"Kee" Points with Jim Kee, Ph.D.

  • Current State of the World
  • Monetary Mystery

Current State of the World

When I look at the world’s economies and stock markets today, it all more-or-less makes sense. Going back to Fed Chair Ben Bernanke, the government had done what it could do on the monetary policy side, essentially acting as a lender of last resort (asset purchases) and keeping rates low. It was fiscal policy that needed attention, because tax and regulatory burdens were grinding higher. I believe we have seen tax cuts and deregulation lifting growth, only to be cancelled out somewhat by tariffs and tariff threats. Markets seem to reflect this, falling and rising as President Trump’s tariff threats rise and fall. Anecdotally, I have friends who are global supply-chain specialists that have little interest in politics, but each describes the reality of how difficult the trade war has been for day-to-day sourcing and planning. But, good news may be likely to happen soon. According to political strategist Greg Valliere, this weekend’s truce between Trump and Mexico (Trump was going to raise tariffs on Mexican imports this week) could presage a positive meeting with Trump and China’s Xi at the G20 summit this month, as well as with Canada and Europe. However, Valliere also points out that the odds of an unclear trade outlook between now and year’s end are not exactly low, either. Last year (2018), trade angst accelerated, producing “volatility to the downside.” I’d like to see 2019’s trade angst decelerating, producing “volatility to the upside.” I think that is a pretty good description of what we’ve seen so far, with a deviation during the month of May.

Monetary Mystery

There is an inconsistency to the above narrative that bothers me: If monetary policy has not really been a factor for some time, then why is the market so sensitive to Fed policy? Admittedly, a great spectacle of our time is how the media has managed to make routine Fed meetings into major events, and perhaps there is a short-term overreaction (i.e. temporary and soon-to-reverse) phenomenon occurring. But when the market really jumps on a weak payroll number (like we saw last week) because it increases the chances of a Fed rate cut, it makes me look for a more valid reason than that of short-term swings in sentiment. In a recent Bloomberg interview, former Treasury secretary (and President Obama advisor) Larry Summers asserted that when it comes to the Fed, what is really important is the Fed’s perceived operating strategy. If the Fed is raising rates because of a “Phillips curve” assumption that growth (or really low unemployment) causes inflation – and it wants to get ahead of that by raising rates and slowing growth – that’s one thing. I find that framework wanting as guide to Fed policy, and so does Summers. For a given quantity of money, more output should produce disinflation as each dollar would be worth more in terms of goods and services, which means lower prices. Also, and again for a given quantity of money, more spent on wages leaves less money to be spent in other areas, which puts off-setting downward pressure on those prices. So, low unemployment and higher wages don’t cause inflation. Anyone with a computer and access to Federal Reserve data can graph inflation and unemployment over time and see this in about two minutes. Believing that higher wages (or oil prices, or steel prices, etc.) dolead to inflation (i.e. a rise in ALL prices) is known as the cost-push fallacy. I think that when markets believe that the Fed is operating according to Phillips curve thinking, they believe that the Fed is unnecessarily slowing the economy and threating future profits. That is why markets sell off when the Fed raises rates even though inflation is in check. According to Summers, and I agree with this, the Fed should wait for legitimate inflation signals, which in my opinion would be a consistent (i.e. multi-quarter) rise in its core inflation measure, before it raises rates. It should not raise rates based upon a preemptive Phillips curve-based strategy.