65% chance of recession as inflation heats up to 8.6% - Steve Hanke

[00:00:00] Speaker 1: Concerns of a coming recession are on the rise. And actually, if you look at Google Trends, the word recession has been searched continuously over the last few months. And that search term has been rising in terms of search volume. Joining us to discuss a coming recession or a potential slowdown in the economy is Professor Steve Hanke. He is a professor of applied economics at Johns Hopkins University, and he is an expert on all things inflation, monetary policy, and economic growth. Welcome to the show. Welcome back, Professor. I don't know why I say welcome to the show. You're on all the time. But good to see you again, Steve. [00:00:36] Steve Hanke: Yeah, great to see you too, David. [00:00:38] Speaker 1: All right. We'll be covering the economic growth forecast from the Atlanta Fed as well as inflation and the latest from your Hanke Koffner's Gold Sentiment Index, which people can access by going to the link in the video description down below. But we'll cover that in the later part of our interview. Let's take a look at the GDP Now forecast, which is issued by the Atlanta Fed. And I'm just going to read a little disclaimer here by the Atlanta Fed. It says, The GDP Now is not an official forecast of the Atlanta Fed. Rather, it is best viewed as a running estimate of real GDP growth based on available economic data for the current measured quarter. Now, they have previously forecasted second quarter growth to be 1.3%. That was as of June 1st. As of June 7th, which is a few days ago, they've revised that down by a few basis points down to 0.9%. So we're getting closer to zero. And most economists define a recession as two consecutive quarters of negative growth. We're not there yet. But what's worrying me, Steve, is that the Atlanta Fed is revising down their forecast. Is that a concern for you? And do you agree with their forecasts? [00:01:54] Steve Hanke: Well, their now forecast seems to actually have a pretty good record. So the interesting thing, as you point out, David, they're revising things down. Now, once some accurate forecaster starts revising down, you better get worried. So I do have some concern based on these revisions. Also, the Atlanta Fed now is lower. Their forecast for GDP has been consistently lower than the consensus of blue chip forecasters. So all of that is putting a lot of, shall we say, clouds on the horizon coming in. And I happen to think there's a fairly high probability we will have a recession because the Federal Reserve is flying blind. They're scared, afraid about inflation. And usually when that happens, they tend to overdo things, tighten things up too fast, too much, and you end up dumping the economy into recession. So that's one problem. The second problem are these sanctions that we keep ramping up on Russia have really thrown chaos into the commodity markets, oil and food products. And this is a concern. So we have an international thing going on that's very negative with the sanctions. And domestically, we've got the Fed flying blind. They're not watching the money supply. They don't watch the money supply. They're flying in an airplane with an altimeter that is blank. It should have the money supply on the altimeter, but there's nothing on the altimeter. [00:03:53] Speaker 1: Professor, just on your point about the Fed flying blind, is this a pattern that every time we have higher interest rates, a recession necessarily has to follow? I'm just looking at the last time we've had interest rates this high, which was back in the early 80s. And actually, we've had two recessionary periods, a very brief one in 1980, and then a longer one in 81, 82. Now, is that because of Walker's raising of the interest rates to double digits or were recessionary pressures already there in the late 70s? Please brush up on our history here for us. [00:04:26] Steve Hanke: Well, okay. So it is possible to raise interest. First of all, there's kind of a very fuzzy relationship between raising the Fed funds rate and changes in the growth and the money supply. There have been some times when they've raised, there are actually three episodes in which the Fed raised the Fed funds rate considerably and the money supply didn't go down that much. And in those cases, we actually had a soft landing. The economy did slow down, but unemployment actually went down. The economy stayed in very good shape. So those are three episodes. A good outcome, even though the interest rates were raised dramatically and the outcome was good because the interest rate increases really didn't slow down the money supply that much. They didn't excessively slow it down. Most cases, however, most cases when they start raising the interest rate, the money supply goes down pretty rapidly. And when the money supply goes down pretty rapidly, right away, you end up slowing the economy down. And that's what I'm worried about right now. I think they will probably overdo it and we will see the money supply go down pretty sharply and we will have a recession. And if that happens, we'll end up with stagflation because the inflation is already baked in the cake and that will last and will be with us at about a probably 6% rate for the rest of this year and next year. [00:06:26] Speaker 1: Okay. I'm going to come back. [00:06:28] Steve Hanke: And you asked about Volcker. Volcker, that was one case where Volcker was watching the money supply and increasing the interest rates, but to squeeze the thing out, he in fact overdid it. That's why we actually had two recessions with Volcker. One was relatively severe and one was kind of mild. But that was a case, by the way, in which Reagan was the president and Reagan was not interfering with Volcker. He said, do whatever you have to do to kill inflation and get things stabilized. And Volcker did what it took. He kind of overdid it, but Reagan didn't interfere. I think Biden will interfere massively and whatever is going on at the Fed, Biden and the White House will have their fingers all over everything, which is another danger, by the way. [00:07:29] Speaker 1: All right, Professor, I'm going to jump back to economic growth and the GDP forecast in just a minute, but I want to throw out a hypothetical scenario because you know I love doing these with you. Now, suppose you are in the Federal Reserve, suppose you're in Jerome Powell's position right now and you have to make the difficult decision of either letting inflation run hot, which is basically doing nothing, not trying to reduce the money supply and keeping the economy rolling, or option number two, tighten interest rates, which is what they're doing now, but potentially over tighten, like you said Volcker did, and cause a recession. What would you pick? One or two? [00:08:06] Steve Hanke: Well, I'd pick three, and three is I'd want to get the money supply down to the golden growth rate of about 5% to 6% growth rate for M2, that measure of the money supply, and that would allow eventually, eventually, the inflation rate to get down to 2%, which is a Fed's inflation target. And that would allow for a smooth landing. We gradually would get inflation out of the system. It's going to be around, by the way. It will be around for the next couple of years because we have been growing the money supply on average since early 2020 at about 18% per year. That's about three times higher than the golden growth rate. So that's already baked in the cake. That excess money is out there. We're not going to get rid of it. It will eventually come through the system as inflation, no matter what you do today. Even if you overdid a tightening and you had a recession, you're still going to have that inflation to deal with. So the worst of all possible worlds would be that they don't look at the money supply, which they're not looking at. They're flying blind. And they overdo the shrinkage in the balance sheet of the Federal Reserve. And they increase interest rates too much. And we have a recession. Then you're going to have stagflation. [00:09:42] Speaker 1: Yes. [00:09:43] Steve Hanke: A recession and inflation. And I think there's a pretty good chance that we will have that. And that Atlanta Fed information that we were talking about, that now forecast does make one think maybe things aren't looking so good in terms of real economic growth. [00:10:01] Speaker 1: Yes. Okay. Professor, are you suggesting that there is a possibility of a soft landing, which is the word you brought up? Because the scenario number three that you brought up, that's a soft landing, right? That's the golden spot. [00:10:17] Steve Hanke: Yeah. Yeah. There is a soft landing. If you hit the soft spot of that golden growth rate of the money supply being 5% or 6%, you have to look at the money supply. It's all about the growth and the money supply. And as I say, everybody focuses on these interest rates, but they're a very bad indicator of actually what's going on with the money supply. They're a bad indicator of whether you're tight or whether you're loose. We've had three episodes since 1980 where there was very severe interest rate increases. and that didn't amount to much tightening or over-tightening in the money supply. And we did have a soft landing three times. [00:11:07] Speaker 1: Yes. Okay. [00:11:09] Steve Hanke: So it is possible, but we don't know very well what that relationship is between interest rate increases and the money supply growth. You have to just keep your eye on one thing, money supply growth. [00:11:24] Speaker 1: All right. [00:11:24] Steve Hanke: And get it into the golden growth zone of 5% to 6%. That's as good as you can do. [00:11:31] Speaker 1: All right. Well, we'll see if the Fed is able to do that. We'll definitely follow up with you later. [00:11:35] Steve Hanke: And remember, we're talking about a Fed that got us into this mess in the first place, highest inflation we've had in 40 years, and they were never able to anticipate or predict it even. They didn't know what they were doing. They were flying blind. This is a perfect indicator of what happens if you're flying blind. They ended up making a lot of mistakes, creating a lot of excess money, and giving us this terrible inflation. That's the Fed. I'm going to come back to that point. We've got the same people flying the aircraft. Do you have much confidence that they're going to be able to land the thing softly? [00:12:18] Speaker 1: There are some people that would disagree with your point on who caused inflation, but I'm going to come back to that. First, let's finish up on the scenario. Let's move away from the hypothetical, come back to... [00:12:28] Steve Hanke: I would say there are a lot of people who don't have a clue about the causes of inflation. There's always one cause, excess money. We're going to come back to that. Forget supply chains, the war in Ukraine, Vladimir Putin, all this other nonsense. They have purchased at the Fed and the White House giant industrial washing machines that have massive spin cycles in them, and they've turned [00:12:57] Speaker ?: and they've turned [00:12:57] Steve Hanke: those things on and distorted and really turned out so much nonsense about the cause of inflation that it's hard to even keep track of it. [00:13:09] Speaker 1: I'm going to circle back to that. Moving away from the hypothetical now back to our current situation, you said that there is a higher probability of a recession. Suppose it happens, Professor. How severe is this coming recession? That's what people want to know. [00:13:24] Steve Hanke: Well, I'd like to know too, but my crystal ball does not tell me that kind of information and I don't think anyone does. I would agree. I saw recently Larry Summers who's, as you know, former Secretary of Treasury, a well-known economist, indicated that he thought the probability of a recession was about two-thirds, 65%. [00:13:59] Speaker 1: Recession by when? This year? Next year? [00:14:02] Steve Hanke: What? [00:14:02] Speaker 1: Recession by when, Professor? [00:14:06] Steve Hanke: I'm not certain that he put a date on that. [00:14:10] Speaker 1: I think somebody [00:14:11] Steve Hanke: just asked him what the chances were and he said about 65% and somebody asked me what I thought about Summers' estimate and I said I think it's a pretty reasonable one. [00:14:24] Speaker 1: All right. [00:14:24] Steve Hanke: I'm pretty comfortable with 65% which is, you know, a pretty high number. [00:14:31] Speaker 1: Okay. Let's go back to inflation. You recently wrote an article in the Wall Street Journal. I'm just going to read the headline cancel Milton Friedman and inflation is what you get. You've talked about this with me in multiple sessions over the course of the last year about how monetary theory teaches us that excess money supply causes inflation which is something that Jerome Powell denied last year. Remember we talked about that? So that was what your article was about. I'm going to bring up a counter argument not to trigger you professor but to show the audience that there is a counter view to the monetarist school of thought and people point out to the fact that back in 2008 after the financial crisis of 2008 there were multiple rounds of quantitative easing by the Federal Reserve QE 1, 2, 3, and 4 balance sheets of central banks all around the world expanded to at the time record levels and we didn't get an increase in CPI to the same extent that we did today. So they would say that back in those days inflation didn't happen because of QE and now inflation happened not because of QE but because of something else. Those are just coincident indicators not a causation. How would you respond? [00:15:48] Steve Hanke: Well, number one they have no idea what they're talking about. 2008 let's go back to 2008 we had three rounds of quantitative easing in the United States but the money supply broadly measured if you even go out to Divisia M4 that never grew more than four and a half or five and a half percent. The money supply didn't grow they never look at the money supply they don't know what they're talking about. This is literally fake news it's all of these people that should be put in my encyclopedia of economic stupidity. this is the most ridiculous thing and it goes on and on and on and the spin cycle by the way that spin cycle coming out of Washington D.C. it just spins and spins and spins and the journalists of course never look at the numbers anyway they just copy and repeat each other so this story just has legs this idea that they had quantitative easing and we had no inflation yeah we had quantitative easing but the money supply never grew very rapidly [00:17:03] Speaker 1: I'm just curious [00:17:04] Steve Hanke: it grew very slowly [00:17:06] Speaker 1: I'm just curious why did the money supply not grow very rapidly last time we have three rounds of QE like you said [00:17:12] Steve Hanke: arguably four the key to understanding this there are two contributors to the money supply one is the Federal Reserve and two is a commercial banking system and in normal times actually the commercial banking system produces most of the money in the United States most of the money in the United States about 90% of it is normally created by the commercial banks so what happened in 2008 we had the mortgage crisis as you know and Lehman went bankrupt et cetera et cetera Bear Stearns went under and the Washington D.C. crowd went against bankers they said all these problems are caused by banks bankers we got to regulate them more so so we had something called Dodd-Frank legislation that came in that could tighten things up started regulating banks more or and we had something called Basel III that came in at that same exactly the same time that required a higher capital asset ratio for banks that meant that the money supply being created by the banking system David actually went down their contribution actually went negative at exactly the same time the economy was slowing so fortunately for in this case fortunately Ben Bernanke was the chairman of the Fed then they went into QE1 that mitigated some of the damage that was being done by the money supply going down that was being contributed by the commercial banks and then they did QE2 and QE3 the upshot of it on balance you had the commercial bank contribution going down the Fed contribution going up and we had very slow growth in the money supply as a result of that it was actually below the golden growth rate [00:19:29] Speaker 1: would you make the statement that Bernanke understimulated the economy [00:19:36] Steve Hanke: well I know you know they just they mitigated a lot of damage and actually did I think on balance a pretty good job [00:19:49] Speaker 1: all right [00:19:50] Steve Hanke: it was one in which by the way the key thing was over tightening by the bank regulations that were coming in that was what was causing the trouble the trouble was in Washington in the Congress this Dodd-Frank legislation coupled with Basel III that was putting a noose around the commercial banks and sinking totally sinking the money supply and to mitigate that damage the Fed came in and did QE1 2 and 3 that's really what was going on but these people who talk about the poo-poo monitorism literally don't know what they're talking about they don't even know how money is created by commercial banks being the big players and by the Fed the elephant in the room is always the commercial banks not the Fed [00:20:48] Speaker 1: all right fair enough okay so we've covered economic growth and inflation potentially stagflation let's finish up on gold please give us the latest update from the Hanke Kofnus gold sentiment index which for those of us watching who may not be familiar with this index it parses articles and text from the internet and assesses a bullish or bearish sentiment for the price of gold given what's been written about gold in the press so please tell us what's going on right now currently [00:21:21] Steve Hanke: okay well now we're kind of in a neutral stall the sentiment index keeps it gets bearish when the conversation is more and more on inflation and the reason it does that the reason it gets bearish and we get a negative sentiment signal when these stories come out inflation inflation inflation inflation that gets people bearish because they think the Fed will be very aggressive and tightening up and increasing the interest rates but we're getting also as we just talked about David with this Atlanta Fed information we get more and more talk about recession then we get a bullish signal because people think that the Fed will back off and they'll be more worried about the economy collapsing and going into recession so they won't be as quite as aggressive and tightening up that that's a bullish signal so right now we're just flopping between inflation recession inflation recession inflation recession inflation negative hanky cough signal on sentiment and more talk about recession if that dominates that is bullish and and we [00:22:43] Speaker ?: we [00:22:43] Steve Hanke: get a positive number on the hanky cough sentiment so right now it's just a standoff the bulls and the bears are just struggling [00:22:53] Speaker 1: yeah the gold price has been the gold price has been reflecting your sentiment indicator in the sense that it's been stalling i'm just going to end on this thought professor and i'll let you go uh there's one i i guess uh theory or um notion that higher interest rates may actually in today's environment at least may actually be a bullish indicator for gold now we know that gold and negative i'm sorry gold and real interest rates have historically held a negative correlation but suppose interest rates do rise that does signal to us a deteriorating economic environment which may be bullish for gold is that something that you agree with and whether or not you consider factoring into the index [00:23:32] Steve Hanke: well uh no that's that's really not the not not the not the way the sentiment is going what's driving the sentiment is the following that this this step more and more talk about recession and people think oh the fed's going to back off they're not going to be aggressive in raising interest rates and that's going to be bullish for gold that's that's what's driving the sentiment or alternatively the on the on the bearish side if if there's a lot of talk about inflation that starts dominating what we're finding is that people think oh the fed will get very aggressive and increase the interest rates very rapidly and that's that's going to be bearish for gold so that that's that's how that's how it's working the two key words are inflation and recession [00:24:27] Speaker 1: all right well both themes we covered today inflation and recession excellent thoughts professor as usual thank you for coming on kitco and don't forget down below in the video description we have a link to the hanky kaufner's gold sentiment index you can click on it and learn more about this index by going to the website thank you again professor and we'll speak to you again next time thank you and thank you for watching kitco news i'm david lynn stay tuned for more and don't forget to subscribe to our youtube channel