the money game

The Pain the Fed Is Inflicting Around the World Could Hit Americans Next

Illustration: Daniel Jurman

Recessions happen. The last one was the shortest on record, but what a blip: About one-sixth of the country lost their jobs over 60 days when COVID hit, and it could have been worse if not for a worldwide plan to subsidize everyone and everything. Twelve years had elapsed since the start of the prior recession — a jerky climb out of a Wall Street–made mess with a Wall Street–made bailout that, in turn, warped an anything-goes national psyche into a distrustful, paranoid one. Now another recession feels all but inevitable just as we’re totally out of faith in the government’s ability to do anything about it.

The economy today, propped up by stimulus and slowed by a pandemic, is weirder than it has been in decades. There are more jobs available than there are people to perform them, but thanks to inflation, nearly every facet of life outside the office has become increasingly unaffordable, making the point of work a little harder to articulate. The fixes for this range from the never gonna happen, like raising taxes on the wealthy, to the bleak, with the Federal Reserve taking further steps to deliberately downshift the economy. That would push more companies into bankruptcy and force more people into unemployment. Jerome Powell, the Fed chair, has referred to this as “pain,” which is apt enough, except that it elides the fact that his central bank is delivering targeted blows. Not everyone will suffer equally. For some, the worst of it will be higher interest payments. For others — typically the ones who can least afford it — it’ll be the loss of a job.

What makes this moment so extraordinary is that, whether the U.S. enters a recession or not, Fed-inflicted pain is already being felt on a global scale. Since March, the central bank has been hiking interest rates at a furious clip to strengthen the dollar and curtail inflation here. Essentially, that limits the flow of dollars around the world and makes borrowing them a more expensive proposition. Because most global trade is invoiced in dollars, especially for commodities like oil and food, nations with weaker currencies (which is to say just about all of them) are now having to pay a premium to obtain those essential goods. It has become such a crisis internationally that the U.N. Conference on Trade and Development has asked the Fed to knock it off with a report estimating that poor countries’ economic output will fall by $360 billion over three years just from the rate increases already made. So far, Fed officials haven’t given much indication that they care. Two days after the U.N. report, Mary Daly, the president of the San Francisco Fed, said more hikes were “necessary” to crush domestic demand. The Fed is an institution with two mandates set by Congress — keep employment high and inflation low — and neither of those goals encourages near-term concern for the exchange rates of other countries.

The problem is that, eventually, dominating other currencies could come back to hurt us. The world was already at risk of a broad economic decline thanks to Russia’s invasion of Ukraine and China’s COVID isolation policies clogging up trade and finance lines. (Even the U.K., ordinarily thought to be a pretty stable economy, was forced into emergency maneuvers in late September to address panic in its bond market.) The more that countries have to pay to transact in dollars, the more likely they are to become insolvent. Brent Johnson, the CEO of the financial-advisory firm Santiago Capital, predicted this phenomenon years ago. “As that dynamic worsens, there starts to be a rise in global defaults,” he told me recently. “Once these defaults start to happen, it can have a knock-on effect, which creates more defaults and more financial volatility and more contagion. And now with global growth slowing, they are all hitting the wall. They don’t have the cash to make those dollar-denominated payments that just keep rising in their local currencies.”

In Johnson’s analysis, there’s an even worse way the Fed’s 2022 playbook could backfire: As the supply of dollars shrinks, investors around the world could turn to other major currencies as a baseline for trade. China could take steps to make the yuan more attractive as an alternative, or a basket representing some combination of euro, sterling, and gold could emerge. That scenario is somewhat remote, with U.S. influence still strong around the world and technical hurdles to overcome, but even a relatively small adoption of dollar substitutes would have world-historical repercussions. “Whatever that transition to a new system looks like,” Johnson said, “it will probably be violent, both economically and militarily.”

If we’re embarking on a disaster, there may be no way to change course that wouldn’t risk calamity of a greater magnitude. Powell’s immediate predecessors, Ben Bernanke and Janet Yellen, flooded the world with cheap debt after the 2008 financial crisis. When they sought to tighten the economy, investors revolted, and central bankers relented each time. Through a combination of their missteps and his own, Powell is essentially locked into a path of continuing to raise rates. He has already established a reputation as someone who misread the markets; he dismissed early signs of inflation last year as “transitory,” and by his own admission he was too optimistic about COVID vaccines being an economic panacea. Until March, his Fed was still propping up the markets with its largest-ever program of buying corporate and government debt — some $6 trillion of it. His volte-face since then includes the fastest pace of rate hikes in 40 years. If he abandons the strategy now, it could create a window for more inflation to return and damage the authority of what’s supposed to be the biggest, soberest, and most consequential player in international markets.

As Mohamed El-Erian, the former CEO of bond giant PIMCO and the current president of Cambridge’s Queens’ College, recently told my colleague Jen Wieczner, “I don’t think they can stop now because their credibility is so damaged that, if they were to stop now, people would immediately say, ‘This is the Federal Reserve of the 1970s. This is the flip-flopping Fed, and we will have prolonged stagflation.’ And if people start believing that, they will behave in such a way that will produce prolonged stagflation.” If you’ve forgotten that particular Carter-era portmanteau, it’s high inflation plus high joblessness plus a lifeless economy.

El-Erian thinks it’s remotely possible that Powell can avoid a recession. He’s not the only one. The argument for optimism is that Americans are still spending money, employment remains high, and no market has yet broken. Economists across Wall Street have been making the case for believing in a “soft landing” that could tame inflation without wider economic turmoil. But in moments like this, I tend to think of a prayer I learned in Catholic school. You’ve heard it: “Grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.” After reciting it a few thousand times — something I imagine Powell, a Jesuit-school graduate, might also have done — I realized something. There’s a reason people call it the Serenity Prayer and not the Courage Prayer or the Wisdom Prayer. More often than we’d like to admit, we’re just boxed in.

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