“Scary,” is how Prof. Illyan Meichov describes the steps that will be required from the US Federal Reserve to take control of inflation. Meihov is Dean of INSEAD, one of the world’s leading business schools – and is also a macroeconomist by training. In fact, he wrote his Ph.D. at Princeton, under Ben Bernanke, who later became chairman of the Federal Reserve.
The “naivety” of the Federal Reserve
Meihov, who visited Israel last week, attended the Globes “Economy in Shake” conference in collaboration with Bank Hapoalim, after which he expanded on his analysis in an interview. “Historically, in order for inflation to go down, interest rates have to be higher than inflation,” explains Meihov. “Fed Chairman Jerome Powell said emphatically that he hoped for a ‘soft landing'” – that is, a scenario in which the Fed would be able to control inflation without causing a recession – “and he referred to three episodes in U.S. history in which there was a soft landing: 1965, 1984 and 1994 “.
But according to Meihov, in all three of these cases, the central bank’s interest rate has already been higher than the inflation rate. That is, the real interest rate, offsetting inflation, was positive in the first place. “When the real interest rate is positive, it is already pushing inflation down. The Fed has really raised interest rates a bit in these episodes, and the economy has not entered a recession, but in those cases there was already a factor that moderated inflation.”
“Today, by contrast, the Fed interest rate stands at an upper limit of 1.75%, and core inflation (excluding food and energy prices) stands at 6%. “At least when you look at American economic history. That’s the worrying scenario.”
The implication of such a scenario, continues debiting, is also declines in the capital market. This is because stock prices are supposed, in theory, to reflect the present value of the income and dividends that companies will generate in the future. And in the formula used to calculate this value, the interest rate plays a key role – the higher the interest rate, the less equal future income is, and therefore the value of the stock decreases. “If we see interest rates rise to as much as 5% or 6%, we will see a lot of declines in value, especially for growth companies. It’s a matter of mathematics.”
We have already seen the values of the companies go down.
“It was expected, I’ve been talking about it for a year, and I think it will continue. I don’t care it’s over.”
US interest rate shock waves
You live in Singapore. Do you recognize any worrying signs in nearby economies?
“There are two major issues in Asia that need to be addressed in the economic development of countries,” says Meihov. “There’s a point called the middle income trap.” This is a scenario where after a period of rapid growth, wages in developing countries reach a level that makes it difficult for them to continue to grow without another leap in labor productivity that will allow them to compete with advanced economies: thus the economy is “captured” at a medium income level.
“Once China reaches this point,” explains Meihov, “it will have to reform its institutions. The Soviet Union collapsed in the 1980s just as they reached the development level of the middle-income trap. The big question is whether China will reform or not, and the direction of “Chinese President Xi Jinping is not very encouraging. Of course, if China gets into a shuffle, it’s a big problem for the rest of the world.”
“The second issue in Southeast Asia, or in Asia in general, is that we have learned from history that whenever the US raises interest rates, and the flow of capital turns in its direction, the rest of the world has problems. In the 1980s, Fed Chairman Paul Volker raised interest rates and then there was the debt crisis in Latin America (the countries of the region, borrowed in dollars in the 1970s, entered the crisis in the 1980s when the dollar interest rate rose AP). In the 1990s Alan Greenspan raised interest rates and then the peso crisis occurred (when the sharp rise in US interest rates in the mid-1990s led to a capital flight from Mexico AP). “In my opinion, today countries like Indonesia and Malaysia can experience serious liquidity problems.”
“We stopped programs with Russian companies”
Ilyan Mihov (56), is a native of Bulgaria, and grew up until his twenties under Soviet rule. In an interview with him, he explains that he still believes that the hand of globalization and liberalism will be on the top in the long run, but in the same breath speaks with concern about the growing influence of the non-liberal ideology made in Russia and China in Eastern Europe.
How do you personally experience the events in Eastern Europe?
“I am a native of Bulgaria, but between the ages of 4 and 8 I lived in Kiev. It is very sad for me to see Kyiv attacked and destroyed. In this war it makes no sense. It is important for me to show solidarity with Ukraine. “They certainly do not support the war. But they pay taxes that fuel it.”
“However, it is important to keep in touch with Russians who want to be on our side. I was recently thinking about what brought about change in Eastern Europe (and the fall of the Soviet Union, AP). One reason is the economic difficulty – and the current sanctions are causing economic difficulty in Russia. But there was another very important component: we had the Voice of America, the free European radio, we listened to things that told us we did not have to be in this situation. In other words, Eastern Europe changed not because the West invaded it, but because of the economic difficulty and information that came from Western Europe. “Without internal support for Russia, it will be very difficult.”
Identity card: Ilyan Meichov
personal: Born in Bulgaria at the age of 56. He currently resides in Singapore
professional: Macroeconomist and Dean of the Leading School of Business Administration INSEAD since 2013. PhD in Economics from Princeton University. He completed his doctorate under the supervision of Ben Bernanke, who later became chairman of the Federal Reserve
Something else: In 2010 he received an offer to serve as Deputy Prime Minister of Bulgaria – and refused