A satanic list of inflationary factors

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Pushkin.

We're nearly there, listeners. This year, warts and all, is nearly over.
It's been a ride.

Probably the biggest thing to take away from it in terms of high finance is the huge shock to the system that came in the early part of Donald Trump's second presidency.

He blew apart the global alliances we've all grown up with and made very serious people question whether the dollar could remain the glue that holds the whole system together.

Today on the show, we're asking, was that outbreak of nerves in April just a blip? Is it business as usual?

This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at FT Towers in London.

And today I'm joined, yes, by that fella in New York, Rob Armstrong.

But also we have snagged a serious thinker about markets to help us unpack this question today, none other than Adam Posen, president of the Peterson Institute for International Economics and way back when, a rate setter at the Bank of England just up the road from here.

Adam it's a real pleasure to have you here. Thank you for coming in.
Thanks Katie and to you and Rob for having me.

Listeners if you get confused Adam is the one who knows what he's talking about and Rob

Rob is doing that loud American thing from down the other end of the line.

I should mention to the audience that there's actually someone else here in the studio with me. There is? There is.
I am joined by Taco the Reindeer, which takes a little explaining.

So as you know, I coined this phrase, taco, Trump always chickens out, which may be relevant to our discussion today.

And one of our colleagues on the audio team was walking down the street and saw a little wooden reindeer tapped together out of bits and bobs of Christmas trees with a little name tag around her neck with the word taco on it.

That's awesome. And she's sitting at my side.
And, you know, it's like you make up some dumb phrase in an economics newsletter, and before you know it,

Christmas is following you around forever.

You have manifested the perfect toy.

Adam, I don't think anyone's made any Adam Posen toys, but tell us a little bit about the Peterson Institute. Like, it says wise things about important issues, but what is it?

Wow, I didn't realize I was going to get free ad placement. Thank you, Katie.

The Peterson Institute is a non-partisan, non-profit think tank, and we are basically the intellectually honest pro-globalization people.

Most of our fellows are people who spent careers, got a PhD, did some research, and then went into public service or government work, at least temporarily.

People like Olivia Blanchard or Maury Obsfeld, who were chief economists at the IMF after their academic careers.

And then there's people like me who, before joining the think tank, spent time in central banks.

This has been a really big year for the sorts of stuff that you think about.

And I know that earlier this year, sort of April, May time, you were one of the more vocal people saying, okay, this bond of trust that's existed for decades between the U.S.

writ large and markets and finance is creaking.

Why hasn't it snapped?

I think it has. I think it just hasn't fallen apart yet.
I think there's a difference. So imagine you've got...
two things tethered together and they've been settling into the mud for years. Right.

And the tethers snap.

And And so they start slowly easing away. But until something comes that really pushes them apart,

you don't see it. And I think this is a good analogy for markets: that maybe there has been a change in the behavior of the dollar.
Yeah.

You know, the dollar occasionally now is behaving like an EM with interest rates going up when the rate goes down on bad news. Yeah.

So it's more like an emerging market currency or sterling or something like that. Yeah.

And that the dollar people, serious people, it's sovereign wealth funds, pension funds,

international reserve managers are hedging dollar exposure.

China, of course, has really moved a huge amount of assets, trillion plus out of dollars into gold. So there's a lot of changes, but it makes sense, frankly, and I never expected otherwise, that

you sort of loosen the tether, you loosen the anchoring, but something big and bad has to happen.

And then when there is that bad thing happening or that crisis or something, which could be generated by things within the U.S.

That's when you start to see the break. Putting it differently,

we've spoken about, we've used the phrase decentering of the dollar.

So it's not that the dollar is sold off or cratered, it ceased to be a reserve currency, but it's less, fundamentally less central and therefore less stabilized than it once was. Aaron Powell,

one thing that I believe is that regimes, at least in markets, and I suspect this might be true of economies too, they change with a crisis. Right.

And so we've got a change in this relationship, but we've managed to avoid a crisis. Well, I mean, it just hasn't happened yet.

I don't think we've done much to avoid it, but it just hasn't happened yet.

But I agree with you. It's what the political scientist Robert Gilpin used to write about decades ago called punctuated equilibrium.

You don't get steady, slow evolution for the most part. You get these changes in environment, changes in era or what you would call regime, and that's when the change happens.
And now it may build up.

I don't know if you were one of these people, but certainly a lot of people thought that the imposition of heavy tariffs would precipitate a crisis.

And I think we've all been struck by

how global economies have taken tariffs that are not as high as originally threatened, but still quite high, and sort of taken them in stride. Are you surprised by that? No, I'm not.

I'm actually, I have a record on this.

It was a little over a year ago, September 2024, Peterson Institute published work by Warwick McKibben and Marcus Nolan simulating what would happen to the U.S.

economy because of tariffs and also anti-migration policies and central bank independence lack. And all of them pretty bad.

But all of them, if you go back and look at the models and how we discussed it, it was built built in that it would take like a year for it to kick in.

Now, I don't mean that we literally forecast one year from the day of April Fool's Day, it would happen. But what I meant was none of us expected it to be immediate.

And forward-looking markets, I kept saying, wouldn't necessarily price it in because there was some genuine uncertainty. There are many determinants.

But the biggest thing is that there's real reason why it would take businesses and households and investors time time to adjust. So

going to your taco point,

tacos don't always have points, but anyway, going to your taco point, no one was sure that Trump would maintain it or that he would

not negotiate it away. No one was sure which countries or which industries or even which specific companies would be exempted versus tariff.

The president directly threatened in public, and God knows how much in private, various specific companies.

Don't you be the first, you know, whether it was Walmart or GM or whatever, you know, don't you be the first to raise prices.

So there were all these factors at work. And then most importantly, particularly in the manufacturing sphere, you had to make very difficult decisions about your supply chains.

Even if you're Toyota or Caterpillar or somebody incredibly sophisticated like that, it's still difficult to decide, okay,

Given the tariffs, what stuff do we bring home? What stuff do we put in Mexico versus China? Where do are the alternative suppliers? Who do we use? What do we invest in?

And if that's true for these companies, just imagine what it's like for the American Mittelstrand, for all the middle-sized companies and supply chain companies.

So there were a lot of good reasons to think that the tariffs were going to take a while to take effect. And in my view, it's going to happen.
It's happening right now, frankly.

Is your view that inflation is laying relatively dormant and that it's still going to bite? My view, I am out of consensus.

I believe inflation is going to be significantly higher than the current forecasts by a year from now, by probably by third quarter of 2026.

Because of tariffs or because of tariffs plus other factors? Tariffs plus other factors. So I talked about this in a presentation.
I'm just saying this so that the record is clear.

I talked about this in a presentation at the start of October. But basically, you've got unanchored inflation expectations, no matter what the Fed survey said.
You've got

a lot of fiscal policy.

And I warned starting last spring that the tariff revenue collection would eventually go down and that they were going to spend money for households, and we're going to get both of those.

So you're getting additional fiscal stimulus. We've got dollar going down,

which has some effect on inflation, not huge. And then the tariffs.
And then I and my colleagues at Peterson who've done the analysis would say that

anti-migration policy is also stagflationary. It also contracts growth, creates shortages, raises prices in certain industries.

And so you put all that together. It's just there's this huge list of things that to me are going to push up on inflation.

And you're going to have a justified debate about how much it's a one-round effect and the expectations remain anchored and so it doesn't persist.

Aaron Powell, Jr.: I very much agree with your whole kind of satanic laundry list of inflationary factors there.

But where do you see the unanchored expectations? When I look at a lot of the standard measures, I don't see that. Where do you see that? No, you're right.
We don't see it yet.

So the two main ways that the Fed and most people look for inflation expectations are there are two well-known surveys.

There's the Federal Reserve Bank of New York has one and the University of Michigan has one. And then there's

things backed out of what are called the five-year, five-year forwards or the tips market,

which are bond market indicators. And if you look at both of these, they're pretty sticky.

There was a period earlier this year that the UMichigan survey was high and rising, and while the Fed New York survey was flat, we've looked at it a little.

There's no econometric evidence and no design issues of either survey that suggests that one should put more weight on either the Michigan or the New York. They're basically the same.

There's plenty of things we can point to, some of which both of you have written about in your columns, like the Million Prices Project at Harvard Business School, like the cross-sectional data that people at the Peterson Institute or Goldman Sachs have written about, about different sectors showing different price increases.

There's a bunch of stuff we can point to about inflation underway. But you're right.
There's no direct evidence of inflation expectations going up. What I say is

I still don't buy it.

There's very little reason to believe that steady survey measures of inflation expectations are good predictors of shifts in inflation.

Second, there is a paper that we published by two former Fed officials in which they showed very clearly using cross-sectional data and COVID that countries that had experience of inflation within the last few years had a much bigger rise in inflation expectations

off a given shock. Because people think, I've seen this movie before.
Right, exactly. And this is very intuitive, but this was the first time anybody really documented it.

And if you think about the 1980s, which you guys are too young for, but anyway, you know, Volcker had more trouble getting down inflation in 1985 than he did in 82, because in 82, they arguably only took it down to four-something percent and then let it stay.

and then had to go through disinflation again when inflation came back in 85. This leads us on to the big question of the day, right, which is about who is going to be the next Fed chair.

So Jay Powell steps down from the chair position in May. Right.
It looks like now his replacement is going to be Kevin Hassett. It's been a battle of the Kevins.
Right.

Tell us about Kevin Hassett, because he's the sort of, you know, happy-smiley person who appears on TV talking about how great Trump's policies are. I really don't like talking about individuals.

Fine, fair enough.

What I will say is there was this group of four people who were seen as combined

loyal to President Trump, ideologically appropriate, credible to markets at a minimum level.

And that was Kevin Hasick, Kevin Warsh, Scott Besant, and Christopher Waller.

Basically, we knew it was going to be one of those four.

And to a first approximation on inflation and interest rate policy, it doesn't matter that much. People tend to emphasize the fact that it's a committee.

That's a factor. But I think more importantly is

if we get obvious inflation, what do I mean by obvious inflation?

So it's running, say, above 4.5% for a few months in a row, then even if Governor Waller or somebody or the next Fed chair, if it's Kevin Hassett, wants to argue this is a one-off, we can look through it, if you see that, the members of the FOMC and the markets will get nervous.

And I think whoever is the Fed chair at that point, not wanting to be outvoted by the committee, which happens in the Bank of England, but never happens in the Fed,

It's never allowed to happen in the Fed.

Worried about their legacy, that they don't want to be known as Arthur Burns, worried about their job prospects when they're done at the Fed. For a variety of reasons, in the end, we'll raise rates.

I don't want to say this is costless. I think if they're behind the curve and they dawdle,

it will take longer, it'll be more costly, and the number of point years of inflation will suffer through are higher than it could have been.

Probably, not certainly, the number of point years of unemployment it requires to get inflation back down will be higher than it was. So it's not costless.

But in the end, the FOMC will, if you have obvious inflation, it'll be like 2021, 2022. They'll be behind, but they'll catch up.

I am particularly worried about financial stability.

I think where whoever is the Fed chair matters is crises in general,

that you have to make decisions quickly and get the committee with you and make assessments of information and make tough calls, but also specifically ongoing, where crises usually come from, decisions about financial stability.

When people have the image of the FOMC, they tend to forget

the Federal Committee. It's the Open Market Committee.
It's the committee that votes on interest rates and other monetary policy.

It combines a subset of the Reserve Bank presidents and the Board of Governors.

But most of the decisions about financial rules and bank supervision under the Fed are made either by the Vice Chair for Supervision, currently Michelle Bauman, appointed by the Trump people to that role, or by a majority vote of the Board of Governors, not the FOMC.

And very soon, the Trump team will have appointed and I would argue have extreme control over, likely, a majority of the Board of Governors.

And I think that sets us up for potentially very problematic financial stability risks. Aaron Powell, Jr.: What kind of risks are you talking about here, Adam?

What kind of scenarios are you imagining?

I have one generic scenario and one specific scenario.

So the generic scenario is simply ideologically you have, and Vice Chair Bauman has made this very clear, you have a Fed supervisory apparatus, Rob, that says we're going to coordinate much more with the Treasury and the other regulatory supervisory agencies and pursue the administration's agenda rather than let technocrats and standing rules matter.

And this is part of the more general approach to trying to centralize deregulation and have White House control in this administration. And that extends to all financial, environmental, labor rig.

But secondly, specifically in that context, you end up with a crypto sector that is currently basically unregulated, unsupervised, and that I think they're going to create a penumbra or an impression is going to be subject to bailouts and

being too important to fail. And this is going to come through two forces.
One is, as

Secretary of Treasury Besent has said, they want to issue a lot of what are called stable coins backed by short-term government treasury bills.

And a lot of the crypto issuing firms or handling firms or market making firms are the same ones who will be issuing or handling or market-making for stablecoins.

And so these firms, which will probably in reaction is deliberately both issue crypto and

stablecoins on treasuries, will

make it so that they seem or are too systemic to fail.

The second factor is members of President Trump's family, members of Secretary of Commerce Lutnik's family, members of Middle East Ukraine negotiator Ritkov's family, and other people in the administration

have publicly acknowledged totally legal, but have very substantial investments in a number of crypto firms, ranging from Tether to very specific narrow new firms.

And again, whatever their intent, and they will say they're doing this because it's a bet on the future of the U.S. And again, it's legal.

But that will further reinforce the impression that the firms that are involved in this are too big to fail.

Now, the events of the last week and a half, where suddenly Bitcoin is down a lot, may take care of us. If we do see things blow up now,

before this all kicks in, maybe people will get scared off these worthless,

I shouldn't say worthless, zero fundamentals. Go ahead and say worthless.

Worthless.

Yeah, no,

it's basically a fear-based trade.

If you're not terrified or conspiratorial, these things have no value. I don't mean the stablecoins.
I mean the crypto.

But anyway, so if the current market meltdown in that space dissuades vast numbers of Americans from investing, that's a good thing.

But if it doesn't, then I view against the generic background of much too much light touch regulation, much too little supervision and transparency into large parts of the financial system as a matter of ideology, as a matter of loyalty to the administration.

Then specifically, you have these favored or perceived as favored crypto firms. Then you have things like basically the small banks handling government bonds in southern Europe.

You have firms that are seen as too important to fail, too politically connected to fail. And whether or not that's true, it becomes sort of self-fulfilling because people put money in.

So that's right up there with your list of, there's a bunch of things that can test the institutions, whether that is a run-up in inflation, you know, it's a macro thing,

whether it is some sort of, you know, other crisis. You know, it's not so long since we had a bunch of regional banks in the States falling over.
Absolutely.

Or it's something in crypto, which is not difficult to imagine. And

yeah, then the question is, then what? So, you know, Rob's kind of almost his role on this podcast is to kind of be the sort of, you know, stereotypical American who's like, everything's awesome.

What are you, Brits, worrying about?

You know, I'm putting words in your mouth, Rob, but I'm not a million miles away. That's fair.
That's fair. You're not a million miles away.

But yeah, it is what happens next time something goes wrong. Something you see the dollar tested.
You see financial stability regimes tested.

You see independence of the Fed tested, you see the deliberate downgrading of the technocrats who make errors but ideally don't repeatedly in the same direction make errors or are not incompetent.

You see a whole bunch of things. And then it gets back to what you and Rob raised initially in the context of fraying international alliances, fraying concerns about these underlying relationships.

So I published this article earlier this fall in Foreign Affairs called The New Economic Geography, where I stress this idea that there has been a fundamental shift and people are hedging against U.S.

relationships in the literal sense that you both have talked about that

the best we can get data, very serious money people are buying hedges on dollars in a way we haven't seen since the late 70s, early 80s, and which is basically unusual and expensive.

So even if they're not dumping dollars, they're viewing dollars as less risk-free, treasuries as less risk-free than they used to be. But hedging more broadly, do you do trade with other countries?

Do you try to self-source things? Do you do your own military? One of your columnists wrote a big piece, I think, the other day writing about, you know, Europe has to prepare.

So I think there's a lot, the way you put it, Katie, I think, you know, there's an accident waiting to happen, and the resilience of the system is much worse than it used to be.

Aaron Powell, Rob, are you able to counter with some sort of cheerful Wall Street guy kind of vibe?

Here's a broad question.

Tell me whether this should reassure me or not. And now I'm straying into the domain of politics where I know almost nothing.

But I suspect, Adam, that you know more, or at least are in contact with colleagues who know a lot more about the political side of this. Let's go with the contact.

But anyway, yeah.

It seems to me that the Trump administration is

striding boldly into the lame duck period of its history already. already, it seems like this administration and its power are a bit of a wasting asset right now.

And you can see that in a lot of different ways. Does that make them less dangerous or more dangerous in the context of

financial stability, financial crises, the kind of things you've just been talking about? That is a really astute question, Rob, hidden amongst your American bonhomie.

So let me try to respond in a couple ways. The first thing is I do there was a reassuring message from the elections we had last month in Virginia, New Jersey, and elsewhere.

Reassuring in the sense for the system, not what partisanship you are, that there seemed to be a lot of voters who voted for Trump who actually were economic voters.

So that they voted against Biden because of inflation, because they didn't like being forced to have Harris, but they were not ideologically committed to the entire Trump agenda.

And I think that's stabilizing for the system, just as in any case when you have voters who are less ideological, more pragmatic.

And so that is the sense in which I think there is a sense of decaying lame ducking to some degree for the Trump administration.

In that sense, I would be hopeful because both for its own sake against radicalism, but also because it would just say some of the normal things about U.S. politics still apply.

The other thing I would say that is more hopeful, you said something like devilish or demonic or whatever a moment ago, ago, is that AI may turn out to be the devil eggs mashina.

That, you know, it will, if there really is a pony there, and I think there is, we're uncertain what size pony, we're uncertain when the pony is going to appear, but I have very high confidence there is a pony there, meaning that there will be a sustained rise in productivity growth that really moves the needle for several years when it comes.

If that's true, if it's anything close to true, then then that can offset a huge number of sins. And for this, the Trump administration would bear no credit, no responsibility.

This is classic Robert Solow exogenous technological growth, meaning the invention just came along when it was ripe and it's very powerful and it matters.

And unless you're, you know, a communist regime really squelching everything, it will have its effect.

I think the anti-science, anti-migration, anti-investment policy of the Trump administration have made it already far less likely that the next general purpose technology will be developed in the U.S.

But this is already baked in. If it's there, it's already baked in.
This one, they haven't messed up that part. So anyway, I think that's the other really large-scale driver.

And so when we talk about inflation or growth or whatever for the U.S.

for the next few years, there's going to be this ongoing investment, maybe not at this crazy level, but there's going to be ongoing investment in AI, and we may start to see real productivity gains from it at some point in the next one to five years.

Trevor Burrus, Jr.: And productivity is just a natural offset to inflation. It makes inflation less dangerous in some way.
Aaron Powell, Jr.: Exactly.

I mean, there are, just as with the tariffs, there's a question of how much is it one-off and how much is it recessionary versus raising prices. Similarly, with the AI, there is a subtlety here.

It's not necessarily wholly inflation reducing.

It could be it just raises real income. So think of the Internet when it came came on.
It just suddenly offered us something we didn't have before.

And in terms of utils or real income, your possibilities of life, your enjoyment of life until you get manipulated by the networks.

But anyway, your ostensible enjoyment of life goes up, but it doesn't necessarily bring down the prices of other things. So

yes, productivity growth is an unmitigated good in economic terms. It increases purchasing power, but it doesn't necessarily disinflate.
It depends on how it's experienced and how it gets embodied.

I always thought a Udel was like a salty snack of some kind. No, no, that would be a bugle.

Glad we cleared that up.

I'm going to clarify that for listeners. Adam, thank you so much for sharing your brain there.
We've given our listeners plenty of things to worry about.

Let's see if we can lighten the mood in just a sec.

Don't forget, I said AI is going to save them all.

We're going to try and lighten the mood in just a sec with Long Short.

At PGM, our global perspective today unlocks investment opportunities tomorrow.

Our 1,400 investment professionals provide global expertise and local insights to help you navigate the complexities of a changing world.

We offer a diverse range of active strategies across public and private markets to help you identify opportunities and achieve your long-term goals. PGM, our investments shape tomorrow, today.

Okie doke, it's time for long short, that part of the show where we go long, a thing we love, or short a thing we hate. Adam, as you are our guest, what would you like to select?

I'm long the New England Patriots. I've always been long the New England Patriots, even when they sucked and now they're great again.
I'm long the New England Patriots. I'm short crypto.
Hey.

We're going to get emails. Rob, what about you? First of all, I'm also long the Patriots.
I love the Patriots. They had a great win this last weekend.

Just because Adam mentioned it, I'm long the bugle. That is an underrated snack right there.
Well said.

That is like the prince of the cornmeal-based snack.

Are they like

these little triangular cones with rough edges. They're available in fine-duty free shops and WH Smiths all over the UK and Europe.

Yes. And I want to be clear, whoever produces them is not a supporter of the PIE.
This is a genuine taste thing.

Other snacks are available.

I am long financial repression, which I know is a very boring answer, but I was writing about this today.

It was a good column. I read it.
It was a very good column.

Governments are desperately trying to find ways to relieve the general public of their hard-earned savings and convince them to get money out of deposits on banks and put it somewhere useful.

So just know, listeners, everyone's going to be banging on about financial repression next year. It is coming.
And Bugles and the Patriots.

We're going to have to leave it there. Rob, you have been Rob.
Adam Posen, thank you so much for coming in and helping us out today.

Listeners, we'll be back in your ears on Tuesday, so listen up then.

Unhedged is produced by Jake Harper and edited by by Brian Erstadt. Our executive producer is Jacob Goldstein.
Topha Vorges is the FT's acting co-head of audio.

Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free.
A 30-day free trial is available to everyone else.

Just go to ft.com/slash unhedged offer. I'm Katie Martin.
Thanks for listening.