Cao Yuanzheng: The risk of a shift in US monetary policy should not be underestimated

　　China-Singapore Economics and Latitude, December 2 Title: The risk of a shift in US monetary policy should not be underestimated

　　Author Cao Yuanzheng Chairman of BOC International Research Co., Ltd. and former Chief Economist of Bank of China

　　U.S. monetary policy is facing a severe test that has emerged since the 1980s, namely, that the world may face new stagflation. As the economy begins to recover after the impact of the epidemic, the US economy has entered normalcy since the second half of 2021, and the economic growth rate has declined relative to the second half of 2020 or the beginning of 2021. At the same time, prices are on the rise. There are two reasons for the high price increase: one is the cost drive, and the other is the demand pull. The most important is that the US monetary policy, even in Europe and the world, has been extremely accommodative under the impact of the epidemic, resulting in extremely strong demand. In addition, there are also major problems on the supply side, including the stagnation of production under the impact of the epidemic, the risk of supply chains and transportation, so prices have risen.

　　Some say it's similar to stagflation. There is now a global debate about whether monetary policy is to be transformed. From the perspective of the United States, including the global situation, as the economy enters the normal state in 2022 and prices are at a high level, anti-inflation may become the target of global monetary policy. This is the consensus that the entire market has begun to form.

　　The previous monetary policy basically affected the money supply through interest rates, but after the 2008 financial crisis, the situation changed, because interest rates have fallen to around zero, and it is almost impossible to affect interest rates, so monetary policy has become a balance sheet that affects the size of the balance sheet, that is, the expansion and contraction of the central bank. Over the past decade, monetary policy has largely controlled the expansion and contraction of central banks' balance sheets. However, after the new crown pneumonia epidemic, there has been a major change, that is, the new practice of MMT (modern monetary theory), in other words, fiscal and monetary policies have "worn a pair of pants", and the issuance of treasury bonds in the treasury is mainly supported by the issuance of central bank currency. As a result, a new situation has emerged, such as the possibility of separating monetary policy and fiscal policy in the past, but now it is almost the same as the same advance. In the past, it could also be said that there was a proactive fiscal policy, a prudent monetary policy, or the opposite policy, but now it is either stable or expanded together. Starting in 2021, we've seen them shrink in sync.

　　In terms of asset demand, the Fed has begun to taper (balance sheet reduction), and at the current rate, it will basically return to a normal central bank balance sheet state after June 2022. The U.S. Treasury is also reducing Treasury issuance, and unsurprisingly, issuance will be reduced by about $1 trillion in 2022. This is a synchronous contraction, which will bring a new situation: in order to curb inflation, it is likely that there will be economic overshoot, coupled with the need for demand expansion in the impact of the epidemic, but now prices are rising, this policy that cannot be separated from the operation will bring about a strong phenomenon of in or out.

　　Monetary policy and fiscal policy cannot be operated separately, and it is also a new problem facing the world. What are the consequences of this problem? On the one hand, the balance sheets of residents and enterprises are relatively healthy, but on the other hand, the balance sheets of the government and the balance of payments are still high, which creates a leverage wall. There is a fear that if something goes wrong, the "wall" will be pierced. If it is not penetrated, it will be manifested as the rise and fall of the market, without affecting the contraction of the leverage; if it is penetrated, it is a new crisis.

　　If the US monetary policy and fiscal policy turn in the second half of 2022, it is not excluded that there will be a big rise and fall in the capital market price. This volatility is likely to be the norm in 2022, but it is instantaneous, and as long as the instantaneous fluctuations do not penetrate the leverage wall, it may not cause a balance sheet recession and will not have a crisis like in 2008. Of course, how big this fluctuation is, and whether it will penetrate the lever wall is still a question mark. Even without penetrating the leverage wall, the global market is diverging, mainly manifested in the differentiation of exchange rates, the fluctuation of the US dollar index, and the change in the flow of funds caused by the fluctuation of various currencies against the US dollar index. If the US monetary policy tightens in 2022, the rise of the US dollar will be a high probability event, and it is likely that funds will flow out of developing countries and into the US market. This will have a significant impact on developing countries.

　　In short, the market in 2022 is fraught with risk. The US economy will enter a normal state, the growth rate will be flat, the inflation level will be high, the monetary policy shift is a high probability event, and the risks brought by the shift should not be underestimated. (This article is based on Cao Yuanzheng's speech at the CMF Macroeconomic Hotspots Seminar (No. 39) and has not been reviewed by me.) (Zhongxin Jingwei APP)

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