In order to bring the US economy back to where it is meant to be, the government must be walking a very fine line. Whatever policies are being devised now, however much stimulus is being unleashed, it may simply come down to an almost binary outcome. Will the White House and Congress be able to kick-start growth and create a sustainable recovery, for years to come, or will the demand shock merely produce a blip and leave a desert of inflation without growth thereafter?
The 1.9 trillion package will certainly not achieve the desired objective. It is a mix of helicopter money destined for both relief consumption and the reset of state finances that will at best distort the trade balance and current account even further. All eyes must be on the 2+ trillion infrastructure package to come, as this is deemed to be money directly flowing into the real economy. There, Biden & Co will have a chance to sow the seeds for a longer-term boom.
Inflation already serves as an indicator that things are seriously on the move. Commodity markets have been on fire for the past 12 months, from crude to copper to lumber. Price rises are picking up on a serious note. PPI prices are rising at the fastest pace in 11 years. The home price index surged +12% in February. The latest quarterly corporate earnings are nothing to be scoffed at. All in all, it looks like we are in lift-off mode.
The big question now that keeps rearing its ugly head is will the economy reach altitude and not stall halfway into its ascent? Red flags are all over the place. Global logistics is having a hard time re-igniting to return to pre-Covid activity. Supply chains are clogged up, not least because of the geopolitical pressures Washington has instigated. There is still pressure on immigration that has been so necessary for a high-flying US tech economy in the past.
If the global trading system doesn’t play ball, the requisite productivity gains will fall flat. All we’d be left with in such a scenario is the inflation. But there wouldn’t be much growth to go with it. And after what the world has been through in the wake of the pandemic, an at-best environment of stagflation in America is the last thing we need. We better take a step back from some of those pundits’ rejoicing over the big and mind-boggling headline numbers on stimulus etc.
As I have claimed in the past, policymakers in Washington have basically one shot. They are already kitchen-sinking it. And they must not get it wrong. It’d be a disaster on both fiscal and monetary fronts. Deficits would still be sky-high, as the money helicopter was more important than ever. Tax receipts would likely not even make a difference, as material increases will be hard to pass through Congress anyway and nothing left to be shared with in case of an economic crash landing.
This space has for the longest time taken a constructive view on the Treasury market and contended that 10-year rates would probably not exceed 2%. It is still my base case scenario, as a sustainable recovery combined with productivity gains can quickly moderate this immediate inflation blip. But it will not be a simple task. The Biden team and Jay Powell don’t have the luxury of making mistakes and probably need to take some unpopular decisions within the various political constituencies.
