means new space for building is limited. But an arguably much bigger problem is the vested interests of the government and big property developers in keeping prices high.

Hong Kong’s low tax rate and big fiscal surplus—the government over the past three years earned on average close to 20% more than it spent—is in fact funded largely by government land sales, which were 27% of total revenues in fiscal year 2017/2018. To make matters worse, the proceeds of land sales go into the Capital Works Reserve Fund, which is slated for infrastructure development. Hong Kong already has exemplary infrastructure. Residents watch in frustration as the authorities splurge on Beijing-backed political white-elephant projects like the multibillion-dollar sea bridge to Macau and high-speed rail link to Shenzhen, all while they can’t afford basic housing.

High property prices also make it hard to start small businesses—particularly since antimonopoly enforcement is already weak. Hong Kong, unlike most of its global peers, didn’t even have a comprehensive competition law in substantive effect until 2015. That has enabled property tycoons to fortify their empires with near-monopolies in areas such as utilities, transport and grocery stores, raising prices and stifling growth.

The government’s main solution to exorbitant property prices is the Lantau Tomorrow Vision, a proposed land-reclamation project near the territory’s largest island with an estimated cost of about $80 billion. New apartments, however, wouldn’t be available until the early 2030s—meaning a whole generation of young people could essentially remain priced out of the market even if the plan works. Critics say land supply could be boosted much more rapidly and cheaply by redeveloping existing brownfield commercial and agricultural sites as housing.

Mainland China’s political model works to the extent it does because citizens sacrifice a direct say in their future with the understanding that things will continue to improve. Denying people a say while simultaneously offering no real hope that things can improve is a far tougher sell.

US yield curve sends strongest recession warning since 2007

Bond market indicator worsens as questions swirl about Federal Reserve’s next move

Colby Smith in New York and Brendan Greeley in Washington


A widely watched bond market indicator sent its strongest recession warning in more than a decade on Wednesday, as the global growth outlook dimmed and questions swirled about the Federal Reserve’s commitment to cut interest rates in light of rising US-China trade tensions.

The yield on three-month US Treasury traded as much as 41.23 basis points above that on the benchmark 10-year government bond — the widest gap since March 2007. Such an inversion of the yield curve — in which short-term yields are higher than longer-term ones — has preceded every recession of the last half century.

The difference narrowed by about 10bp later in the day as US stock prices gained ground and a government bond market rally lost steam, but the persistence of the yield curve inversion underscored the anxieties in global financial markets.

Analysts said fears about global growth were exacerbated by interest rate cuts by New Zealand, India and Thailand, a dismal industrial production report in Germany and the growing likelihood that the UK will leave the EU without a deal in October.

“The next recession couldn’t have been better telegraphed,” said Mark Holman at TwentyFour Asset Management. “There is a trade war between the two global superpowers with both sides digging in their heels and the clock is ticking towards a hard Brexit, so it really does make sense to take risk off the table.”

Michael de Pass, the global head of US Treasury trading at Citadel Securities, said the deeper inversion of the yield curve traced back to concerns the Fed is moving too slowly to lower rates.

“The message that the market appears to be sending is that the Fed is behind the curve and is at risk of a policy error,” he said. “It is too early to say whether it actually is behind the curve but that line of thinking has certainly been a key driver of price action over the last few sessions.”

Comments by James Bullard, St Louis Fed president, on Tuesday, deepened these concerns, according to John Briggs, the head of strategy for the Americas at NatWest Markets. At an event for the National Economic Club in Washington, Mr Bullard said it was unrealistic to expect the Fed to react to trade rhetoric.

“If you tried to respond every time there’s a threat or counter-threat in a tit-for-tat trade war, you would destabilise monetary policy,” he said.

Mr Bullard said the Fed had already responded in July to what he called “trade uncertainty.” July’s rate cut, he said, was “insurance” against what was not known about the trade situation.

Chicago Fed President Charles Evans toed a more dovish line on Wednesday, signalling to Reuters his support for further rate cuts given that inflation remains persistently below the Fed’s 2 per cent target.

But investors are still worried that the Fed will deliver when it comes to easing monetary policy in line with market expectations.

“Until we get some sort of indication that the Fed is open to additional action, the yield curve will continue to invert,” Mr Briggs said.

Traders are pricing in a more than 60 per cent chance the Fed slashes its benchmark interest rate by 25bp in September, with nearly 40 per cent betting on a more aggressive 50bp cut.

Powell, Tariffs And Trump: A Friday Tragicomedy

by: The Heisenberg

- On Friday morning, China retaliated against forthcoming tariffs from the Trump administration, throwing equities and risk assets for a loop.

- Jerome Powell's Jackson Hole speech was acceptable, and briefly stabilized things.

- Then, President Trump weighed in on Twitter, chancing a conflagration in "tinderbox" markets.

Here's a quick take, including a brief recap of why this is a dangerous setup.
On Thursday afternoon, in a somewhat cautious post for this platform, I gently suggested that one of the major risks headed into Jerome Powell's closely-watched speech at Jackson Hole was that the Fed Chair wouldn't come across as dovish enough to satisfy President Trump, setting the stage for a scenario in which the White House refuses to accept the implicit pushback, instead opting to escalate the trade war further in a bid to test Powell's mettle.
As I write these lines, we're still hours away from the closing bell on Wall Street, but it's been an eventful day. China announced retaliatory tariffs on $75 billion in US goods, including new 5% levies on soybeans and oil from September 1, and the reinstatement of 25% duties on autos starting on December 15.
That news sent equity futures tumbling, but fortunately, Powell's Jackson Hole speech was replete with references to the darkening global growth outlook and allusions to geopolitical turmoil. He specifically mentioned weakness in the data out of China and the worsening situation in Germany, and he checked all the boxes when it comes to letting the market know he's apprised of the potential for political frictions to boil over, with negative ramifications for investors. To wit, from the speech:
We have seen further evidence of a global slowdown, notably in Germany and China. Geopolitical events have been much in the news, including the growing possibility of a hard Brexit, rising tensions in Hong Kong, and the dissolution of the Italian government.

Crucially, Powell said the Fed's "assessment of the implications of these developments" will inform the effort to sustain the expansion. Although not overtly "dovish", per se, that was most assuredly a sign that the Fed will assign a heavier weight than they otherwise might to international developments when deciding how best to ensure that the longest US expansion on record gets even longer.
US equities (and risk assets in general) recovered most of their morning swoon as traders digested Powell's remarks.
And then the president started tweeting. I don't think I have to quote directly from Trump's tweets (nor do I want to), but suffice to say he took his irritation with China's retaliatory measures out on Powell, who he explicitly called an "enemy" on par with "Chairman Xi". The President also said he would "respond" soon to China's retaliatory tariffs.
Irrespective of what form that response ends up taking, the fact of the matter is that Powell delivered what could reasonably be expected of him, especially in light of the hawkish setup from regional Fed presidents as discussed in the linked post above.

That is, there was every indication that Powell's remarks in Jackson Hole would lean overtly hawkish, betraying a desire for the Fed to stick to the "mid-cycle adjustment" script, but instead, we got a Fed chair who emphasized the myriad international developments weighing on growth and investor sentiment. That market-friendly lean was reflected in the bounce off the morning lows.
Have a look at this chart:
Powell did his job. He stabilized both equities and the yuan. Trump wanted more, although as I noted elsewhere, it's not entirely clear what the President expected. It's not as though Powell could re-write his speech an hour ahead of the public release and he certainly can't just cut rates from the podium in Wyoming.
In any event, that chart says it all, and the only saving grace as of lunchtime on Friday in New York is that the curve bull steepened a bit as the market still seems to think that trade escalations will be enough to force a Fed relent, especially in light of Powell's internationally-focused comments.

The dollar came off pretty sharply as well, and all else equal, that's a positive development for risk assets, but right now it doesn't matter - markets are spooked.
Barring a turnaround (which is possible depending on what the President says later), this will be the fourth consecutive week of losses for US equities. The last time that happened was, of course, in May, when Trump's decision to break the Buenos Aires trade truce threw stocks for a loop after Powell engineered a mammoth four-month rally.
Far be it from me to question the White House's trade policies, but I would suggest that the administration is wading into dangerous waters with markets. As Nomura's Charlie McElligott wrote on Friday morning, we'll be dealing with "still-weak post-summer holiday volumes [and] depth of book" along with "tight liquidity and VaR constraints from dealers" for weeks to come. Market depth has dried up in both rates and equities at various intervals in August, exacerbating the price action.
Dealers' gamma profile now looks to have flipped negative again (see visual below) and on some models, we're back near de-leveraging levels for some trend-following strats.
If the White House doesn't exercise some restraint, we good see equities careen through key levels and strikes, triggering systematic flows (both from trend-follower de-leveraging and dealer hedging) into a thin, August market.

At the same time, any further rally in bonds could bring more hedging flow, catalyzing another forced duration grab, which could push long-end yields even lower, sending a further risk-off signal to the market and, if the short-end can't keep up, inverting the 2s10s again, only this time sustainably.
This is something of a tragicomedy. China's retaliation was expected and, as alluded to above, Powell's speech in Jackson Hole was generally fine. Friday's drama was wholly unnecessary, and entirely dangerous when markets are, as I described them here a few days ago, a "tinderbox."

Legality is not the problem with parallel currencies

Critics of Italy’s mini-BOT identify the threat in the wrong place

Izabella Kaminska

Claudio Borghi, economics spokesman for Italy's League party. The government wants to use mini-BOTs to help deal with its debt © Getty

For a while now the Italian government has been toying with the idea of introducing mini bills of treasury — so-called mini-BOTs — to help it pay debts to private sector businesses. A parliamentary vote in May which endorsed the proposal helped give the idea further credence.

But there are many who have not taken the idea seriously. This is an error. Some wrongly believe that because the securities would be considered a parallel currency they would be deemed illegal in the eurozone.

This is because European Central Bank members are obliged to hold the euro as legal tender in their respective sovereign states. Thus, the scheme would be impossible to implement unless Italy was prepared to leave the euro. It is rightly assumed that Italy is not prepared to do that.

When asked about the mini-BOT plan, ECB president Mario Draghi did not hold back. He noted: “They are either money and then they are illegal, or they are debt and then that stock goes up.”

But this view overlooks the fact that parallel currencies can circulate without legal tender status. It also fails to acknowledge that parallel currencies have always been with us, and that in most western economies there is no prohibition on settling commercial debts in other forms of mutually agreed securities or assets. Not even in the eurozone.

Legal tender status helps in establishing and popularising a currency, but it is not essential. The system as it stands features a plethora of parallel currencies, none of which are legal tender, but which all seamlessly interact with each other without any legal contradiction.

As the Bank of England points out, cheques, debit cards and contactless payments don’t constitute legal tender. They too are a form of parallel currency.

The reason we have possibly forgotten the extent and breadth of the pre-existing parallel currency network — which features everything from store-issued points, bank money to the eurodollar market — is because in recent years it has been overshadowed by the emergence of cryptocurrencies. These differ from traditional parallel currencies in that they have no overt issuer or guarantor.

But it is this wider context that makes Mr Draghi’s stance on mini-BOTs disingenuous. He should recognise that in being issued by a national treasury and capable of being accepted as payment for taxes, mini-BOTs have a better chance of succeeding as a highly liquid currency than most other rival parallel systems (certainly more so than Facebook’s proposed cryptocurrency, Libra).

As the economist Willem Buiter noted last month in a research note, if mini-BOTs do acquire the property of moneyness, they have the potential to make a real difference by transforming illiquid government liabilities (arrears) into liquid ones. Indeed, once the private sector becomes willing to hold zero interest mini-BOTs, despite there being other risk-free assets with positive interest rates, the market begins to view them as “fiscal money”.

This in turn allows the state to use that liquidity to raise public spending on real goods and services. According to Mr Buiter, in an economy with slack, output and employment could rise leading to an increase in tax receipts.

There are certainly other examples where such fiscal monetary exercises have paid dividends.

Consider the IOUs California began issuing in 2009. These helped to inject enough liquidity to spare the state from bankruptcy. Those IOUs were a form of debt, which also worked like a currency with very positive impact.

Clearly, the eurozone is far more fragile than the dollar system ever was. So the analogy with California is not perfect. Another possible parallel is with the other famous state that used monetary fragmentation to tackle growing imbalances: the Soviet Union.

The original goal there was to create a system that transferred value so seamlessly that money itself would, in theory, no longer be needed. Except, as imbalances built up, the state was forced to issue three different types of money, with varying usability profiles. Unfortunately, the managed nature of these currencies, plus the lack of slack in the system, inhibited growth. A system-wide economic collapse with inflationary consequences followed.

With precedents like that, it is unsurprising that Mr Draghi was inclined to talk down the mini-BOT plan: it could genuinely undermine the euro. The legality question, however, is a distraction — something that Mr Draghi’s successor Christine Lagarde, a former lawyer, will be aware of.

Fed’s Warning: We Can’t Solve Everything

As China tensions mount and President Trump fumes, Fed chairman reminds world of limits to monetary policy

By Justin Lahart

Federal Reserve Chairman Jerome  Powell probably wishes his job was as easy as not talking about the elephant in the room.

Elephants, while large, aren’t vocal critics of Fed policy. One could reasonably talk about the natural rate of unemployment while a staffer quietly handed the elephant peanuts.

But the Fed chairman has to contend with PresidentTrump,who has been berating the central bank and calling for lower interest rates for over a year. And who clearly wants the Fed to clean up any damage to the economy from trade tensions, which escalated Friday as China said it would impose tariffs on $75 billion worth of U.S. goods.

The Fed’s shift from tightening to easing has been a balm for a stock market that might otherwise be a lot lower as a result of the trade fight. And Mr. Powell, in his remarks in Jackson Hole, Wyo., on Friday made it clear that the Fed is ready to respond with more cuts if trade tensions worsen the economic Outlook.

But Mr. Powell also said that when it comes to trade, there are limits to what the Fed can accomplish, and investors should be mindful of that. President Trump didn’t seem to take that well, wondering publicly on Twitter whether Mr. Powell is a greater threat to the U.S. than Chinese President Xi Jinping.

Part of the problem is that the Fed has no real sense of how it should proceed, Mr. Powell noted. So far this year, for example, employment and consumer spending have continued to do well even as business confidence has eroded, making it unclear how much easing the economy actually needs. For the Fed to keep cutting rates beyond next month, it might need a clearer indication that the job market and consumer spending are at risk.

Moreover, if trade uncertainty does spill over into the broader economy, the Fed’s ability to counteract the damage may be limited. First, there is the simple matter that with rates already low, the Fed only has so many rate cuts to give. But there may also be limits to what monetary policy can do to offset trade troubles.

The Fed’s safety net might be flimsier than investors believe.

America Needs an Independent Fed

The economy functions best when the central bank is free of short-term political pressures.

This article is signed by Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen.

As former chairs of the board of governors of the Federal Reserve System, we are united in the conviction that the Fed and its chair must be permitted to act independently and in the best interests of the economy, free of short-term political pressures and, in particular, without the threat of removal or demotion of Fed leaders for political reasons.

Collectively, we served our nation across nearly 40 years and were appointed and reappointed by six presidents, both Republican and Democratic. Each of us had to make difficult decisions to help guide the economy toward the Fed’s legislated goals of maximum employment and stable prices. In retrospect, not all our choices were perfect. But we believe those decisions were better for being the product of nonpartisan, nonpolitical assessments based on analysis of the longer-run economic interests of U.S. citizens rather than being motivated by short-term political advantage.

Photo: Getty Images/iStockphoto

The Fed’s nonpartisan status doesn’t mean it is unaccountable. Congress sets the Fed’s powers and charges it with maximizing employment and promoting stable prices. The chair and other Fed leaders testify before Congress and speak regularly in public, explaining their views of the economy and how they plan to meet their mandates. Presidents, members of Congress, financial-market participants, pundits and many private citizens advocate that the Federal Reserve make particular monetary policy decisions. In our system of government, that is the right and privilege of every person, one we don’t question. The Fed welcomes open dialogue, as evinced by the “Fed Listens” program, in which Fed leaders have engaged with the public about possible changes to the Fed’s policy framework. A robust public debate helps make monetary policy better.

History, both here and abroad, has shown repeatedly, however, that an economy is strongest and functions best when the central bank acts independently of short-term political pressures and relies solely on sound economic principles and data. Examples abound of political leaders calling for the central bank to implement a monetary policy that provides a short-term boost to the economy around election time. But research has shown that monetary policy based on the political (rather than economic) needs of the moment leads to worse economic performance in the long run, including higher inflation and slower growth. Even the perception that monetary-policy decisions are politically motivated, or influenced by threats that policy makers won’t be able to serve out their terms of office, can undermine public confidence that the central bank is acting in the best interest of the economy. That can lead to unstable financial markets and worse economic outcomes.

Because nonpartisan, independent monetary policy is so important, Congress wisely established the Federal Reserve as an independent agency with regional participation and safeguards against political manipulation. Among these safeguards are 14-year terms for Federal Reserve Board members (four years for the chair and vice chairs) and the provision that Fed governors, including the chair and vice chairs, may be removed only for a cause related to violations of law or similar misbehavior, and not for policy differences with political leaders. This system of fixed terms is designed to ensure that the Fed makes decisions that best serve the economy—and all of us—regardless of short-term political considerations.

Elections have consequences. That certainly applies to the Federal Reserve as well as to other government agencies. When the current chair’s four-year term ends, the president will have the opportunity to reappoint him or choose someone new. That nomination will have to be ratified by the Senate. We hope that when that decision is made, the choice will be based on the prospective nominee’s competence and integrity, not on political allegiance or activism. It is critical to preserve the Federal Reserve’s ability to make decisions based on the best interests of the nation, not the interests of a small group of politicians.

The Race Card in America

Donald Trump has racialized American politics more than any US president in living memory, and many are blaming him for acts of racist violence, like the recent mass shooting in El Paso. But, given that what makes politics in the United States so complicated is the conflation of race, class, and culture, his opponents should not follow his example.

Ian Buruma


LONDON – The recent mass shooting in El Paso, Texas, carried out by a young white man who had posted a hate-filled anti-immigrant screed shortly beforehand, has called attention to US President Donald Trump’s own rhetorical affinity for white supremacy. Trump has consistently insulted Mexicans, African Americans, and other people of color. He referred to Haitian and African immigrants as coming from “shithole countries.”

Last month, he told four new members of Congress, Alexandria Ocasio-Cortez, Rashida Tlaib, Ayanna Pressley, and Ilhan Omar, to “go back” to where they came from. All four Congresswomen are, of course, American citizens. All but one (Omar) were born in the United States.

Trump’s Republican supporters deny that he is a racist. Who knows? But he is clearly appealing to his followers’ darkest instincts, which are angry, vengeful, bigoted, and prejudiced in ways that can only be described as racist. By stirring up hatred, Trump hopes to mobilize enough voters to be reelected next year.

The president is careful not to incite people openly to commit violence. But many violent people feel licensed by his words to do so. This makes Trump’s behavior dangerous and contemptible, and he must be held to account for it. He deserves to be called a racist. Some of his critics go further than that. They argue that race should be the central issue of the 2020 elections.

Because Trump relies on angry white voters, diversity, anti-racism, and the elevation of people of color should be the counterstrategy.

This course would be morally justified. The question is whether it would be the most effective way to vote the scoundrel out, which should be the main aim of anyone who sees Trump as a danger to the republic, let alone to people who are targeted by angry racists. There is room for doubt.

Some people don’t actually mind being called racists. At a rally of the French National Front in 2018, Trump’s former advisor Steve Bannon told the crowd to wear the word “racist” as a badge of honor. But many Trump supporters don’t think of themselves as racists and resent the allegation. Quite a number of these people, often from the white working class, voted twice for Barack Obama. The Democrats need to get some of these voters back into their fold, especially in pivotal Midwestern states.

But fear of offending Trump supporters who don’t regard themselves as bigots is not the only reason to be careful about racializing politics even more than it already is. The fact that Trump plays that game is no reason for his opponents to follow his example. What makes politics in the US so complicated is the conflation of race, class, and culture.

Senator Lindsey Graham of South Carolina criticized Trump for getting too personal in his hostile comments about the four congresswomen. But it was all too typical of a particular way of thinking to call them “a bunch of communists,” as Graham did. The women are left-wing by most American standards, but certainly not communists. Communism, or even socialism, is regarded in certain right-wing circles as “un-American” by definition. That was the thinking in the early 1950s, when Senator Joe McCarthy was on the prowl for un-American “communists” – often ruining the lives of people who were merely on the left.

By the same token, writers, professors, or lawyers who favor reproductive freedom, or who don’t believe in God, or argue in favor of equal rights for people of all genders and sexual orientations, or support universal health care for all, are often accused of being more like namby-pamby godless Europeans.

Leftist or secular views cannot be associated with any particular race. If anything, highly educated white people are likely to espouse them. And those who believe that a coalition of non-white minorities is best placed to oppose Trump’s white chauvinism should be wary. A significant number of African Americans and Latinos are religious and socially conservative.

Of course, race plays an important part in the American culture wars. And the concept of “white privilege” is not invalid. But to see the country’s political, social, and cultural fissures in terms of a racial divide is, well, too black and white. To make opposition to white privilege the main platform in the fight against Trump not only risks alienating people the Democrats need on their side, but could also set Democrats against one another.

Former Vice President Joe Biden is far from an ideal candidate for the Democrats. He is too old and not quick enough on his feet. But to attack him, and even demand an apology from him, because he said he was once able to work with colleagues whose racial prejudices he clearly didn’t share, is a mistake. Working with people with whom you disagree, or actually abhor, is the stuff of politics.

Trump has managed to push the Democratic Party further to the left than it was under Obama. This suits him well. He would like to make the four congresswomen into the face of his political enemies.

Biden, who is proud to associate himself with the Obama years, is criticized by his younger rivals for being out of step with our more racially sensitive times. The second night of last week’s Democratic debates was marked by a spirit of antagonism toward the Obama administration. Biden found this “bizarre.”

He had a point. Obama managed to be successful precisely because he minimized race in his politics. He didn’t ignore it. Some of his best speeches were about it. But he carefully avoided making race into the main issue. He didn’t have to. His election made the point for him. And he is still more popular than any other politician alive.

Biden, alas, is no Obama. But the fact that he has more support among black voters than any of his competitors, even those who are black, should tell us something. If the Democrats want to beat Trump, they attack his flawed but infinitely better predecessor at their peril.

Ian Buruma is the author of numerous books, including Murder in Amsterdam: The Death of Theo Van Gogh and the Limits of Tolerance, Year Zero: A History of 1945, and, most recently, A Tokyo Romance: A Memoir.

Why the China-U.S. Trade Conflict Won’t Become a Currency War

The U.S. trade war with China reached a new phase on Aug. 5 after the U.S. labeled China a currency manipulator. That followed a surprise move by the Chinese government to let the yuan break through the long-standing 7-to-1 exchange rate for the first time in 11 years. Tensions eased slightly when China’s central bank fixed the exchange rate a bit higher than the lowest point the yuan hit, but global financial markets remained rattled.

Recent events in the trade dispute have been fast-moving. On Aug. 1 President Trump announced new tariffs on China – 10% on an additional $300 billion in goods — saying China had not bought large amounts of U.S. farm products as promised. Four days later, China devalued the yuan, and the U.S. currency manipulation charge followed. Then on Aug. 6, China said it may increase tariffs on U.S. farm products. But Wharton Dean Geoffrey Garrett explains why U.S.-China dispute is unlikely to become a full-on currency war, in this opinion piece.

Global markets were spooked yesterday by the Chinese Renminbi crossing the psychologically important barrier of 7 RMB to the greenback—sparking speculation that the current trade war will metastasize into a currency war between the world’s two biggest economies. The fact that the Trump administration responded immediately by officially labeling China a “currency manipulator,” for the first time in 25 years, is only grist for the mill.

The logic is straightforward. A weaker Chinese currency cushions the blow to Chinese exports of American tariffs. But greater Chinese exports to America would increase America’s trade deficit within China, creating incentives for the Trump administration to retaliate with a tit-for-tat weakening of the dollar.

Despite this logic, there are three powerful reasons why the trade war won’t become a currency war. In increasing order of importance they are:

1. Donald Trump loves showing America’s strength—and to many, there is no better signal of strength than a strong U.S. dollar.

What’s more, when the global economy wobbles, investors turn to the U.S. dollar as a port in the storm. 

2. The Trump administration cannot unilaterally manipulate the dollar, even if it wants to.

This is true on multiple levels. The dollar floats on global foreign exchange markets without the capital controls that allow a country like China to manage the value of its currency. The single most direct way to weaken the currency is for the central bank to lower interest rates. In the U.S. that is the domain of the Federal Reserve. To Trump’s chagrin, the Fed remains independent of the White House, and its charter asks it to balance the risks of unemployment and inflation, not the exchange rate. And the Fed told the financial markets just last week not to expect further cuts to interest rates.

3. The Chinese government cannot afford the risk of an RMB in free fall.

All the charges by America in the past decade that China is a currency manipulator belie the fact that for more than a decade after 2005, the Chinese currency actually appreciated considerably against the U.S. dollar. This no doubt reduced China’s exports to America, but to China it was worth the price. The specter of mass capital flight has been an existential fear of the Chinese government since the Asian financial crisis in the late 1990s. China then saw the devastating effects of capital flight and vowed that it would never happen in China. With the slowdown of the Chinese economy giving itchy feet to holders of RMB, the last thing China’s government wants is to turn market nervousness into a full-on rush for the exits.

There is no doubt that allowing the RMB to cross 7:1 against the dollar was Xi Jinping’s shot-across-the-bow response to Trump’s threat of imposing tariffs on all Chinese imports on September 1. Just don’t expect the single shot to become an ongoing fusillade.

The Anatomy of the Coming Recession

Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.

Nouriel Roubini


NEW YORK – There are three negative supply shocks that could trigger a global recession by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.

The first potential shock stems from the Sino-American trade and currency war, which escalated earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator.

The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “Thucydides Trap,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.

The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.

All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains.

Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.

Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.

It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.

Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.

Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.

In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession.

The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.

Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.

In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.

Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.

Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus.

But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term.

Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.

Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

Daily chart

America has half a million fewer jobs than previously thought

As central bankers meet in Jackson Hole, the Fed ponders its next move

IT IS NOT easy being a central banker these days. Jerome Powell, the chairman of the Federal Reserve, has come under particular scrutiny in recent months. Some commentators believe he has been too hawkish, even though he cut the Fed’s main interest rate by 25 basis points last month, and should cut rates more aggressively. President Donald Trump, who appointed Mr Powell, is now his most vocal critic, and recently tweeted that the Fed should cut its benchmark rate by “at least 100 basis points”.

Lowering interest rates would be a natural response to an economic downturn, but optimists have taken comfort from labour-market figures, which suggest that America’s economy is still humming along. The country’s unemployment rate currently sits at just 3.7%, its lowest level in five decades. The labour-force participation rate of “prime-age” workers aged between 25 and 54, although still below where it was before the financial crisis, has been rising steadily since 2015.

Still, investors are anxious. America’s trade war with China shows no signs of abating. The country’s manufacturing sector is growing at its slowest pace in nearly three years; and business investment contracted in the second quarter. Meanwhile Germany, Europe’s economic powerhouse, appears to be tipping into recession. Recent news from America’s Bureau of Labour Statistics has not helped matters. On August 21st the agency revised its figures, saying that employers added half a million fewer jobs in the year ending March 2019 than previously reported (see chart). The 0.3% downward revision to total non-farm employment was the biggest in a decade.

The bond market is also sending worrying signals. The yield on America’s short-term government bonds currently exceeds that of its longer-term debt. Such “inversions” have preceded each of the past seven recessions. A forecast from the Federal Reserve Bank of New York issued on August 2nd, based on historical data from the government-bond market, estimated that there was a 31% chance of a recession within the next twelve months. Up-to-date data would yield an even scarier forecast. Mr Trump was at one point so concerned that he floated the idea of issuing a new wave of tax cuts, though he appears to have since reconsidered.

All eyes are now on Mr Powell, who is due to speak tomorrow at an annual gathering of central bankers in Jackson Hole, Wyoming. Financial markets currently suggest the Fed has a 98% chance of cutting its benchmark rate by at least 25 basis points by September. Whether such a cut will be enough for Mr Powell to stave off a recession and placate his critics remains to be seen.