‘That cocktail of stubborn elevated inflation and very sluggish economic growth’ is far-ranging in terms of its impact: Dr Adrian Saville – Genera Capital.
SIMON BROWN: I’m chatting now with Dr Adrian Saville of Genera Capital, and of course professor at Gibs Business School. Adrian, I appreciate the early morning time. You and I [were] chatting, I think it was two years ago, where you spooked me silly. The debate then was actually about deflation. Of course, that quickly moved away and we’ve been talking around the US – are they behind the curve, inflation coming through. And now here we sit [with] US inflation at 40-year highs, two 75-point increases in a row. We hadn’t seen that before. I think 1994 was the previous time. And of course yesterday’s negative GDP. This is messy.
ADRIAN SAVILLE: [Chuckling] Morning, Simon. That is a good way to describe it. This is messy, yes, and you have to rewind certainly to the 1980s to find a similar type of messiness in the economic circumstance. And in turn that cocktail of stubborn elevated inflation and very sluggish economic growth starts to translate into hiking unemployment, more wide dispersions in industrial performance, and challenges to business profitability and capital markets. So it really is wide-reaching and far-ranging in terms of its impact from economics to social impact, and business and capital market effects.
SIMON BROWN: I want to go down some rabbit holes there but, before we do, you mentioned unemployment. That is the one thing in the US which does remain strong (low), and [is] kind of almost head-scratching. If you look at two quarters of negative GDP, you look at all the other data out there, and then the unemployment just remains robust [holding steady at 3.6%].
ADRIAN SAVILLE: Yes, which allows [US Fed chair Jerome] Powell and [US President Joe] Biden to then talk with some wonderment – what do you mean by a recession? I’m certainly sympathetic to that. If the unemployment numbers are so robust then you can sort of scratch your head and ponder where is the recession, because, in the case of the US in particular, recession is measured by or determined by a group, a panel of economists who look beyond just the GDP number. They look at the unemployment number, the industrial production, and then they determine well, yes, this does look like a recession [or not].
SIMON BROWN: That’s the National Bureau of Economic Research. I think there are about eight to 10 people on that. Technically I’m old – maybe I’m new – I look at two negative quarters, and to me that was a recession. They’re going to pronounce on it either way. We have chatted around the inflation – was it going to be a hard landing or a soft landing, notwithstanding the Bureau of Economic Research still to pronounce. Now can we say, look, guys, it is now actually a hard landing and is there a policy response that the Fed can do, or do they just need to carry on with their rates?
ADRIAN SAVILLE: Well, in response to recession, the lever the Fed really needs to pull is the interest-rate lever, and to take interest rates lower. Here you immediately see the bind that they’re in, because to wrestle with inflation they have to take interest rates higher; and, if anything – you used the term earlier – they are a very long way behind the curve.
The Taylor Rule, which measures the economic slack and the rate of optimal inflation … points to an interest rate in the US that has something like 3% still to go in terms of interest-rate hikes. So that’s what inflation is calling for.
Inflation is calling the Fed much higher on interest-rate action, and economic activity is calling the Fed lower on interest-rate action. They’re in a bind.
SIMON BROWN: I suppose it’s why they earn the big bucks. At least I hope they earn the big bucks. And they’re in a bind and what it leaves us is a US economy – and we don’t need to remind anyone, it is the largest economy in the world – that is in a really, really tough place. There’s almost no way to turn, and this is going to have those ripple effects. We appreciate that unemployment is strong, although if that starts to weaken it gets ugly.
But this suggests to me that the next sort of six to 12 months from the US economy is going to be a real struggle, and inflation might start coming down – base effect. And maybe rates don’t go up as fast as some had feared. But none of it looks good. It goes back to what I said right up-front – this is messy.
ADRIAN SAVILLE: Yes. Just keep in mind, I’m talking about the US economy [which] is very much a consumer-led economy, which means it is that much more sensitive to hiking interest rates, that it is the consumer who will respond to the fullest extent in the US economy, making the interest-rate watchers that much more sensitive to any Federal policy move. When you take the observations of Jerome Powell into consideration, he’s starting to talk inflation lower and suggesting that the worst might be behind us, [almost saying] ‘Nothing to see here, folks, this is all over.’ And so, in that way, he’s trying to sort of talk markets and in particular consumers into a position that ‘there’ll be a little bit more pain to go, but we’re nearly there, just stay with us’. And also very importantly, trying to manage expectations – which you and I, Simon, have also spoken about before.
SIMON BROWN: And does that work, as a last question? Because there is a world in which, in 12, 18 months, the last half of next year, where this has kind of moved through – because this is not like we had in 2008 where it really was a financial crisis, or 2020 where it really was a pandemic. This in a sense is just good old-fashioned economics. This is what markets do. They move through recessions. They move through high-inflation areas and we come out the other side. Is that the base case, or is that the optimistic head-in-sand case?
ADRIAN SAVILLE: [Laughing] I like that descriptor. Inflation is very much a behavioural animal. That’s where classroom economists try to insist it is supply and demand curves moving around. What really is going on in the engine room of most inflation epochs is it is expectations that are driving inflation. So if you can keep expectations low, if you can manage people’s beliefs that this inflation will pass, they’re not going to then bake it into contracts and agreements and wage negotiations with the same vigour. And in that way, this expectations element is a very, very important component. So that’s what Powell is trying to do in terms of that language.
SIMON BROWN: One data point maybe he is winning: the wage growth in the last set of unemployment numbers was only 5.1%, which is behind inflation, which means maybe he is winning that sort of battle of talking down.
We’ll leave it there. Dr Adrian Saville of Genera Capital, I always appreciate the insights.
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