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by  Eric Lascelles Oct 5, 2021

In this video, Chief Economist Eric Lascelles visits ongoing themes that have been worrying financial markets. He argues that while growth is slowing compared to last year, forecasts remain strong. Supply chain challenges persist, however, especially in the U.K., where Eric explores a shortage of truck drivers and gasoline. Finally, he reviews potential outcomes as the Bank of Canada is set to renew its mandate.

Watch time: 14 minutes 03 seconds  |   Hover your cursor over the video to see chapter options

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Hi, everyone. Welcome to our latest video MacroMemo. And as usual, quite a number of topics to cover off over the next little while.

We’ll start, as we always do, with a few thoughts on COVID-19 and the government response, though we’ll tread fairly lightly in that direction. We will, though, talk about whether this is a stagflationary environment. I think probably not, but let’s talk about that.

We’ll talk about U.S. politics, including an averted government shutdown recently. We’ll revisit Chinese property concerns, which has been a hot-button topic for a while and worthy of an update, I think.

We’ll talk about UK shortages. And so there are supply chain issues around the world, but seemingly nowhere more intense than in the UK.

This month, October, happens to be when the Bank of Canada will likely renew its mandate. It does that every five years. And so we’ll speculate on what that might look like.

And then lastly, we’ll visit with modern monetary theory, which is one of those ideas that’s been bouncing around for a number of years in terms of how governments might behave differently. And we’re, frankly, skeptical, but nevertheless, it’s worth addressing some of the key ideas and some of the issues we have with those ideas.

All right. Let’s start with the COVID file, as usual. And so, COVID-19 infections are continuing to decline globally, which is a most welcome development. And even as northern hemisphere weather gets colder, which is thought to be quite a challenge for controlling COVID, we still see fairly positive numbers.

I will admit, not every country is actively getting better. Canada, in fact, is probably more on a sideways trajectory right now, roughly steady. One might make a similar description of the UK situation. However, looking at the U.S., looking across emerging market countries, looking across continental Europe, quite impressive improvements, in fact, over the last month or longer at this point in time.

I will admit, turning back to Canada, one concern I have is that the fatality numbers are a little bit higher than I might have imagined. In fact, they are getting close to the peak level from the prior wave, even though infections aren’t as high. And in theory, the opposite thing was supposed to be happening. We were supposed to be seeing some reduction in infections because of vaccines, but a bigger reduction in quite adverse outcomes.

And so it’s not quite holding together as precisely as we’d like there. So that’s a concern I think worth watching. But the broader message is one in which we’re not getting the explosion of additional cases that you might have expected based on the Delta variant alone or based on the fact that we saw quite an increase in cases last fall, perhaps in part for seasonal reasons.

Now related to that, of course, governments have been trying to limit COVID, but some countries have actually tended to go further. And so a number of countries had pursued a zero-tolerance policy for COVID-19, and Australia and New Zealand featured centrally in that. They wanted no cases. When there were cases, they locked everything down until there were no cases again.

And while theoretically attractive, this has proven to be quite challenging with this more contagious Delta variant. And so, for instance, the Australian and New Zealand economies on track to shrink in the third quarter because of recent lockdowns. As with everywhere, public acceptance starting to diminish. No end arguably in sight because the Delta variant is so much harder to control.

And so, both countries have now pivoted. And so they are now trying simply to limit COVID-19 rather than to eliminate it, and so, I guess, joining the pack, joining most other countries in that regard. Less economic damage, but unfortunately, more infections likely as a result. Many countries pursuing instead vaccine mandates and vaccine passports, and I think that’s likely to be at least a relatively good strategy.

The exception, though, is China. China is still on that zero-tolerance pursuit. And, actually, if anyone is capable of pulling that off, they probably are because they have such an ability to exert control over their population, and they can shut down individual apartment blocks, and these sorts of things. And so, they may well pull that off. But in the meantime, there is some economic damage China will suffer as it deals with little waves as they emerge.

Okay. Let’s talk economic data for a moment. Just a high-level thought here, which is that when we look at the consensus global growth forecast out there, both for 2021 and 2022, we’re starting to see those hook a bit lower. Simultaneously, the economic surprise indices we look at have pivoted from being profoundly positive over the last year to being pretty notably negative over the last little while.

And so, we take all of that as a signal that it probably makes sense to have a below-consensus growth forecast right now. That’s probably the winning bet. You probably see the consensus forecasts keep falling. The surprises have tended to disappoint. And so that’s exactly where we are positioned in terms of our growth forecast.

It’s not just that. It’s not only technical signals that motivate that. We’re also mapping in fiscal assumptions, and monetary assumptions, and currency assumptions, and all of the things one needs to incorporate, but we’re very content to be below consensus given these other factors as well. Let me be clear, this is still an economic recovery, but it’s just one that’s proceeding at a somewhat slower clip than it was over the first half of this year.

Let’s talk stagflation or maybe lack thereof now. And so, stagflation is an environment of low growth and high inflation, and it’s generally not very desirable. People like high growth and low inflation. It’s the opposite of what people want.

Are we in that right now? And so, let’s start by acknowledging this is a period of high inflation and so you’re at least halfway there, though I might quibble and say I don’t know that it’s a structurally high period of inflation. I’m not sure this sticks around for a long time. But nevertheless, for the moment, it is high inflation.

On the growth side, well, growth is slowing, and we are below consensus in our growth forecast. But I think the main point here is that growth is still quite good.

And so that’s where the stagflation argument really breaks down. We’re still at nearly 4% growth. That’s the opposite of stagnation. That is, in fact, very quick economic growth.

Furthermore, when you think about it from a theoretical perspective, stagflation is usually from a negative supply shock like the 1970s oil embargo. And so, suddenly, a product disappears; the price of those products go up; that’s inflation. The economy grinds to a halt; that’s stagnation. That’s how you get stagflation.

Yes, there are some small supply shocks out there in the world right now, but I would argue far more profoundly the issues we’re seeing are positive demand shocks. People buying a lot more things; supply struggling to keep up. But it’s ultimately people buying a lot more things. And to me, that actually squares better with the evidence.

We can say that from an economic standpoint, economic growth is quite good, consistent with a positive demand shock, and inflation is high, consistent with a positive demand shock. So I don’t view this as being stagflation as much as it’s an unusual and somewhat tricky environment right now.

Okay. Let’s pivot to politics. And so, from a U.S. perspective, the good news is, the U.S. managed to fund its government. There was nearly a government shutdown at the end of September. It was averted, and so that’s great.

However, it was only averted for another two months. And so, December 3rd is the new deadline. It was just a temporary bump forward. They didn’t get a whole extra year of government funding out of the political action that was taken.

Also, there is another major issue that will confront the U.S. in the next few weeks, which is, there is a debt ceiling issue. The U.S. isn’t allowed to borrow beyond around October 18th, and so there is the risk of problems associated with that.

I will say that, having been through quite a number of these over the years, my rule of thumb is that these generally do get dealt with, if at the last possible moment. So I think a default is quite unlikely, I think another government shutdown is fairly unlikely, and so I don’t expect disaster.

But nevertheless, it is a bit of a messy time from a political perspective. And part of the messiness is that, simultaneously, there are a lot of infrastructure negotiations going on right now. And our suspicion is this big $3.5 trillion Democrat proposed bill will get whittled down to something more like $2 trillion by the time this is all done. But this could remain quite intense and interesting over the next few months.

Let’s talk Chinese property markets now. And so, Evergrande, its second-largest builder, ran into some serious problems over the last several weeks.

On the positive side, we can say Evergrande is seemingly managing or at least in the process of selling off some of its units, which will help to raise funds and help it make its debt payments that it has struggled to make. Reportedly, the company had also restarted construction on something like 20 projects. And so there are some good things there.

However, the company is still not paying the entirety of its overseas bond interest. In fact, it missed another payment recently. I think there is still a significant risk that the company isn’t just illiquid but also insolvent, and so government involvement is quite likely at some point in the not-too-distant future, in my estimation at least.

There is now another builder running into trouble. And so China’s Fantasia, which is a midsized builder and indicated it had no problem just a few weeks ago, it does now seemingly have a problem. It failed to make payment on its debt owing on October 4th and so it has formally defaulted.

And so really, the story here is one in which the government in China has cracked down on excessive leverage in housing. It’s trying to cool housing. And there are some side effects to that. Some companies are failing or at least struggling right now, and I think it needs to be viewed less through a financial market lens, which is to say, I’m not convinced there’s contagion into other markets or other housing sectors or anything quite as grand as that. I tend to think of it more as the Chinese economy is very housing oriented. It needs to slow to some extent as housing cools and as these housing issues are dealt with. And that has consequences for the global economy as well.

Okay. Let’s talk about supply chains and, most specifically, the UK supply chain right now because it is experiencing quite intense gas shortages. It is beginning to experience some prospective meat shortages as well, and there are reports of other items that are also difficult to come by, above and beyond the generalized supply chain issues that the whole world is confronting right now.

It does seem like Brexit is actually the big reason. We’d almost forgotten that term. So many other things seemed more important, and the pandemic was the dominant driver for quite some time. But foreign truck drivers essentially have disappeared from the UK, and it turns out they’re needed to get products to market. And so, that is the acute issue.

And so, for the moment, the UK economy is quite hobbled. It’s extremely hard to get gasoline. The great majority of gas stations have none, as an example. And there is also some panic buying, I should admit, making things worse; everyone now wants to fill up their car, whereas maybe they previously wouldn’t have bothered. Some of that panic buying can go away, but nevertheless, we’re in a situation in which it’s probably several months before the UK can fully address some of its acute shortages.

And whereas the UK economy had seemed to be on one of the better growth trajectories, maybe we need to take a little bit out of that. That’s certainly where our thinking is going right now.

Okay. Let’s talk of Bank of Canada mandate review. Every five years, the Bank of Canada renegotiates its mandate with the government. And in the past, in fact, for the last, gosh, 30 years, it’s kept its 2% inflation target. And so that’s the most likely outcome.

However, it is interesting that the U.S. Federal Reserve has shifted its mandate over the last little while to average inflation targetting, basically saying, if there’s low inflation, they’re going to actually actively pursue a bit of extra-high inflation to offset it, whereas normally, one doesn’t do that. The ECB made some small tweaks as well. And so the question is what the Bank of Canada might do.

There was a recent piece of research from the Bank that argued that some other approaches were equally good as the existing 2% inflation target. One was the U.S. approach, average inflation targeting. One was a dual mandate where you more formally incorporate the labour market as well. And so, conceivably, they could pivot, but I think it’s unlikely. They found those things to be equally good. You don’t change to something that’s equally good as the thing you already have. You generally stick with the tried-and-true approach.

And so I think they are likely to stick with a 2% inflation target. Conceivably, they give themselves or are granted a bit more flexibility to the extent that they could say, well, inflation’s been low, we’ll let it be a little higher; not as formally as average inflation targetting but giving them a little bit more flexibility. Maybe all else equal, that makes them a bit more dovish, less likely to raise rates, but I happen to think they’ve already been implicitly operating with that framework for some time. And so I’m not convinced the world changes all that drastically. But nevertheless, do watch that for the month of October.

And then lastly, let me finish with modern monetary theory. And so, the idea behind that—and it’s gained some traction and popularity, particularly in the U.S. Democrat party—is to give the money printing controls to the government and take it away from the central bank. And whenever inflation is low, a government could print money and then spend that money on people and implement new spending programs. And, if inflation got too high, you could then cool the economy off by raising taxes. And so that’s the idea. Sort of attractive that governments could spend more money maybe. But I think there are some pretty big issues here.

And so, in practice, not clear that this sort of thing would work. There is a reason politicians generally aren’t given control of the money supply. They tend to be myopic; they want to be elected; they like to spend money; they’re not worried about 10 years from now. Certainly, there’s a history of problems from Weimar, Germany to Venezuela to Argentina to Zimbabwe to post-World War II China when governments did get control of the printing presses; they printed an awful lot of it and a lot of inflation resulted.

And you can think of it really as, if you print more money but the economy still makes the same amount of stuff, the price of things is going to go up. You’ve got more money chasing after the same amount of stuff. And so that really is the risk here.

I will say that, certainly, central banks have been printing a lot of money recently. So how come they get to, but governments don’t? I think it’s because it’s been a special situation. You’re doing that in recessions where the velocity of money is collapsing; you need more money sloshing around just to get a normal amount trickling out into the economy.

Central banks can pull back their money printing. They did much of that after the financial crisis; they will likely do that after this. You can’t pull back money that you’ve given to people and they’ve spent on food. That money is gone. It can’t be pulled back in the future.

And so, I’m not convinced modern monetary theory would work. I guess the good news, from my perspective at least, is I don’t think it’s very likely to be implemented either.

Okay. Why don’t I stop there? Hopefully you found some of that interesting. Thanks for tuning in, and I wish you the best with your investing.

For more information, read this week's #MacroMemo.


Publication date: October 5, 2021

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