DANIEL LACALLE is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”
Daniel Lacalle
The Federal Reserve’s ‘Dovish’ Tapering
The US central bank has once again exposed why the dollar is the world's reserve currency
I
n f l at i o n h a s s k y rocketed, and aggressive monetary policy is the key factor in understanding it. I already explained it in my article “The Myth of Cost-Push Inflation.” The Federal Reserve has finally recognized this and has made a U-turn to its policy of keeping buybacks and rates low. The Fed now expects core inflation to remain above 2.7 percent in 2022 (previously, it expected 2.3 percent) and that it will be above 2 percent in 2023 and 2024. That means the consumer price index will probably remain above 4 percent in that period. Considering that it will close the year above 6 percent, we’re talking about inflation of more than 14 percent in three years, a great risk to the recovery, real wages, family savings, and investment. The Fed has at least acted and will reduce its monthly sovereign bond purchases by $20 billion and mortgage-linked assets by $10 billion by 2022. In addition, it will accelerate the rate increases to three moves in 2022, three in 2023, and two in 2024 to reach a 2.1 percent reference rate in 2024. It’s still a modest reduction for the magnitude and scope of an overly aggressive and even counterproductive stimulus program that has been active for too many years, since no one can understand what the Fed is doing buying mortgage-linked assets with the real estate market at its highest or raising rates to 2.1 percent with core inflation above 2 percent during 2022–2024. The central bank will continue to purchase up to 50 to 60 percent of net Treasury issuances into 2024 and keep rates below target inflation—a very “dovish” tapering. But the Fed is doing something
48 I N S I G H T January 7 – 13, 2022
The Federal Reserve has once again exposed why the dollar is the world's reserve currency and why no one should copy the central bank's policy without the global demand for currency enjoyed by the dollar. The Fed can afford a sharp change in monetary policy and to see how the markets reward it and attract more demand for dollars. The euro doesn’t have that luxury. more important and key: It’s generating much greater demand for dollars and absorbing savings from the world into the United States, by making the traditionally safest investment (the U.S. 10-year bond) more attractive to global investors. The Fed has taken the reins again and left the European Central Bank (ECB) with a changed pace and wrong policy. Despite runaway inflation that’s the highest in three decades in
the euro area, the ECB is maintaining its extremely aggressive monetary policy, negative rates, and bond purchases that account for 100 percent of the net issuance of the member states. The ECB is caught between a rock and a hard place because it can’t take decisive action as states have become accustomed to the unprecedented monetization that has led the ECB’s balance sheet to be 81 percent of eurozone GDP compared to 37 percent for the Fed with respect to U.S. GDP. If the ECB reduces its so-called expansionary policy, states such as Spain or Italy will not be able to withstand the slightest rise in borrowing costs. On the other hand, if the ECB maintains a huge buyback program and negative rates, the inflation tax and stagnation may condemn the eurozone to a stagflation that some countries have already experienced in the past. The ECB has launched into the Japanization of Europe, and now, it can’t back down. The Federal Reserve has once again exposed why the dollar is the world’s reserve currency and why no one should copy the central bank’s policy without the global demand for currency enjoyed by the dollar. The Fed can afford a sharp change in monetary policy and to see how the markets reward it and attract more demand for dollars. The euro doesn’t have that luxury. The ball is now in the court of Christine Lagarde and the ECB: Will it choose to continue inflating the bubble of debt and wasteful spending of deficit-laden and fiscally irresponsible states, or will it choose to regain monetary sanity and avoid stagflation? I hope, for our sake, it chooses the latter.
