‘Roaring’ Inflation To Force Rate Hikes; This Explodes Next | Steve Hanke

Key Concepts

• Monetarism: An economic school of thought emphasizing the role of governments and central banks in controlling the amount of money in circulation.
• Quantity Theory of Money (MV=PY): The economic theory stating that the total amount of money in an economy (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by real output (Y).
• Inflation Genie: A metaphor used to describe inflation that has escaped control and is difficult to suppress once it has risen significantly above target levels.
• Commercial Bank Credit Creation: The process by which commercial banks, rather than central banks, create approximately 80% of the money supply through lending.
• Strait of Hormuz: A critical maritime chokepoint for global oil transit, now identified as a strategic vulnerability due to potential Iranian control.
• Dot Plots: A chart used by the Federal Reserve to visualize the interest rate projections of individual FOMC members.

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1. Federal Reserve Policy and the Kevin Warsh Era

Professor Steve Hanke analyzes the first FOMC meeting under new Fed Chair Kevin Warsh.

• Interest Rate Strategy: Hanke argues that the decision to keep rates steady was prudent, as the market had already priced in no change (99.6% probability). Furthermore, a rate hike would have exposed a lack of unanimity within the FOMC, which Warsh sought to avoid.
• Communication Shift: Warsh is moving away from complex, multi-page statements toward clearer, more concise communication. Hanke supports this, noting that the Fed’s previous communication style was designed to confuse rather than clarify.
• Task Forces: Warsh has established five internal task forces (communications, balance sheet, data, productivity/jobs, and inflation framework). Hanke criticizes this as an "intra-family" exercise that lacks outside perspectives and is unlikely to produce radical new ideas.

2. The Monetarist Perspective on Inflation

Hanke presents a strong argument that the Federal Reserve is ignoring the primary driver of inflation: the money supply.

• The Money Supply: Hanke asserts that the Fed is "peanuts" compared to commercial banks, which create 80% of the money supply through loans. He warns that if bank regulations are loosened, banks will have more capacity to lend, further accelerating money supply growth and keeping inflation high.
• Critique of Current Models: Hanke argues that modern macroeconomics has been "destroyed" by post-Keynesian models that omit money as an aggregate. He maintains that money is the most important factor in the macroeconomy and that the current 4.2% inflation rate is a direct result of excessive money supply growth over the last 18 months.
• Warsh’s Stance: While Jerome Powell explicitly rejected monetarism, Hanke views Warsh as a "monetarist light." Warsh’s past skepticism regarding Quantitative Easing (QE) and balance sheet expansion suggests he may be more open to quantity theory than his predecessor, though he has yet to explicitly embrace it.

3. Geopolitical Analysis: The Iran-US Framework

Hanke characterizes the US-Israeli conflict with Iran as one of the greatest strategic losses in US history.

• Strategic Consequences:
  • Strait of Hormuz: Hanke argues that the Strait is no longer under free passage; it is now de facto controlled by Iran. He suggests that future transit may require "management fees" or tolls, and insurance companies are already pricing in this risk.
  • Failed Objectives: The primary goal of the war—regime change—was not achieved. Instead, the US depleted its weapon stockpiles and suffered a massive loss of international trust.
  • Disproportionality: Hanke notes that Iran has adopted a new doctrine of "disproportional counterattack," making them potentially more dangerous than they were before the conflict.
• Economic Impact: The $300 billion investment fund outlined in the memorandum is viewed by Hanke as "war reparations." He predicts that oil prices will rise again as the US is forced to refill depleted strategic inventories, which will require running a deficit in oil supply through the end of the year.

4. Synthesis and Outlook

• Inflation: Hanke believes the "inflation genie" is firmly out of the bottle and will remain there, as the money supply continues to support nominal GDP growth at the expense of price stability.
• Economic Growth: The economy is expected to "plug along"—not booming, but not collapsing—supported by the ongoing growth in the money supply.
• Conclusion: Hanke concludes that the market’s recent volatility was driven more by geopolitical events (the G7 and the Iran memorandum) than by the Fed’s policy announcements. He remains skeptical of the current administration's ability to manage the economic and strategic fallout of the conflict, predicting continued inflationary pressure and geopolitical instability.