Regime of Uncertainty | Steve Hanke on Money Supply Shock, Tariff and Current Account, and Why Recession Remains Base Case For 2025

Episode Summary

Executive Summary: Steve Hanke argues the U.S. is headed for recession because money growth has been too weak for too long, while Trump-era tariffs and policy shifts create damaging regime uncertainty. He says tariffs are both a tax and a source of uncertainty, trade deficits are largely the result of American overspending and are not inherently bad, and fiscal deficits are the real unsustainable problem requiring constitutional reform.

Main Topics: U.S. monetary conditions and recession risk (Priority: 5/5): Hanke says M2 has been flat since 2022 and money growth is below his 'golden growth rate,' implying slower nominal GDP, lower inflation, and a high recession probability this year. Tariffs and regime uncertainty (Priority: 5/5): He criticizes the Trump administration’s tariff policy both for raising the effective tax on trade and for creating unstable, day-to-day uncertainty that discourages spending, investment, and guidance from corporations. Trade deficits are not the real problem (Priority: 5/5): Hanke argues trade deficits reflect Americans spending more than they produce and are financed by global demand for U.S. dollar assets; he says they are sustainable and even beneficial in U.S. conditions. Fiscal deficits and constitutional reform (Priority: 5/5): He distinguishes fiscal deficits from trade deficits, calling large government deficits unsustainable and advocating a constitutional convention under Article V to impose balanced-budget rules like Switzerland’s. Dollar strength and international currency dominance (Priority: 4/5): Hanke says the dollar remains the world’s dominant currency despite vulnerability from sanctions and weaponization; he views fears about imminent dollar collapse as overstated. China, money growth, and currency policy (Priority: 4/5): He rejects the claim that China’s yuan is intentionally weak, arguing China’s real issue is too-slow money growth, which keeps inflation and nominal growth below target. Bank regulation, QE, and money creation (Priority: 4/5): He explains that commercial banks create most broad money and that post-2008 regulation tightened bank lending; loosening liquidity rules could raise credit supply, though recession may still reduce loan demand.

Key Arguments: Money supply growth is too low to support 2% inflation; Hanke estimates the needed 'golden growth rate' at about 6.3%, versus current growth around 4.1%. The recession risk is high because monetary conditions set years earlier are now working through the economy with long and variable lags. Trump’s tariff policy is harmful both because tariffs are taxes and because policy whiplash creates regime uncertainty that freezes business and consumer decisions. Trade deficits are not caused by foreigners; they arise because Americans spend more than they produce, which is visible in national accounting identities. The U.S. trade deficit is sustainable because foreigners want dollar assets and U.S. capital markets are deep and liquid. The U.S. should worry more about fiscal deficits than trade deficits; persistent government deficits are unsustainable and drive the external imbalance. Bank regulations and capital/liquidity requirements are a major, often ignored, part of monetary policy because they affect how much money commercial banks can create. China’s weak yuan is not the main explanation for its trade position; China’s money growth is too slow relative to its inflation and nominal growth targets.

Data Points: M2 money supply level: Almost exactly where it was in summer 2022 - Hanke says the broad money stock has flatlined for over two years. Current M2 growth rate: 4.1% per year - He says current money growth is below the rate consistent with 2% inflation. 'Golden growth rate' for 2% inflation: 6.3% per year - Hanke’s quantity-theory-based estimate for money growth consistent with the Fed’s inflation target. Inflation rate: 2.3% per year - He cites current inflation and expects it to fall toward target. Forecast inflation path: 2% or slightly below - He expects inflation to ease further as the earlier money contraction works through. Recession probability: around 90% - Hanke says the chance of recession this year is very high. Average tariff rate: 3% before election; 18% today (as cited in discussion) - He uses this to illustrate the magnitude of tariff escalation. Trade deficit / spending gap: $903 billion - He notes U.S. consumption + investment + government spending exceeded GDP by this amount in 2024, matching the trade deficit. Services surplus: over $300 billion - He says the U.S. runs a sizable services-account surplus that is ignored in tariff rhetoric. Chinese money growth: 7% per year - He argues this is too low for China’s targets. China’s inflation target: 2% - Used in his quantity-theory calculation for China. China’s real growth target: 5% - He says China’s nominal target is 7% when combined with 2% inflation. China’s nominal target: 7% - 5% real growth plus 2% inflation. Fed-era peak M2 growth in 2020: a little over 18% per year - He links the COVID-era money surge to the later inflation spike. Peak inflation: 9.1% - He says the inflation peak matched his quantity-theory forecast. U.S. dollar/euro fair value range: 120 to 140 - Hanke says this is his comfort range for the exchange rate. Current dollar/euro exchange rate: about 113 - He describes the dollar as still very strong. Commercial bank contribution to money growth: about 3.2% - He says bank lending growth is slow even as the Fed’s contribution has fallen.

Pivotal Quotes: "There are kind of two parts to this. One part is what I call the, shall we say, the monetary regime and the state of the money supply." — Steve Hanke: He frames his macro assessment around money supply conditions before discussing Washington policy. "The probability of a recession this year to be quite high, actually. I've said before, I think it's probably around 90%." — Steve Hanke: He gives his explicit recession forecast tied to weak money growth and policy uncertainty. "The only time we've had this, to put it into context, is during Franklin Delano Roosevelt and the New Deal. We had regime uncertainty then." — Steve Hanke: He compares today’s policy instability to the New Deal era.

Implications: Listeners should expect slower growth, softer inflation, and elevated recession risk if weak money growth persists. Investors may face volatility from tariffs and policy uncertainty, while the biggest structural issue remains U.S. fiscal discipline and bank-regulation-driven credit creation.