No "Soft Landing" Is Possible For An Economy Already In Recession
No "Soft Landing" Is Possible For An Economy Already In Recession
The Only Operative Question Is How Hard Will The Crash Be?
US Treasury Secretary Janet Yellen has drunk way too much of the Wall Street Kool-Aid, and now thinks the Federal Reserve will engineer a “soft landing” for the US economy with its fight against persistent consumer price inflation.
“I see a soft landing as being a possible outcome and the one that I hope we will be able to achieve,” Yellen said. “The economy is fundamentally in good shape, and inflation is coming down if you measure it on a 12-month basis.”
St. Louis Federal Reserve President James Bullard expressed similar opinions after chugging a similar amount of Wall Street Kool-Aid.
Bullard at a conference in Columbia University, New York, said that a “soft landing is feasible in the U.S. if the post-pandemic regime shift is executed well.” He shared a similar level of optimism earlier this year.
Both get their “soft landing” optimism from their misguided belief that the US Economy is strong and robust, rather than weak and stagnating.
First, we must understand what economists mean by a “soft landing”, as opposed to a “hard landing.”
A “soft landing
” occurs when a country’s central bank raises rates just enough to bring or keep inflation under control, and manages to only slow the economy down as opposed to tipping it into a recession.A soft landing, in economics, is a cyclical slowdown in economic growth that avoids recession. A soft landing is the goal of a central bank when it seeks to raise interest rates just enough to stop an economy from overheating and experiencing high inflation, without causing a severe downturn. Soft landing may also refer to a gradual, relatively painless slowdown in a particular industry or economic sector.
Similarly, a “hard landing
” is just the opposite scenario: a country’s central bank raises interest rates too high too fast and tips the economy into a significant if not severe recession.A hard landing refers to a marked economic slowdown or downturn following a period of rapid growth. The term "hard landing" comes from aviation, where it refers to the kind of high-speed landing that—while not an actual crash—is a source of stress as well as potential damage and injury. The metaphor is used for high-flying economies that run into a sudden, sharp check on their growth, such as a monetary policy intervention meant to curb inflation. Economies that experience a hard landing often slip into a stagnant period or even recession.
For obvious reasons, it is the objective of every central bank head—including Federal Reserve Chairman Jay Powell—to engineer soft landings when tinkering with monetary policy. A prevailing strain of thought both in Washington and on Wall Street is that Powell might actually succeed in guiding the US economy to a soft landing.
Some even flirt with the possibility that the US economy will manage to avoid any sort of slowdown or recession at all—a “no landing” scenario.
The risk is a “no landing” scenario, which would mean more downside for U.S. stock and credit markets because it will force the Federal Reserve to raise its benchmark interest rate higher than market participants or central bankers currently expect, said Torsten Slok, chief economist and partner at Apollo Global Management, in a phone interview on Tuesday.
The Federal Reserve’s efforts to slow the economy and bring down inflation are often likened to landing a jumbo jet, with economists and Fed officials frequently talking of the effort to achieve a “soft landing” as opposed to a “hard landing.” A “no landing” scenario implies that an economic slowdown can be avoided or at least delayed, though with the risk of a later reckoning as the Fed continues tightening monetary policy.
The benefits of this scenario are problematic, however, as it necessarily implies that the Fed continues to tighten and raise interest rates indefinitely.
Other economic observers argue that, as the economy is already slowing down, the “no landing” option is already off the table.
So all good and its back to the brandy, eh? Perhaps not. The macro news has indeed given some cause for cheer relative to some of the more dour scenarios we’ve been looking at in the past few months. We’ll take the best unemployment rate since before the 1969 moon landing, for sure. But “no landing” is a misleading sentiment. The economy is starting to slow down – that is evident from the vast majority of corporate management calls we’ve been tracking this earnings season. It’s a question of when, not if.
Certainly there are plenty of reasons to doubt both the “no landing” and the “soft landing” outcomes.
For starters, household debt is at a record $16.9 Trillion, according to the New York Federal Reserve Quarterly Report on Household Debt And Credit
.
At the same time, delinquency rates are increasing for nearly all forms of household debt.
These high debt loads, the service of which is increasingly problematic, have been fueling a large portion of nominal retail sales growth during the past year, but the bulk of that growth has been due to inflation.
Whether the economic slowdown turns into a recession or not, and if so for how long, depends mainly on consumer spending as that single metric accounts for nearly 70 percent of total GDP. When we look at where companies have been showing sales growth for the past twelve months, much of it has come from pricing power. Sales is a function of volume and price; how many units of something you sell, and at what price. For many companies especially in the consumers goods space, that function has largely gone as follows: we sold fewer units but we sold them at higher prices, so the net effect was that our sales grew. Customers happily (or maybe grudgingly but still willingly) paid whatever price was on tap.
As a direct consequence, real sales ex inflation have been either flat or declining throughout 2022.
Moreover, those high debt loads mean an increasing proportion of retail sales have been funded with debt. This is the inevitable consequence of the relative growth in credit card debt exceeding the relative growth in retail sales for all of 2022.
Unfortunately for vendors, delinquency rates are increasing along side the debt.
Eventually, rising delinquencies must choke off inflation-fueled increases in sales, even if nothing else is done to alter the economic outlook (e.g., raising interest rates).
These trends are strong arguments that there will be a “landing” for the US economy, and it will not be a soft one.
It is data such as this that has led one Wall Street economist, David Rosenberg, to conclude the “no landing” scenario is nothing but a “hoax”.
Rosenberg also argues the economy is already in recession.
As readers of this Substack already know, that the US economy is experiencing an ongoing and worsening stagflationary recession is an argument I have made more than once.
Moreover, in a white paper presented at the US Monetary Policy Forum
on February 24, economists Stephen G. Cecchetti, Michael E. Feroli, Peter Hooper, Frederic S. Mishkin, and Kermit L. Schoenholtz argue central banks have never successfully tamed consumer price inflation without causing a significant recession.What do history and a simple model teach us about the prospects for central bank efforts to lower inflation to target from recent multi-decade highs? To answer this question, we start by analyzing the large disinflations that occurred since 1950 in the United States and several other major economies. Then, we estimate and simulate a standard model over several time periods, using various linear and nonlinear measures of labor market slack. We draw three main lessons from the analysis: (1) there is no post-1950 precedent for a sizable central-bank-induced
disinflation that does not entail substantial economic sacrifice or recession; (2) regardless of the Phillips curve specification, models estimated over a historical period that includes episodes of high and variable inflation do a better job of predicting the post-pandemic inflation surge than those estimated over the stable inflation period from 1985 to 2019; and (3) simulations of our baseline model suggest that the Fed will need to tighten policy significantly further to achieve its
inflation objective by the end of 2025. Going forward, our analysis supports a return to a strategy of preemptive policy. We also argue that raising the Fed’s inflation target is a misguided alternative to incurring the sacrifice needed to achieve the 2 percent target.
The Cecchetti white paper is important because the research team looked at disinflation scenarios beyond those in the US, and no central bank in any of the countries scrutinized made significant disinflation happen without a significant recession along the way. Disinflation via recession is the historical norm.
Thus the current data and the history of central banking since WW2 come together to issue a compelling rebuttal to Janet Yellen’s “soft landing” optimism.
Against that history especially, the prevailing rebuttal by the Federal Reserve is little more than “this time is different.”
That was the explicit conclusion of Federal Reserve Governor Phillip Jefferson in his response
to the Cecchetti white paper.The current situation is different from past episodes in at least four ways. First, the pandemic created unprecedented disruptions to global supply chains. Second, the pandemic is having a long-lasting effect on labor force participation rates. Third, the credibility of the central bank is higher now than it was in the 1960s and 1970s. Fourth and most importantly, unlike in the late 1960s and 1970s, the Federal Reserve is addressing the outbreak in inflation promptly and forcefully to maintain that credibility and to preserve the "well anchored" property of long-term inflation expectations.
Moreover, one point cannot be stressed often enough: Recession is the ultimate goal of the Federal Reserve’s strategy of interest rate increases, and always has been. Janet Yellen might choose to overlook this reality, but we know this because Federal Reserve officials, such as Richmond Federal Reserve President Tom Barkin, have said as much quite explicitly.
However, further on down, Barkin said the quiet part out loud about what “whatever it takes” really means (emphasis mine).
Barring an unanticipated event, I see rising rates stabilizing any drift in inflation expectations and in so doing, increasing real interest rates and quieting demand. Companies will slow down their hiring. Revenge spending will settle. Savings will be held a little tighter. At the same time, supply chains will ease; you have to believe chips will get back into cars at some point. That means inflation should come down over time — but it will take time.
Let that bit sink in. The reason rate hikes “work” to cure inflation is that rising interest rates make the cost of credit (aka, the “cost” of money) too high for consumers to utilize. Consumers are forced to spend less. Along the way, a few jobs are wiped out, a few workers are laid off, and eventually prices come down.
Fed Chairman Jay Powell himself delivered substantially that same message at last year’s Jackson Hole symposium.
The way interest rate hikes tame inflation has always been by triggering a recession. That is exactly how the process works. That is how the process worked during Paul Volcker’s tenure as Fed Chair and that is exactly what the Federal Reserve has stated time and again. Contrary to Fed Governor Phillip Jackson’s rather pollyannish belief, this time is no different than the last.
Even if the history of disinflation episodes offered some encouragement for the “soft landing” scenario, that option is confounded by the reality that the Federal Reserve has lost whatever control over consumer price inflation it ever had.
The Federal Reserve’s strategy of rate hikes has been losing forward momentum even on interest rates—its increases in the Federal Funds Rate have since November produced only minimal upward movement on Treasury bills.
Even if the economy were not already in a recession, and even if the Federal Reserve were not actively planning on causing a significant and severe contraction in the economy, we would still be staring at a “hard landing” outcome simply because the Fed does not have a handle on its own strategy.
How much harder the landing then, given that the economy already is in recession, and the Federal Reserve is actively planning on making that recession worse?
Barring a miracle, we may be confident of this much: the US economy is heading for a very hard landing, in the form of a deep and potentially long-lasting recession.
It is pointless to talk of a “soft landing” for the economy, of somehow avoiding a recession, when the Fed insists on a recession. It is absolutely silly to speak of avoiding a recession when the economy is already in recession.
Greenwald, I. Soft Landing: Definition and History in Economics. Investopedia. 17 Nov. 2022, https://www.investopedia.com/terms/s/softlanding.asp.
Chen, J. Hard Landing. Investopedia. 26 Apr. 2022, https://www.investopedia.com/terms/h/hardlanding.asp.
Quarterly Report On Household Debt And Credit. New York Federal Reserve. Feb. 2023, https://www.newyorkfed.org/microeconomics/hhdc.html.
Cecchetti, S. G., et al. Managing Disinflations. US Monetary Policy Forum, New York, 24 Feb. 2023. Conference Presentation. http://www.chicagobooth.edu/research/igm/USMPF/USMPF%20Paper.
Jefferson, P. N. Speech by Governor Jefferson on Discussion of the Paper “Managing Disinflations.” US Monetary Policy Forum, New York, 24 Feb. 2023. Conference Presentation. https://www.federalreserve.gov/newsevents/speech/jefferson20230224a.htm.