【Text/Observer Network columnist Li Quan】
The Fed raised interest rates again on the 2nd of this month. This is not only the sixth rate hike this year, but also the fourth 75 basis point hike since June.
Although the Fed expressed in the communiqué its firm commitment to the policy objective of reducing inflation to 2%, even if we believe that this is indeed the Fed's real purpose, given the 8.2% annualized rate of the year-on-year increase in the US consumer price index in September, and the lag in the role of monetary policy itself, how long it will take for US inflation to come down is a key question. The reason behind this is that this process overlaps with the 2024 US election cycle, and the Fed's policy choices now will greatly affect the state of the US between now and 2024, and the potential political impact behind it goes far beyond the economy itself.
At the level of the US domestic economy, this year's series of interest rate hikes seem to be starting to play a role. The soaring house prices in the United States since the pandemic are beginning to show signs of slowing, with the increase in the house price index falling to 13% in August from 15.6% in July. [1] But the hidden concern is of course that if the continuous interest rate hikes lead to a "hard landing" of the US economy, enter a deep recession, and inflation does not ease, then the United States will once again enter the "stagflation" state of the 70s of the last century, which will directly shape the long-term trend of the next two or three decades after 2024, in short, whether the United States will choose to start a "Reagan cycle" again.
The chart below shows how the number of private residential construction permits in the United States has changed over the past 60 years as plotted by the Federal Reserve in St. Louis. From this, we can intuitively understand the changes in the macro political economy of the United States.
In the eight years before Reagan took office in 1980 and in the eight years since, the U.S. economy as a whole has not emerged from the old-fashioned cyclical shocks. From 1990 to 2005, the so-called economic cycle was largely flattened, and even if there was a small recession, it did not affect its long-term upward trend. During this period, Americans not only lived in bigger houses, but also changed their cars and got bigger and bigger. The media once boasted thanks to Alan Greenspan, who served as Fed president from 1987 to 2006.
But the Fed has not lacked the best smart people since 1913, and the United States has been overwhelmingly dominant in the Western camp since 1945, but it still failed to solve the problem of large cyclical shocks before 1990. From this perspective, the Cold War dividends from the collapse of the Soviet Union and the basic means of subsistence provided by China's reform and opening up are two key external factors that helped the United States smooth out the cycle.
Private residential permitting is often used as a leading indicator of a U.S. recession, and the rapid decline in permits from 2005 to 2009 in the chart above perfectly foreshadows and fits into the Great Recession of 2008. At that time, Russia and China had no desire to challenge the United States, but wanted to be more integrated into the economic cycle dominated by the United States. The fact that the United States has fallen into the worst recession since World War II without deteriorating the external environment can only be said to be the result of a series of internal decision-making mistakes after the 2003 Iraq war.
U.S. soldiers disembark from a plane at Andrews Air Force Base near Washington, D.C., on August 28, 2010. Photo by Xinhua News Agency reporter Zhang Jun
Although the United States has emerged from a technical recession after 2010, reflected in the resurgence of residential permits, a policy factor that cannot be ignored is the unprecedented "quantitative easing" of the Federal Reserve. The resulting path dependence has led to the fact that under the impact of the epidemic, it can only rely on larger fiscal deficit monetization policies to deal with it. Behind the innovation of monetary and financial policy instruments is actually the shrinking of the Fed's decision-making space. Now the Fed has to respond with the traditional continuous interest rate hike under the pressure of inflation, indicating that the United States has a trend to restart the "Reagan line".
Under the impact of the "stagflation" environment in the 1970s, the "New Deal system" started by Roosevelt in its political cycle came to an end, and Carter, as the last president of the system, was diligent but unable to recover, failed in re-election, and could only give way to Reagan. Greenspan's predecessor was Volcker, who served as Fed chairman from 1979 to 1987. Although he was appointed by Carter, his term largely overlapped with Reagan's, and he was eventually forced to resign because of contradictions with Reagan's policies.
In response to inflation of as high as 15% in 1980, Volcker raised the federal benchmark interest rate to a maximum of 20% in a short period of time. This soon led to a severe recession in 1980-1982, and although inflation fell to 3% in 1983, unemployment also exceeded 10% at one point. [2] This directly pushed Reagan's approval rating below 50 percent to just 42 percent, causing the Republicans to lose 28 seats in the 1982 midterm elections, giving back most of the seats they had won from Democrats in 1980. [3]
Theoretically, the coordination of monetary and fiscal policy is the best option to curb inflation. But at that time, based on his political philosophy, governing base, and political future, Reagan adopted the opposite fiscal policy to Volcker, choosing to pass a large-scale tax cut unprecedented after World War II in 1981, reducing the top marginal tax rate from 70% to 28%, and increasing federal government spending by increasing military research and development.
Former Federal Reserve Chairman Paul Volcker (1927-2019)
But the tax cuts led to a sharp reduction in federal revenue, forcing Reagan to make a 180-degree U-turn and start raising taxes again in 1982, 1983, 1984 and 1987. The end result is that U.S. inflation, while contained, has not performed well, as reflected in the ebb and flow of homebuilding permits throughout the eighties. Even if the United States won the Gulf War during the old Bush's tenure, it still ushered in another wave of recession. To make matters worse, the federal government's budget deficit tripled when Reagan left office, and total public debt soared from $100 billion to $2.9 trillion, an increase greater than Reagan's previous debt since the founding of the United States. [4]
In order to get out of the predicament, the United States chose the so-called neoliberal path of deregulation and financial liberalization during the Reagan administration, and one of the landmark events was the replacement of Volcker with Greenspan, who believed more strongly in free markets. The entire process of financial liberalization reached its first high point in 1999 during Clinton's tenure. Clinton signed a bill to re-allow financial institutions to operate in mixed businesses, completely overturning the red line that Roosevelt had drawn for the financial industry after the Great Depression of the 1930s.
After George W. Bush took office, his neoconservative team was obsessed with forging a new world order and continued to allow financial liberalization at home, which eventually led to the 2008 financial crisis. Obama, stuck in the path dependence that has formed, can only allow Bernanke, who succeeded Greenspan, to continue to print money in the form of quantitative easing in the face of "too big to fail" private financial institutions. Trump borrowed Reagan's slogan "Make America Great Again" to come to power, and his economic policies are still nothing more than the two axes of Reagan's tax cuts and liberalization. Now in the hands of Biden, as inflation began to rise again, the last round of the "Reagan cycle" has basically come to an end, and the United States faces a choice about where to go.
Powell's current increase in the federal benchmark interest rate to 3.83 percent would be the best outcome for the United States if he could bring inflation down before it reached double digits without causing a deep recession and financial turmoil, at least in terms of monetary policy. However, if "stagflation" is formed, whether to choose to go back to the "Reagan cycle" becomes a question that must be considered.
Customers shop for food at a supermarket in Washington, D.C. Xinhua News Agency (Photo by Shen Ting)
However, the United States now faces several more unfavorable internal environmental factors than it was then.
First, America's total public debt is no longer the $2.9 trillion Reagan had in the year, but $31 trillion. Debt was only 56 percent of the $5.2 trillion gross domestic product in 1988 and now 135 percent of the $23 trillion gross domestic product. The room for tax cuts and spending increases has shrunk compared to the Reagan era, and the dollar's credit is much less than it used to be.
Second, after financial liberalization, the lives of ordinary Americans, especially retirees, have become inseparable from financial markets. As more "baby boomer" Americans retire, a large portion of their pensions will come from pension funds that invest in the stock and bond markets. If raising interest rates to curb inflation collapses financial markets, the livelihoods of many elderly people will be in question, which in turn will increase the financial and social burden.
Third, the last round of financial liberalization has largely completed the financialization of domestic economic entities in the United States, and various collateral securitization and reinsurance transactions have played the number of changes in the financial game to an exponential level, and the space for financial reliberalization is not comparable to that of Reagan's time before the emergence of new revolutionary industrial innovations.
In addition, as mentioned above, domestic policy adjustment in the United States cannot be separated from the support of necessary or even sufficient external conditions. At that time, a series of coordination within the Western camp was represented by the Plaza Accord in 1985, and outside the Western camp, it defeated the Soviet Union and pulled China and other third world countries into the cycle of basic necessities production.
With more headwinds facing today, the United States needs a more favorable international environment than it did then. Starting from Chinese thinking, the best path for the United States is probably to choose to work in harmony with other countries. However, the strategic thinking of the United States emphasizes more on winning by firepower and firmly believes that vigorous efforts can produce miracles. From this perspective, the more unfavorable the domestic environmental factors, the more likely it is to push US policymakers after 2024 to choose the "Reagan line", counting on a new "Reagan cycle" to suppress inflation and continue to maintain the dominance of the United States.
It's the midterm elections, and predictions have largely put Republicans in a majority in the House of Representatives, but the Senate is uncertain. Compared with the specific number of seats, a more critical point is actually how many Trump-backed candidates can end up in both houses.
If the people Trump supports perform well, then it will further promote the "Trumpization" of the Republican Party, and Trump will be more confident to declare his participation in the 2024 election. If the people Trump supports do not perform well, it will be interesting to see whether the handling of the election controversy is decisive and effective. On the day Powell announced the rate hike, Biden also delivered a speech calling on Democratic supporters to go to the polls, and specifically reminded that the post-election vote count time may be extended due to controversy. If that's the case, it will take some time for the Senate to find out. However, judging from the current disclosure, the people Trump supports have not achieved as they wished.
But whatever the outcome, this midterm election is just a preview for 2024. Based on the future trend of inflation in the United States, we will see more clearly whether there will be a "new Reagan line".
The "old Reagan line" was characterized internally by pro-market and pro-capital "trickle-down economics" and externally by a tough containment of the Soviet Union. The Fed's interest rate hikes have begun to trigger currency depreciation in other countries, leading to more dollar debt crises, similar to the international impact after Volcker's interest rate hike.
Caricature satirizing "trickle-down economics"
But history, of course, does not simply repeat itself. Today, the domestic and international environment in the United States has changed greatly. Including Biden, they have once criticized "trickle-down economics", and it is uncertain whether US allies and non-allies can still cooperate with US adjustment as they did in the eighties and nineties. In the end, whether the United States will seek the sword or change its course will certainly be the result of a fierce game between all sides.
Resources:
[1]https://www.cnbc.com/2022/10/25/home-prices-cooled-at-a-record-pace-in-august-sp-case-shiller-says.html
[2]https://www.nytimes.com/1987/06/03/business/volcker-out-after-8-years-as-federal-reserve-chief-reagan-chooses-greenspan.html
[3]https://news.gallup.com/poll/242093/midterm-seat-loss-averages-unpopular-presidents.aspx
[4]https://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_reaganomics.html
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