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In this comprehensive discussion with David Lin, Professor Steve Hanke, a renowned expert in applied economics and global monetary policy, analyzes the current state of inflation, monetary policy, and the Japanese yen carry trade, highlighting their implications for global financial markets, particularly U.S. equities and bonds. The conversation begins by examining the recent Personal Consumption Expenditures (PCE) report, indicating inflation remains above the Federal Reserve’s 2% target despite a slight decrease in core inflation. Hanky emphasizes that inflation is unlikely to be tamed in the near term because of several loosening monetary factors: an anticipated Federal Reserve rate cut, the removal of the supplementary liquidity ratio on commercial banks in April (which will unleash significant credit expansion), the cessation of quantitative tightening, and the monetization of the U.S. fiscal deficit through short-term Treasury bill issuance. These factors collectively suggest a growing money supply, which historically correlates strongly with rising inflation.
Hanky reveals a shift in his stance, now warning of accelerating inflation due to an expected surge in M2 money supply growth, particularly driven by bank-produced money already exceeding the “golden growth rate” of 6%. He predicts this could potentially reach 10% year-over-year growth, implying inflation could rise to around 5% or higher, contrary to earlier expectations of inflation easing. The discussion also touches on political ramifications, affordability concerns, and the Fed’s apparent oversight in focusing on inflation data rather than the money supply, which Hanky insists is the most critical metric.
The conversation then moves to the Japanese yen carry trade, an influential global capital flow phenomenon where investors borrow cheaply in yen (due to Japan’s long-standing ultra-low interest rates) and invest in higher-yielding assets abroad, particularly U.S. bonds. With the Bank of Japan signaling potential interest rate hikes and yen appreciation, this carry trade faces a significant reversal risk. Such a reversal—triggered by yen strengthening—could force massive unwinding of positions, leading to capital outflows from U.S. markets and increasing volatility. Hanky explains this relationship’s importance by illustrating the strong correlation between the USD/JPY exchange rate and the S&P 500, suggesting yen appreciation could be a catalyst for a U.S. equity bubble burst.
Finally, the discussion covers the outlook for U.S. monetary policy, with prediction markets favoring Kevin Hassett, a known proponent of looser monetary policy, as the next Fed Chair. This would likely support a continuation of rate cuts and credit expansion, reinforcing the inflationary pressures Hanky anticipates. The episode closes with advice for investors to rebalance portfolios amid these uncertainties, rather than making drastic moves, emphasizing prudence given the complex interplay of loosening U.S. monetary policy and the potential carry trade reversal.
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