With his speech last week to the virtual Jackson Hole conference, Jay Powell, the chairman of the Federal Reserve, might have raised the curtain on the final act for the US dollar as the global reserve currency. It may not be the end, but it is the beginning of the end.
Mr Powell’s address largely conformed to news reports in the days running up to it. He said that the Open Market Committee would target average inflation — in a shift to Flexible Average Inflation Targeting, or FAIT, from Flexible Inflation Targeting — and that monetary policy decisions would be informed by the assessment of the shortfall from the undefined maximum employment level.
The wide latitude that the central bank has assumed to keep interest rates lower for longer does not bode well for the US dollar. If the Fed were to be seen as tolerant of high inflation to make up for low inflation in the past, faith in the dollar as a store of value will be eroded. For a global reserve currency, that would be strategically costly.
Inflation has remained dormant for so long not because central banks were successful in taming it. Former Fed chairman Paul Volcker brought down price rises in the 1980s, but at the cost of two recessions. Afterwards, expanding global trade, the decline in the crude oil price and the advent of ecommerce pitched in.
Above all, the balance between capital and labour shifted in favour of capital. Globalisation — the outsourcing of jobs and offshoring of manufacturing — weakened workers’ bargaining power, compressing wages and, thus, operating costs for companies. Profit margins could expand without end-user prices having to rise too much.
Thus, independent central banks targeting inflation did not tame inflation, but the erosion of labour power and the consequent moderation in wages did. Central bankers had nothing to do with it. If they really were responsible for lowering the inflation rate, they should have been able to push it higher. Since the turn of the millennium, first Japan and then others have tried valiantly to generate inflation but in vain.
If a medicine did not work, a good doctor should ask herself whether the medicine was the wrong one, rather than keep increasing the dosage. If not, the medicine loses whatever potency it has and creates substantial side effects. That is precisely what has happened with ultra-loose monetary policy since 2008.
Yet Mr Powell is going all-in on failed policies. He has admitted that inflation has never returned to 2 per cent on a sustained basis and productivity is on the decline. These outcomes are not in spite of Fed policy but because of it.
Zombie companies — those that do not earn enough to cover their interest payments — are nearly one-fifth of all listed businesses in America, according to Deutsche Bank, from virtually zero at the turn of the millennium. Meanwhile, the top 10 per cent of the population owns 87 per cent of the stocks, so the rising market perpetuates inequality, leaving the other 90 per cent with bank accounts that earn nothing.
Rather than trying to take credit for a “Great Moderation,” the Fed should be recognised for achieving a great polarisation — social and economic, and consequently, political.
Together with its support of the fiscal deficit through the continued purchase of Treasury securities, and with the purchase of risky instruments across the spectrum, the Fed is fostering bubbles in financial assets. Inflation will remain tame, despite the acronym changing from FIT to FAIT, as long as the balance of power is tilted against labour.
For inflation to raise its head, labour needs to acquire pricing power. Until then, money creation will simply juice assets and make them a bigger source of instability. We shall see if a new administration tilts the balance. If it does, then along with fiat money debasement, the inflation fire will be lit. That could be the last straw for the US dollar.
The return of inflation will also end asset price inflation. Investors should be prepared for the return of the 1970s; perhaps worse, with social turmoil accompanying stagnant growth and high inflation.
Emerging markets will have a new problem this decade — that of managing the appreciation of their currencies. They can and should pay down their debts and focus on supporting consumption through domestic production, as currency strength would be a drag on exports. Those that execute that strategy well will find favour with investors.
The good news for America is that no other currency is a better store of value than the dollar because the race to debase currencies is global. But that is bad news for investors. The only anti-dollar in the world is gold.
Anantha Nageswaran is an adjunct professor at Singapore Management University and is the Distinguished Visiting Professor of Economics at Krea University