The Fed Fighting Inflation

Prices at the gas pump and in the grocery store are climbing at the fastest pace since 1981.  As inflation spreads throughout the economy, it is proving painful for working families.

The Federal Reserve has raised interest rates three times so far this year and has signaled it plans to keep doing so in coming months.  The country is in the eye of the storm; the price spiral is nowhere close to over.

The Fed is passing off these interest rate increases, in bits and bobs as the British say, as a coherent strategy organized around a defining theme: to fight inflation and put the beast back in its cage without tipping the economy into a recession.

The American public has been told with monotony by various media outlets that the central bank has a laser-like focus on cooling the economy and limiting demand for goods and services, noting that the Fed has not hiked interest rates by 0.75 percentage points in one go since 1994.

The media was so transfixed with this figure that if you had a frequent flyer mile for every time it was mentioned you would have enough miles to circumvent the globe by now.

What is absent from this reporting is that the funds rate is now in the 1.5 to 1.75 percent range.  The Fed plans on the rate reaching a relatively modest 3.4 percent by year’s end.

Meanwhile, inflation hit 8.6 percent in May, the fastest rise in 40 years, with more pain to come.  Interest rates are still way below the rate of inflation.  It is crucial that the Fed take the cost of borrowing well above the inflation rate for price pressures to cool.

The reasons behind the current inflation are not hard to fathom, from the global pandemic to supply chain issues and the war in Ukraine.  The expansionary monetary and fiscal policies of 2020 and 2021 surely put a fire under the economy, driving up consumer demand and putting upward pressure on prices.

While it might not quite be true that, as Milton Friedman memorably put it, “inflation is always and everywhere a monetary phenomenon,” it is still a large part of the explanation.  Skip over blaming Putin.  To believe that is to think in political cliché.  Inflation was high before the Russian invasion of Ukraine.

By any normal reckoning, the Fed and others steering the economic ship remained conspicuously in the wrong for a long time when it came to dealing with the rise in prices.  By to-ing and fro-ing and insisting that inflation was transitory last year and hoping it just went away as though it didn’t exist, inflation got out of hand.

For the U.S. to defeat inflation, it will take real leadership.  To put it crassly, the Fed needs leadership like that provided by its former Chair Paul Volcker, the consummate public servant, a rarity on par with Halley’s comet.

As Volker understood it, inflation can be defeated, but it takes a willingness to make tough choices and the minerals to face down critics.  He did everything except kick extra points to deal with runaway inflation, explaining to the public the tough road ahead, the sacrifices to be made and the fact that there was no alternative.

For example, when inflation reached 15 percent in 1980, Volcker understood the need to go for inflation’s jugular and ratchet up interest rates above the rate of inflation.  He raised interest rates to over 20 percent to crush raging inflation.

That gives a foretaste of what the U.S. will experience in the coming years if the Fed does not move more aggressively and quickly to combat inflation.

While predicting the future is beyond difficult, if the Federal Reserve is to get inflation under control, it has a long way to go when it comes to raising interest rates.

Corporate America and Income Inequality in the U.S.

Economic inequality, the gap between the rich and poor, has always existed. This disparity has increased dramatically in the U.S. over the last four decades.  Inequality can be measured in many ways, frequently using income.

The Gini coefficient is one of the most utilized measures of how income is distributed across the population with 0 being perfectly equal (where everyone receives an equal share) and 1 being completely unequal (where 100 percent of income goes to only one person). The measure has been in use since its development by Italian Statistician Corrado Gini in 1921.

The United States has a Gini Coefficient of 0.485, the highest it has been in 50 years according to the Census Bureau, outpacing that of other advanced economies.  This measurement finds that the U.S. is the most unequal high-income economy in the world.

The top 1 percent of earners made a little over 10 percent of the country’s income in 1980.  Currently they take home about 20 percent, more than the entire bottom half of earners.

Academicians and politicians argue over whether automation or overseas manufacturing is more responsible for eliminating American manufacturing jobs and keeping wages lower.  The question is debatable, but the answer is surely a mosaic from globalization to automation.

One factor that catches the eye time and time again has been the role of corporate America.  Sure, automation and globalization have transformed labor markets across the globe, but it is important not to overlook corporate America’s role in accelerating these effects.

The late Jack Welch, the CEO of General Electric from 1981 to 2001, captured this reality when he talked of ideally having “every plant you own on a barge”.   He turned the firm from a manufacturing company into more of a financial services firm while offshoring American manufacturing jobs.  In 1999, Fortune Magazine named him manager of the century.

Other leading companies followed Welch’s path. For example, General Motors moved production to low-wage areas like northern Mexico starting in the 1980s.  In 2017 Boeing, America’s biggest exporter, opened a plant in China for its 737 planes.

From both an economic and national security perspective, the US needs to strengthen smart manufacturing and provide good jobs for future generations through effective public policies.  War and the pandemic have exposed the fragility of supply chains. Increasing domestic production of items like energy, food and medicine would better secure supply chains and create high value jobs and support American workers and their families.

For example, semiconductors (chips) are foundational for many industries, as everything digital has transformed all sectors of the economy. Bear in mind that digital technologies are disrupting entire industries and blurring industry boundaries.  Still, the US is suffering from a severe shortage of semiconductors.

While the US global share of semiconductor manufacturing capacity was 37 percent in 1990, the number has fallen to an alarming 12 percent today.  The US has become an outlier in an industry that is a major engine of U.S. economic growth and job creation.

The US has grown dependent on other countries that provide government subsidies and incentives to make it easier and cheaper to manufacture semiconductors.  The European Union is planning to provide the industry with $48 billion over 10 years.

More importantly, China is investing $100 billion into the sector. The Chinese government is funding the construction of more than 60 new semiconductor fabrication plants and is poised to have the single largest share of chip manufacturing by 2030.

When push comes to shove, the political class should remember that the US must be the world leader in advanced manufacturing: “Not only the wealth but the independence and security of a country appear to be materially connected with the prosperity of manufacturers”.

Who said that? The never less than interesting Alexander Hamilton, of Broadway fame in his Report to Congress on the Subject of Manufactures in 1791.

Why the U.S. should be concerned China is making moves in ‘America’s backyard’

The United States is losing ground to China in the battle for influence in Latin America and the Caribbean (LAC). The People’s Republic of China (PRC) is strengthening its relationships in the region often called “America’s backyard”.

China’s growing footprint in the region has raised concerns in Washington that the PRC is leveraging its economic might to further its strategic goals and displace American dominance in the region.

As General Laura J. Richardson, commander of the United States Southern Command, testified before Congress in March, “The PRC continues its relentless march to expand its economic, diplomatic, technological, informational, and military influence in LAC and challenge U.S. influence in all these areas”.

The region is increasingly important to China in both economic and political terms.  It possesses an abundance of natural resources and raw materials, and a productive environment for trade and investment.

In addition to securing strategic resources, expansion in the region helps China increase its sphere of influence and achieve certain political goals in the global geopolitical chess game by challenging the U.S. in its own neighborhood; one the U.S. overlooked for years as it focused on the Middle East and elsewhere.

The PRC is now South America’s top trading partner and a major source of foreign direct investment and lending in energy and infrastructure.  It is also forging cultural, educational and political ties.

For instance, in 2000, less than 2 percent of LAC exports went to China. By 2021, that number had risen to $450 billion.  China is currently the second largest trading partner for LAC after the U.S., and LAC-China trade is expected to more than double by 2035.

Another Chinese objective is to use economic agreements to isolate Taiwan by persuading LAC countries to abandon diplomatic recognition of Taiwan’s sovereignty.  Currently, 25 of the 33 Latin American countries recognize the PRC rather than Taiwan.

The COVID-19 pandemic further elevated China’s status in the region. Beijing supported Latin America early on with large shipments of masks, personal protective equipment, medical supplies such as ventilators, diagnostic test kits and vaccines to curry favor with the various countries.

In September 2013, Beijing officially launched the trillion-dollar Belt and Road Initiative (BRI), using a name that harkens back to the famed Silk Road.  It is at the center of Chinese foreign policy and includes a web of investment programs that seek to develop infrastructure and promote economic integration with partner countries. It represents a direct threat to the US because China is seeking to use it as a connective link with the whole world on its path to becoming the global superpower.

Since 2017, 21 LA countries have signed on to the Belt and Road Initiative and more are expected to join.  In the face of China’s footprint in LAC, the Monroe Doctrine seems to have been forgotten.

In response to China’s impressive trajectory in LAC, President Biden, who took the lead on LAC policy during the Obama administration, and the G-7 leaders agreed in June 2021 to launch a global infrastructure initiative, Build Back Better World (B3W).  This initiative is consistent with the view that China is a strategic competitor to the U.S. in the global superpower game that some call a new Cold War.

B3W seeks to offer an alternative to China’s BRI. Its goal is to advance infrastructure development in low -and middle- income countries, including LAC. It is an international extension of the White House’s domestic Build Back Better proposal.  The LAC is the first region on the B3W’s radar.

How the initiative will be implemented to compete successfully with China in LAC is an open question.  What is clear, however, is that the superpower rivalry is good news for LAC countries.

History may show Latin America to be among the winners of the new Cold War. The U.S. will now pay the requisite amount of attention to the region and provide welcome resources.