US Economy, Stock Market Are 2 Problems Keeping Steve Hanke up at Night

What keeps the money doctor up at night?

Steve Hanke, a veteran economist and applied economics professor at Johns Hopkins University, said there are two significant problems in the US economy and markets that are keeping him from getting a good night’s sleep.

One is inflation, which he thinks could start to spiral out of the Fed’s control.

The other is high stock prices, which will start crashing back to earth, he told Business Insider.

“What is keeping me up at night is the idea that the Fed is going to be unable to hit its inflation target in 2026,” the veteran economist and commodities trader wrote.

“As far as the stock market is concerned, my Dr. X’s Bubble Detector is sitting at an all-time high, indicating that we are in a bubble,” he added of equity prices.

On the inflation front, there are a few signs that price growth in the US is starting to heat up again. Headline inflation was cooler than expected in November, but still considerably above the Fed’s 2% target.

Hanke, who has described himself as a “money doctor” and has long held the view that the money supply is a key driver of inflation, also pointed to the recent growth in the M2 money supply. That’s a measure of the amount of cash flowing around the economy, and it has climbed by $3.5 trillion over the past five years, according to Federal Reserve data.

“For me, that is the most important metric,” Hanke said of the inflation outlook. “It looks like the money supply is going to be goosed, if not over-goosed.”

There are a few developments that look like they can stoke inflation leading into the next year, Hanke said:

1. Fed rate cuts. The Fed has started cutting interest rates and just issued its third rate cut last week. That helps loosen financial conditions, but inflation still isn’t fully contained, which means that price growth could accelerate down the line, Hanke suggested.
2. End of quantitative tightening. The Fed stopped its quantitative tightening regime this month, which involved the central bank shedding long-term Treasurys from its balance sheet to tighten financial conditions. It was another tool for the Fed to get a lid on inflation following the pandemic.
3. Lending rules will be rolled back. Some lending rules, like rules around capital requirements at banks, will be eased early next year. That will give banks great power to increase the money supply, adding to inflationary pressures, Hanke said.
4. US Treasury issuance. The US Treasury is issuing more T-bills, partly to fund the government deficit. That also increases the money supply and could stoke inflation, Hanke said.

“My concern is that, after letting the money supply explode in 2020-21 and imposing inflation on Americans, the Fed has failed to put the inflation Genie back in the bottle,” Hanke said.

The outlook for the stock market doesn’t look much better, in Hanke’s view. He pointed to bloated valuations in the tech sector as the mania for artificial intelligence reaches new heights.

“As far as the warning signs concerning the course of an AI bubble, you will never know when you will realize a Wile E. Coyote moment,” he said, later adding that he advised investors to rebalance their portfolios.

Hanke, known for his persistently bearish forecasts for markets and the economy, has long forewarned of trouble heading for the US. In October, he speculated that AI companies today could eventually see a dot-com-style fate once they started missing their growth forecasts.

Last year, he also doubled down on his call that the US economy was headed for a recession, but told Business Insider he had recently started leaning away from that stance on account of hotter inflation.