The Breakdown - Economists See Increasing Risk of Recession and Stagflation

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, April 18th, and today we are discussing why economists are seeing an increasing risk of recession and why you're hearing a lot more discussion about a lot more discussion about. stagflation. Before we dig into that, however, a few housekeeping items. There are two ways to enjoy the breakdown podcast. You can listen on the Coin Desk Crypto Podcast Network feed, which features the breakdown and other Coin desk shows. You can also listen on the breakdown only feed which has just this show. Both come out on the same day with CoinDesk coming out in the

Starting point is 00:00:57 afternoon and the breakdown only feed coming out in the evening. Whichever feed you listen to, if you're enjoying the show, please go subscribe to it, give it a rating, give it a review, and if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or get a bit.lee slash breakdown pod. Also, a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. Now, today we are focusing on the macroeconomic environment, and we're kicking it off with what is a growing chorus around the possibility of a recession. Bloomberg writes, Goldman Sachs sees U.S. recession odds at 35% in the next two years. So what's going on? Well, of course, right now the Federal Reserve is trying to navigate the U.S. to a soft landing.

Starting point is 00:01:43 Inflation has gotten too high, and so they need to shift monetary policy to try to cool it down. The tightrope that they're trying to walk is that they want to do that and reverse inflation without causing a recession on the other side of it. Remember, in 1979, when Paul Volker came in as the chairman of the Fed, he had to raise rates to nearly 20% to tamp down the inflation that had characterized the 70s. In the ensuing recession, the unemployment rate hit over 10%. So the Fed is trying now to stop inflation, but without having that dramatic consequence on the other side. What are the tools in the Fed's toolkit? Interest rates are one. The Fed can effectively increase the cost of money. When money costs more in the form of

Starting point is 00:02:29 higher interest rates that disincentivizes borrowing and other credit formation activities which could be contributing to an overheated economy. The other tool has to deal with assets. We're living through a shift from balance sheet increases, aka quantitative easing, where the government buys treasuries and mortgage-backed securities, to a balance sheet normalization process, where we stop increasing our balance sheet through the purchase of those assets and keep it at a consistent level. We will move then into a balance sheet reduction or quantitative tightening period where we actively reduce the level of those asset holdings. Now, as I've discussed before, this doesn't usually involve direct selling of assets into the market. Instead, it means letting those

Starting point is 00:03:11 asset terms mature without replacing them. This reduces the size of the balance sheet and removes liquidity in the system. The question, of course, is how effective are these tools likely to be? And a lot of that depends on the nature of the inflation we're experiencing. Broadly speaking, economists tend to define two types of inflation as either demand, pull, or cost push. Demand pull inflation is when demand is rising without supply also rising, causing a chain reaction of higher prices, leading to higher wages, leading to higher prices, and so on and so forth. Monetary policy tends to be a bit better at this, as its tools more directly impact demand

Starting point is 00:03:47 by making money and borrowing more expensive. The other type of inflation is cost-prudely. push where some factor creates a situation in which aggregate demand has stayed roughly the same, but supply has been reduced. This is a bit harder for central banks to address. Sure, the Fed can impact the price of money, but they can't print more oil. What's more, while lower interest rates and consequently cheaper money can stimulate more supply, in that businesses might be incentivized to take advantage of that cheap money, and thus increase supply, we've been living near zero interest for a really long time, and so it's a bit hard to squeeze more blood from that particular stone.

Starting point is 00:04:24 Of course, in the real world, it's not as clean as economist book definitions. Indeed, what we've been living through the last few years is clearly some combination of these two types of inflation. There have obviously been huge exogenous supply shocks. First, in terms of COVID, which saw major supply chain disruptions that have been far more persistent than many imagined. And now in terms of the war in Ukraine, which has the double factor of disruptions based on the field of battle, such as Ukrainian wheat not being able to get anywhere, plus a new crop not getting planted and harvested, as well as and even more significantly fallout from sanctions against Russia, which is the world's largest exporter. Particularly pertinent

Starting point is 00:05:03 are the implications of Europe and the rest of the world not having easy access to Russian oil and natural gas. However, at the same time, this inflation is clearly not just from the supply side. On the demand side, you had both the big increase in consumer demand coming out of COVID shutdowns, which was exacerbated by the big secular shifts in demand that were accelerated by COVID. For example, people racing to get out of cities and buy houses, which came into an already undersupplied housing market, but you also had injections of cash directly into people's pockets. All of that has a demand increasing effect as well. As you might expect, then, there is a ton of debate about what particular combination of

Starting point is 00:05:43 factors got us to this heightened level of official inflation. I think these are quite clearly the biggest political questions of this election cycle. Whatever the causality from the professional investor side, the story is all about increasing likelihood of a recession. Goldman Sachs writes in a new report, the Fed faces a hard path to a soft landing as it aims to narrow the job workers gap and bring inflation back towards its 2% target. We now assign roughly 15% odds to a recession in the next 12 months and 35% within the next 24. months. It is not just Goldman Sachs that sees the likelihood of a recession growing. From Bloomberg, economists recently have seen increasing odds of a U.S. recession, with 27.5 percent expecting a

Starting point is 00:06:25 contraction in a Bloomberg survey in the first week of April up from 20 percent a month earlier. The Wall Street Journal has similar numbers. Twenty-eight percent of economists surveyed by the Wall Street Journal last week see the economy sliding into recession within the next 12 months. At least one major bank, however, is going farther. to the Goldman report, which said that it was still far from inevitable that we would see a recession, Deutsche Bank has become one of the first major banks to predict exactly that in a report called Over the Brink. The lead economists from Deutsche Bank say, our call for a recession in the U.S. next year is currently way out of consensus. We expect it will not be for so long.

Starting point is 00:07:09 Looking for ways to step up your crypto game? Then go with Nexo. For starters, you get free crypto for each purchase or swap. How about earning guaranteed yields? Up to 17. $19% paid out daily. Ideal for you hardcore hodlers. You don't even need to sell. Instead, borrow instant cash against your assets. Get the most out of your crypto with nexo at nexo.io. That's nexo.io.

Starting point is 00:07:41 Meet Arculus, the next generation cold storage wallet. Arculus secures your crypto using three-factor authentication, providing a simpler, safer, and smarter way to store, buy, swap, send, and receive crypto. Arculus is offline cold storage. Your private keys are encrypted on the Arculus keycard and are never online. Stay safe from hackers with no cords, no charging, no Bluetooth. Just crypto security made simple.

Starting point is 00:08:07 Buy Arculus on Amazon today. The breakdown is sponsored by FTXUS. FtXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees.

Starting point is 00:08:40 Download the FTCS app today and use Referral Code Breakdown to support the show. In addition to this discussion of recession, there is another term that's worth honing in on because you're likely hearing it a lot more. That term is stagflation. The simplest possible definitions of stagflation are either a period of inflation with persistent low or negative GDP growth or a period of high inflation that also sees slow economic growth and high unemployment. The term was coined in the mid-60s in the United Kingdom. And by the end of that decade, the United States had joined the UK in that situation. At the end of that decade,

Starting point is 00:09:18 in the beginning of the 1970s, the Nixon administration implemented price and wage controls, together with closing the gold window in 1971. This was in response to an unemployment rate of 6.1% and an inflation rate of 5.84%. These wage and price controls were intended to stabilize the dollar in combat inflation. They originally were intended to be a 90-day program but remained for over three years. 70s stagflation, however, was really put into overdrive by the oil shock in 1973. That was when the U.S. and other Western nations were embargoed from purchasing Saudi oil. The global price of oil tripled within six months, with the embargo nations experiencing much higher price spikes than the general global price increase. You're starting to hear this stagflation term thrown around again a lot.

Starting point is 00:10:03 CNN from Thursday, for example, Christine Lagarde keeps options open as Europe grapples with stagflation. Market analyst math and soma writes, just for context, if you normalize monetary and fiscal policy, to multi-decade averages, most major developed nations will be in stagflation or recession. Chow Wang, a core contributor at the Alliance Dow, writes, been thinking about how to position in a stagflationary environment with a Fed that's determined to tighten at all costs. Matthew Dixon writes stagflation is the scariest scenario that has no solutions in the fiat world. This could be what eventually precipitates the move to crypto. The Fed are between a rock and a hard place. They can't raise rates because there is no growth. They must raise rates because inflation is

Starting point is 00:10:41 spiraling out of control. Even super mainstream economists are debating this. Paul Krugman wrote a short threat about a longer threat about stagflation risks. He says, what does worry me is mainly labor markets. High wages are good, but unsustainably high wage growth isn't. This looks like an overheated labor market. If we get to an economy where everyone gets 6% annual wage increases because they expect everyone else to be getting 6% annual wage increases, that's stagflation. The Putin disruption less so, even though it's hurting real incomes everywhere. The theory of core inflation in which swings in volatile prices like food and energy and now used cars don't have much impact on longer run inflation has been a smashing success. I'm not ready to drop

Starting point is 00:11:20 that theory yet. By the way, that goes in both directions. There are early indications that the bullwhip effect may lead to sharp drop in shipping rates and maybe even some commodity prices soon. That could mean a fall in headline inflation, but would not end stagflation dangers if the job market stays this tight. So I would not advise the Fed to call off rate hikes after a couple of low CPI prints. Much more important is whether the economy is cooling off, which it very well might. Fed funds rate has barely risen, but expectations have driven interest rates relevant to real activity much higher, likely to be a very confusing few months, and I may well find myself less stovish than some other economists. Now, I would be surprised if a lot of my listeners

Starting point is 00:11:58 tend to share Krugman's enthusiasm for the theory of core inflation. But I think the point is that last part, that it's likely to be a very confusing few months, and that this notion of stagflation is the threat that people have their eyes on. Some, however, aren't buying it. Token State writes, I'm hearing we're in a stagflation period like the 70s, which couldn't be further from reality. stagflation is when there is high inflation, high unemployment, and slower negative real economic growth. Unemployment is at historical lows and economic growth isn't slower negative. One interesting response that some have pointed out is that while unemployment is low, we have a couple interesting factors that make the story more complicated.

Starting point is 00:12:35 The first is the great resignation and the number of people who have left the workforce entirely. The second is to point out that though unemployment is indeed low, wages have not been keeping up with inflation. in fact, they've been falling farther and farther behind. So even though wages have been growing in nominal terms, they have not been growing in real terms, and that could be a herald of problems to come. What's clear is that people are getting nervous. Cody Sanchez, the founder of contrarian thinking, writes, what I'm sending all my portfolio companies. Slowing GDP everywhere, rising cost of capital, quantitative tightening, no new fiscal stimulus, 8% plus inflation, market still overvalued, falling consumer sentiment, China about to close its second largest port city,

Starting point is 00:13:17 smart. On that last part, there are some truly amazing satellite images of ships waiting to be unloaded in Shanghai. The number of ships waiting to load or discharge at Shanghai is, in fact, over 300, which is more than double the average over the last five years. Still, not everyone is ready to sign up for the stagflation bet. Brent Donnelly points to a Bank of America survey from last week and says, B of A survey shows collapsing growth expectations and max long commodity. an extremely aggressive stagflation bet. I doubt both views will be vindicated from here. The best cure for high commodity prices is collapsing demand,

Starting point is 00:13:57 or demand holds and commodities rally. Not both. Three hours capital, Suu writes, agree. Case for stagflation becomes weakest, precisely at the moment it is perceived as most likely. So the key takeaways here are that no one really has a clear idea of how this resolves, but what is clear is that that lack of clarity is impacting everything.

Starting point is 00:14:21 Indeed, this is a market in which you can get a straight-faced headline this time from Coin desk that says, Sheba, Dogecoin, among biggest losers as macro fears lead to market fall. Still, that may not be ultimately crypto's part of this story. Mr. Brown writes, innovation is the only cure for stagflation. Crypto will lead us out of this. And it is indeed true that if you look at what really got us out of that stagflation, period in the 70s. One can make an argument that it was dynamism and deregulation and increased market activity in the early 80s. But before that, we are certainly in for some more volatility.

Starting point is 00:14:58 And of course, as that happens, I want to say thanks again one more time to my sponsors, nexo.io, Arculus and FTX for supporting the show. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, Breakdown listeners, come join CoinDesk's Consensus 2022, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto-newbies, investors, entrepreneurs, developers, and creators.

Starting point is 00:15:38 Don't miss speakers like Kathy Wood, SBF, C-Z, Punk 6529, and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindesk.com slash consensus 2022.

The Breakdown - Economists See Increasing Risk of Recession and Stagflation

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.