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90% chance a ‘pretty big recession' strikes by 2023 as money supply shrinks at ‘unprecedented' rate - Steve Hanke

Kitco News

Third quarter real Gross Domestic Product (GDP) rose by 2.6%, according to data released by the U.S. Bureau of Economic Analysis on Thursday. This was higher than the consensus estimate of 2.4%, and follows two consecutive quarters of GDP contraction.

Steve Hanke, Professor of Applied Economics at Johns Hopkins University, believes that a recession is still likely. In fact, Hanke told David Lin, Anchor for Kitco News, that he has recently updated his probability of an upcoming recession to 90%.

The shrinking money supply is mainly responsible for deteriorating economic conditions to come, Hanke said.

“Where we’re going is determined by where the money supply is going,” he said. “The Quantity Theory of Money is a way to determine national income determination. We had the money supply being goosed in early 2020, when COVID hit, we had the money supply growing, on average, about three times faster than it should have been growing to hit a 2% inflation target. As a result, we had a lot of inflation.”

Quantitative tightening from the Federal Reserve has been reversing the growth rate of the money supply by an ‘unprecedented’ rate, Hanke said.

“The last seven months, the money supply has actually contracted by 1.1%. That’s almost unprecedented. That means, of course, you have a big change in the money supply and then there’s a transmission mechanism. There are lags between the thrusts in the money supply, whether it’s going up or it’s going down, and what happens to the real economy. Some time, in 2023, we’ve got a pretty big recession baked in the cake. So these [GDP] numbers, they’re a great thing and you can celebrate it today, it’s not negative anymore, we had a positive number...the whole picture looks like the economy is kind of flat for the last year, but it’s going to hit south,” he said.

Fed Pivot

On the possibility of a "pivot,” the Federal Reserve would likely reverse rate hikes only once a liquidity crisis hits.

“The most likely thing that would cause a real pivot would be a crisis in the financial markets due to the illiquidity problem that might result from this no growth or negative growth in the money supply,” he said.

There have been historical precedents of the Fed pivoting as soon as markets experienced liquidity crises.

“That happened, by the way. [The Fed] started to do quantitative tightening several years back,” he said. “Remember the big problem we had in the repo market? There were a lot of failed trades in the repo market and that was due to quantitative tightening coming in, and the basically the Fed had to pivot immediately because there was really a crisis in the financial engineering aspect of the financial markets.”

For Hanke’s year-end inflation rate forecast, watch the video above.

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