As It Barrels Ahead, Is the Fed Flirting With Disaster?

The stock market has rallied nearly 9% over the past two weeks, proving that even in this grimmest of seasons, hope springs eternal. The hope, in this case, rested on the suggestion by Mary Daly, the President of the Federal Reserve Bank of San Francisco, and member of the Federal Reserve’s rate-setting Federal Open Market Committee, that the Fed should begin to consider how and when to reverse course from its unrelenting drive to push the nation’s economy into recession. It is on such modest suggestions that market rallies hinge these days.

For months now, the Governors of the Federal Reserve have insisted that they would not be deterred from raising interest rates until there is strong evidence that inflation is coming down, and since the release of the inflation numbers for September, the Fed has been barreling toward another large increase in interest rates. Then, seemingly out of the blue – with no particularly positive news on the inflation front to point to – a few Fed Governors started whistling a different tune. Perhaps, Fed Vice Chairwoman Lael Brainard suggested in a speech in Chicago on October 10th, they should act more judiciously, and pause to see the effect of the steps the Fed had already taken. This was not a radical suggestion. After all, as any student of monetary economics could tell you, it will take time to gauge the full impact of the steps that the Fed has already taken to tighten the screws. 

Surely, the Fed Governors all know this to be the case, as the existence of a time lag between monetary policy actions and outcomes – generally viewed to be in the range of nine months to two years – is axiomatic. And Fed Chair Jerome Powell, Lael Brainard, and their colleagues have experienced this time lag first hand, as the inflation they are fighting today is at least in part a product of the actions they themselves took two years ago, when they increased the money supply by trillions of dollars to keep the economy afloat in the wake of the Covid pandemic.

If, in their zeal to prove themselves equal to the task of preventing a 1970s-style inflationary cycle – and perhaps along the way sidestep blame for a mess at least in part of their own creation – Fed Governors lost sight of that most basic truth of monetary economics, it was thrown in their face by a meme that rocketed across the financial community even as Vice Chair Brainard was speaking in Chicago. Sometimes, when people are closeted in their own information bubble and immune to reasoned discourse, ridicule can wake them up. And so it was when market analyst Peter Boockvar gave up debating the nuances of monetary economics and offered instead “The Weed Gummy Theory” to explain the seeming inability of the Fed Governors to consider the risks they are running as they continue to raise interest rates without pausing to assess the impact of their actions. 

According to Boockvar, the Fed is like “an eager but inexperienced consumer of weed gummies, which, notoriously, take longer than anyone expects to kick in… In other words, we may find ourselves in 2023 doing the macroeconomic equivalent of curling up in the fetal position on the couch, murmuring to no one in particular that that last gummy was too much, man.”

If Boockvar’s parody helped some here at home understand the risks inherent in the pace of Fed rate hikes, the rest of the world has not needed weed analogies to understand the potential adverse impacts from the pace of Fed rate hikes, as the Fed actions to date have already ignited a tsunami of consequences across the rest of the world.

As the Fed pushed interest rates upward over the past six months, it has shifted the flows of capital across the world into the U.S. dollar and out of other currencies. As illustrated in the graph below, Fed interest rate hikes since the beginning of the year have triggered declines of 20% or more in the value of other currencies. Among other consequences, the dramatic rise in the value of the dollar has amplified the inflationary impact of increases in the cost of energy and agricultural commodities caused by Vladimir Putin’s war. Because those commodities are priced in dollars, inflation in those countries now reflects both the higher cost of the commodities on world markets, as well as the cost of converting their currency into dollars. As a result, inflation across much of the world is higher than it is here at home, in part due to the actions of the Fed: CPI inflation in the U.S. remained just over 8% in September, but it has reached 11% in the European Union, while in Egypt, one of the world’s largest consumers of Ukrainian and Russian agricultural products, it now stands at 15%. 

The response of central banks across the globe has been swift, as they have found themselves forced to raise interest rates, both to mute the inflationary impact of the rise in the dollar, and to stem the pace of capital flight. The result has been that central banks in countries that had barely rebounded from Covid-related recessions are now raising interest rates, with the likely consequence of throwing their local economies back into recession, and, ultimately, severely cutting back economic growth across much of the globe. 

It was not that long ago that Fed chair Ben Bernanke embraced the role of “central banker to the world” in the face of the 2008 global financial crisis. As the global financial system teetered on the verge of collapse, countries around the world looked to the United States for leadership, and the Federal Reserve in turn assured that resources were available to prevent the collapse of financial institutions across the globe. Two years ago, as the spread of Covid-19 similarly threatened to collapse economies across the globe, the Fed again stepped into the breach, assuring access to dollar reserves and liquidity for central banks around the world. 

This time, however, things feel different. It is fair to say that the Fed now finds itself between a rock and hard place. While Fed Chair Jerome Powell and Vice Chair Brainard publicly  acknowledge the impact of Fed policies on other countries, the persistence of domestic inflation and the emergence of inflation as the paramount focus of midterm elections seem to have left them with little wiggle room to moderate Fed policies with an eye to the impact on the world beyond our borders. Yet, it is the Fed’s singular focus on its domestic 2% inflation target that may yet bring a tsunami of unintended consequences to our shores.  

2% inflation has become synonymous in the public imagination with the “good old days.” However, like many things today that we have come to view as normal – double-digit annual stock market returns, a world awash in capital, and 3% home mortgages among them – the Fed’s 2% inflation target has not been around that long, and simply may not be a prudent objective. 

The Fed’s 2% target was established in 2012, four years after the introduction of zero and negative interest rate policies by central banks across the globe in response to the near collapse of the global financial system. It was a time when deflation, rather than inflation, loomed as the major threat to global economies. While inflation remained below 2% for the ensuing decade – leading people to see it as “normal” – there was little normal about it. Indeed, the last decade prior to the 2010s when inflation averaged 2% or lower was the 1950s. 

Even inflation in the range of 2.5 to 3% – the average rates of inflation during the 2000s and 1990s, respectively – may be an unrealistic target, as so many of the factors that enabled the past four decades of low inflation are quickly slipping away. Perhaps as much as any other factors, inflation in the 2 to 3% range over the past three decades was made possible by the fall of the Berlin Wall, the opening of China under Deng Xiaoping in 1978, and China’s entry into the World Trade Organization in 2001. 

Together, those events brought more than a billion people into the global, market-based economic system, and engendered a global competition in labor costs. Among the impacts of the ensuing process of global economic integration were the shipping of millions of American manufacturing jobs overseas and downward pressure on domestic wages, which together helped keep inflation in check. Now, with the combination of domestic (and global) labor shortages, support for trade unions at the highest level in 60 years, increased tensions with China, and post-Covid moves toward “onshoring” and “friend-shoring” of corporate supply chains, those trends appear to be reversing. 

Perhaps the Fed can succeed in pushing back against that tide. A restoration of stable, 2% inflation is achievable, former Treasury Secretary Larry Summers insists, through a deep and long recession of sharply elevated unemployment over several years. 

But Summers' suggested roadmap raises a second factor that the Fed cannot afford to ignore, which is the dependence of the United States on the support of nations across the globe, and the potentially catastrophic consequences of the Fed failing to take into account the impact of its actions on other countries. Since the Second World War, and in particular since the early 1970s, when the United States reached an agreement with the Kingdom of Saudi Arabia providing for the U.S. commitment to defend the Kingdom in exchange for the recycling of “petrodollars” into the U.S. economy, we have benefitted from the “exorbitant privilege” of living in a world where the dollar is the global reserve currency and trade is conducted in dollars. It is a privilege that for decades has protected the United States from consequences that other countries routinely face for running trade deficits, budget deficits, or, as we see today, being captive of inflation driven by escalation in value of a foreign currency. 

We have come to treat that privilege as an entitlement, yet it rests, spoken or otherwise, on the consent of the rest of the world. Should the Fed fail to take into account the distress that its actions are causing in other countries, and should a consensus emerge across the globe that our actions have become too nakedly self-interested, we should not be surprised to see a fraying of that consent. 

Over the past few weeks, we have been given a glimpse of what such an erosion of support might look like. Largely unreported outside of the financial press in recent weeks has been the sudden exit of major global buyers from the U.S. Treasury market, putting upward pressure on U.S. bond rates. Japan, which surpassed China in recent years as the largest holder of Treasury securities, has reduced its holdings by 10% over the course of this year, and stopped purchases of new securities, due to the high cost of hedging yen-dollar risk as the dollar has continued to rise. For its part, China has not been a net buyer of Treasury securities for more than a decade. Farther down the list, Russia, once among the largest holders of treasuries, completely exited the market following its annexation of Crimea in 2014, while Saudi Arabia's decoupling from its alliance with the US has trimmed its holdings by 50%.

The possibility of a continued dislocation in the Treasury market should shake people up, as the consequences of Treasury bonds falling out of favor globally would have significant domestic ramifications. Like the Fed’s 2% inflation target, the world of 2% to 3% long-term Treasury interest rates that we have come to view as “normal” over the past decade has been the exception, not the rule, and only came about in the context of the global recovery from the 2008 collapse. 

Yet, in its ten-year budget projections, the Congressional Budget Office continues to assume that Treasury yields will remain in the 2.9 to 3.8% range for the balance of this decade. Should, however, long-term Treasury yields return to the range of 5% to 7% – the rate environment that prevailed for the two decades preceding the 2008 collapse – the impact would be significant, as cost of interest on the national debt would rise from $350 billion last year to around $1.5 trillion five years from now, an amount exceeding the combined cost of Medicaid and Defense spending. 

As the Fed continues its single-minded pursuit of restoring 2% inflation, it may be pursuing an unsustainable goal, given the emerging trends in a de-globalizing economy. And as Peter Boockvar suggested, and much of the rest of the world already understands, it may be risking dramatic, unintended consequences for the world, and ultimately for us. Given the deterioration of our politics during what objectively have been the best of times, one can only imagine how we will manage should that outcome come to pass. 

Yet it could happen. While events may yet force a change in the Fed’s thinking – such as cascading defaults in emerging market countries, or perhaps growing political instability – the Fed appears to be undeterred. Perhaps, before a tsunami of adverse, unintended consequences reverberates back on our shores, someone should remind Jerome Powell that when Paul Volcker left office in August 1987, inflation was 4.7%, and it remained in the 5% range for the next two decades. While the Fed’s 2% inflation goal has acquired almost mystical significance, the single-minded pursuit of that objective may instigate reactions that will be far more difficult to control.

Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of "FedExit! To Save Our Democracy, It’s Time to Let Alabama Be Alabama and Set California Free."

Artwork by Joe Dworetzky.  Follow him on Twitter @joedworetzky or Instagram at @joefaces. And thanks to Damon Langlois https://www.damonlanglois.com/ for summing up our current state of affairs in his sandcastle sculpture of one-time Republican Abraham Lincoln.

The metamorphosis of Jerome Powell.

Federal Reserve Chair Jerome Powell finally won his war. 

No, not the fight against inflation, which has been front page news for months now. That battle has certainly been on Powell’s mind; but behind the scenes, a different war has been raging for the better part of the year, this one between the Federal Reserve and Wall Street. It has been the battle to convince the elite cadre of professional money managers and stock and bond traders whose decisions drive markets on a day to day basis that Jerome Powell is the second coming of Paul Volcker – the legendary Fed chair who crushed post-Vietnam War inflation by boosting interest rates well into double digits and casting the nation into a deep recession. And it has been a titanic struggle, with trillions of dollars and Powell’s legacy on the line. 

For decades now, Wall Street traders and deep-pocketed investors have come to rely on the Fed to step in and make sure that stock market downturns, when they happen, do not get out of hand. Dating back to Alan Greenspan’s appointment as Fed chair in 1987, the Fed has been enamored of the “wealth effect,” which suggests that the Fed should step in – meaning reducing interest rates and pumping money into the system – should stock market declines hit the 20% threshold, or thereabouts. The notion was that it was in the broad public interest to make sure that the loss of wealth among the investor class did not become severe enough to adversely impact the rest of the economy. 

The wealth effect, in other words, was essentially trickle-down economics stood on its head: if a rising tide was presumed to lift all boats – a core tenet of modern capitalism – it only made sense that rough seas could sink all boats. And from such logic was birthed the Greenspan “Put” – a term that encapsulated the belief on Wall Street that when push came to shove, the Federal Reserve would step in to stem market losses (in the manner of a “put” option, a type of investment product that can insulate investors from declines in the price of a stock). 

Over the ensuing decades, belief in the Greenspan Put (subsequently renamed the “Fed Put” as Greenspan’s policies were embraced by subsequent generations of Fed leaders) has been pervasive. Indeed, Jerome Powell made his bones as Fed chair by his remarkable performance in early 2020, when stock markets were collapsing as the implications of the novel coronavirus first became apparent. Faced with deepening market turmoil, Powell drew from the playbook created by then-Fed chair Ben Bernanke in response to the 2008 global financial crisis, and used all the tools at the Fed’s disposal to keep money flowing through the economy.

And it worked: in the wake of a 30% decline in the S&P 500 from mid-February to early-March 2020, the Fed moved aggressively to stabilize the financial markets. By the end of May, the stock market declines had largely been reversed, and even as Covid-19 shutdowns wrecked havoc across the economy, the flood of liquidity pumped into the system by the Federal Reserve marked the beginning of a new bull market, and bond and stock markets alike soared to new historic highs. 

While the Fed’s performance in 2020 was widely hailed, it set the stage for the struggle between Powell and Wall Street that played out over the course of the past year. When inflation emerged as the new scourge facing the country, Jerome Powell pivoted from the Ben Bernanke playbook and sought to remake his identity as a stern inflation-fighter in the model of Paul Volcker. But as much as he tried to insist that the era of the Fed Put was over, stock and bond traders did not buy it. Instead, they took Fed interest rate hikes this year in stride, and every time Powell or one of his colleagues on the Fed Board of Governors went public to insist that they were serious about pushing up interest rates to tackle inflation, a day or two of market losses were inevitably followed by market rallies, as traders remained confident that when the time came, the Fed would reverse course and bring interest rates back down. 

After a battle that continued back and forth for most of the year, Powell finally prevailed two weeks ago. With the Fed’s latest three-quarters of a point hike in interest rates, and continued quantitative tightening (Fed-speak for selling long-term bonds to force long-term interest rates higher) pushing mortgage rates to the highest level since before the 2008 financial collapse, traders threw in the towel. Bond and equity markets tumbled, and market indicators turned broadly negative, suggesting a widespread expectation that the economy will experience a recession of some duration, and that the Fed will not pivot to bring interest rates back down until 2024 at the earliest. 

If Jerome Powell had a credibility problem, it was of his own making. He came late to the conviction that inflation was a problem that needed to be tackled with strong medicine, as for most of 2021 he argued that inflation was a “transitory” problem that would resolve itself in time. But the irony of his efforts to channel Paul Volcker as his inflation-slaying role model ran far deeper. 

After all, Volcker was picked to lead the Fed by Jimmy Carter to tackle inflation that had become a chronic problem in the wake of the sustained expansion of the money supply by the Fed over the decade preceding Volcker’s appointment. The pattern of double-digit growth in the money supply that Volcker inherited is highlighted in the graph here, which tracks the “M2” supply of money in the economy against inflation, as defined by the Consumer Price Index. At the far right side, the graph also illustrates the far more dramatic growth in the money supply in 2020, when the Fed’s coronavirus response led to a massive increase in the money supply. 

The expansion of the money supply under Powell’s leadership had no precedent in recent history. As much of the country shut down in 2020, the Fed pumped $5 trillion into the economy, ultimately resulting in a 40% increase in the money supply. By way of comparison, in the wake of the 2008 financial collapse, the increase in the money supply barely exceeded 10% in any one year. In the view of monetarists – economists who view growth in the money supply as the most important factor leading to inflation – it was only a matter of time before this massive increase in the money supply impacted price levels across the economy. In simple terms, they would argue that Jerome Powell is now fighting a problem of his own making. 

Yet over the course of the Fed’s battle with inflation, Powell has had little or nothing to say about the expansion of the money supply on his watch. When questioned during Congressional hearings in early 2022 on the potential consequences of the substantial expansion of the money supply in 2020, Jerome Powell demurred. In the new world order of financial innovation, he argued, the linkages between the money supply and inflation is no longer as clear as it once was. Instead, in testimony before the Senate Banking Committee he embraced the widely held view that current inflation had been unleashed by the combination of the impact on energy and commodity prices of Putin’s invasion of Ukraine and global supply chain disruptions caused by the Covid-19 pandemic. 

Powell’s ardent advocacy for expanding the money supply to address the coronavirus problem made his subsequent insistence for much of 2021 that inflation was a “transitory” problem that would go away of its own accord all the more puzzling. Traditionally, there is a considerable time lag between monetary policy actions taken by a central bank, and when the impact of those actions ripple across the economy – whether those efforts are targeted at stimulating the economy, which the Fed sought to do by expanding the money supply in 2020, or stemming inflation as it is now seeking to do. And the emergence of inflation in the second quarter of 2021 appeared to be a case in point, as the first surge in the rate of inflation – 2.6% to over 5% from March to July 2021 – came right within the nine to eighteen month time lag that monetary economists would predict from when the Fed began expanding the money supply in early 2020, to when it began to impact price levels. Whatever other factors were present – Putin’s war and global supply chain issues – it is hard to imagine that as a central banker responsible for monetary policy, Powell would not have expected that increasing the money supply by 40%, as the Fed did in 2020, would not have some degree of inflationary impact a year or two down the road.

Jerome Powell is an enigma. Four years ago, in a quieter moment, he compared Fed policy making to walking through a room full of furniture in the dark, “What do you do? You slow down. You stop, probably, and feel your way.” Managing a complex modern economy with the blunt tools available to a central banker, his words suggest, is an art, as much as a science, complicated by the long lag time between actions and effect. 

Then the crises hit. First Covid-19, and then inflation, and that notion of feeling your way along seemed to have fallen by the wayside. In 2020, the previously stoic, cautious Jerome Powell morphed into a sort of Ben Bernanke on steroids, as his notion of carefully feeling his way along gave way to an aggressive “go big, go fast” philosophy, and a 40% increase in the money supply – four times the rate of growth Bernanke oversaw in 2008. Now, having embraced his Volckerian persona, Powell has again left his “slow down, feel your way” stance in the rearview mirror. Once again, it is pedal-to-the-metal, just heading in the opposite direction this time.

History may not treat Powell well. Interviewed last week, long-time Wall Street wizard Carl Icahn offered a harsh retort to Powell’s newfound embrace of Paul Volcker, as Icahn compared the Fed’s expansion of the money supply in 2020 to the debasement of the currency that brought about the fall of the Roman Empire. Others fear that in his zeal to tighten the economic screws, there is a real possibility that Powell will overshoot to the downside this time, and leave the nation trapped in a deflationary spiral. 

In the end, it is not the extremes of Powell’s actions that are difficult to comprehend, as the challenges he has faced are truly historic, but the refusal to acknowledge the potential unintended consequences of his actions, as the nation is whipsawed from one crisis to the next. Perhaps this will not be the end of the world as we know it, as Icahn suggests, but while Jerome Powell continues to try to reframe his persona in the heroic image of Paul Volcker, a more apt analogy may be the arsonist who hops on the fire truck and seeks to lead the effort to put out the blaze, hoping beyond hope that no one will notice the box of matches in his back pocket.

Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of "FedExit! To Save Our Democracy, It’s Time to Let Alabama Be Alabama and Set California Free."

Artwork by Joe Dworetzky.  Follow him on Twitter @joedworetzky or Instagram at @joefaces. 

Today’s inflation is a harbinger of changes that lie ahead

 Inflation is widely viewed as the number one problem facing the country – even Donald Trump’s continuing efforts to relegate American democracy to the dustbin of history takes a distant back seat – and barely a quarter of the public apparently believe that the Inflation Reduction Act passed by Democrats in Congress will do anything to help get inflation under control. And when the federal Bureau of Labor Statistics – the official inflation record-keeper – published data for July that indicated that the annual rate of Inflation had dipped to 8.5% – down from 9.1% in June – people just shrugged. 

After all, at 8.5%, the year-over-year rate of inflation for July remained the highest rate since December 1981 – except, of course, for the 9.1% rate in June. But it was a big deal, and may well turn out to have been a sign of things to come. Why? Because while the 8.5% rate of inflation was the composite of the preceding 12 monthly rates, the rate of inflation for the month of July actually came in at zero. 

For anyone who has filled up their gas tank recently, this should not have come as a surprise. After all, while global oil prices peaked this past March at $120 per barrel in the wake of Vladimir Putin’s invasion of Ukraine, and the price of gasoline peaked two months later at over $4 a gallon nationwide, oil and gasoline prices have each declined by 25% from those peak levels. 

And it’s not just gasoline prices that have come back down. The price of wheat, which was similarly impacted by the war in Ukraine, nearly doubled in March, but has since fallen back to where it was last year. Lumber and eggs, prices of which made headlines as inflation surged, have each tumbled 70% and 50%, respectively, from their peaks. Even the cost of air travel is coming down. 

And financial markets have taken notice. Market expectations of the rate of inflation over the next five to ten years – calculated by comparing the trading relationships between traditional fixed-rate US Treasury securities and “inflation-indexed” securities – have fallen back to 2.5%, just a bit above the Federal Reserve Bank’s 2% target.

Arguments abound about the confluence of events that have brought inflation roaring back to 1970s levels. Putin’s invasion of Ukraine upended global markets for oil and natural gas, as well as agricultural commodities. Covid-19 has had wide ranging impacts, roiling labor markets at home and global trade abroad. Millions of Americans, who may have previously given little thought to business or economics, have been forced to grasp the implications of “global supply chains.” 

And there are those who reject all of those factors, and assert instead that the singular cause of the sudden spike in inflation was the massive printing of money by the Federal Reserve Bank in the face of the collapse of economic activity at the onset of the coronavirus pandemic. This view – held by “monetarists,'' a school of economics that argues that inflation is primarily a function of money supply – is straightforward. As the economic activity shut down in early 2020, the Fed responded by flooding money into the economy with the hope of forestalling an economic collapse. Once the Fed did that, it was only a matter of time before that flood of new money flowing through the economy drove up prices. Forget Putin’s war and global supply chains; inflation, in the monetarist view, is simply about the money.

We may never know whose explanations are correct, but we will know in a few short weeks if the zero percent rate of inflation in July is matched again in August, and whether the evidence begins to suggest that inflation is indeed moderating. But whichever way it turns out, the impacts of the war, the pandemic, and the Fed’s printing of money may only be the first chapters in a larger inflation story.

As we debate the causes and trajectory of inflation today, the common expectation is that it will in relatively short order be brought back down to the 2% range, as reflected in financial market expectations. After all, low inflation has been with us for decades now, dating back to Fed Chairman Paul Volker’s determined success in taming post-Vietnam War inflation.

But an essential underpinning of the low inflation environment that we have come to take for granted since the 1990s was the fall of the Berlin Wall, the end of the Cold War, and the steady integration of Russia, China and other nations into the world economic order. Since the end of the Cold War, US foreign policy toward our Cold War adversaries has been built around a military policy of containment – implemented through regional military alliances – coupled with economic policies promoting rule-based, free trade and global economic integration, generally referred to as globalization. While economists disagree on the extent of the impact of globalization on inflation, it is generally viewed as having kept inflation in check by engendering global labor competition that suppressed wage growth and reduced the costs of manufactured goods. 

Enthusiasm over the entry of China and Russia into the World Trade Organization went beyond the potential economic benefits. In his 2005 book, The World is Flat, Thomas Friedman argued that free trade and economic interdependence would be the key to preventing future conflicts. In what he dubbed the "Dell Theory of Conflict Prevention," Friedman argued that "No two countries that are both part of a major global supply chain, like Dell’s, will ever fight a war against each other as long as they are both part of the same global supply chain." And others took the geopolitical case for globalization a step further, arguing that economic integration would necessarily bring in its wake political liberalization in Russia and China and other, smaller, authoritarian countries.  

Over the past decade, in events that foreshadowed what we have watched over the past year, Friedman’s theory was dealt severe blows, as Russia and China each demonstrated that rather than economic interdependence moderating their behavior in the world, it would be used as a weapon against their trading partners. 

In China’s case, in 2012, during the months leading up to Xi Jinping’s appointment as General Secretary by 18th Central Committee of the Chinese Communist Party, anti-Japanese demonstrations spread across China, ostensibly related to a dispute over uninhabited islands held by Japan, and Japan’s occupation of China in the 1930s. In response to the public outcry, and in violation of WTO rules, China halted the sale of critical rare earth metals that were essential to Japan’s electronics industries. The Japanese government has since warned Japanese companies of the political risks of investing in China and relying on it as a supply chain partner, and Japanese investment in China is now less than its investment in most other, far smaller, Asian nations.

For his part, Vladimir Putin has proven adept at using the dependency of European nations on Russian natural gas as a weapon in international affairs. In 2014, he cowed European nations into quietly acquiescing to his first war with Ukraine and annexation of Crimea out of fear that Russia would shut off natural gas supplies. 

When Xi Jinping and Vladimir Putin met in Shanghai on the eve of Russia’s invasion of Ukraine, they effectively put a nail in the coffin of the Dell Theory. In a paraphrasing of Tip O’Neil’s dictum that “all politics is local,” they declared in no uncertain terms that the pursuit of national interest – which really meant their own political interest – would henceforth prevail over whatever rules of conduct the United States and other nations might seek to impose. Ukraine and Taiwan were clearly in the cross-hairs, economic interdependence be damned. 

Three months after the Shanghai declaration, no doubt shaken by the harsh western sanctions levied against Russia in response to Putin’s invasion of Ukraine, Xi sought to tamp down rising geopolitical tensions and focus international attention instead on solidifying and expanding trade under the auspices of the WTO. 

But the horse had already left the barn. This past June, Apple Computer announced plans to diversify production away from China, notably to Vietnam, as well as India and Brazil. Apple’s decision mirrored recommendations from the Biden administration a year earlier that companies carefully consider geopolitical risk exposure in order to increase the resilience of their global supply chains. 

In the wake of Apple’s announcement, the words “Reinventing Globalization” were emblazoned across the cover of The Economist, and the magazine editorial observed that Apple’s migration away from China is becoming the norm, rather than the exception: “The pandemic and war in Ukraine have triggered a once-in-a-generation reimagining of global capitalism in boardrooms and governments… This new kind of globalization is about security, not efficiency: it prioritizes doing business with people you can rely on, in countries your government is friendly with.”

With the devastation of Ukraine continuing unabated, and Xi’s Taiwan rhetoric escalating by the day, advanced industrial nations that have long promoted unfettered globalization now have been given a clear vision of its downside: A move by China against Taiwan, which Xi appears to be suggesting is inevitable, if not imminent, would wreak havoc on the global supply of critical semiconductors. In the near term it would force the shutdown of Taiwan-based TSMC – the world’s largest supplier of advanced microchips – and, should China succeed, it would leave a geopolitical adversary in control of 90% of global advanced chip production. 

Globalization has always been a two-edged sword. In purely economic terms, the global search for low cost labor and profit maximization engendered an era of economic growth and the low inflation world that we have come to take for granted. Along the way the outsourcing of production from advanced economies to emerging economies across the globe contributed to a dramatic reduction in the percentage of the world population living in extreme poverty, most notably in India and China. 

But globalization did not come without costs. Here at home, placing American workers in direct competition with low wage workers across the globe eviscerated the manufacturing heartland of the United States. It contributed to the rising tide of income inequality. And, as exemplified by Donald Trump’s rise as the avatar of the aggrieved American working class, it ultimately contributed to the fracturing of our political system, and shredding the image of the United States as a beacon of democracy in the world. 

As we wait to see what lies ahead in the inflation reports for the next few months and learn whether this round of inflation is behind us, under the radar screen of much of the media, a reconfiguration of the global economic order is underway that could have far more lasting ramifications than the rate of inflation from one month to another. The era of globalization, characterized by the global search for low cost labor and profit maximization above all other considerations, is clearly coming to an end. The question that remains, as the editorial in The Economist asked, is whether the next era of globalization, which prioritizes security over efficiency, and doing business with people and nations you trust, can be accomplished without a new descent into protectionism and worsening inflation.