A year ago, there were still plenty of people on Wall Street who didn't see the inflationary tsunami - unleashed by federal spending, surging oil & gas prices and the labor crunch that has given American workers unprecedented power to demand higher wages - coming. Macquarie's Viktor Shvets was among them.
While many inflation skeptics have since thrown in the towel, Shvets continues to believe that over the long term, inflationary pressures will be overcome by secular deflation - although price pressures might be slow to subside.
During an interview with MacroVoices, Shvets pointed out that the fiscal stimulus unleashed in the wake of COVID will soon dry up (especially now that the Democrats have, to their credit, sabotaged their own economic spending program that many fear would unleash even more aggressive inflation). In the coming years, the US is on track to see the biggest fiscal contraction since WWII, Shvets says. Unfortunately, economic growth might also be an unwitting casualty of this shift from expansive to contractionary policies.
To be sure, Shvets focuses his view on the G5 economies - the US, UK, eurozone, China and Japan.
So if you think of again, G5 economies we peaked at about 11-12% fiscal deficits in 21. That's going to be down to maybe around 6% in 22 and maybe closer to five in 23. Now, that's a biggest fiscal contraction since World War Two. And unless something terrible is going to happen, I think that contraction will be a real. Nobody is going to go for primary surpluses, nobody is going to be doing crazy stuff that we used to do. But nevertheless, fiscal delta will remain very negative. And the same applies to monetary delta. Almost every central bank is now believing that they are behind the curve, which I disagree with. But nevertheless, that's what they feel and so monetary delta will be declining exactly the same time as a fiscal delta. And so without fiscal and monetary support, without really cyclical recovery, the way we had nearly 21 I think both reflation and inflation will start coming off. And so both growth and inflation at the end of 22 will be lower than at an earlier part of the year. Now how far lower? I think G5 will end up with probably around 2%, down from 4.5%. Even more inflationary countries like US and UK, probably will have inflation at least 300-400 basis points lower.
From this, Shvets concludes that without the influence of public spending to boost demand, disinflation will ultimately prevail.
Now, how can we go wrong in this thesis? Well, a couple of things can go wrong. Number one, supply and demand curve don't move together. There are other disruptions, things happen, and you just can't get ahead of the curve just like we couldn't in 21. The other problem will be if central banks as inflation persist into early 22. Just overdue sayings in other words, they really commit a sequence of policy errors that will very quickly extinguished both growth and inflation at the same time. And the third area is really external factors. We did that we can't control things like geopolitics. Nobody is factoring in right now anything to do with Russia versus Ukraine, or South China Sea or anything else. So don't say a question, Erik, I'm stealing the pendulum. I'm basically arguing that without public sector, without strong fiscal and monetary support, disinflationary forces are stronger than inflationary. And so if you remove those props, inflation will go down, our gross will go down. And the question then becomes really whether you should start stimulating again into 23
Shvets also has some interesting thoughts about the connection between "rolling asset bubbles" and growth. As Shvets aptly explains, the Fed's new role in the global economy is to act as a kind of "intermediary" between financial markets and Main Street. After all, after a certain extent, a catastrophic selloff in asset markets will have a seriously deleterious impact on the real economy, since we need these asset bubbles to finance growth.
With this in mind, he concludes that COVID actually hasn't changed much about the nature of our economies. Instead, they are even more dependent on financialization than ever before.
So to me, COVID, hasn't actually changed the underlying policy settings. We're still very much driven by financialization, we're still very much driven by leverage, by assets and asset prices being acute to what we do. It's still very much driven by technology that continues to lower marginal cost. We're still driven by demographics, deteriorating demographics, and most places, and we're still very much driven by wealth inequalities. Remember in most countries, the bottom 50-60% of the population own nothing, and almost all assets up to 70% are concentrated really in the top one to 10%.
And so you can argue top 1, top 5% pretty much everything and the bottom 50 60% own on a net basis, nothing. But those people must continue consuming, they must be encouraged to continue to borrow and consume, because remember, otherwise, the assets control by the top one or 5% will simply collapse. And so the role of Federal Reserve is not inflation or unemployment, that's not their mandate. Their mandate is being an interlocal, effectively, between two spheres. One is financial markets and capital markets, which are 510 times larger than the underlying economies. And the other thing is underlying economists where normal people live and reside and cook their meals and do whatever.
And so the interlock is between the two, They must make sure that those two spheres are moving in unison, or at least in some degree of harmony. And so to me, that's the essence of our economies. And that is why we relied on rolling asset bubbles to generate growth rates that capital markets find acceptable, and also societies find acceptable. That's why rolling bubbles was absolute necessary in order to preclude the R* or equilibrium rate collapsing to a much much lower negative level. And so to me, that's the essence of our economies.
Shvets and MacroVoices host Erik Townsend went on to discuss other issues, like the geopolitical risk that markets refuse to price in until it's too late. Readers can listen to the podcast below: