Beyond Recession Probabilities

By Jeffrey Snider
Jeffrey Snider
Jeffrey Snider
Jeff Snider is Chief Strategist for Atlas Financial and co-host of the popular Eurodollar University podcast. Jeff is one of the foremost experts on the global monetary system, specifically the Eurodollar reserve currency system and its grossly misunderstood intricacies and inner workings, in particular repo/securities lending markets.
July 28, 2022 Updated: July 28, 2022

Commentary

The shortened U.S. trading week restarted on the Fourth of July with an enormous bang. Not some leftover fireworks, but rather chaos, disorder, and serious illiquidity across global financials. Most of it was focused, tellingly, on commodities, those like copper and oil which have until recently “benefited” maybe the most (apart from aluminum or nickel) from favorable supply-side bottlenecks.

Those supply constraints haven’t disappeared — for the metal, they’ve gotten worse.

Crude benchmarks crashed while Dr. Copper foretold of serious and growing demand difficulties ahead. As much of the American public already “feels”, there’s more than a whiff of recession in the air.

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But not just recession, no garden-variety downturn. There’s more to it, warning signs around the system that indicate this isn’t likely to repeat the ultra-mild 2001 contraction; the so-called dot-com recession that was so unusually modest most people hadn’t noticed its start and even today believe it was attributable to the 9/11 aftermath when, in fact, the business cycle had peaked a full half-year before that terrible tragedy.

These worrisome alarms are of a particular, devilish sort which is consistent with the falling commodity prices everyone last year said were the start of a “super-cycle” that would accompany untamable inflation. In other words, the mainstream verdict on 2021 was overheating combined with supply difficulties leading to 1970s-style consumer prices.

Policymakers Flip-Flopping

At first, the Federal Reserve famously disagreed; calling (correctly) the acceleration of those “transitory.” Then policymakers infamously flip-flopped, claiming they’d been fooled by something or other with the unemployment rate (they were never fooled, they’d been hijacked by CPI retail politics).

Either way, as of right now the FOMC remains firmly committed to what has become a single-minded purpose. According to the laws on the books — laws that were created and updated, by the way, the last time the Federal Reserve was this confused about inflation and the economy — those at the “central bank” must devote their efforts to maximizing unemployment while minimizing the harm of sustained consumer price increase.

As the U.S. CPI has reached highs not seen since around the time those acts were written four decades ago, officials have indicated they’re going to focus more exclusively on only the price stability part of this dual-mandate

The most recent published minutes released for last month’s FOMC policy meeting leave no doubt this remains the case.

For most everyone else, the world has moved on to something else — including, partly, those who last year declared the economy overheated.

The term “stagflation” has been recycled if only to try to incorporate the recession they didn’t see coming into their undeterred supercycle narrative. Like our hapless policymakers in D.C., this, too, stems from a gross misunderstanding of both inflation and basic economics.

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One that is easily corrected by focusing instead on what markets, particularly those for actual money, have been telling us all along; that it was never inflation, that the economy (globally) had never recovered, rather people (somewhat understandably) got caught up in the hype surrounding CPIs and simply mistook their acceleration for rapid, red-hot recovery.

To achieve legitimate inflation like that from the 1970’s Great Inflation requires actual and effective money printing. None had been, and we know this without doubt because the actual monetary system itself has unequivocally declared it this way.

Without such monetary heft most of the public took for granted, this building deflationary pulse combined with recession probabilities risks turning the current economy from “mere” downturn (one like 2001) into a perhaps deep maybe prolonged slump.

As I’ve written several times recently, the easiest way to see what I mean is simply to observe the U.S. dollar’s exchange value. One long-unnoticed yet mainstream BIS study* found years ago: “The focus on the U.S. dollar as the currency underpinning global banking lends support to studies that have emphasized the U.S. dollar as a bellwether for global financial conditions.”

The dollar goes up, that’s bad for the whole world. When it does, we know without fail (pun intended) banks must be scaling back (the bellwether) and since banks (never central banks) literally make all our money this can only mean less of it available for commerce, for markets, for everything. Less money, being the opposite of too much, will undoubtedly end up with deflationary consequences around the globe.

Those we’re already seeing.

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And while this feature isn’t one-to-one, there has been consistent evidence (including after Bear Stearns had failed in March 2008) of proportionality; meaning, the faster and farther the dollar goes up against other currencies, the worse it must be money-wise.

So far this year, the dollar has skyrocketed, wrongly attributed to the same Fed and its same pursuit of the wrong risks.

India’s rupee, for instance, just pegged another record low even as oil has dropped. Instead of following crude (as many surmise), the rupee crash follows global monetary conditions very closely (what I’ve labeled as Euro$ #5 representing the fifth outbreak of global dollar shortage in the eurodollar system since 2007, the real global reserve currency system).

That’s the other ingredient to this building commodity slump, in addition to all the negatives currently being priced in financial curves. Not just perceptions of falling demand, but also tighter liquidity means less money available for leverage as well as commerce.

Deflation, in this broad sense, can easily be found nearly everywhere…outside the Federal Reserve, anyway. Even the TIPS market heavily influenced by crude oil (on the way up) has seen inflation expectations (breakevens) plummet; long-run market-based CPI expectations never got all that high to begin with, and are now among their lowest of the past several years.

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One article posted on July 6 from “Barron’s Magazine”, typically a leader among the Fed cheering section, sums up the situation rather nicely: “The Fed’s Minutes Are Hawkish. They Also May Be Out of Date.”

This is not stagflation.

The use of that word is born from desperation to keep the idea of secular inflation alive in the face of what’s almost certainly recession, to use the Fed’s badly-calibrated, outdated view of domestic risks. Judging by the dollar’s behavior (and so much more), and what that truly represents in terms of global monetary conditions now and just ahead, stagflation could end up having been the better option.

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*Bruno, Valentina and H Shin (2013); “Capital Flows and the Risk-Taking Channel of Monetary Policy”; Griswold Center for Economic Policy Studies Working Papers, No. 237b.

Jeff Snider is Chief Strategist for Atlas Financial and co-host of the popular Eurodollar University podcast. Jeff is one of the foremost experts on the global monetary system, specifically the Eurodollar reserve currency system and its grossly misunderstood intricacies and inner workings, in particular repo/securities lending markets.