The U.S. Economy at a Cross Road
Where is our nation’s economy heading? It seems to be pointing in a multitude of directions leading to wide differences in the predictions of well-respected economists. This, in large measure, is a bi-product of the Covid-19 pandemic which not only has disrupted international supply chains, but also has altered the consumption and work habits of many Americans. Thus, in a very real sense, the pandemic has reshuffled our nation’s economic deck sowing confusion and providing politicians of both parties with a bounty of ammunition with which to attack their opponents.
Although U.S. gross domestic product (GDP) fell by 3.5% in 2020, it began to rebound sharply this year. In the first quarter it was up by a whopping 6.4%. That was followed by an even more impressive 6.7% increase in the second quarter. These startling increases were undoubtedly powered by the successful launch of the nation’s vaccination program which triggered a precipitous drop in Covid infections and led to the re-employment of millions of Americans. Then, along came the Delta variant causing a new surge in Covid cases beginning in early July. That resulted in slower job growth and a drop in third quarter GDP growth to a more normal 2.0%. This dramatic reversal of fortune has prompted a re-examination of the direction of the nation’s economy.
Since their dramatic drop in the Spring of 2020, the U.S. stock markets have been steadily moving upward and are now at or near their all-time highs. Stock prices are viewed as “forward indicators” and high stock prices reflect an anticipation of future economic growth. Countering this rosy indicator, the consumer price index has jumped by over six percent during the past twelve months, the fastest increase in more than thirty years. This has prompted Jeremy Siegel, a seasoned market analyst, to warn that if inflation continues to rise the Federal Reserve, as its Chairman has warned, is likely to tighten interest rates which could trigger “a serious [stock market] pullback” which could usher in a period of slower economic growth.
Some economist have even voiced concern that an increase in interest rates could plunge the nation’s economy into a period of stagflation (i.e., high inflation coupled with stagnate economic growth) similar to that experienced in the early 1980s when the Federal Reserve was compelled by chronic inflation to increase short-term interest rates to over 20%. That fear, however, is largely born out of panic than an understanding of the differences between today’s economic conditions and those that existed when Ronald Reagan took office. At that time economic investment and productivity growth were declining. Today, we are embarking on a major wave of new investments and technological advancements are having a very positive impact on productivity growth.
There is also currently a wide difference of opinion as to whether the current increase in inflation is simply a transitory reaction to the economic disruptions caused by the pandemic or the result of underlying long-term economic factors. Among those who believe that the current period of inflation is simply an after-effect of the pandemic are Paul Krugman, a Nobel laureate in economics. He is joined in this view by Austan Goolsbee, an economics professor at the University of Chicago who served as the chair of President Obama’s Council of Economic Advisors, Jerome Powell, the current Chair of the Federal Reserve Board, and Janet Yellen, the former Fed Chair and the current Treasury Secretary. They contend that the nation’s economy is currently suffering economic dislocations similar to what our nation experienced after the end of World War II when pent-up demand for goods and services caused a spike in inflation that was followed by a period of prolonged economic growth.
They have determined that the economic dislocations that are causing the current spike in inflation will work themselves out over the course of the next twelve months and are neither a threat to the nation’s future economic growth nor a cause for alarm. Specifically, because Americans were forced to stay at home while the pandemic was raging, they increased their purchases of goods and decreased their demand for services. This, in turn, caused the price of consumer goods to rise, a problem compounded by slower production of goods resulting from the pandemic’s disruptions to work forces around the world. Also underlying these dislocations were pandemic-related disruptions in the production of materials and components used in the production of products here and abroad.
Supporting this view is the fact that price increases have been focused in only a few industries specifically impacted by the pandemic. For example, the prices of meat and poultry are up by 12%, used car prices are up by roughly 25% and energy is up by 30%. Although Professor Krugman and his colleagues concede that the nation will be beset with inflation over the next year until the causes of these price increases are remediated, they take comfort in the fact that the economy is being positioned to grow rapidly with the enactment of the Infrastructure Act and the pending enactment of the Build Back Better bill. They conclude that when the supply-chain problems have been worked out inflation should return to an acceptable 2% range. Until then, most American consumers, flush with cash being doled out under the Covid Rescue legislation enacted last March, should be able to comfortably handle the resulting price increases.
Among those fearing that the current spike in inflation is indicative of a long-term problem are Larry Summers, a Harvard economist who served as Treasury Secretary during the Clinton administration, and Mohammed El Erian, the chief economic advisor at Allianz and the chair of Gramercy Fund Management. While agreeing that the current inflation poses a long-term threat to the nation’s economy, they come to this conclusion from different directions.
Summers’ main concern is that the federal government, with its $1.7 trillion Covid Rescue plan, its $1.2 trillion Infrastructure legislation and its $1.5-$2.2 trillion Build Back Better legislation, is pouring a tremendous amount of liquidity into the nation’s economy. This is increasing the demand for goods and services that will push prices higher. These programs will be continuing for several years providing on-going upward pressure on consumer prices. While Summers is not wrong, he may be over-estimating the impact of these programs. Even though they represent economic investments of a magnitude not undertaken in decades, they are nevertheless relatively small in comparison to the U.S. economy. While the impact of government spending tends to get magnified by a multiplier effect (see my article entitled “The Myth of Republican Economic Managerial Superiority”), most of the expenditures contemplated by these acts will be financed with tax dollars which will partially offset the inflationary pressures that they will generate.
El Erian sees danger emanating from another source. He has expressed concern that the pandemic led to reduced demand for energy which, in turn, triggered a suspension of efforts to extract and produce fossil fuels, both here and abroad. That cut-back in production is now causing a spike in the prices of gasoline, natural gas and heating oil as the world economy starts to regain momentum. While El Erian has projected that the price of crude oil might climb as high as $100 a barrel, others have expressed fear that the price of crude oil is headed for $200 a barrel. There is no question that high energy prices will adversely impair economic growth in a myriad of ways. High energy costs will not only cause the price of gasoline to rise, but will also increase the costs incurred by both manufacturers and service providers which will be reflected in higher prices for their goods and services. That, in turn, will slow consumer spending and the economy as a whole.
How high energy prices will rise and how long will they remain high are debatable. With crude oil now at almost $80 per barrel, oil and gas production is likely to accelerate around the world. This is especially true in the U.S. where the costs associated with extracting oil from the ground are high. Therefore, a high world price for crude oil will have a greater effect in this country in restarting deferred production. In addition, the amount of energy being derived from renewable sources, spurred by governmental incentives, is increasing rapidly and electric powered cars are now starting to replace those powered by gasoline. These factors will tend diminish the demand for, and price of, fossil fuels and their impact on inflation. Even assuming that energy prices will rise further and stay high for a couple of years should not prevent the nation’s economy from growing considering the wave of new investments that will take place over the next five years.
Also raising questions as to the future direction of the nation’s economy are recent employment figures. When Congress enacted the Covid Rescue legislation last March conservative politicians argued that the federal government’s $300 per week supplement to state unemployment benefits would discourage unemployed workers from re-entering the work force. At the beginning of the summer 25 states (principally those controlled by Republicans) discontinued dispensing these supplemental payments even though the program providing them did not expire until September. Contrary to their assertions, employment did not increase faster in their states than in those that continued to dispense the federal unemployment supplemental payments. Even more baffling was that when the program did end in September, workers began leaving their jobs in large numbers. In what has been dubbed the “Great Resignation” over six million Americans walked away from their jobs in the months of September and October. This caused the number of available job openings to exceed the number of unemployed Americans by more than three million.
This unusual development has been attributed to a number of factors including (a) resistance to employer mandates relating to vaccinations and wearing masks, (b) dissatisfaction with low pay levels and working conditions and (c) employee burnout among healthcare workers. Moreover, the pandemic, which required many American to work from their homes, changed employee attitudes toward their jobs. Some decided that they were equally, if not more, productive working away from their offices. Others concluded that life was too uncertain and too short to continue working in a job they detested. Still others remained fearful of becoming infected and were reluctant to return to a workplace where they would be placed in close proximity to potential carriers of the Covid pathogen.
Another major factor affecting the job market is that a disproportionate percentage of Americans who have not returned to their jobs are women. Because of the pandemic schools pose a serious danger to children who, until the beginning of this month, were not even eligible to become vaccinated. This also posed a potential danger to the parents and grandparents of those children living in the same household. This apparently prompted many families to keep their children at home and their mothers out of the workforce. The pandemic also caused childcare programs to be less safe and less affordable which similarly impeded women from returning to the workforce. When enacted, the Build Back Better bill should alleviate these problems.
Adding to the confusion, this past week it was reported that over the course of the last four months employment figures were understated by 626,000 jobs. This is an astoundingly large discrepancy (roughly 20% per month on average) which raises the question as to how such a large oversight could have gone undetected for four months. Was this a case of data sabotage to make the Biden administration look bad? That, however, doesn’t seem likely as the 25 states that chose to prematurely discontinue the federal unemployment supplemental benefits had an incentive to begin reporting higher, not lower, employment data. Thus, in all probability, this SNAFU simply seems to be the product of an overwhelmed Bureau of Labor Statistics confused by an onslaught of conflicting economic data. Still, it is likely to add to cries from conservative politicians that our federal government can’t be trusted to provide Americans with accurate financial data.
In an era when everything is being politicized, it seems prudent to ignore what the politicians and media pundits are proclaiming and concentrate on what the seasoned economists are saying. Of course, even that is not particularly useful advice as there is a always a question as to which economists are worthy of credibility (recall the “Four Of Course Men of the Apocalypse” described in my article referenced above). The problem is even more complex since the economic forces identified by reputable economists espousing different views are unquestionably real. The problem is quantifying the impact of those forces and the extent to which they are being offset by countervailing factors.
The monetary tools available for addressing runaway inflation are particularly blunt instruments and can have numerous unintended consequences. Accordingly, when inflation is focused in specific segments of the economy, it is generally prudent to first take measures designed to address only the those segments rather than immediately proceed to ratchet up interest rates or reign in the nation’s money supply. This is currently the course of action being taken by the Biden administration. It is also the path currently favored by Jerome Powell and Janet Yellen. They are not only well-respected economists (with little political baggage), but also have access to all available economic data. Perhaps even more importantly, they have the responsibility of managing the nation’s economy which means that their reputations are riding on their getting things right.