Markets seem to be missing the risks on US inflation

The Fed will eventually have to do more than ‘budge’ on interest rates

Rebecca Patterson

Fed chair Jay Powell prefers to wait for pandemic-related distortions to subside before judging whether inflationary pressures are persistent © Bloomberg


The US economy today is about as strong as it has been in generations, with the tightest labour markets and highest inflation rates seen in decades. 

That is even accounting for a recent moderation of growth driven by the spread of the Delta variant of Covid-19, reflected in Friday’s disappointing August jobs data.

Yet financial markets continue pricing in both that the inflation will prove transitory and that policymakers will barely need to budge in response. 

We see this potential combination of outcomes as unlikely.

Let’s first consider the outlook for inflation — persistent or transitory? 

We certainly would not expect the record-high consumer price prints from earlier this year to be sustained.

But aggressive fiscal stimulus (including another $2-3tn in spending likely to be passed before year-end), accommodated by money printing, is fuelling demand without commensurate supply.

Households are flush with cash with high levels of wealth and benefiting from low borrowing costs. 

They are spending, including on housing at a time when supplies are very limited and unlikely to materially improve soon.

That broad, strong consumer backdrop is also resulting in companies needing to hire — with job openings outstripping the number of job seekers and pushing up wages in a way we similarly think could be sustained and feed into a self-reinforcing economic recovery. 

Not surprisingly, the reflationary trends we have seen in recent quarters has led to an increase in expected monetary tightening, with two 0.25 percentage point rises now discounted over the coming two years and asset purchases expected to be wound down by the start of 2023.

But the shift in expected tightening is modest relative to any previous cycle and remains extraordinarily easy compared with the strength of the US economy. 

At the same time, the inflation break-even curve is charting a path back to normality within just a few years, and both nominal and real rates are near secular lows.

Ultimately, the Fed will react to economic conditions, which gets us to the second part of this market vision of the future. 

Will the policy-setting Federal Open Market Committee “barely need to budge”? 

There’s no question that central bankers are unusually challenged to read the economic tea leaves amid a pandemic. 

This difficulty at the Fed is evident in the increasingly vocal debate around how to interpret labour-market and inflation conditions.

Minutes from the July FOMC meeting highlighted, for instance, that employment remained well below its pre-pandemic level, reflecting elevated unemployment and people dropping out of the labour force. 

At the same time, though, it noted firms reportedly struggling to hire workers, and thus raising wages or providing additional incentives to attract or retain workers.

With both labour and inflation, the Fed is wrestling with the degree to which supply shortages reflect pandemic-related disruptions that can be easily resolved, and where conditions will settle when pandemic influences fade.

In recent weeks, several Fed officials have suggested that they may need to start the tightening cycle sooner and potentially at a faster pace than is currently discounted. 

For now, this is a minority view.

More dovish members, including the majority of today’s FOMC voters and chair Jay Powell, would prefer to wait for pandemic-related distortions to subside before judging whether inflationary pressures are persistent and whether labour markets are consistent with the Fed’s goal of eliminating “shortfalls”

These conversations are happening in the context of lessons learnt from the last few decades. 

Keeping monetary policy too tight and not being able to ease enough is seen as a bigger risk than allowing inflation to rise and needing to tighten and catch up later. 

With the Fed’s newfound commitment to allow inflation to overshoot 2 per cent, the more dovish perspectives are carrying the day for now.

Given the Fed’s goal to prevent low inflation or deflation from becoming entrenched, as it has in Japan and to a degree in Europe, we empathise and agree with the shift toward easier policy. 

We also do not envy how the Fed will have to balance the difficult trade-off between growth and inflation risks.

The Fed’s deliberations (and the composition of who actually votes and chair Powell’s inclinations) for now point toward slower tightening. 

We expect the Fed will still have to eventually do more than “budge” on rates.

More immediately, though, we think market pricing, data trends and the Fed’s evolving reaction function underscore a very real need for investors to protect portfolios against higher, more sustained inflation.


The writer is director of investment research at Bridgewater Associates. 

Connecting the Dots in China

The new dual thrust of Chinese policy – redistribution plus re-regulation – will subdue the entrepreneurial activity that has been so important in powering China’s dynamic private sector. Without animal spirits, the case for indigenous innovation is in tatters.

Stephen S. Roach


NEW HAVEN – All eyes are fixed on the dark side of China. 

We have been here before. 

Starting with the Asian financial crisis of the late 1990s and continuing through the dot-com recession of the early 2000s and the global financial crisis of 2008-09, China was invariably portrayed as the next to fall. 

Yet time and again, the Chinese economy defied gloomy predictions with a resilience that took most observers by surprise.

Count me among the few who were not surprised that past alarms turned out to be false. But count me in when it comes to sensing that this time feels different.

Contrary to most, however, I do not think Evergrande Group is the problem, or even the catalytic tipping point. 

Yes, China’s second-largest property developer is in potentially fatal trouble. 

And yes, its debt overhang of some $300 billion poses broader risks to the Chinese financial system, with potential knock-on effects in global markets. 

But the magnitude of those ripple effects is likely to be far less than those who loudly proclaim that Evergrande is China’s Lehman Brothers, suggesting that another “Minsky Moment” may well be at hand.

Three considerations argue to the contrary. 

First, the Chinese government has ample resources to backstop Evergrande loan defaults and ring-fence potential spillovers to other assets and markets. 

With some $7.5 trillion in domestic saving and another $3 trillion in foreign exchange reserves, China has more than enough capacity to absorb a worst-case Evergrande implosion; recent large liquidity injections by the People’s Bank of China underscore the point.

Second, Evergrande is not a classic “black swan” crisis, but rather a conscious and deliberate consequence of Chinese policy aimed at deleveraging, de-risking, and preserving financial stability. 

In particular, China has made good progress reducing shadow banking activity in recent years, thereby limiting the potential for deleveraging contagion to infect other segments of its financial markets. 

Unlike Lehman and its devastating collateral damage, the Evergrande problem hasn’t blindsided Chinese policymakers. 

Third, risks to the real economy, which has entered a temporary soft patch, are limited. 

The demand side of the Chinese property market is well supported by the ongoing migration of rural workers to cities. 

This is very different from the collapse of speculative housing bubbles in other countries, like Japan and the United States, where supply overhangs were unsupported by demand. 

While the urban share of the Chinese population has now risen slightly above 60%, there is still plenty of upside until it reaches the 80-85% threshold typical of more advanced economies. 

Notwithstanding recent accounts of shrinking cities – reminiscent of earlier false alarms over a profusion of ghost cities – underlying demand for urban shelter remains firm, limiting downside risks to the overall economy, even in the face of an Evergrande failure.

China’s most serious problems are less about Evergrande and more about a major rethinking of its growth model. 

Initially, I worried about a regulatory clampdown, writing in late July that the new measures took dead aim at China’s internet platform companies, threatening to stifle the “animal spirits” in some of the economy’s most dynamic sectors, such as fintech, video gaming, online music, ridesharing, private tutoring, and takeaway, delivery, and lifestyle services.

That was then. 

Now, the Chinese government has doubled down, with President Xi Jinping throwing the full force of his power into a “common prosperity” campaign aimed at addressing inequalities of income and wealth. 

Moreover, the regulatory net has been broadened, not just to ban cryptocurrencies, but also to become an instrument of social engineering, with the government adding e-cigarettes, business drinking, and celebrity fan culture to its ever-lengthening list of bad social habits.

All this only compounds the concerns I raised two months ago. 

The new dual thrust of Chinese policy – redistribution plus re-regulation – strikes at the heart of the market-based “reform and opening up” that have underpinned China’s growth miracle since the days of Deng Xiaoping in the 1980s. 

It will subdue the entrepreneurial activity that has been so important in powering China’s dynamic private sector, with lasting consequences for the next, innovations-driven, phase of Chinese economic development. 

Without animal spirits, the case for indigenous innovation is in tatters.

With Evergrande blowing up in the aftermath of this sea change in Chinese policy, financial markets, understandably, have reacted sharply. 

The government has been quick to counter the backlash. 

Vice Premier Liu He, China’s leading architect of economic strategy and a truly outstanding macro thinker, was quick to reaffirm the government’s unwavering support for private enterprise. 

Capital markets regulators have likewise stressed further “opening up” via new connectivity initiatives between onshore and offshore markets. 

Other regulators have reaffirmed China’s steadfast intention to stay the course. 

Perhaps they doth protest too much?

Of course, on one level, who wouldn’t want common prosperity? 

US President Joe Biden’s $3.5 trillion “Build Back Better” agenda smacks of many of the same objectives. 

Tackling inequality and a social agenda at the same time is a big deal for any country. 

It is not only the subject of intense debate in Washington but also bears critically on China’s prospects.

The problem for China is that its new approach runs counter to the thrust of many of its most powerful economic trends of the past four decades: entrepreneurial activity, a thriving start-up culture, private-sector dynamism, and innovation. 

What I hear now from China is denial – siloed arguments that address each issue in isolation. 

Redistribution is discussed separately from the impact of new regulations. 

And there is also a siloed approach to defending regulatory actions themselves – case-by-case arguments for strengthening oversight of internet platform companies, reducing social anxiety among stressed-out young people, and ensuring data security.

As a macro practitioner, I was always taught to consider the combined effects of major developments. 

Evergrande will pass. 

Common prosperity is here to stay. 

A regulatory clampdown, in conjunction with a push to redistribute income and wealth, rewinds the movie of the Chinese miracle. 

By failing to connect the dots, China’s leaders risk a dangerous miscalculation.


Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Digital Currencies Pave Way for Deeply Negative Interest Rates

If people can’t hoard physical money, it becomes much easier to cut rates far below zero

By James Mackintosh


Investors have been ignoring progress toward government-issued electronic money, even as many countries are progressing rapidly toward their own online cash. 

They should ask two questions: Will the Federal Reserve issue a digital dollar? 

And will it eventually replace physical bank notes?

I think the answer to both questions is yes, and those who agree should be assessing the impact on future monetary policy already, because dramatic change is likely within the timespan of the 30-year Treasury.

The main monetary power of the digital dollar comes from the abolition of bank notes. 

If people can’t hoard physical money, it becomes much easier to cut interest rates far below zero; otherwise the zero rate on bank notes stuffed under the mattress looks attractive. 

And if interest rates can go far below zero, monetary policy is suddenly much more powerful and better suited to tackle deflation.

Before going on, a quick definition: I’m talking here about central bank-issued money usable by you and me, just as bank notes are. 

It might (or might not) pay interest, but it is different to money in an ordinary bank account, which is created by the commercial bank; the existing central-bank digital money, known as reserves, are used only to settle debts between banks and certain other institutions, not available for ordinary use.


Deeply negative rates won’t come straight away. 

Initially, central-bank digital currencies will almost certainly be designed to behave as much like ordinary bank notes as possible, to make their adoption easy and minimize disruption, while use of physical cash will be allowed to wither away. 

But those close to the development agree that monetary caution is unlikely to last.

“Central banks are making lots of effort to make sure that CBDC isn’t seen as a possible monetary-policy instrument,” says Benoît Coeuré, head of the Bank for International Settlements’ innovation hub and a former European Central Bank policy maker. 

“My take is that that discussion will come only later.”

This matters for investors, because if rates can be taken deeply negative it would shift the long-term outlook for interest rates and inflation. 

The ECB has a rate of -0.5%, the Bank of Japan -0.1% and the Swiss National Bank -0.75%. 

But none think they can go below -1%.

The main limit is that deeply negative rates would encourage people to switch to bank notes to “earn” zero on their savings, instead of losing money. 

There are costs to hoarding large amounts of physical money, including storage and insurance against fire or theft, which allows slightly negative rates. 

But go deep enough, and negative rates would be applied to an ever-shrinking pool of savings, undermining their efficacy and draining the banks.

The monetary impact of removing, or at least reducing, this effective lower bound, as economists call it, is profound. 

Instead of turning to new and still unproven tools like the bond-buying of quantitative easing, central banks would be able to keep cutting rates when a crisis hit. 

And they would cut a long way—the trillions of dollars of QE and other experimental policies were equivalent to a “shadow policy rate” for federal funds of minus 5% by 2011, according to BIS research.

The bank note alternative isn’t the only thing preventing central banks from taking rates to -5%.

“It isn’t natural,” Mr. Coeuré told me. 

“Negative rates aren’t easy to understand. 

There will be a reluctance both by central banks and financial institutions to go there [deeply negative].”

Resistance from politicians and the public would make policy makers cautious about such radical policies, and some central bankers already worry about the side effects from prolonged periods of negative rates. 

But as Mr. Coeuré, who oversaw bond-buying while at the ECB, could tell you, what once seemed to be an impossibly extreme monetary policy can quickly become the norm.

Accept that interest rates might be deeply negative in serious recessions, and there is still a puzzle: Does that make long bond yields lower, or higher?

The argument for lower yields is basic mathematics. 

A 30-year bond should yield the average of the fed-funds rate over the period, plus or minus a risk premium. 

Take away the lower bound on rates, and the occasional negative rate should mean a lower average, all else equal.

As usual in economics, though, all else isn’t equal. 

The aim of deeply negative rates would be to stimulate the economy, creating a quicker recovery and allowing the central bank to raise rates again more quickly than if it was stuck at the lower bound for years, as the Fed was from 2008 to 2015 (the longest period without a rate change since at least 1954).

If negative rates worked, it might not mean a lower average over time. 

Instead, it might mean higher average inflation, and similar or even higher rates, as the economy could quickly be jerked out of the rut of secular stagnation, and rates and inflation return to normal.

“It is hard to say which way it would go,” says Eswar Prasad, a professor of economics at Cornell University and author of a forthcoming book on digital currencies, “The Future of Money.” 

“At times of extreme peril, it could make a difference.”

Making a decision comes down to how you view monetary policy. 

If you think it doesn’t really work as stimulus anyway, then negative rates would provide little to no extra support; a Japanified economy with even more negative rates might just have lower bond yields, and still no inflation.

If you agree with the central banks that interest rates are a powerful tool for reflating the economy, then digital money removes the asymmetry that prevents rates being used to tackle deflation. 

That should remove much of the risk of persistent deflation, justifying higher long-term bond yields.

Either way, interest rates matter for bond yields, and electronic money can give central banks more freedom with interest rates. 

How long it takes is up for debate, but some countries have already moved beyond the experimental stage, and policy makers are feeling the pressure from crypto developers, especially so-called stablecoins tied to the value of ordinary currency. 

It is time for long-term investors to start paying attention.

Breaking Bad Bond Buying

It is understandable why a central bank would print money to purchase assets at the height of a financial crisis. But continuing such policies under conditions of relative tranquility makes little sense – and raises serious risks.

Andrés Velasco


LONDON – In the run-up to the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming, last month, the discussion had focused on whether monetary policy should be tightened in response to higher US inflation. 

By suggesting that asset purchases would be tapered first, and that interest-rate increases would come much later, Fed Chair Jerome Powell has shifted the conversation to the question of how policy should be tightened.

While printing money to buy bonds and reduce long-term interest rates is justified during crises like those in 2008 or 2020, the case for maintaining quantitative easing (QE) in more tranquil times is far from obvious. 

To see why, it helps to dispel three misconceptions about QE.

The first misconception is that QE is a monetary policy. 

It is not. 

Or rather, it is not just that. 

It is also a fiscal policy. 

In every country, the central bank is owned by the treasury. 

When the Fed issues money – central bank reserves, in fact – to buy a government bond, the private sector is getting one government liability in exchange for another.

The second misconception is that the government (including the treasury and central bank) always comes out ahead from such a transaction, because the private sector is left holding a security that pays a lower rate of interest. 

That need not be so. 

Central bank reserves can be held only by commercial banks, which have limited use for them. 

To induce banks to hold more reserves, central bankers must pay interest on them, as the Fed and the Bank of England started doing in response to the 2008 financial crisis.

The third misconception is that whenever the interest rate on central bank reserves is zero or lower than the rate on government bonds, the government can spend what it pleases, when it pleases. 

This is the central tenet of so-called Modern Monetary Theory. 

It is pithy, spiffy, snazzy, and wrong.

Yes, financing from money creation (economists call it seigniorage) is feasible whenever the yield on money is below that of government bonds. 

But as the central bank prints more and more money, it must pay higher and higher interest rates on that money to ensure that commercial banks and the public will want to hold it. 

Sooner or later, the interest-rate gap closes and there is no more seigniorage to be had. 

If the central bank keeps printing money beyond this point, the private sector will begin dumping it, causing currency depreciation, inflation, or both.

Once one accepts these three provisos, one must ask the multi-trillion-dollar question: Does QE make sense, from a fiscal point of view, in the United States today? 

The answer is no, for at least two reasons.

In late August 2021, the Fed was paying 0.15% interest on commercial banks’ reserve balances at a time when the interest rate on short-maturity Treasury bills was oscillating around 0.04%. 

That means it is cheaper (for the US taxpayer) to finance expenditures by issuing bonds than by printing money.

This might seem paradoxical. 

But it is important to remember that yield is a proxy for liquidity. 

Reserves at the Fed can be held only by banks. 

They do not serve as collateral and are subject to capital requirements. 

Treasuries, by contrast, can be held by anyone. 

They are traded in a huge, deep market and are routinely used as collateral for other financial operations. 

No wonder investors view Treasuries as more liquid and demand a lower yield from them.

Debt maturity is the other reason why additional QE makes little fiscal sense. 

Treasury bonds come in many maturities, stretching out to 30 years. 

But the non-required portion of Fed reserves comes in only one maturity: instantaneous (since commercial banks are free to withdraw them at will). 

Hence, every time the Fed issues reserves to buy a long-term bond, it is lowering the average maturity of government-issued debt.

If the interest rates on long-term Treasury bonds were high, such a policy would be sound. 

But the rate on the oft-quoted ten-year Treasury today is substantially below the Fed’s targeted inflation rate for that period, which implies that people around the world are effectively paying for the privilege of handing their money to the US government for the next ten years.

Under these circumstances, as Lawrence H. Summers recently argued in the Washington Post, the right policy is to “term out” public debt – locking in the very low rates for as long as possible – not to “term in” the debt as the Fed is doing with QE. 

Here, a government is like a family looking to take out a mortgage: the lower long-term rates are, the more sense it makes to borrow long.

The homebuyer’s analogy also illuminates the other risk introduced by short maturities: exposure to future interest-rate hikes. 

In the US, where 30-year fixed-rate mortgages are common, a new homeowner need not worry about what the Fed will do with interest rates next year – or even in the next couple of decades. 

But in the United Kingdom, where floating-rate mortgages are the norm, homeowners are always fretting over what the Bank of England will do next.

In managing its debt, the US federal government has gone the way of British homeowners. 

Though interest rates will not rise tomorrow, they certainly will someday, and when that happens, rolling over huge stocks of debt at higher yields will have a non-trivial fiscal cost.

One can also imagine nasty financial dynamics at work: a rising interest burden causes more debt to be issued, and this increase in supply reduces the liquidity premium on the new bonds, further raising interest rates and requiring ever-larger bond issues.

Moreover, unsavory political dynamics could emerge. 

When the central bank’s decisions have a big impact on the public purse, politicians will be more tempted to cajole central bankers to keep rates low. 

Skeptics will counter that this kind of thing doesn’t happen in the US. 

But America’s previous president was not above browbeating the Fed via Twitter, which was not supposed to happen. (Presidents like Donald Trump were not supposed to happen, either.)

These are not arguments for a more contractionary monetary policy; the Fed can keep the short-term interest rate as low as needed. 

Nor are they arguments in favor of a more contractionary fiscal policy; if the Biden administration wants to spend more, it can issue long-term bonds or raise taxes. 

Printing money to pay for the deficit used to be the progressive thing to do. 

Not anymore.


Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.  

The strange death of American democracy

A constitutional crisis looms as Trump tightens his grip on the Republicans ahead of 2024

Martin Wolf 

© James Ferguson


“An American ‘Caesarism’ has now become flesh.” 

I wrote this in March 2016, even before Donald Trump had become the Republican nominee for the presidency. 

Today, the transformation of the democratic republic into an autocracy has advanced. 

By 2024, it might be irreversible. 

If this does indeed happen, it will change almost everything in the world.

Nobody has outlined the danger more compellingly than Robert Kagan. 

His argument can be reduced to two main elements. 

First, the Republican party is defined not by ideology, but by its loyalty to Trump. 

Second, the amateurish “stop the steal” movement of the last election has now morphed into a well-advanced project. 

One part of this project is to remove officials who stopped Trump’s effort to reverse the results in 2020. 

But its main aim is to shift responsibility for deciding electoral outcomes to Republican-controlled legislatures.

Thus, health permitting, Trump will be the next Republican candidate. 

He will be backed by a party that is now his tool. 

Most important, in the words of David Frum, erstwhile speechwriter for George W Bush, “what the United States did not have before 2020 was a large national movement willing to justify mob violence to claim political power. 

Now it does.” 

It does so because its members believe their opponents are not “real” Americans. 

A liberal democracy cannot long endure if a major party believes defeat is illegitimate and must be rendered impossible.

Here is a political leader who has ousted anybody who opposes him from positions of influence in his party. 

He believes himself unjustly persecuted, defines reality for his followers and insists that a legitimate election is one he wins. 

A constitutional crisis looms. 

The 2024 election, warns Kagan, could bring “chaos. 

Imagine weeks of competing mass protests across multiple states as lawmakers from both parties claim victory and charge the other with unconstitutional efforts to take power.”


Assume that Trump is re-elected, legitimately or by manipulation. 

One must assume that his naive and incompetent approach to the wielding of power in his first term will not be repeated. 

He must now understand that he will need devoted loyalists, of whom there will be plenty, to run the departments responsible for justice, homeland security, internal revenue, espionage and defence. 

He will surely put officers personally loyal to himself in charge of the armed forces. 

Not least, he will get his loyal Republican party, as it will be, to confirm the people he chooses, if it holds the needed Senate majority, as is highly likely to be the case.

Equally surely, he will use the pressure that he can then exert on the wealthy and influential to bring them into line. 

Crony capitalism is among the probabilities. 

Ask the Hungarians who live in an “illiberal democracy” under a man admired by US rightwing pundits.

“Americans — and all but a handful of politicians — have refused to take this possibility seriously enough to try to prevent it”, notes Kagan. 

“As has so often been the case in other countries where fascist leaders arise, their would-be opponents are paralysed in confusion and amazement at this charismatic authoritarian.”


Just consider what happened during Trump’s intended coup against the 2020 election and how Republican legislators and supporters have since rallied round in order to prevent anybody important, above all Trump himself, from being held accountable. 

The only significant players who have been punished are those who resisted or condemned the coup. 

The Republicans have crossed their Rubicon already.

Why has this happened? 

The answer is a mix of greed, ambition and anger in a country that has grown increasingly diverse and an economy that has failed to give secure prosperity to a large proportion of the population. 

This has created a familiar coalition built on “othering” outsiders, glorifying the nation, protecting the wealthy and worshipping a great leader. 

Fifty seven per cent of Republicans consider a bad reaction to the vaccine riskier than Covid-19 itself. 

This is a measure of tribalism.


Can a collapse of liberal democracy in the US still be prevented? 

Possibly. 

But it will not be as easy as many suppose from the failure of Trump’s attempt to overturn the outcome of the 2020 election. 

He is in full control of his party. 

Should the normal cycle of politics give the Republicans control of the House and Senate, he will be both protected and served by Congress from 2022. 

He holds, in principle, a big majority in the Supreme Court. 

Republicans also control all branches of government in 23 states, while the Democrats control only 15. 

Kagan pins his hopes on a decision by a sufficiently large number of Republican senators to pass voting rights legislation and on the refusal of the judiciary to overturn such legislation. 

Yet even those who loathe Trump remain loyal to the party. 

And, as the debt ceiling debate shows, they are determined to make Biden fail.

Suppose Trump comes back to power in 2024, determined to exact vengeance on his foes, backed by Congress and the Supreme Court. 

Yes, even this might be just an interlude. 

Trump is old: his passing might be the end of the authoritarian moment. 

But neither the electoral system nor the Republican party will go back to what it was. 

The latter is now a radical party with a reactionary agenda.

The US is the sole democratic superpower. 

Its ongoing political transformation has deep implications for liberal democracies everywhere, as well as for the world’s ability to co-operate on vital tasks, such as managing climate risks. 

In 2016, one could ignore these dangers. 

Today, one must be blind to do so.


The strange death of American democracy | Financial Times (ft.com)

Covid-19 has made fighting inequality more critical than ever

The pandemic has widened the gulf between rich and poor, but by co-operating we can rebuild a more sustainable world

Ian Goldin

A nurse in Madagascar waits for healthcare workers to arrive for their first Covid-19 vaccine in May. Only 1.8 per cent of people in poor countries have received a single dose © Rijasolo/AFP/Getty


The climate emergency, Covid-19 crisis and Afghan debacle have in common the dismal failure of leading powers to work together. 

These crises have exacerbated underlying inequalities in health, nutrition, gender, ethnicity and income. 

Many of these are defined geographically. 

Rather than globalisation producing a world that is “flat” or leading to the “death of distance”, place matters more than ever. 

Global-scale crises have particularly devastating consequences for poor people. 

In Africa the crops and livelihoods of those living on the most fragile land are the first to be destroyed by climate change. 

And whereas only 1.8 per cent of people in poor countries have received a single Covid-19 vaccine dose, the vast majority of people in rich countries have. 

The pandemic is also compounding economic inequalities. 

While rich countries have found over $17tn to sustain their businesses, retain jobs and reinforce safety nets, poor countries have little capacity to do likewise. 

As a result, over 100m people have been pushed into extreme poverty and around 118m more people have faced chronic hunger, making the economic consequences of Covid-19 more deadly than the virus itself.

The failure of rich countries to live up to their commitments to assist poor countries has led to the Sustainable Development Goals and Paris commitments to contain global warming to 1.5C being derailed.

The climate, Covid and conflict crises have not only widened the gulf between rich and poor countries; they also are widening inequality within high-income countries. 

In the UK, people in the poorest 10 per cent of areas were almost four times as likely to die from Covid as those living in the wealthiest. 

A million more people are likely to swell the ranks of the unemployed when the UK government’s support for businesses is removed in the coming months.

In the rich countries, government spending might have diminished the economic pain, but after a lull caused by lockdowns, 2023 threatens to be a year of peak carbon emissions as spending on infrastructure results in soaring demand for coal, steel and cement.

Globalisation has been the source of the greatest improvement in livelihoods in the history of humanity. 

But the failure to manage it is leading to spiralling systemic risks, such as cyber attacks and financial crises. 

Rising nationalism undermines co-operation, with slower growth and recurrent crises leading to a widening of inequality. 

This fuels anger against an increasingly unfair system and deepens support for populist politicians who offer the false promise of cocooning citizens from global threats.

It was the anger and inequity of the financial crisis that laid the foundation for Brexit in Britain and Donald Trump’s victory in the US, as well as the rise of extremist politics across Europe. 

Divided societies lead to a more divided world. And a divided world is dangerous.

All may not be lost, with the forthcoming United Nations General Assembly and COP26 climate summit among the opportunities to change course. 

This requires overcoming the retreat to nationalism, starting with an effective commitment to the global distribution of vaccines and to a global green new deal.

We need to learn from the lessons of a century ago, when massive policy errors during the Roaring Twenties led to growing nationalism, widening inequality and global recriminations, culminating in the second world war. 

The determination of Winston Churchill and Franklin Roosevelt to ensure that future catastrophes would be avoided meant that in the midst of that tectonic battle a new world order was created. 

The UN, Bretton Woods institutions and Marshall Plan were designed to provide peace and economic reconstruction abroad, and the welfare state to address inequality at home. 

The result was the “golden age of capitalism”.

What is required now is not a bouncing back from the pandemic to what we had before, or a reset to the pre-Covid operating system. 

That is what led to the climate, conflict and Covid crises we face. 

Unless we reduce the growing inequalities within our countries and between them, we are heading towards a bleak future.

Change can be daunting, but it is far less scary than the alternative. 

Radical changes in government policy, in business behaviour and in our personal choices over the past 18 months demonstrate that previously unthinkable actions can be undertaken. 

This commitment now needs to inform a wider spirit of renewal if we are to overcome inequality and build the foundations of a more inclusive and sustainable world.


The writer is professor of globalisation and development at Oxford university and the author of ‘Rescue: From Global Crisis to a Better World’ 

The Economy Looks Solid. But These Are the Big Risks Ahead.

One concern is that political leaders will mismanage things in the world’s largest and second-largest economies.

By Neil Irwin

A line of container ships waited off the ports of Long Beach and Los Angeles last week. The twin ports are seeing unprecedented congestion. Credit...Mario Tama/Getty Images


The low-hanging fruit of the pandemic economic recovery has been eaten. 

As a result, the expansion is entering a new phase — with new risks.

For months, the world economy has expanded at a torrid pace, as industries that were shut down in the pandemic reopened. While that process is hardly complete — numerous industries are still functioning below their prepandemic levels — further healing appears likely to be more gradual, and in some ways more difficult.

Reopening restaurants and performance arenas is one thing. Fixing extraordinary backups in shipping networks and shortages of semiconductors, among the most vivid examples of supply shortages holding back many parts of the economy, is harder.

And a range of risks, including the hard-to-predict dynamics of Covid variants, could throw this transition to a healthy post-pandemic economy off course.

One looming risk is if political leaders mismanage things in the world’s largest and second-largest economies. 

Namely, in the United States, a standoff over raising the federal debt ceiling could bring the nation to the brink of default. 

And in China, the fallout from the property developer Evergrande’s financial problems is raising questions about the country’s debt-and-real-estate-fueled growth.

The Organization for Economic Cooperation and Development last week projected that the world economy would grow 4.5 percent in 2022, downshifting from an expected 5.7 percent expansion in 2021. 

Its forecast for the United States shows an even steeper slowdown, from 6 percent growth this year to 3.9 percent next.

Of course, a year of 3.9 percent G.D.P. growth would be nothing to scoff at — that would be much faster growth than the United States has experienced for most of the 21st century. 

But it would represent a resetting of the economy.

After the global financial crisis of 2008-9, the great challenge for the recovery was a shortfall of demand. 

Workers and productive capacity were abundant, but there was inadequate spending in the economy to put that capacity to work. 

The post-reopening stage of this recovery is the opposite image.

Now there is plenty of demand — thanks to pent-up savings, trillions of dollars in federal stimulus dollars, and rapidly rising wages — but companies report struggles to find enough workers and raw materials to meet that demand.

Dozens of container ships are backed up at Southern California ports, waiting their turn to unload products meant to fill American store shelves through the holiday season. 

Automakers have had to idle plants for want of semiconductors. 

Builders have had a hard time obtaining windows, appliances and other key products needed to complete new homes. 

And restaurants have cut back hours for lack of kitchen help.

These strains are, in effect, acting as a brake that slows the expansion. 

The question is how much, and for how long, that brake will be applied.

“The kinds of growth rates we are seeing were a bounce-back from a really severe recession, so it’s no surprise that won’t continue,” said Jennifer McKeown, head of the global economics service at Capital Economics. 

“The risk is that this becomes less about a natural cooling and more about the supply shortages that we’re seeing really starting to bite. 

That may mean that economic activity doesn’t continue to grow as we’re expecting it to, as instead there is a stalling of activity and price pressures starting to rise.”

The problem is that the supply shortages have many causes, and it is not obvious when they will all diminish. 

Spending worldwide, and especially in the United States, shifted toward physical goods over services during the pandemic, more quickly than productive capacity could adjust. 

The Delta variant and continued spread of Covid has caused restrictions on production in some countries. 

And the lagged effects of production shutdowns in 2020 are still being felt.

Then there are the risks that lurk in the background — the kinds of things that aren’t widely forecast to be a source of economic distress, but could unspool in unpredictable ways.

Debt ceiling brinkmanship in Washington is a prime example. 

Senate Republicans insist that they will not vote to increase the federal debt limit, and that Democrats will have to do so themselves — while also planning to filibuster Democratic attempts to do so.

Failure to reach some sort of agreement would risk a default on federal obligations, and could cause a financial crisis. 

For that reason, a deal in these cases has always ultimately been done — even if, as in 2011, it created a lot of uncertainty along the way.

The risk here is that both sides could be so determined to stick to their stances that a miscalculation happens, like two drivers in a game of chicken who both refuse to swerve. 

And to those who are closest to American fiscal policymaking, that looks like a meaningful risk.

“Chances of a default are still remote, and Congress will likely increase the debt ceiling. but the path to a deal is more murky than usual,” said Brian Gardner, chief Washington policy strategist at Stifel, in a research note. 

He added that the political game of chicken could spook markets in coming weeks.

And on the other side of the Pacific Ocean, the Chinese government has its own challenge, as Evergrande struggles to make payments on $300 billion worth of debt.

Real estate has played an outsize role in China’s economy for years. 

But few analysts expect the problems to spread far beyond Chinese borders. 

The Chinese banking and financial system is largely self-contained, in contrast to the deep global linkages that allowed the failure of Lehman Brothers in 2008 to trigger a global financial crisis.

“Everyone’s learned a trick or two since 2008,” said Alan Ruskin, a macro strategist at Deutsche Bank Securities. 

“What you have here is the world’s second-largest economy, and one that has lifted all boats, could be slowing more materially than people anticipated.

I think that’s the primary risk, rather than that financial interlinkages shift out on a global basis.”

All of which could make for a bumpy autumn for the world economy, but which in the most likely scenarios would lead to a solid 2022. 

If, that is, everything goes the way the forecasters expect.


Neil Irwin is a senior economics correspondent for The Upshot. He is the author of “How to Win in a Winner-Take-All-World,” a guide to navigating a career in the modern economy.  

Will Biden Make a Historic Mistake at the Fed?

The past 30 years should have taught Democrats to put their own economic policy priorities before symbolic gestures of "bipartisanship." If US President Joe Biden does not replace Federal Reserve Chair Jerome Powell with Lael Brainard, he will almost certainly regret it.

J. Bradford DeLong


BERKELEY – In 1987, Alan Greenspan was appointed by Republican President Ronald Reagan to chair the US Federal Reserve Board of Governors, succeeding Paul Volcker. 

Eight years later, President Bill Clinton, a Democrat, was impressed by Greenspan’s willingness to use monetary policy to offset his administration’s fiscal retrenchment. 

This kept growth from stalling in the 1990s, and Greenspan did it despite partisan opposition from Republicans who denounced him for too-loose monetary policy. 

In 1996, Clinton reappointed Greenspan to a third term, and then to a fourth in 2000.

But Greenspan’s nurturing of the (highly beneficial) 1990s dot-com boom turned out to be the last time he would act bravely, wisely, and in a nonpartisan fashion. 

In the 2000s, he put partisan loyalty first, endorsing Republican President George W. Bush’s 2001 and 2003 tax cuts even though he evidently considered them to be bad policy.

When Fed Governor Edward Gramlich warned that mortgages, derivatives, and mortgage derivatives demanded much closer scrutiny and regulation, Greenspan rejected this argument, insisting that it wasn’t his place to get in the way of lenders who want to lend to home buyers who want to borrow. 

Never mind that this macroprudential philosophy was in direct contradiction to the one famously articulated by his earlier predecessor, William McChesney Martin, who in 1955 explained that the Fed chair’s job is to remove the punch bowl before the party gets too raucous, even though partygoers are likely to protest.

When Greenspan retired in January 2006, he was succeeded by Ben Bernanke, a Bush appointee who impressed Democratic President Barack Obama with his willingness to work on a bipartisan basis to push the perceived limits of monetary policy in fighting the Great Recession. 

In 2009, Obama duly reappointed Bernanke, who held the line by continuing the Fed’s quantitative-easing (QE) policies despite howls of outrage from Republicans.

By 2010, Republican economists and non-economists had decided that their top priority was to ensure that Obama was a “one-term president.” 

They started demanding rapid normalization of monetary policy – which was certain to produce higher unemployment – and dismissed as a sham whatever prosperity had been created by monetary expansion.

The prosperity wasn’t a sham, but it was meager enough that the argument gained traction. 

In December 2009, the US employment-to-population ratio was 58.3%, still far below its pre-crisis level of 63.4% (in December 2006). 

Three years later, in December 2012, it was only 58.7%; and when Bernanke stepped down, in January 2014, it had not risen any higher.

Not surprisingly, Bernanke was bitterly disappointed by the anemic post-2008 recovery. 

As recently as the late 1990s, he had argued vociferously that the Bank of Japan should do whatever it takes to restore the Japanese economy to full employment. 

But things looked different to him when he left academia to become a central banker. 

Not until after his departure from the Fed did the US employment-to-population ratio start rising at the one-percentage-point annual rate needed to bring the economy within striking distance of full employment. 

It reached that level under single-term Republican President Donald Trump, who replaced Obama’s second Fed chair, Janet Yellen, with Jerome Powell.

Now, it appears that President Joe Biden, a Democrat, is poised to reappoint Powell to another four-year term. 

Why he would do such a thing is beyond me. 

Powell’s views on financial regulation and macroeconomic management are not even remotely aligned with those of the Democratic near-consensus. 

Though he has spent the past four years following interest-rate and QE policies that do accord with the prevailing Democratic view, it is important to consider the two main factors behind this.

The first reason is that the Republican Party has been split down the middle, and thus neutralized, by a bitter conflict between the hard-money kneejerk instincts of GOP worthies and the soft-money kneejerk instincts of Trump the real-estate developer, for whom money can never be too cheap. 

The second reason is that Fed Governor Lael Brainard has been extremely persuasive in arguing that the current neutral rate of interest is still below zero, and that the supply-shock-driven inflation caused by the COVID-19 pandemic should be accommodated.

The first factor is fading away. 

Without Trump in office, and without the fear that tight money will erode vote margins in the short run, Republicans are about to unite overwhelmingly behind the talking point that monetary policy needs to be substantially tightened immediately. 

Powell, being a Republican worthy, will listen and toe this line.

If you think that the standard Republican hard-money perspective is good policy at this stage in the recovery, that is your prerogative. 

But if you do not sympathize with this view, you should be staunchly against Powell’s reappointment. 

The obvious alternative is Brainard, a former academic economist and under secretary of the US Department of the Treasury who has served on the Fed Board since 2014.

To reappoint Powell, Biden and his advisers would have to offer a convincing argument against Brainard. 

Are they going to tell us that she lacks the necessary technical skills, experiences, charisma, or persuasiveness on monetary and regulatory policy? 

I certainly hope not. 

Brainard stayed the course at her post through the dark days of the Trump administration. 

For a Democratic administration that currently enjoys only the barest majority in the Senate, her appointment as Fed chair should be an easy decision.


J. Bradford DeLong is Professor of Economics at the University of California, Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.

It is not just CEOs who should benefit from equity ownership

The conditions are ripe for a rethink of pay norms

Andrew Edgecliffe-Johnson

© Matt Kenyon


It was Charlie Munger, Warren Buffett’s partner in quotable business aphorisms, who once quipped: “Show me the incentive and I will show you the outcome.” 

So it is no surprise that, over the decades in which the consensus set in that a chief executive’s main job was to create value for their shareholders, boards began adding ever more stock to CEOs’ compensation packages. 

This, the refrain went, was the way to match up the interests of managers and owners.

Yet a couple of strange things have happened in the two years since the US Business Roundtable made its symbolic break with shareholder primacy.

First, the investors, with whose interests executives were supposedly so well aligned, have begun voting against CEOs’ compensation packages in ever larger numbers. 

Second, heedless of Munger’s mantra, executives’ incentives have remained overwhelmingly focused on shareholder outcomes, even as they have been busy professing what fine stakeholder capitalists they are. 

So the way companies now pay their top officers is failing to satisfy shareholders while undermining executives’ credibility as guardians of other stakeholders’ interests.

This week, a study spanning seven European countries found an 18 per cent increase this year in shareholders dissenting over pay resolution. 

In the US, too, protests over executives’ rewards have hit a record high, with once placid institutions baulking at the $230m GE gave CEO Larry Culp and the $155m Bobby Kotick took home for running Activision Blizzard. 

You don’t have to be Bernie Sanders to wonder how much empathy a CEO earning nine digits has with employees and other stakeholders barely scratching a living. 

Yet it is still startling that three-quarters of investors now think that executive pay is simply too high, as a recent London Business School survey found. 

Only 18 per cent of investors bought the familiar argument that such high pay is needed to “recruit and retain” the best executives. 

But what about the non-shareholders? 

In a controversial analysis of Business Roundtable members’ actions since signing 2019’s stakeholder pledge, two Harvard Law School academics last month found that none had yet tied directors’ compensation to stakeholders’ interests. 

That seems unlikely: other studies suggest that more than one in five US companies now includes some environmental, social or governance metrics in their incentive plans, such as goals for increasing diversity or cutting carbon emissions. 

But those stakeholder metrics which boards have adopted typically focus on annual bonuses and put little of the CEO’s total compensation at risk. 

Investors suspect that boards are simply adding complexity to already conveniently impenetrable packages. 

Meanwhile, as accounting standard setters have yet to agree common definitions for most ESG measures, there is equal concern that boards are picking pet metrics and setting targets that will be hard to miss, inflating packages further.

The conditions are ripe, then, for a rethink of compensation norms, but can incentives be redesigned to produce outcomes that satisfy both shareholders and other stakeholders? 

The answer lies in the economic logic that persuaded so many executives to espouse the stakeholder agenda in the first place: that, at least in the long term, doing the right thing by employees, customers and the environment builds value for shareholders. 

That is making investors increasingly keen to see more CEO packages take the form of simple grants of equity, held for at least five years, says Alex Edmans, one of the authors of the LBS study. 

Most environmental and social goals cannot be achieved in the time between annual bonus awards. 

Better, instead, to incorporate only the most relevant and clearly measured of them into longer-range stock awards, of which a significant portion will be at risk if the goals are missed. 

If more stock sounds a perverse prescription for a stakeholder-driven age, it need not be if boards take two further steps.

First, directors need to ask whether they can justify the potential payouts to all of their stakeholders. 

It is becoming clearer that the worst excesses of C-suite pay are damaging relations with shareholders and trust in capitalism more broadly. 

Reining them in would not only head off clashes with investors or hostile politicians seeking to impose pay caps — it might just rebuild some trust. 

Second, if boards truly believe that equity ownership is vital for focusing executives on shareholder value creation, then they should extend that logic to other employees.

As one Harvard Business School study found, businesses with widespread employee ownership “are more productive, grow faster, and are less likely to go out of business than their counterparts”. 

If anything would align the interests of investors and the staff who the majority of CEOs see as the most important of their stakeholders, it is making more employees shareholders.

Given that most CEOs are already multimillionaires, boards might even reflect on what might happen if they took a chunk of the stock reserved for executives and distributed it around people for whom even a small stock payout would be a transformative incentive. 


What Could Go Wrong?

By John Mauldin 


I have written several letters on the theme that the best investment posture is cautious optimism. 

Pessimism and bearishness never get you in the game, while untamed optimism means that at some point, you’ll have a serious setback. 

The cautiously optimistic investor asks both, “What could go wrong?” and “What could go right?”

Dave Portnoy notwithstanding, stock prices don’t always go up. 

Investors got a little reminder last week when financial media suddenly had some drama to report. 

Then it subsided, and the market went right back up.

The latest volatility may or may not turn into something more extended. 

Some of the most respected market analysts are turning bearish. 

Still, others expect the bull market to continue. 

Timing is hard. 

Yet nothing has happened to make bear markets impossible. 

Stocks are overextended by many different measurements, so at some point, the bears will take control. 

More than a few investors aren’t ready for that possibility.

Today, I want to show you how richly valued the market is and then review some of the top risks that could force it downward. 

Like those sandpiles I talk about, we don’t know exactly what will trigger a collapse. 

We know something will do it. 

Sandpiles don’t grow to infinity.

But then we’re going to ask what could go right? 

Sandpiles don’t grow to infinity, but they can grow a lot higher for longer than many expect.

Different scenarios suggest different strategic responses. 

It pays to think about what could happen. 

It will let you plan ahead and maybe make some decisions in advance.

Starting Price Matters

Making money in stocks is really quite simple. 

You buy a stock and then sell it at a higher price. 

That means two things need to happen.

  • The stock price rises above your purchase price.
  • You sell while it is up there.

This is why your starting (buy) price matters. 

The higher it is, the fewer chances you have to sell at a profit. 

Buying a stock whose price is already extreme puts the odds against you. 

That’s what people have been doing, and, to be fair, it’s worked well for many. 

But the jury is still out on that because most of those folks haven’t yet sold.

The so-called “Buffett Indicator” is one of the best high-level valuation measures. 

This is simply a ratio of stock market capitalization to GDP.

It makes sense because, over long periods, stocks should track economic growth. 

Here is a graph by my friend Michael Lebowitz.


Source: RealInvestmentAdvice


This ratio recently surpassed its tech bubble peak around 20 years ago. 

This means stocks are more expensive relative to GDP than ever seen in the modern era. Could they get still more expensive? 

Sure. Some stocks could (and almost certainly will) buck the trend. 

But this shouldn’t reassure anyone who is putting new money into the market or who holds unrealized gains.

Michael has another interesting chart on price/earnings ratios. 

He calculated a running sigma, which is the number of standard deviations the current month’s P/E is above/below its ten-year average.


Source: RealInvestmentAdvice

I’ll quote his explanation.

The current reading, of roughly three sigmas, matches or exceeds seven other peaks in the last 100 years. 2009 is the exception. However, that significant overvaluation is a function of earnings collapsing, not excessive prices. In all the cases, the ratio fell to at least zero.

The current sigma is at prior peaks, so any upside appears limited.

If the market reverts to a zero sigma, we should expect 36% losses. 

Again, a decline to negative readings will compound the losses.

For P/E to simply return to what was “normal” over the last ten years will take a 36% loss. 

But past bear markets didn’t stop there. 

Long periods of overvaluation get balanced by subsequent undervaluation. 

So, it’s entirely reasonable to think the next bear market, whenever it comes, will chop prices in half. 

That’s not crazy. 

It is what we should expect.

B-List Triggers

Again, let me stress that the timing is hard. 

We never know exactly when the sandpile will collapse. 

We just know it will. 

The chart above shows the Buffett Indicator has been at worrisome levels for several years. 

This could continue. 

But the longer it does, the bigger the sandpile gets, and the bigger the eventual collapse will be.

The ultimate trigger may be something none of us have yet considered—an unforeseeable bolt from the blue—but many plausible triggers are perfectly visible. 

Some are more plausible than others. I’m going to name several, starting with the “B-list” and then moving to the one I think most likely, and most dangerous, too.

China Crisis

I used to call Japan “a bug in search of a windshield.” 

Lately, I wonder if it could be China, instead. 

Or perhaps China is actually the windshield. 

In any case, China’s sheer size means its problems affect everyone.

The latest China problem is debt-laden property developer Evergrande, which has missed some payments and, as of today, is in default. 

There is never just one cockroach. 

While we don’t know the extent, I will bet you a dollar to 47 doughnuts China has dozens of other “Evergrande lite” problems. 

It’s unclear if the government can help much or even wants to. 

Xi Jinping is responding to popular unrest with a new “Common Prosperity” theme that looks less business-friendly. 

Some Chinese commentators I respect seem to believe that the government will take what money the developers still have and use it to finish projects so consumers aren’t hurt.

I would not want to be a bank or funds holding dollar-denominated Chinese debt. 

They can form all the debt-holder committees they want, but if the CCP is on the other side of the table, you won’t have much leverage. 

There is no rule of law. 

There is the CCP and Xi Jinping.

However, the dollar-denominated debt, while seemingly huge, is a drop in the bucket. 

The rest will be absorbed internally within China, and that is their problem. 

More likely is a slow-burn crisis.

But the world does have one problem. 

China is currently the world’s fastest-growing major economy and a critical supplier to most others. 

If Evergrande depresses construction and business activity while raising the cost of capital, growth in China could slip to a very low level. 

The real estate and commodities world has grown accustomed to China growing at a compound 6–8%. 

Any lasting drop would affect businesses worldwide and slow global growth down. 

This could certainly combine with other forces to generate crisis conditions.

US Political Gridlock

As I write this, the US government is days away from a government shutdown, should the Senate not pass a stopgap spending bill by September 30. 

Democratic leaders have combined that bill with a debt ceiling suspension the Republicans find unpalatable. 

It’s not clear if Democrats have the votes on their own side, and some GOP senators could choose to filibuster. 

So we don’t know what will happen, but it’s another potential fiasco.

In any case, the US Treasury will hit its legal debt ceiling in the next few weeks unless Congress passes some kind of extension, with potentially serious market effects. 

As Jim Bianco recently explained on Twitter, the SEC ruled in 2013 that any government security that doesn’t pay on maturity date is in technical default and must be valued at $0. 

This means money market funds holding T-bills would have to mark down their portfolios if a debt ceiling fight interrupts interest payments. 

They would “break the buck,” in other words. 

This risk has created a kink in the yield curve.


Source: Jim Bianco

However, Jim notes this kink is much smaller than a similar one in the 2013 debt ceiling fight, so traders seem to think the risk is low. 

We should all hope they are right. 

And I should point out, after over 40 years of watching this charade, somehow we always seem to increase the debt ceiling. 

Count me in the group that thinks that risk is low.

US Tax Changes

Congress is also trying to pass a pair of infrastructure bills, one of which has bipartisan support but could fail anyway. 

They have become bargaining chips in other disputes, both between the two parties and within them. 

Senator Kirsten Sinema has made it clear she will not vote for any reconciliation bill if the infrastructure bill does not pass. 

Some House Democrats have made the same declaration.

These aren’t just spending bills, though. 

They are also tax bills—potentially problematic ones. 

The House Democratic version includes a provision that would prevent investors from holding non-publicly traded assets like hedge funds and real estate in IRAs. 

Those who currently have such would get two years to move the assets out of IRA form, at which point, any gains would become taxable.

Where would people get the cash to pay those taxes? 

Many would have to sell other assets, like stocks. 

That wouldn’t be good for stock prices. 

Fortunately, my sources say even many Democrats are against this particular idea, so it (hopefully!) won’t happen.

Other tax changes are quite possible, and even likely, as the negotiations seek “pay-fors” to cover their desired spending. 

The risk of unintended side effects is high, particularly when the people writing legislation don’t understand how markets work or are being advised by special-interest lobbyists.

The moderate Democrats negotiating with Biden have stated both to him and publicly that they want to know what tax increases Biden needs/wants before they agree to the size of any bill. 

Reading the tea leaves suggests that corporate taxes and capital gains taxes will rise 4%+, and that income taxes at the highest levels will go back to 39.6%+, Medicare, etc. 

These would be a drag on the economy, but less so than the original, much-higher proposals—which, (hopefully) are now off the table.

COVID Recession

The pandemic continues to affect economic activity almost everywhere, though the particulars vary. 

We hear a lot about supply-chain problems. 

Some of it begins in the exporting countries when virus outbreaks shut down ports and factories. 

This could continue since vaccinations are proceeding slowly in many of those places—the effects cascade through the economy.

Here in the US, COVID seems to have taken several million people out of the labor force. 

Some are choosing to retire early, and others are homeschooling their children, changing careers, dealing with “long COVID” disability, etc. 

There seem to be several million workers who are reluctant to come back to the workforce when COVID is still a significant factor. 

All of this combines to explain why we have 10 million job openings, increasingly high wages to attract workers,  yet few workers are responding. 

This comes on top of demographic trends that were already reducing the working-age population.

It’s a problem because we need a sufficient number of productive workers to generate GDP growth. 

I’ve said I expect 1% average growth over the rest of the decade. 

Note the “average” part. It could and probably will include recessions with below-zero growth. 

Recession is rarely good for corporate earnings, which is what underpins the present bull market.

Policy Risk

Now, to the main risk. 

As of a few months ago, quite a few economists expected the September Fed policy meeting would mark the initial tapering of its pandemic stimulus programs. That meeting occurred this week. 

They still aren’t tapering.

They did throw us a little bone, though. 

The Federal Open Market Committee (FOMC) statement noted “a moderation in the pace of asset purchases may soon be warranted” if everything goes well… blah, blah, blah. 

It included all their typical hedge clauses and escape hatches. 

They promised nothing and may well do nothing at the next meeting, either.

We’ll never know, but I suspect the weak August jobs numbers probably spooked some FOMC members. 

They have lashed themselves to the “full employment” mast. 

If that’s not happening, tapering now would generate major credibility questions.

The next FOMC statement will be on November 3. 

By then, they will have seen the September jobs report and maybe had a peek at October’s (the Fed, like the White House, gets an advance copy of the Friday BLS public releases). 

If it shows them some plausible path to maximum employment, then maybe they’ll take a first step. I don’t expect it, though. 

By then, we may also know whether Powell will be reappointed, as seems likely. 

At that point, Powell may well be willing to begin a taper that might be faster than normal.

Sadly though, I think the Fed has already waited too long. 

The FOMC members are hoping for some kind of magical return to normal. 

If inflation pressure keeps growing, it will eventually force their hand. 

Real rates will become even more negative, and the Fed will have no choice but to begin applying the brakes, possibly harder and faster than the market currently anticipates.

That won’t be pretty, but it’s a real possibility. 

I consider it the Number 1 risk to both the economy and the stock market. 

They needed to start tapering last year as soon as it was clear the financial system would hold together. 

Now they’re boxed in… and we’re all in the box with them.

What Could Go Right?

Sentiment drives markets, at least in the short term, which presents us with a conundrum. 

Markets are near their all-time highs, yet sentiment is weakening. 

Let’s quote from my friend Philippa Dunne of TLR Analytics.

This morning, Langer Research Associates reported that those who believe the economy is improving fell 11 percentage points, to 27%, between mid-August and mid-September, the sharpest dive in 13 years. 

Those who believe the economy is getting worse rose by 7pps to 40%. 

Since 1985, the spread between brightening and darkening outlooks has averaged -17 points, so the sudden September decline is the bigger concern. 

Outlooks among households making less than $50,000 fell by 16 points, among higher earners by 5 points, among Democrats by 21 points, and among Republicans by 13 points.

LRA highlights that their current-sentiment gauges have also fallen over the last three weeks from what they are calling their pandemic peak, and unevenly. 

Rating the national economy, the largest losses were among Republicans, 9.7pps, households making less than $50,000, 9.2pps, with losses of 8.7pps among Southerners, and 6.3pps among women. 

Personal finances and buying climate are both off by about 2pps.

In his morning missive, David Kotok flagged the Conference Board’s 18-point jump from 24% in June to 42% August, in those ranking risk of contracting Covid personally among their greatest concerns about returning to work, with women and millennials more concerned about catching Covid themselves and about spreading it to their families, another rising share.

Our friend Danielle DiMartino Booth of Quill Intelligence put that data into charts:


Source: The Daily Feather

That data and charts reflect the view outlined above of what could go wrong. 

But what could go right? 

What could change that sentiment?

Last week my doctor, Mike Roizen, told me COVID models, developed by scientists who advise CDC, that  are finally beginning to improve. 

One scenario suggests infections will fall 80% or even more by March.

Getting past this pandemic could create a huge turnaround in the country’s mood. 

Workers would feel far more comfortable coming back to work, you could find millions of people—especially in the lower-income ranges—finding jobs, the unemployment number would drop significantly—much closer to 4%—the economy would improve, and sentiment would potentially come roaring back.

The Fed would have room to finish the taper faster and actually begin raising rates to something that looks like “normal.” 

In another six months, more supply chain problems will be solved (with the exception of computer chips), and the economy will resume functioning normally. 

Business travel will begin to pick up, though maybe never to the prior level since we now know how to have events online. 

Those of us who speak for a living may actually find ourselves in front of crowds again.

Homebuilders could finally catch up with the demand from first-time homebuyers. 

Businesses would see new opportunities and make capital investments again. 

You know, like normal.

Maybe we even get an honest-to-God 10%+ correction in the markets, creating a buying opportunity as that sentiment begins to build. 

The Cowboys might even win the Super Bowl. 

(Okay, maybe not that last one, but we can dream.)

Optimistic? 

Yes, but appropriately and cautiously optimistic. 

We keep our eyes on the COVID statistics. 

We pay attention to the supply chains. 

We watch the sausage factory in Washington DC hopefully not do too much damage to the tax structures and create too many job-killing regulations.

But a rally from here because of the relief of COVID being behind us is not out of the question. 

I can think of other things that can go right. 

New technologies will be amazingly powerful drivers of not just wealth but jobs and opportunities. 

New medicines and drugs. 

New ways to do things cheaper.

The contrast between what could go right and what could go wrong has hardly ever been starker. 

I still think we are in a market where I would rather diversify among trading strategies rather than buy-and-hold index funds, which reflects my cautious optimism. 

I am in the markets, but there is a hedge. 

And, of course, I still look for those truly transformational technological innovations. 

It is actually a wonderful time to be alive.

A Suggestion

As you may know, I distill information for a living. 

And while I have access to almost any research I want, there are a handful of writers on my “must-read” list. 

Jared Dillian is one of them.

I find that Jared challenges my viewpoints—which is a positive thing in the world of investing. 

His is a voice I want to keep in my ear.

More than anything, Jared understands investor sentiment and market psychology. 

That is why I—and countless other professionals—listen to his views and watch, with keen interest, how he chooses to invest.

This week, at my request, Jared is opening his private, daily letter to Mauldin Economics readers.

If you are looking for a fresh, contrarian voice, you may be interested in learning more about his letter, The Daily Dirtnap, and what it could do for you.

When you follow this link, you will gain a good introduction not only to The Daily Dirtnap but to Jared Dillian himself. 

He had quite the career on Wall Street and has riveting (and entertaining) stories to tell about his time there. 

The five minutes spent reading his letter to you may be some of the most diverting and valuable of your Saturday.

New York, Dallas, and Boosters

Theoretically, I qualify for my booster shot next week. I’m beginning to make plans to come to New York in October and definitely Dallas for Thanksgiving. 

I might extend my stay in New York and take a day trip to Philadelphia. 

We will likely have new client meetings and/or presentations in at least both cities and maybe a few others.

It seems almost every week that one of my readers decides to take a trip to Puerto Rico and drops by Dorado to see me. 

There have been some great conversations of late. 

I always enjoy your feedback and appreciate you taking the time to read me. 

Follow me on Twitter and have a great week!

Your cautiously optimistic and hoping for a large reduction in COVID cases analyst,



John Mauldin
Co-Founder, Mauldin Economics