Roubini:The Deadly Dirty D-Words: “Deflation”, “Debt Deflation” and “Defaults”.

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Don't worry folks, he's got this

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The debt overhang and zombie companies were propped up starting 13 years ago after the last depression Roubini predicted, first with the TARP, then with a decade plus of QE and zero bound interest rates.

Propping up creditors isn't working, unpayable debts need to be restructured or forgiven, and imprudent creditors bankrupted.

Recession indicators are ringing and key commodities have plunged into a bear market, signaling a downturn may be on the horizon. And Nouriel Roubini dismissed hopes that an incoming recession will be shallow.

The famed economist, who called the 2008 financial crash, told Bloomberg that the economy is headed for a severe recession as well as a severe debt and financial crisis.

Roubini, also known as "Dr. Doom," said debt ratios are historically high at 420% for advanced economies and climbing, while bailouts during the pandemic have resulted in "zombie corporations" that put the economy at risk.

In contrast, the stagflation seen during the 1970s was accompanied by low debt ratios, and the debt crisis during the 2008 financial crash saw falling inflation.

https://markets.businessinsider.com/...ictions-2022-7

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Because so much of credit and trade is dollar-denominated, US interest rate hikes have dramatic implications for debtor nations and emerging economies, with corresponding deflationary headwinds for the US.

As Sri Lanka struggles to service the $45 billion in long-term debt it owes, of which over $7 billion is due this year, it could join countries that have defaulted during the pandemic, including Argentina and Lebanon, which is heavily dependent on wheat imports.

The pattern illustrates the procyclical dynamics of developing-world finance: Under looser monetary conditions, capital moves in fueling debt run-ups, like the ones that financed the former president’s white elephant projects. It flees just as quickly.

THE REPORT’S LE refers to the period in 2013 when the Federal Reserve and the European Central Bank (ECB), having pulled out of the 2008 financial crisis, dialed back their bond-buying. In a so-called “taper tantrum,” investors pulled out of emerging markets like Brazil and Turkey in favor of advanced economies, where bond yields had started to look more attractive.

Now, as the Federal Reserve hikes interest rates, it could once again suck capital back from developing countries to the Global North, causing currency depreciation with dangerous knock-on effects. Meanwhile, contractionary monetary policy in rich countries can dampen domestic economic activity and lower demand.

UNCTAD stops short of forecasting the outcome of interest rate hikes by the Fed and European Central Bank. Another taper tantrum is hard to predict, the report argues, since it would be set off by herd behavior in markets, not just fundamentals. But even absent quick capital withdrawal, developing countries are being urged to readopt austerity budgets that could send them into recession.

The upshot, the report explains, is that the developing world will undergo a painful adjustment one way or the other, whether “by volatile liquidity-driven cross-border financial flows, or by the slower grind of diminished policy space, fiscal and monetary tightening and squeezed incomes.”

https://prospect.org/world/developin...ry-tightening/

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James Galbreath once quipped that "the only function of economic forecasting is to make astrology look respectable," but Roubini did get it right in 2008.

This time around he's predicting a severe, stagflationary recession. In that scenario, the political temptation to fight fire with gasoline will be hard to resist.

Unlike in the 2008 financial crisis and the early months of COVID-19, simply bailing out private and public agents with loose macro policies would pour more gasoline on the inflationary fire. That means there will be a hard landing – a deep, protracted recession – on top of a severe financial crisis. As asset bubbles burst, debt-servicing ratios e, and inflation-adjusted incomes fall across households, corporations, and governments, the economic crisis and the financial crash will feed on each other.

To be sure, advanced economies that borrow in their own currency can use a bout of unexpected inflation to reduce the real value of some nominal long-term fixed-rate debt. With governments unwilling to raise taxes or cut spending to reduce their deficits, central-bank deficit monetization will once again be seen as the path of least resistance

https://www.project-syndicate.org/co...oubini-2022-12

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BlackRock's 2023 outlook cites similar themes: recession plus persistent inflation.

The Great Moderation, the four-decade period of largely stable activityand inflation, is behind us. The new regime of greater macro and marketvolatility is playing out. A recession is foretold; central banks are oncourse to overtighten policy as they seek to tame inflation. This keeps ustactically underweight developed market (DM) equities. We expect toturn more positive on risk assets at some point in 2023 – but we are notthere yet. And when we get there, we don’t see the sustained bull marketsof the past. That’s why a new investment playbook is needed.

We laid out in our 2022 midyear outlookwhy we had entered a new regime – and areseeing it play out in persistent inflation andoutput volatility, central banks pushingpolicy rates up to levels that damageeconomic activity, rising bond yields andongoing pressure on risk assets.Central bankers won’t ride to the rescuewhen growth slows in this new regime,contrary to what investors have come toexpect. They are deliberately causingrecessions by overtightening policy to try torein in inflation. That makes recessionforetold. We see central banks eventuallybacking off from rate hikes as the economicdamage becomes reality. We expectinflation to cool but stay persistently higherthan central bank targets of 2%.What matters most, we think, is how muchof the economic damage is already reflectedin market pricing. This is why pricing thedamage is our first 2023 investment theme.Case in point: Equity valuations don’t yetreflect the damage ahead, in our view. Wewill turn positive on equities when we thinkthe damage is priced or our view of marketrisk sentiment changes. Yet we won’t seethis as a prelude to another decade-longbull market in stocks and bonds.This new regime calls for rethinking bonds,our second theme. Higher yields are a gift toinvestors who have long been starved forincome.

And investors don’t have to go far upthe risk spectrum to receive it. We like shortterm government bonds and mortgagesecurities for that reason. We favor highgrade credit as we see it compensating forrecession risks. On the other hand, we thinklong-term government bonds won’t play theirtraditional role as portfolio diversifiers due topersistent inflation. And we see investorsdemanding higher compensation for holdingthem as central banks tighten monetarypolicy at a time of record debt levels.Our third theme is living with inflation. Wesee long-term drivers of the new regime suchas aging workforces keeping inflation abovepre-pandemic levels. We stay overweightinflation-linked bonds on both a tactical andstrategic horizon as a result.Our bottom line: The new regime requires anew investment playbook. It involves morefrequent portfolio changes by balancingviews on risk appe e with estimates of howmarkets are pricing in economic damage. Italso calls for taking more granular views byfocusing on sectors, regions and sub-assetclasses, rather than on broad exposure

https://www.blackrock.com/ins utio...tlook-2023.pdf

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Jamie Galbreath throws cold water on Phillips Curve, NAIRU, potential output, and money-supply growth hypotheses for inflation. He think the Fed may do more harm than good by treating the symptom than the cause, which in his opinion is cost driven.

6. US household behavior in slump and stimulus

The United States had a poor and badly disorganized public health response to the onset of the Covid-19 pandemic, with a rapid spread of the virus and a chilling death toll, albeit heavily weighted toward the elderly, immunocompromised, and otherwise at-risk parts of the population. However, the economic response was rapid and administratively efficient, providing a cash transfer through the tax system and a very substantial extended unemployment benefit, which, at $600 per week initially, represented a raise for a large segment of the working population. For this reason, despite a spectacular collapse in employment and working incomes, there was little-to-no increase in poverty and certain indicators of well-being, such as food insecurity, actually declined (Schanzenbach 2022).

What did households do with the money? For the vast majority, laid-off from low-to-moderate-wage service jobs, the best answer (Peterson Foundation 2021) appears to be that they kept up with their ordinary, fixed, and customary expenses: rent, utilities, groceries, gasoline, education. They did not splurge, but for these households, there was only a modest increase in savings. For households in the upper tiers of the distribution, the picture is different. They had previously spent heavily on the services that employed the large majority of American workers; they were less likely to become unemployed and the assistance was a less-important share of their incomes. But they were cut off from the ordinary use of their earnings. So they saved what they could not spend, and aggregate savings rose temporarily to about one-third of aggregate income. These savings then found their way into asset markets: real estate, corporate equities, collectibles, and the like, with purchases abetted by extremely low long-term interest rates. Asset prices, accordingly, recovered quickly and rose sharply as the pandemic wore on.

None of this supports the notion of an inflationary spending spree fed by a reckless “stimulus” policy. There was, to a degree, a shift of purchasing power, blocked from services, into household appliances, vehicles, home renovations, and new construction. But (as ins utionalist theory would predict) the result of this shift toward newly-produced goods was (mainly) backlogs and queues and shortages rather than price increases, and in many cases the backlogs were of imports, leading to epic congestion in the container ports of the US West Coast (USDOT 2022). Price effects were (again, as theory would expect) stronger in asset markets. As stated above, these are not markets for produced goods and therefore not normally considered to be elements of inflation, even if they do appear in some components of the Consumer Price Index. On the contrary, the usual word for a general increase in asset prices is “boom.” And booms, as history shows, are deeply vulnerable to increased interest rates.

In brief summary: The price increases of 2021-2022 were cost-driven, accompanied by an asset price boom incident to the disruption of the service economy. They were not driven by macroeconomic excess, neither fiscal nor monetary. But they did hand the Federal Reserve a political problem, which it proceeded to solve, in what may prove to be the worst way.

7. The Fed waves its wand

According to President Biden (Irwin 2022) and to the large consensus of mainstream economists and the voices of the financial sector, the “inflation” problem of 2021-2022 fell within the responsibility of the Federal Reserve. This was convenient for each player in the drama. For the President, it meant that political responsibility for price increases and (worse) for the consequences of dealing with it could be shuffled off onto an impregnable ins ution outside his control. For the banks, vested through quan ative easing with vast excess reserves, it would mean earnings without risk or effort, since the Federal Reserve pays interest on reserves at the official rate. For the economists and central bankers, it would mean vindication of their long-held beliefs and a boost to their perceived influence. The costs would fall elsewhere – on other countries and their banks, on speculative markets, on homebuilders and homeowners, on the indebted, and, eventually although not necessarily soon, on businesses and the presently employed.

The Federal Reserve therefore acted. Interest rates rose in large tranches from early 2022 through the late fall. Higher interest rates quickly quelled the housing market, while supporting the dollar and therefore keeping a lid on the price of imports. Stocks, especially in the technology sector, and cryptocurrencies fell in value. By raising interest rates aggressively, the Federal Reserve also received credit for an end to price increases in core commodities that would have stopped rising in any event, especially after the administration started selling petroleum from the Strategic Reserve and oil prices were brought back down. The fact that absolutely no prior theory or evidence supports the notion that tight monetary policies can end inflation within just a few months was, in the main, conveniently overlooked (Galbraith 2022b). The Federal Reserve is a very lucky ins ution.

However, there is a fly in the soup. It is the relationship between the short-term interest rate, which the Federal Reserve controls, and the longer-term rates, on Treasury bonds and in the private sector, over which the central bank exercises very little immediate influence. Long-term rates, for a safe asset like Treasury bonds, are a compound of current short-term rates and the expected future course of short-term rates over the lifetime of the bond. This second element has been conditioned (very reasonably) for years to expect very low short-term rates, and thus to view a rise in rates as a temporary aberration, likely to be reversed once the economy falls into a deep enough slump. The result is that the yield curve, normally upward-sloping, is now inverted. There is therefore no reason for any investor to buy or hold a long-term security – the short-term assets are not only safer, but also a better deal.

This is why an inverted yield curve is almost always followed by a slump in business investment, home construction, housing prices (and therefore the viability of mortgages), and of course in stocks and bond markets (Galbraith, Giovannoni and Russo 2007). At present writing, many observers can see the coming storm. But the Federal Reserve is stuck. If it relaxes policy, it will appear over-sensitive to economic risks, inconstant, and non-credible. If it continues down the present path, it is steering economic activity toward a cliff. Again, not necessarily soon. But in due course, and inevitably – opening the door to another financial crisis and yet another round of crisis interventions.

In this climate, at present writing, the Federal Reserve’s leadership has shown its colors and commitments (Galbraith 2022a). The interests of the dollar and the US banking sector in world compe ion are paramount. So far as the domestic political economy is concerned, the priority is primarily toward ensuring that wages never catch up to the price increases that have already occurred. In recent speeches (Cohan 2022), Chairman Powell has made this commitment abundantly clear – and even the fact that wage growth has slowed in recent months seems to be making little impression on the course of policy. Unemployment must rise, labor markets must soften, capital must gain, and workers must lose. That is where matters presently stand.

8. The prospect for prices

The most likely course of events is therefore a renewed slump and a further shock to employment and wages. Apart from construction, however, this may not happen soon; contrary to commonly expressed liberal worries (Olander, 2022), the next big one may not yet be in sight. Businesses and households have a way of trying to survive, when conditions begin to get worse, by taking on new debts even on unfavorable terms. Lenders usually find such deals attractive; they bring good returns and the assets, such as they are, can often be securitized and fobbed off on the unwary. This can continue until it stops.

And so, it also remains possible that the crisis of prices, such as it was, may not have run its course. There are three reasons to fear additional problems on the cost front in the period ahead.

First, there is a problem of gross markups. In normal times, with general price stability, these are stabilized by convention and habit, by the economic equivalent of good manners. Businesses are cautious about antagonizing their customers; they do not like to acquire the reputation of a price gouger. (This is why, for instance, hardware stores do not generally jack up the price of plywood when a hurricane is on the way). But in a general melee, with prices going up all around, a different mentality sets in, an impulse to grab what one can, and not be the sucker left behind. An inflation driven by profits (Bivens 2022), not wages, can therefore reverberate for some time. Unlike a wage spiral, a profit spiral gets little media attention and policy response – for obvious reasons.

Second, there is a risk of more shocks to core commodities, especially in the energy sector. Oil prices came down in 2022 thanks to sales from a finite strategic reserve. Now with the mid-term election past, the administration plans to buy oil from the market to replenish the stock (White House 2022). Will production suffice to cover both regular demand and storage? So far as known, no one really knows; both the geology and the strategy of the producing firms and refiners are uncertain. But energy markets are financialized, and there is in them the capacity for speculative manipulation – what I have called the choke-chain effect (Galbraith 2014). We shall see whether we are in for another round of that.

Third, there is the effect of higher interest rates on business costs. Interest, after all, must be paid. Sooner or later, the higher short-term rates will bleed into the accounts of business borrowers, and some of the effect will be passed along, so far as conditions permit, to their customers. To that degree, a tight monetary policy is inflationary before it is disinflationary

.https://www.ineteconomics.org/perspectives/blog/the-quasi-inflation-of-2021-2022-a-case-of-bad-analysis-and-worse-response

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Does raising interest rates curb inflation? Some economists think not. Data collected by Blair Fix suggests the opposite may be true.

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Fed agrees that accelerated markups were a major factor in the growth of inflation in 2021, but puts it down to expectations of future inflation.

Inflation reached a 40-year high in 2021 and continued to climb in 2022. Record corporate profits received significant public attention as a potential explanation for high inflation. Although corporate profits and inflation do not have a direct accounting relationship, inflation is directly affected by growth in the markup, or the ratio between the price a firm charges and the firm’s current marginal cost of production. Thus, the sum of the growth in the marginal cost of production and the growth in the markup is the inflation in a firm’s price. Markups can change over time for many reasons, including firms’ expectations for their marginal costs in the future.


Andrew Glover, José Mustre-del-Río, and Alice von Ende-Becker present evidence that markup growth was a major contributor to inflation in 2021. Specifically, markups grew by 3.4 percent over the year, whereas inflation, as measured by the price index for Personal Consumption Expenditures, was 5.8 percent, suggesting that markups could account for more than half of 2021 inflation. However, the timing and cross-industry patterns of markup growth are more consistent with firms raising prices in anticipation of future cost increases, rather than an increase in monopoly power or higher demand.

https://www.kansascityfed.org/resear...ent-inflation/

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Far leftists at WSJ agree.

Big Companies Thrive During Periods of Inflation

Some think rising inflation means companies are forced to raise their prices. But as WSJ’s Dion Rabouin explains, it actually works the other way around: Corporations actually drive inflation, and data show that they have been and will continue to push prices up for some time.

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the ultra low cost of credit distorted economics for ten years

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Hope the Fed doesn't overshoot with rate hikes -- if it hasn't already.

Historically, negative money supply correlates strongly with recession.

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Bankers gripping over their exposure to historically normal interest rates. AFAIK, Congress isn't considering anything like this yet, it's just an op-Ed in American Banker.