Those demand leakages drove up the last year’s trade deficit by 7.7 percent to $810 billion — an event that should infuriate the president who promised to stop, and reverse, such a worsening decades-old trend. And, in view of the president’s past rhetoric, it seems particularly galling that China’s $375 billion surplus (an 8.1 percent increase from 2016) accounts for nearly half of America’s widening trade gap.
Markets don’t need perfect foresight to see that the growing excess demand coming down the pike will inexorably lead to rising inflation and increasing budget and trade deficits. They also know that an avalanche of American public debt issues will follow.
Now, please note: That is not a one-off event; that is a process of changing growth, inflation and deficit dynamics driven by an explosive policy mix.
With that in mind, those expecting a quick return to steadily rising asset values may wish to think again.
Indeed, the Fed’s long hesitation waltz must now give way to an accelerating pace of policy restraint to “normalize” the credit stance, and to balance out the policy mix in response to a strong fiscal easing.
So far, the Fed has done virtually nothing. During the three months to January, the Fed’s monetary base (the right-hand side of its balance sheet) was trendless. Over the 12 months to January, that monetary aggregate — the only one that the Fed directly controls — expanded by $293.2 billion, showing an annual growth rate of 6.4 percent. Similarly, excess reserves (loanable funds) in the banking system at the end of last month were still a huge $2.1 trillion, or 4.5 percent more than a year earlier.
Meanwhile, the effective federal funds rate — the Fed’s key policy instrument — remained stable at 1.41 percent (well below the 1.50 percent target) since mid-December, while, over that period, the yield on the benchmark Treasury’s 10-year note rose 39 basis points, finishing the last Friday’s trading session at 2.85 percent.
That sharply steepening yield curve is telling the Fed to get going — presto.
