Good morning,
While recession talk seems to have receded in some corners, 56% of CFOs surveyed recently expect a recession in the second half of 2023. One prominent economist agrees—and has a scalding take on how the Fed has mishandled the economy, not once but twice.
Steve Hanke, an economist who forged a 50-year career as a global “Money Doctor” advising heads of state and finance ministers, asserts a root cause of high inflation is how the Fed has handled the U.S. money supply. Hanke, a professor of applied economics at Johns Hopkins University, claims that "the Fed caused the inflationary burst by ignoring the money supply, while producing it in excess,” Fortune’s Shawn Tully writes in a new piece. Tully explains:
"Hanke is a leading champion of Monetarism, a field holding that changes in the money supply are the top force determining the rate of inflation and expansion or contraction in GDP. Milton Friedman, its most celebrated champion and a Hanke mentor, had the Monetarist formula for changes in its four components, MV = Py (money supply times velocity of money equals the price level times quantity of goods and services) emblazoned on his red Cadillac’s California license plate. As Friedman explained, 'Inflation is always and everywhere a monetary phenomenon, in the sense that it can only be produced by a more rapid increase in the quantity of money than in output.'"
“First, the Fed engineered an absolutely unprecedented explosion in M2 that Chairman [Jerome] Powell claimed would have no effect on inflation,” Hanke told Tully. He's referring to the surge in money supply at the height of the pandemic. “The Fed put up a smokescreen about the causes, all these non-monetary, outside factors that were supposed to be responsible for the soaring CPI. It was the COVID shock, the oil and OPEC shock, the war in Ukraine shock, the supply chain shock."
Hanke continues: "All of those things only affect relative prices, how prices of used cars, say, rise while the cost for appliances stay flat, not overall inflation which is all about the money supply. You have 785 economists in the Fed system, yet none that we know of predicted the inflationary outburst.”
Now the Fed is "overreacting," according to Hanke—"botching" the cure to inflation by "dismissing M2’s importance and squeezing too hard," Tully writes. A combination of the Fed’s high interest rates and the banks’ tightening of credit will eventually contract the amount of money consumers have available to spend, which will pummel M2, Hanke contends. He predicts a painful and unnecessary recession will result.
You can read more about Hanke’s analysis of the Fed’s actions leading up to this point, along with his assessment on the future of the economy here.
Sheryl Estrada
sheryl.estrada@fortune.com
