Inflation, The Deficit & Why the Dollar Stays King with Benn Steil | The Real Eisman Playbook Ep 81

SUMMARY

Steve Eisman hosts Benn Steil, Director of International Economics at the Council on Foreign Relations, for a comprehensive discussion on inflation, Federal Reserve policy, the U.S. deficit, and the global status of the dollar. The conversation also delves into historical turning points, including the roles of Henry Wallace, Bretton Woods, and the Marshall Plan in shaping the international financial system.

MAIN POINTS

• Benn Steil discusses the Federal Reserve's approach to persistent inflation and the importance of maintaining anchored inflation expectations. [2:00]
• Steil critiques the Fed's large balance sheet and questions the effectiveness of forward guidance in monetary policy. [6:00]
• The conversation shifts to Scott Bessent's 'Operation Twist' and the limited impact of Treasury market interventions on long-term rates. [10:01]
• Steil outlines the U.S. dollar's status as the dominant global reserve currency and the lack of viable alternatives except gold. [15:00]
• The discussion turns to France's fiscal challenges, comparing its deficit issues to those of the United States and highlighting the lack of political will for reform. [22:00]
• Steil explains the shift from rate-insensitive to rate-sensitive investors in U.S. Treasuries and the implications for rising interest rates. [25:01]
• Attention moves to Steil's historical research, focusing on Henry Wallace's political career and his influence on U.S. agricultural and economic policy. [27:01]
• Steil analyzes Henry Wallace's admiration for Soviet economic planning and the political maneuvering that led to his removal from the vice presidency. [34:02]
• The Bretton Woods conference is examined, emphasizing Harry Dexter White's role in establishing the postwar international financial order. [40:01]
• Steil details the Marshall Plan's significance in rebuilding postwar Europe and its strategic importance in the early Cold War. [47:01]

DETAILED ANALYSIS

The episode opens with Steve Eisman introducing Benn Steil, an economist and author known for his expertise in international economics and financial history. The initial focus is on the Federal Reserve's current dilemma regarding inflation. Steil explains that while some economists attribute recent inflation spikes to temporary oil shocks, the persistence of inflation has heightened concerns within the Fed.

He notes that the central bank is determined to prevent inflation expectations from becoming unanchored, which could complicate future policy responses. The conversation highlights the internal dynamics of the Federal Open Market Committee, emphasizing the chairman's limited autonomy and the political pressures faced, particularly when inflation data unexpectedly worsens.

Steil critiques the Fed's approach to its balance sheet and the use of forward guidance. He argues that the size of the Fed's balance sheet, which expanded significantly after the 2008 financial crisis, does not impede its ability to control interest rates as long as the policy rate is above zero. However, he is critical of forward guidance, citing empirical evidence that the Fed's forecasting track record is inferior to that of private sector forecasters.

This, he suggests, can lead to unnecessary market volatility when policymakers make public predictions that later prove inaccurate.

The discussion transitions to Scott Bessent's 'Operation Twist,' a Treasury initiative involving the sale of short-term Treasuries to purchase long-term ones in an attempt to influence long-term interest rates. Steil points out the limited scale of this intervention relative to the vast size of the federal deficit and the overall Treasury market, likening the effort to bringing a butter knife to a gunfight. He further illustrates the challenges of such interventions by referencing Japan's currency market actions, where attempts to avoid selling U.S.

Treasuries ultimately failed, demonstrating the overwhelming influence of global capital flows and the limitations of policy maneuvers.

Attention then turns to the U.S. federal deficit, which is running at approximately 6% of GDP. Eisman frames the debate by noting that warnings about unsustainable U.S. debt have persisted for decades without materializing into crisis. Steil responds by describing the U.S. dollar as the 'winner of an ugly dog contest,' emphasizing that global investors have few attractive alternatives.

While some central banks have diversified into gold, the euro and Chinese renminbi (RMB) have not emerged as credible substitutes. Steil recounts recent attempts by China to promote the RMB for international settlements, but these efforts have not displaced the dollar's dominance, except in isolated cases such as sanctions-driven transactions involving Iran.

The conversation explores the structural changes in the Treasury market. Steil notes that the proportion of rate-insensitive investors, primarily foreign central banks, has declined from 76% to 43% over the past two decades. This shift means the U.S. must increasingly attract rate-sensitive investors, which accelerates the rise in interest rates as deficits grow.

France is presented as a cautionary example, facing similar fiscal challenges but lacking the dollar's privileged status. French government bonds are not considered risk-free assets, and the country must offer higher yields to entice buyers, reflecting the broader risks of fiscal indiscipline in advanced economies.

Steil's historical expertise comes to the fore as the discussion moves to his recent books. The first subject is Henry Wallace, Vice President under Franklin D. Roosevelt, whose background as an agricultural geneticist and architect of New Deal farm policies is detailed.

Wallace's advocacy for large-scale farm subsidies and controversial interventions, such as paying farmers to destroy crops and livestock to support prices, are recounted. Steil describes Wallace as an internationalist and an admirer of Soviet economic planning, which ultimately contributed to his political downfall. The Democratic Party's leadership, concerned about Wallace's left-leaning views and the risk he posed in a postwar context, maneuvered to replace him with Harry Truman as FDR's running mate in 1944.

Steil argues that had Wallace become president, U.S. foreign policy might have been dramatically different, potentially resulting in less resistance to Soviet expansion in the early Cold War.

The conversation then examines the Bretton Woods conference, where Harry Dexter White, a senior Treasury official and Soviet fellow traveler, played a pivotal role. Steil explains that Bretton Woods established the International Monetary Fund (IMF), the World Bank, and a dollar-based international financial system. Despite White's sympathies for Soviet interests, the institutions created at Bretton Woods entrenched U.S. economic leadership in the postwar era.

Steil provides evidence from declassified intelligence documents showing White's interactions with Soviet agents and his controversial decisions, such as providing the Soviets with currency plates for occupied Germany, which resulted in significant financial losses for the U.S. Treasury.

Finally, Steil discusses the Marshall Plan, which was implemented under President Truman to rebuild war-torn Europe. The plan marked a strategic shift from FDR's vision of postwar cooperation with the Soviet Union to a clear division between the Western and Soviet blocs. The Marshall Plan provided critical economic aid to Western European countries, helping to stabilize the region and prevent the spread of communism.

Steil notes that the IMF and World Bank, initially intended to facilitate postwar recovery, played a limited role in the immediate aftermath of the war, with the Marshall Plan assuming primary responsibility for European reconstruction. The episode concludes with reflections on the enduring impact of these historical decisions on the modern financial system and the persistent challenges facing the U.S. in managing its fiscal trajectory.

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