Portia Crowe/Business Insider
- The US economy will suffer a recession that could hit stock prices, Steve Hanke warned.
- The veteran economist sees inflation tumbling and the Fed cutting interest rates later this year.
- Hanke flagged the shrinking US money supply as the key reason why a recession lies ahead.
The US economy will slump into recession, putting stocks under pressure, Steve Hanke has warned.
The professor of applied economics at Johns Hopkins University also said inflation is fading fast, paving the way for the Federal Reserve to cut interest rates later this year. He shared the mixed outlook during a recent Capital.com interview.
Hanke slammed the Fed for overstimulating the economy during the first two years of the pandemic, then tightening its monetary policy too aggressively since March. The US central bank cut rates and ramped up its bond-buying to shore up growth in 2020. Since last spring, in response to surging inflation, it has hiked rates from nearly zero to almost 5% and started shrinking its balance sheet.
"The Fed has given us the the biggest whiplash we've ever had in history," Hanke said. "An explosion of the money supply, the huge inflation, and now all of a sudden the brakes have been slammed on and we're going to have a recession."
Hanke, a senior fellow at the Cato Institute and a former economic adviser to President Ronald Reagan, pointed to money supply as the key driver of the American economy. Changes to the amount of cash and short-term savings first affect the prices of assets such as stocks and houses, then the level of economic activity, then the pace of price increases, he said.
Fueled by the Fed's pandemic stimulus, the money supply's three-month annualized growth rate hit an unprecedented 77% percent in May 2020, Hanke noted in a recent National Review column. It swung to -5.4% by December last year, meaning the US money supply shrunk year on year for the first time in decades, he said.
As a result, the pain of soaring prices has been replaced by an impending recession, he told Capital.com.
"Inflation is basically over now given this huge squeeze in the money supply," Hanke said, adding that price growth could flatline by the end of this year. As a result, he predicted the Fed would start lowering rates by the end of this year, or even sooner if a liquidity crisis or severe recession emerges.
The veteran economist cautioned that Fed Chair Jerome Powell and his colleagues are flirting with disaster by paying so much attention to borrowing costs.
"They're focused on interest rates, not the money supply, and that's a very dangerous way to be flying an airplane," he said.
Hanke also addressed the idea that bad news for the economy is good news for stocks as it raises the chances of short-term rate cuts.
"Once people start staring at the recession and see that as something that's coming down the pike, for sure I think that will change," he said.
"It's going to be a tug of war," Hanke continued. "Interest rates softening up a little bit is good for the market, but certainly a recession and earnings coming down is not good for the market."