Shocked! Shocked to Discover a Political Agenda Behind the “Technocratic” Fed-Centric Economic Narrative

Why, politically, do we insist our only economic tool must be a bludgeon?  Why ignore a whole array of more precise, more effective alternative instruments?  I’m talking about simple effectiveness here, not my personal politics.  But politics are exactly why we are left clubbing ourselves with a bludgeon while the toolbox stays shut…

Olivier Blanchard – moderately right-winged pillar of the mainstream Economics establishment –  recently set off an Econ twitter explosion.  How?  He observed that inflation has (gasp) a political dimension (“Distributional conflict” below  = politics).

Obvious, right?  Judging from the reaction… no.  A lot of people do not want to talk about the elephant in the room.

The most vehement objections came from those with the nominally “apolitical” agenda – the technocratic, Fed-centric, Monetary-mechanics.  They want economic policy “kept away from those useless, corrupt politicians.”  Let the experts in the ivory tower of the Fed handle it.  From this flows the “its all the Fed and out of our hands”  narrative of Team Monetary.

Why is this a problem?  Because the Fed can only bludgeon the economy with an incredibly limited, often-ineffective toolkit.

Look at 2022.  The housing and auto sector have come to a screeching halt.  Asset markets have tanked.  The rest of the Real Economy has sailed along largely indifferent.  Eventually the bludgeoning will have some long-lagged impact;  as bludgeoning does.  The Fed itself doesn’t pretend or aspire to much more precision than that.

The Fed’s limitations are pretty obvious if you see inflation’s sources and causes in the Real Economy (supply chains and labor markets and all that supply/demand stuff).

Outside of the housing and auto finance markets, the Fed has remarkably little agency in the real economy.  Basically they raise rates and wait for the famous long-lagged effects to pop up somewhere.  But the Fed Funds rate only raises some rates in some places with a whole lot of weird counter-balancing effects mixed in.

Even large-scale corporate capital investment decisions are remarkably unaffected by Fed-driven changes in interest rates.  Companies invest because they need or want to.  The cost of capital is a factor, but (unsurprisingly) far below “is this a good idea?” on their decision list.

What if we had a scalpel?  A tool that could act with more speed, certainty, and precision?  What if we used – gasp – the Government’s taxation and spending tools to, like, directly affect the economy?

The 2022 scenario below is a counter-factual, but the mirror image of the 2020 stimulus.   The 2020 scenario is very very real – a “factual.”

  • The 2022 alternative scenario:  Inflation explodes.  Some sort of “automatic stabilizer” kicks in and raises taxes – preferably consumption taxes.  Inflation skids to a halt in the face of lower spending.  As a super-beneficial side effect, inflation expectations never really gets going because “everyone” will know that tax hike will snuff it out…
  • The 2020 Actual Real World Scenario (in future):  The economy weakens.  Some sort of “automatic stabilizer” kicks in and sends out checks – preferably to the people most likely to spend the money immediately.  The economy perks up, savings accounts aren’t ravaged, and we have a swift and speedy recovery to pre-slump trend.  The average American still experiences ups and downs, but the downside damage isn’t quite so systemically damaging.

The 2020 stimulus had an unexpectedly massive economic impact.  Its effectiveness and impact surprised nearly everyone – even the super lefty Economics crowd.  The US recovered from 2020 at light speed compared to the post 2008 recovery.

We bounced back so hard, we kindled inflation.  So why not use the same tool to bring inflation down (hard)?  

It is about here that you’ll shake your head and say;  OK in theory, but it is politically impossible…. A true statement, but a political statement.

The scalpel stays in the drawer.  The bludgeon is all we get.  Why? Because of politics.  Not because of sensible economics.  Or technocratic wisdom.  Just greedy, self-dealing politics.  That “distributional conflict” of which Mr. Blanchard dared speak…

So whose politics?  Who would use a bludgeon when they had a scalpel in the drawer?  Who’s narrative leaves no space for political (ie. non-Fed) action?  Who is so deeply wedded to that anti-government narrative that they will gladly impoverish the nation to sustain it?  Why build this technocratic smokescreen to conceal what political agenda?

Hmmmm…

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The Cure for High Prices is… High Prices. Team Transitory Winning After All.

This whole inflation episode has two competing narratives.  Only one can win.  It is looking more and more like “Team Transitory/Real Economy” is going to crush “Team Money Printing/Fed-Uber-Alles.”  The PCE inflation, consumption, and GDP numbers all point in that direction.

  • “Team Transitory/Real Economy” thinks inflation came from real-world supply chain problems meeting the fading end of a huge wave of “checks in the mail” fiscal stimulus.  We can’t use the word “transitory” in polite company anymore, but the idea was that inflation was a situational thing that would fade as the economy normalized.  That took about a year longer than people thought in 2021.  Also Russia/Ukraine didn’t help.  But it looks to be happening now.
  • “Team Money Printing/Fed-Uber-Alles” thinks inflation came from excess money printing.  They put a huge amount of emphasis on the Fed and “liquidity” and the “Finance Economy.”  The Real Economy is assumed to be a sort of a side-car along for the ride.  They have been issuing dire warnings that unemployment “must” go up to 5%-6% to slay the inflation beast our profligate money printing has awoken from the depths.

Team Money printing has a bigger megaphone because it skews towards the interests of the rich.  It also has a simpler story “kitchen table economics” story to tell that resonates.  “If we print all this money it MUST create inflation because….”

Team Transitory has a smaller megaphone because it skews towards the average person on the street and the real-world economy.  Which everyone pretends to care about but the whole point of being rich is to get away from the “average” and enjoy that little flutter of pleasure as the Economy class files past you in the seats up front (there’s a reason the board First Class first…).

Team transitory also has a more complicated story to tell.  You see, all that money printing just went into bank reserves and Money Market funds which were just parked right back in the Fed and never spurred any real-world lending so… (eyes glaze over here).

Team Transitory is, however, looking more right every day.

Team Monetary will likely try really hard to change the subject as their feet slip towards that tug-of-war “loser” boundary line…  For example, the false narrative that the 2008 Real Estate crisis was caused by “Fannie Mae and the government pushing affordable housing” not wildly irresponsible private sector lending to all segments of the population.

Because they have a bigger megaphone, the “Monetary” narrative will probably skew the picture.  The Fed’s role and scope for action will continue to be over-emphasized.  The extraordinary effectiveness of fiscal stimulus will be buried.  Exactly because it was so effective.  But the story is wearing thinner with every economic cycle.

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How do We Manage Major Population decline? No-One Has a Playbook…

A friend wondered if there were any lessons from Japan’s experience of population decline.

The “lesson” from Japan is that no-one has a playbook for managing decline.  Global population has been going up for so long.  So everyone has an opinion on how to manage growth.  But how do you manage….

  • Shutting down whole towns?
  • writing off or maintaining under-utilized or surplus infrastructure?
  • the debt/asset valuation consequences of the above.  (rhyming with “the thing that will make global warming real to most indifferent ordinary people will be when banks will no longer write mortgages and no-one will insure coastal-region homes near (rising) sea-levels…”)

Decay is a very different process than growth.  Per the Cleveland example below, how do you nudge/force people out of their home into smaller clusters so you can start shutting down un-needed fire stations?  When do you stop maintaining the road to reach some dying town? Un-building is very different from building.
One lesson we do have from Japan:  decline will happen faster in some places than others.  The least desirable places look like the Zombie apocalypse.  The top 15% living in the “attractive” places don’t notice a thing – at least until “the deplorables” get your attention by, for example, voting for Trump… 🙂

We will see the same unbalanced dynamic across borders.  Per the Lancet paper, most poor countries are shrinking too.  So the “immigration solution” is just rich countries draining the poorer countries even faster than their population declines would naturally.

Note also that Africa is the only region that will be producing net new people. So “encouraging immigration” really comes down to “encouraging African immigration.” Think about that for a bit. Maybe envision Donald Trump opining on that particular subject…?

Another lesson from Japan.  The immigration solution will run smack into deeply embedded nativist-to-straight-out-racist cultural strains in the US, Europe, AND Asia. The good news? A lot of people will eventually learn to cope with having an African-trained doctor if the alternative is no doctor at all. The bad news? That process will involve a lot of conflict and magical thinking.

More to the point, the world hasn’t even started hollowing out. Like climate change, that will happen gradually and then suddenly.  We live in interesting times.

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Why Deflation? Global Population (and thus Economic) Decline. How Do We Manage It? No Clue…

I was reminded of a post I wrote last year by the news that China’s birth rate dropped by 45%.  As I wrote then:  “A study in the Lancet forecasts total world population will decline A LOT over the next 70 years.  China’s population, for example. could drop by half.  700 million fewer people than their peak population year in 2024.  As the study somewhat blandly puts it…”

Our forecasts for a shrinking global population have positive implications for the environment, climate change, and food production, but possible negative implications for labour forces, economic growth, and social support systems in parts of the world with the greatest fertility declines.”

“Possible Negative Implications?”   Wouldn’t “multi-decade deflationary shock?” be a more appropriate descriptor?

The simplest example is housing.  Fewer people need fewer houses.  What do we do with the left-over homes no-one will ever live in again?  What do we do with the cities and towns where they will be concentrated?

I don’t have any good answers to that and many other questions.  I do worry that no-one else does either.

What we do know is that this trend is deeply deflationary.  Most of those houses now carry some notional value often backed up by very real debt.  But if no-one is there to buy the house when the last owner dies, the asset value (and the associated debt value) are gone.  Buried in his/her grave.

You can make shorter-term arguments that a shortage of job-age workers will drive inflation.  This makes sense,  But the next 80 years will see fewer people occupying fewer house and buying less stuff in a world whose productive capacity and asset based is sized for millions more people who no longer exist.

We live in interesting times.

We are All Japan?  Especially China? World Population DOWN by 2100? China’s Population Cut in Half?

“Barring some sort of birthrate uptick China’s a country of 1.4 billion that very soon is going to have a child population you’d expect in a country of 700 million. Very weird future.”

 

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Why Do So Many Republicans Oppose Ukraine? Fantasy? Self-Defeating Political Short-Sightedness? A Strongman Crush? Traitorous? All of the Above?

So we all know big chunks of the US Republican Party want to stop giving a dime to Ukraine.  But we really don’t know why?

It is clearly in the US national interest to weaken a dangerous, unpredictable rival (Russia) and warn other possible invaders that the world won’t just stand by (China and Iran).  Moreover, we are basically destroying the Russian military with no loss of American life for a ridiculously tiny amount of money.  Especially when you remember that a lot of that “aid” is sending US hardware that will be replaced by spending US dollars in the US.  You’d expect the same Congress that over-funds the Pentagon every year would like that.

So why are the Republicans so opposed?  I can think of 4 explanations.  None of them are good.

  1. Knee Jerk Isolationism:  I can kinda sorta get this, but we are spending peanuts, risking no lives, and avoiding obvious problems (like NATO obligations) down the line.  If you dream of quitting NATO to pull up the drawbridge completely, maybe the isolationist fantasy all hangs together.  But it remains a fantasy.  If we ignore the world, it will still come find us (see “9/11”).
  2. Political Calculation:  Owning the Libs trumps everything else…  If it denies a win for Biden, they will vote for America to lose.  You can’t let “them” claim any successes.  The next election counts for more than the country’s best interests.
  3. Strongman Crush:  There are a lot of people who not-so-secretly admire Putin and Xi.  It is a model they hope to emulate.  Blithely confident they and their families will ALWAYS be on the side of the strongman.  Any eggs that get broken making that omelette will certainly be someone loser leftie’s children.
  4. Just Plain Traitorous:  The Russians have splashed a lot of money around and they have a lot of compromising pictures.  Maybe there is just a lot of smoke and no fire.  But look past the Trump/Putin rumors.  Think about (former Democrat) Tulsi Gabbard’s quixotic, robotic Presidential run that seemed to rest wholly on a platform “lets hand Syria over to the Russians!  This is the most important issue in America today!”  Where did that come from?  Genuine conviction or…?  Is everyone in Putin’s pocket?  No.  But are a few people leading the charge perhaps bent a little?  Maybe…

All of the above doesn’t mean the Democrats are paragons of virtue here.  Tulsi Gabbard used to be a Democrat.  But the Democrats are generally voting to advance what is clearly in the US National interest.  An extraordinarily cheap, bloodless (for us) destruction of a major military threat.  The mystery remains as to why so many Republicans are so loudly against that…

I’d probably guess “all of the above.”  But none of the above are smart or patriotic choices.

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A Tactical Nuke is Just a Branding Exercise. Arguably The Most Toxic One on Earth.

People keep bringing up the “what if Putin uses a tactical nuke?” as if that would change the situation in Ukraine.  It wouldn’t shift the military balance.  It would drastically shift the political entirely against Putin’s own interests.  Threatening to use a nuke is one thing.  Actually using one would be a total disaster for Putin and for Russia.

Militarily, a tactical nuke doesn’t do anything that you can’t do with conventional weapons.  Hence the term “tactical.”  It could be useful IF there was some major supply or military choke point that Russia could hit (like the Kerch bridge to Crimea, but that is Russia’s choke point not Ukraine’s).  But there isn’t any such choke point.  So a big boom would go off and destroy a lot of local assets and people.  But where do you go from there?  Putin no longer has enough trained troops to even exploit the gap in the lines.

So a nuke is largely a “branding” exercise.  Its power lies in the name and nature of the weapon, not the force of the blast.  Using it, Putin would irrevocably cross a line to become most-hated-guy-on-earth.

What do you think happens in the hours days that would follow a Russian nuclear strike.  Will the whole world bow down in humble submission to acknowledge Putin’s steely determination?  No.  A massive howl of shock, anger, and blind hatred explode from pretty much every corner of the planet?  Will we be bowing down to our new overlord Russians in the street?  Or will Russians be strung up from lamp-posts in retribution unleashing this terror on the world?  I’d guess (sadly) lamp posts…

Absolutely no-one is going to do anything but stand up and condemn that act.  Especially because it this is seen as a war of Russian aggression.  There isn’t even a “self-defense” angle.

  • Anyone on the sidelines (China, India, Iran, Global South) will have to move forcibly against Russia.
  • Anyone in the fight (the West) will have a blank check to do whatever they want against Russia.
  • Russians themselves – elites and ordinary folks – will have to decide if they really want to go down with the madman in the bunker.  Or join him in the Hague for what might the Criminal Court’s first and only sentence of capital punishment…

So if Russia goes nuclear

  • any and every military unit outside their borders (including everything in Crimea which is legally Ukraine under international law – so the Black Sea Fleet) is probably vaporized by the US shortly thereafter. ALL the troops they have in Ukraine and Syria are open game.  We will do it to send a message to anyone else dumb enough to try it.  Russian assets on the high seas is a little more tricky but…
  • China and India will have to impose sanctions at minimum. There will be no more market for Russia’s oil at any price.  There will be no more goods sold to Russia at any price.
  • Most important, EVERYONE in Moscow will realize they are either staying on the side of the “single most hated man in the world” or getting on the side of “the rest of humanity.”  If Putin tries to subsequently order more nuclear strikes, he can have ZERO confidence people will carry out the orders.  Hitler in the bunker couldn’t be sure his orders were going to be carried out.  And Putin doesn’t even have anyone knocking at the gates of Moscow to stiffen their spines….

Putin ends up with even less military power, the choice to retaliate/escalate against NATO (not gonna happen and he lacks the weapons), no tactical advantage (there is no strategic choke point in Ukraine) and potentially a nuclear cloud rolling towards Moscow.  If he orders one or more nuclear strikes, he risks precipitating a coup.  With no place on earth (literally) than could offer him shelter.  His next stop is the Hague or the grave.

In short “tactical nukes” are a branding exercise.  The most toxic brand you can imagine.

 

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A Ukraine Stalemate is Possible, But Russian Defeat Is More Likely. Zugzwang isn’t a Stalemate.

We likely get a decisive outcome in Ukraine in the first half of 2022.  This is probably the biggest economic/political “surprise that shouldn’t be one” in store for 2023.  A lot of people seem to be assuming a “continuing stalemate.”  But there is no stalemate even now.  The Russians have been losing since March 2022.  They have no path to anything you might call a victory.  Ukraine does.

Can Ukraine can break through and decisively end the war?  We don’t know.  They do have a pretty good shot at it in the next 6 months.  As in the past, Ukraine will keep wearing down the Russians supplies and hardware.  They likely mount another offensive in February/March ahead of mud season.  If they get lucky, they end the war.  If not, they consolidate their gains, start grinding Russians logistics again, and prepare for the next offensive.  That has been their (successful) pattern since last summer.

Putin has no good options to respond.  Unless he pulls a real rabbit out of the hat, he is just in denial and/or praying for a miracle.  His first army collapsed over the summer.  The conscript army he rushed in to replace it is dying in droves and utterly incapable of taking the offensive.  His next conscript army will fare no better.  In the meantime, he is running low of tanks, missiles, and artillery shells.  Once those are gone, he will have nothing.  We could see a mad lunge towards Kyiv from Belarus.  That likely fails.  Attacking is hard with well-trained troops much less a rabble.

The West sees this.  They are doubling down on a Ukrainian victory.  In the last few weeks, France, the US and FREAKING GERMANY?!?! have broken the “no armored vehicles” taboo.  The US and FREAKING GERMANY?!?! are sending Patriot missile batteries.  When gutless Germany starts showing some backbone, you know they see a Russian defeat as good as done.  They are playing for a (late, unearned) spot in the victory parade. Also, everyone (especially German chemicals giant BASF) would like the natural gas taps turned back on before next winter…

The end game remains uncertain.  We are waiting for the next Ukrainian move.  Putin has lost the initiative.  His only hope is Ukrainian (and Western) exhaustion.  But the West can keep the pot boiling for at least another 6-12 months.  Russia might not make it another three months.  So the outcomes are…

  1. Ukraine’s luck runs out.  Their next offensive fails.  Past attacks have precipitated Russian collapses – Kyiv, Kharkiv, Izium, Lyman, and Kherson.  But Russia’s lines a shorter and maybe Ukraine doesn’t break through this time.  We end up with a “frozen conflict.”
  2. Putin’s shabby, under-supplied conscript army collapses yet again.  He loses now have lost most/all of the territory taken in February 2022.  He also risks a bigger collapse of morale, will to fight, etc…

Putin’s best hope now is a “frozen conflict.”  Hang on grimly while he rebuilds his weapons stocks and chips away at Western unity.  Unfortunately, Western unity looks pretty un-chipped.

On the ground, Putin is stuck.  He can’t move forward.  He can conscript more men.  But he can’t make more artillery shells, missiles, or tanks.  The vast post Soviet stockpiles are squandered.  Untrained conscripts can (maybe) hold ground.  They are never going to manage any sort of real combined arms offensive.

Putin could also retreat any time.  But he obviously feels that isn’t an option either.

So Russia sits in stasis.  Burning down its dwindling stock of shells because it is in a (great new word from 2022!) Zugzwang.

1. What is Zugzwang in chess?  Zugzwang is a German word which basically means, “It is your turn to move, and all of your moves are bad!” There is no “pass” or “skip a move” in chess, so sometimes having to move can lose the game! 

Ukraine’s challenge is to find a weak spot to break through.  The Russian lines are shorter, so the weak spots are probably less obvious.  But, if they can break in behind the Russians, we will see another headlong Russian retreat.  The other risk is Russia might be getting better at retreating.  They did a pretty good job getting out of Kherson intact.  But every and any retreat always risks a collapse.

The other uncertainty is whether that collapse remains local or becomes general.  So far, Russia has been able to fall back and stabilize.  BUt one of these days the troops will just keep running.  They would certainly stop at the Russian border, but that is a clear loss.

So that’s where we stand.  Not a lot of movement.  But definitely not a stalemate.    And Russia is still losing.

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Why is Labor the Only “Acceptable” Variable In the Economy? Because We Can’t Talk About Profits… The Fight Club of Economics…

The first rule of Fight Club is: you do not talk about Fight Club.

Reading the financial press and the freaking New York Times, you would think the only variable in the inflation equation is labor.  “We must see unemployment go up to fight inflation…” is stated as some sort of law of physics.  It is not.  It is an artifact of the stone dead Phillips Curve (see Fed paper below).

Inflation is “prices going up.”  The variable in a price equation are Desired Profit Margin + Cost of Materials + Labor Costs + Capital Costs = PRICE.

Labor is the only “acceptable” variable because we must never, ever EVER talk about “Desired Profit Margin.”  Even though profits are at all time highs (see Fed Data below).

I’m not making a “political” argument here.  Just a practical one.  Per the FRED chart, profits are a pretty variable and relatively fast-moving.  If something in that price equation is going to give, it is more likely to be profits than (sticky) wages.

The pandemic did wonders for profits because discounting disappeared.  Profit margins are still hanging at those pandemic-level highs.  There’s a pretty decent chance margins are the last pandemic-era domino to fall – going the way of Zoom and Peloton.  See the FRED chart below and forecast out one year – up, flat, or down?.

Wages are sticky and slow to adjust.  We also have a labor shortage out there.  You gotta keep paying people to produce.  There aren’t a lot of people to hire.  So you gotta sell on thinner margins.

But why can’t consumers just keep paying current prices?  Because their spending depend on their income – their spednign depend on the “labor” share in the Price equation above.   The USA took an average 2% pay cut in 2022.   Wages are up ~5% on average versus ~7% inflation (so a 2% drop in purchasing power).

That 2% cut has to come out of something eventually (after the pandemic era savings are gone).  It is most likely to be profits.

What if we really did cut back on labor and create the unemployment “everyone” sees as necessary?  Even fewer people will be able or willing to pay current prices.  Profit margins still go down on slowing demand.  Slowing employment only makes the profit problem worse.

This is not good for S&P500 earnings.  Companies with pricing power will do OK.  Companies that have been milking a period of unusual profitability in more competitive markets will do badly.  Companies selling durable goods (which sold big during the pandemic) are facing a nuclear winter.   When is the reckoning?  No idea.  But it isn’t going to be pretty for a lot of sectors.

Key point is that, in all this, wages and employment probably take less of a hit than people expect.  Mostly because falling profits and falling prices solve the inflation problem before wages do.  Sales hold up OK using the labor on hand.  It just gets tougher to turn a profit.

Corporate Profits After Tax (without IVA and CCAdj)/Gross Domestic Product https://fred.stlouisfed.org/graph/?g=1Pik 

Fed Paper – Who Killed the Phillips Curve? A Murder Mystery https://www.federalreserve.gov/econres/feds/who-killed-the-phillips-curve-a-murder-mystery.htm

Is the Phillips curve dead? If so, who killed it? Conventional wisdom has it that the sound monetary policy since the 1980s not only conquered the Great Inflation, but also buried the Phillips curve itself. This paper provides an alternative explanation: labor market policies that have eroded worker bargaining power might have been the source of the demise of the Phillips curve. We develop what we call the “Kaleckian Phillips curve”, the slope of which is determined by the bargaining power of trade unions. We show that a nearly 90 percent reduction in inflation volatility is possible even without any changes in monetary policy when the economy transitions from equal shares of power between workers and firms to a new balance in which firms dominate. In addition, we show that the decline of trade union power reduces the share of monopoly rents appropriated by workers, and thus helps explain the secular decline of labor share, and the rise of profit share. We provide time series and cross sectional evidence.

FYI – My New Year’s resolution was “stop sending individual e-mails to individual people when the content is really a perfectly good blog posts.” So I’m going to experiment with more frequent, shorter, and probably less well edited posts 🙂

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Talk of Peace Talks and the Ukraine End Game

A friend asked me about recent US noises about Ukraine and Russia coming to a negotiated solution.  I figured I’d write it out here.  So what does this tell us?

We are NOT going to see an “appeasement” peace.  A Russian retreat back to pre-war lines would be the absolute minimum offer on the table.  As a simple example, Russia would have to give back Mariupol, Melitipol, and all the other territory it took this year.   Everyone in the West understands we can’t have another Munich.  Whatever result will have to be (and look like) a Russian defeat.

Putin likely won’t (yet) accept the offer on the table.  He is still trying to exit this conflict with some face-saving win.  Keeping Mariupol, for example.  Otherwise, he’d prefer to shift to a “frozen conflict” with static front lines.

The Ukrainians will do all they can to prevent a frozen conflict along a static front line.  They have a window here to 1),  recapture territory.  2).  degrade the Russians further (which the US will be happy to keep funding).

  1. They will keep punching.  Keep the war hot.  They punched through Russian lines around Kyiv, Khakhiv, Lyman, and now Kherson.  The next punches could be towards Mariupol or Melitipol, but also through Luhansk or Donetsk (cutting off Mariupol and Melitipol).
  2. Those punches will aim to open a path into Crimea.  I don’t even have an armchair general guess at what that looks like on the ground.   But Ukraine wants Crimea back.  They understand they can’t take it by slow siege.  They either take it in the next 6-12 months or (likely) not at all.

So the War will still go on (for a while).  Into 2023, but not beyond.

  • Putin still can’t/won’t accept the minimum peace offer the US would put on the table.
  • Ukraine will be grabbing back as much territory and destroying as much Russian hardware and (trained) troops as it can.  Untrained conscripts are a truly sad but necessary part of that killing, but Ukraine and the US are after the officers and NCO’s.
  • The US will keep funding the war (for a while)

The question is when Putin (or his successor) is willing to accept a “no appeasement” peace.  That is hopefully sometime in 2023.

The US “peace” noses mostly tell us two things.

The US is feeling close to achieving its war objectives.  These are…

  1. …the destruction of the Russian military as an effective fighting force
  2. …Russia’s permanent relegation to 2nd tier power status.

The US is ambivalent about duration – not signing up to…

  1. A long drawn-out, “high intensity” war in general.  A frozen conflict is OK, but we can’t keep this pace up indefinitely.
  2. A bloody, grinding Ukrainian push into Crimea specifically

What about Ukraine’s objectives?  Ukraine’s objectives are more expansive.  They want Crimea back.  They desperately want to avoid a frozen conflict hobbling the country for the next 10 years like it did the last 10.  They also want a genuine invitation to join “the West” – with all the economic and security benefits this implies.

Full membership in Europe and the West is probably enough for now.  Ukraine has paid enough in blood to deserve it.  If Ukraine gets rich fast enough, Crimea will eventually be begging to re-join it…  Lets just hope they don’t corruption their way out of a golden opportunity.

Ukraine also understands its artillery shells now come from the US, so they understand the limits to their ambitions. I’d guess those limits are measured mostly in time (months, not years) and somewhere around the Crimea border.

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We’re Just Getting Poorer. Less “Inflation” Than “Stuff Getting More Expensive.”

We aren’t going through an “inflation” so much as a collective impoverishment.

  • Prices are going up.  The October CPI was 8.11%.
  • Wages are not keeping pace with prices.  Wages in September grew 6.3%, slowing down after a peak of 6.7% in August.  Per the Atlanta Fed’s excellent wage tracker.

So we are a couple of percentage points poorer relative to last year.  It really is that simple.  A recent Bank of England explains the dynamics quite nicely.  The details are UK-specific, but the general points apply anywhere prices are rising faster than wages.

for given GDP, rises in the relative prices of goods and energy make us collectively worse off. And that’s exactly what’s happened over the past couple of years, thanks first to the pandemic and then Russia’s cut in gas exports. Over that period the price of the UK’s imports has risen by 20% more than the average price of its output….

As a result, real income for the non-North Sea economy as a whole – how much our collective output is actually worth, in consumption terms – has fallen by over 5% since the end of 2019.

Here is where inflation kinda sorta kicks in…

It’s understandable, faced with this extraordinary squeeze, that people and firms in the UK economy have sought to protect their real incomes – whether pay or profits – through compensating rises in wages and domestic prices. Unfortunately, and at least collectively, those efforts will not make us better off. It’s not as if one group or sector is worse off only because another, within the (non-North Sea) UK, is better off. The rise in import costs has depressed the purchasing power of the country as a whole. So all that can be done is to shift the losses from one place to another.

So what can the Fed (or the UK’s MPC in this case) do about it?  Not much.  He makes an argument for slowing the economy further to keep inflation expectations anchored.  But that amounts to accelerating the economic slowdown being driven by prices going up faster than wages.  If the Central bank does nothing, the economy will still slow down.  Because stuff got more expensive.  So we buy less stuff.

Monetary policy cannot undo the hit to real income. Nor could it ever have done. One often hears that people are worse off “because of inflation”. This is not quite right. Implicitly, it presumes that monetary policy could have prevented prices from rising so fast without doing anything to nominal incomes. Unfortunately, that’s not the case. Even assuming policy had been tightened sufficiently aggressively, and sufficiently early, to have knocked eight percentage points off the current rate of inflation, it would also have depressed nominal income growth by at least as much and almost certainly quite a bit more. Unemployment would be materially higher and nominal wage growth materially lower. Ultimately, this reflects what is known as the “neutrality” of monetary policy: in the long run it has no impact on real economic variables (things like real output or relative prices). It can’t boost structural productivity, for example. Nor can it offset the consequences for real incomes of (say) disruptions to supply chains in Asia or Russia’s curtailment of the supply of gas to Europe. Indeed, in the first instance, at least for a period of time, tighter monetary policy lowers GDP and real incomes. I will say more about this shortly. For the time being, a better short-hand description is this: the pandemic and the war have led jointly to higher inflation and lower real incomes; the MPC will ensure the inflationary effects do not persist into the medium term; but the real-income hit exists either way, and will be reversed only to the extent the underlying shocks themselves go away.

 

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