A Wordsmith's Wit
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Friday, August 5th, 2022
Dear Chris,

Etonian Prime Ministers’ provide a certain kind of entertainment and ebullient energy. The last time an Etonian PM stepped aside was five decades ago. Branded ‘SuperMac’, Harold Macmillan and his cabinet reflected this type of cleverness. Supermac’s Leader of the House was Iain Macleod, a bonafide bridge legend and master wordsmith. Three memorable examples of his fluency are with us still today: the ‘magic circle’ (in reference to an elite cabal), the ‘nanny state’ (used like a sledgehammer by Maggie) and finally ‘stagflation,’ co-opted and altered by subsequent economists. Macleod’s full quote from Nov. 17, 1965 reads:

“We now have the worst of both worlds - not just inflation on one side or stagnation on the other, but both of them together. We have a stagflation, while we have a credit squeeze and a formidable load of debt.”

For Macleod stagflation was no growth with inflation. It heralded a falling standard of living even though unemployment, which was at 3.7% at the time, was a non-issue and stable. However, Macleod’s original stagflation definition was hijacked by American economists. Macleod’s ‘no growth’ became their recession and Macleod’s low unemployment became their high unemployment, though in both definitions inflation remained high.

This new definition had a profound effect on the US central bank’s mandate. At its inception the Fed was to provide ‘currency elasticity and a lender of last resort function’. This mandate moved to ‘full employment’ in 1946 and then in 1978 it changed to ‘price stability and full employment’, where it remains today. The obsession with the 2% consumer inflation target means that if the central bank can control inflation both growth and employment can remain robust.

The conundrum that central banks face today, after a dozen years of negative rates plus a massive balance sheet expansion (which have acted as an implicit form of rate cuts), is that they are now faced with slow growth, inflation, and high debt levels. This is a world that Macleod understood well, his key political objective was to create a higher standard of living. This would be created by growing personal income and having a stable value of money - creating growth in the real income of the citizenry. This means full employment with wages growing greater than inflation - a view now in direct conflict with the Fed’s mandate.

The current Fed’s objective of containing inflation is to create unemployment which will lead to an economic slowdown that then slows down inflation. Maybe…maybe not. Is the Fed fighting the last inflation war? Perhaps a Macleodian lens would help. Macleod had been the Colonial Secretary and appreciated a “declining Empire experiencing a state of high prices, no growth but full employment” - a formula for a falling standard of living that feels like a recession; it explains our current economic state.

In tipping our hat to Iain Macleod, he might now say: “we now have a stagnation of real wages, sustained inflation while still fully employed; we have a stagployment.”

See you on Monday afternoon. Mustafa
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