The week of June 27, 2022: Some ugly numbers, electric vehicles, supply chains, industrial policy, and much, much more.
I would really like to make this a nice Independence Day weekend read, to be enjoyed while you, friends, and family share the one hotdog between you, but it’s hard to find much good news at the moment, and there are times when one just has to face reality. Pass the ramen.
Recession? With the first-quarter GDP numbers revised again, and further down (to a fall of 1.6 percent from 1.5 percent, year-on-year), and the Atlanta Fed now (July 1) forecasting second-quarter GDP to decline by 2.1 percent, a forecast that compares with a prediction earlier in June of 2 percent growth, the picture is not looking very pretty. Meanwhile, writing for CNN, Nicole Goodkind focuses on what really matters, grumbling (in a piece headlined “Who decides if the US is in a recession? Eight White economists you’ve never heard of”) that the formal decision of whether a recession has arrived is taken by an insufficiently diverse group of eight economists.
Okay, okay, but for what it’s worth (and as Goodkind notes), a recession is usually defined as two or more consecutive quarterly GDP declines. I don’t know how accurate the Atlanta numbers will turn out to be, but the trend is depressingly clear. It would not surprise me if we have now hit that point. And I wouldn’t be particularly optimistic about the quarters to come either. Then again, optimism is not my thing.
Compounding the gloom, the housing market is looking a little wobbly (albeit from a high level), and the Conference Board is showing declining consumer confidence as did the University of Michigan’s index of consumer sentiment, which hit a low unseen since the late disco era. Storm clouds are gathering (yet again) over the euro zone, and the war in Ukraine drags on. In another warning of trouble ahead, “Doctor Copper,” a well-known bellwether, has been struggling.
The Financial Post (June 23):
The price of the metal, used to make everything from electrical wires to roofs, briefly dropped below US$4 per pound this week, an important psychological threshold.
Copper is considered a gauge of economic health because it’s a key input in a broad range of big-ticket items such as infrastructure projects and many consumer goods. It even has a starring role in the transition to greener energy, because the metal is a crucial component of electrification.
That was then. Copper is back well below $4, trading on Thursday at around $3.65. As late as mid-April it was trading at $4.80 or so.
And the good doctor is not alone.
Tin just tumbled 21% in its worst week since a 1980s crisis froze London trading for four years.
It’s a dramatic reversal from the past two years, when metals surged on a wave of post-lockdown optimism, inflationary predictions and supply snarls. Now, inflation is here and supplies are still tight. But prices are plummeting as worries about a slowdown in industrial activity across major economies dovetail with slumping demand in China.
As if melting metals prices were not enough, the stock market has delivered its worst first-half performance since 1970. That is worth noting not only as a leading indicator of trouble to come, but also because of the wealth destruction that comes with such a decline, something that is likely to suck demand out of the economy. Ten-year bond yields have also backtracked in recent weeks, falling from a mid-June peak of nearly 3.5 percent to around 2.9 percent at the time of writing (2:30 P.M. on Friday), which may (if indirectly) reflect lower growth expectations.
Some companies are also beginning to sound the alarm about growth. Here, for example, (via the Wall Street Journal) is Micron on Thursday, seemingly echoing Intel earlier in June.
Memory-chip maker Micron Technology Inc. issued a subdued revenue outlook, spooking investors even as it reported a strong rise in earnings for its latest quarter.
“Recently, the industry demand environment has weakened, and we are taking action to moderate our supply growth” in coming quarters, Chief Executive Sanjay Mehrotra said in a statement, adding that he was still confident about long-term demand for memory and storage.
Micron which makes data-storage and memory chips for computers and smartphones, had enjoyed a major upswing in sales and profit during the pandemic, benefiting from surging demand for electronics amid the work-from-home shift. But personal-computer and smartphone sales are on the decline this year, and consumer-spending growth cooled in the U.S. in May, the Commerce Department said Thursday.
I’m old enough to remember the chip shortage.
And inflation?
Well, on Thursday, the latest (May) PCE data was released. PCE? Personal consumption expenditures index, a measure that is, loosely speaking, broader than the CPI (details here). But its real importance is as the basis for the PCE core index, which excludes volatile food and energy prices, and which plays a key role in the Fed’s decision-making.
May’s CPI rose by 8.6 percent year-over-year (against 8.3 percent in April), hitting hopes that inflation had peaked. The PCE index, however, rose by 6.3 percent, the same number as for April and below March’s 6.6 percent, a 40-year high. A more encouraging sign? Core PCE rose by 4.7 percent, down from April’s 4.9 percent, continuing the descent from February’s 5.3 percent. Good news, snipe some, unless you waste money on luxuries such as eating and driving.
The Fed may focus on PCE, and, in particular, core PCE, but the public — understandably — concentrates on headline CPI, and what it sees in the supermarket and the gas station. Given the (somewhat disputed: see Jon Hartley’s piece for Capital Matters) relationship between inflation and inflationary expectations, that can be significant.
Interestingly, the spread between headline CPI and headline PCE is, as Axios’s Javier David notes, running at an unusually high level at the moment. Questions of perception apart, it is the CPI that is, as David writes, “commonly incorporated in cost-of-living adjustments, and other contractual provisions indexed to inflation.” Inflation, lest we forget, has a way of feeding upon itself.
Moreover, when employees try to assess what sort of wage hikes to ask for, they will be looking at the headline CPI (or what that reflects). Their mood, understandably enough, won’t be improved by real-term declines in earnings and disposable income. That said, trade unions, at least in the private sector, are weaker than in the past. Just under 30 percent of private-sector workers were unionized at the beginning of the 1970s versus some 6 percent today (in the public sector, approximately 34 percent are currently unionized). Not only that, but I also suspect that the current labor shortage may prove, uh, transitory (we are already seeing layoffs in certain areas). On balance, therefore, a wage-price spiral of the sort witnessed in the 1970s still seems relatively unlikely, although it certainly cannot be excluded.
It’s become a cliché that some of the factors that have restrained inflation in recent decades, such as the deflationary bonus from Chinese goods (in that particular case, a phenomenon that may have been exaggerated), are weakening. But there may be another shift that is underway, analyzed in a fascinating piece by Alison Schrager for Bloomberg. Schrager notes how, in no small part thanks to innovation, the cost of many items has declined since the 1980s and 1990s (“homes had only one or two televisions — and they weren’t even flatscreens”). That’s a familiar tale, but this was an interesting extension of it:
In the same way the first waves of industrialization made consumer goods (clothing, housewares) cheaper and more accessible, the tech boom made services that were once luxuries (car services, delivery, handymen, digital butlers) widely available and contributed to rising prosperity. It’s indisputable that our standards of living are remarkably higher than they used to be.
But here’s the bad news:
We’ve basically been living a free lunch and now it’s about to end. And that means a drop in our living standards, at least for the next few years.
The Atlantic’s Derek Thompson recently wrote that we have been under-paying for many services we now take for granted. That $10 Uber ride never really made sense when you thought about the cost of fuel and labor. The same is true for food delivery and other app-services that became a way of life for many urban dwellers. Many of the tech firms that supplied these services lost money to keep prices down, gain customers and dominate their markets.
In the tech world, network effects are valuable, but it’s not clear what the long-term business model was for many app-based services. Perhaps they planned to increase prices once they drove off competition. Or maybe they believed that with enough volume, even negative profits would turn positive.
Some of this, of course, was the product of wild entrepreneurial enthusiasm fired up still further (for a while) by dreams of hopping on the train to the dotcom Klondike, and, later, by the long years of ultra-low interest rates, a time in which money was mispriced, and thus invested in ways hard to justify in any other circumstances.
Schrager:
Investors — often venture capital firms — flush with cheap capital and public-sector pension money (which we are all on the hook for), were hungry for risky long-shots. If a few of those long-shots paid off big, everyone would still make money. So they were willing to tolerate losses if their investments could demonstrate a growing market share. Except then the pandemic hit and labor wasn’t so cheap anymore. Then interest rates started to increase and tolerance for losing money evaporated. So now what was once a $10 car ride is $50.
Low rates didn’t just allow investors to sustain money-losing tech ventures. They also meant companies could bulk up on corporate debt, which subsidized even more cheap services. Before the pandemic, Netflix earned a junk bond rating because it took on so much debt to offer endless content. Now higher rates have increased the cost in borrowing and subscriptions have declined, so we’ll all have to watch ads (effectively a tax on our time) or pay more every month.
It’s worth adding that the (likely) end of ultra-low interest rates is almost certainly going to spell trouble for companies which took advantage of that enticingly cheap money with, perhaps, not enough thought of what the consequences of a sharp turn upwards in rates might mean.
The Financial Times (June 4):
US corporate bonds sold by low-rated companies have slumped in price, signalling lenders’ intensifying worries that scorching inflation and higher interest rates are beginning to hit borrowers most vulnerable to an economic downturn.
Bonds assigned a triple C rating or below, the lowest rung on the ratings ladder, have posted a negative return of 2.8 per cent since the end of April, according to an Ice Data Services index. The performance starkly contrasts a 1.3 per cent gain for debt rated double B, the highest quality segment of the junk bond market.
The sharp divergence follows a period of relative outperformance for triple C rated debt, with the change reflecting investors’ souring mood over the outlook for the American economy and the health of US companies that are already beginning to buckle.
Some companies will be able to adjust their prices in the ways described by Schrager (more on that below), but others will not, and may struggle to survive. If money continues to be repriced in a more realistic direction (whatever that may mean, but I am assuming that it will continue to be upwards), sorting out the wreckage that ultra-low rates have left behind may well add to the length and depth of any recession. If so, this could be a recession that may be accompanied by prices still rising at an unhealthy pace — thanks to external energy and food-supply shocks, greenflation, and the repricing of services previously subsidized by ultra-cheap money — meaning that, as should be obvious by now, the specter of stagflation cannot easily be dismissed.
In the meantime, we are already seeing shrinkflation (a phenomenon I discussed here), among delights that also include “drip-pricing.”
Schrager:
This is when we are charged extra fees for things that used to be included in the price, from picking your airline seat to paying for credit card transactions. Now with higher inflation, firms are trying new, more opaque way to pass on their costs to customers. But even if inflation goes back down, many of these fees will probably remain. And if you’re suddenly paying “fuel surcharges” and “kitchen appreciation fees,” you probably won’t be indulging quite as often.
Good times.
And then there’s the small matter of what higher interest rates are going to mean for the cost of servicing this country’s swollen debt, a subject that Brian Riedl has examined in all its horror.
That’s a subject to be returned to before too long, but I’ll just conclude with an extract from a recent Wall Street Journal piece on this topic:
Total federal gross interest cost over the 12 months ending on May 31 was $666 billion. If we include the impending extra interest on Treasury bills and the maturing notes, that figure rises to $863 billion. This is a staggering cost. National military spending was $746 billion over the past 12 months; Medicare spending was $700 billion.
With the federal government in perpetual deficit, where will the Treasury find money to make extra interest payments? New taxes? Lower spending? Fat chance. In all likelihood, it will have to borrow to pay interest.
Who will buy Treasurys?
Time for that scrap of hot dog, I think. Happy Independence Day!
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 73rd episode David is joined by his Radio Free California co-host, Will Swaim. Fresh off a week-long trip to Grand Rapids, Michigan for the annual Acton Institute’s university symposium, David speaks to Will about his path from Marxism to Markets, and where good intentions and good results can both find a home in a properly ordered vision of liberty.
The Capital Matters week that was . . .
Cryptocurrencies
Lummis and Gillibrand have put together a Rorschach test of a bill. As far as we can tell, the only thing animating it is the belief that innovative digital currencies already exist, or soon will. But if you take away that belief, the bill does very little. As art, satire, or a mirror for the mass delusion of crypto, it may be perfect; but as legislation, it is deeply unsatisfying . . .
Inflation
State governments can’t solve inflation by sending people money, but that doesn’t mean they won’t try.
California has announced that 23 million residents will be getting checks for up to $1,050 for the purpose of “inflation relief” as part of the state’s budget deal for the upcoming fiscal year.
Politicians are pulling these funds out of the state’s $97.5 billion surplus. California’s surplus this year was larger than most states’ entire budget.
The checks will be sent in late October. The elections for governor, lieutenant governor, half the state senate, and all the state assembly will occur on November 8. How convenient . . .
While I’ve warned since early 2021 that inflation could be on the rise following copious amounts of fiscal stimulus in the form of social transfers, the rise in long-term inflation expectations is a new development that should be particularly concerning for those following the New Great Inflation.
Macroeconomic theory since the rational-expectations revolution of the 1970s and 1980s (which was developed in part in response to old Keynesian theories being unable to explain the Great Inflation) has posited that inflation expectations are a key driver of sustained inflation — that is, inflation expectations are (in a sense) self-fulfilling.
If the recent inflation were truly “transitory” and merely a one-time change in the price level caused by supply chains or the Russian invasion of Ukraine rather than a sustained increase in inflation, then long-run inflation expectations wouldn’t be rising in the way they are now.
Some might remember a much-derided White House tweet from 2021, boasting that Americans would save a whopping 16 cents on their families’ Fourth of July cookouts compared with 2020. The source for that tweet was the American Farm Bureau, which does an annual survey of how the costs of the cookout change from year to year.
The bureau released its 2022 report today, and the cost of an Independence Day cookout rose more than ten dollars from last year. Americans’ parties will cost them $69.68 this year, rather than the 2021 total of $59.50, a 17 percent increase.
Illinois
Caterpillar was a proud Illinois company for nearly a century, but for the past decade, the clearly outlined needs from its CEO were ignored by elected leaders.
Former CEO Doug Oberhelman was serving on a state advisory panel in 2012 when he wrote that, although his company was growing, it wouldn’t grow in Illinois unless state leaders got control of their spending, taxation, and workers’ compensation costs. He warned that Caterpillar was not alone in those worries, especially when other states offered more fertile conditions to increase revenue and the number of jobs.
“Let me be clear. Caterpillar is not threatening to leave Illinois,” Oberhelman wrote. “Rather, we want to grow our presence in the state. For Illinois to really compete for new business investment and growth, the state must address these matters.”
The state didn’t. Now Caterpillar is moving its corporate offices and 240 workers to Irving, Texas.
Supply Chains
What do we notice around the world with labor in the transportation sector? First, they’re taking inflation very seriously. A 3 percent pay raise when inflation is at 1.5 percent is perfectly reasonable, but a 3 percent pay raise when inflation is at 8 percent is not. When inflation around the world was very low for years, employers were accustomed to modest pay raises, which workers will not accept this year. The Wall Street Journal editorial board wrote that the 14 percent raise for United pilots should sound alarms about a possible wage-price spiral.
For the West Coast dockworkers, the wage concern is secondary. They’re already paid exorbitantly, so a few percentage points difference in a wage increase isn’t make-or-break. The larger issue for them is automation, and they’ve long been willing to play hardball to stop it.
Which leads to the second trend we notice around the world: Organized labor isn’t afraid of the larger supply-chain struggles . . .
Singapore is investing $14 billion in port improvements that will result in the world’s largest automated port by 2040. It will double the capacity of the current port, which is already the top port in the world for trans-shipments.
It’s the kind of project the U.S. could really use right now, but nothing like it could occur under our current laws and regulations . . .
Electric Vehicles
Best guess: Electric vehicles would find widespread acceptance once the problems attached to their adoption — many of them infrastructural, some of them technological— had been ironed out, even without the help of the highly coercive steps (most notably bans on sales of new internal-combustion-engine vehicles) planned in the next few years.
But climate policy-makers are an impatient bunch. It’s not much of a guess to suppose that forcing the take-up of EVs at the pace that is now envisaged is going to lead to significant problems, not to mention raise some environmental . . . issues.
These include the sources of the electricity that will be powering EVs. That’s a question here in the U.S., and, as for India, well . . .
As I’ve written before, there’s nothing wrong with the idea of electric vehicles. They could well be the future, and if the government wants to put a (small) thumb on the scales to encourage the development and adoption of what may be a promising, cleaner technology, that’s fine.
However, for governments to attempt to force through the adoption of these vehicles combines hubris with economic illiteracy, two flaws traditionally associated with exercises in central planning such as this. EVs (and, critically, the infrastructure needed to support them) simply are not ready for prime time — and are highly unlikely to be so in 2030–35, the period in which, on both sides of the Atlantic, various mandates will put a halt to the sale of new internal-combustion vehicles. In the U.S., so far, this is confined to certain states, and in Canada the deadline, depending on the type of vehicle, will either be 2035 or 2040. To stick to the timetable currently being pushed by climate fundamentalists looks like an invitation to disaster. The way things are going, it will be accepted.
So, a few more recent stories to add to a growing pile.
Regulation
The SEC is on the cusp of enacting rules to compel companies to disclose “climate risk.” Commentators have critiqued the rules as misguided and beyond the SEC’s statutory authority. But the proposed rules have a more fundamental flaw that will doom them when the inevitable court challenges are filed. The rules violate the First Amendment . . .
Federal agencies must really love black markets.
Last week, the Food and Drug Administration (FDA) announced a plan to limit nicotine in cigarettes and ban Juul e-cigarettes. A court quickly stayed the Juul decision, so Juul products will remain on shelves for now. But both measures, if they were to take effect, would create incentives for black markets.
E-cigarettes such as those made by Juul are a safer alternative to tobacco, and an effective quitting aid for smokers. Mandating that tobacco cigarettes have a lower nicotine content would encourage smokers to smoke more to get the same nicotine effect — or to go underground to look for higher-nicotine cigarettes . . .
Amtrak
“Amtrak spent 11 years and $450 million to save Acela riders 100 seconds,” reads a headline from Vice. Amtrak began a project in 2011 to upgrade a 24-mile stretch of the Northeast Corridor in New Jersey to accommodate speeds of 160 miles per hour, instead of the 135 miles per hour it was operating under.
That project was supposed to take six years, which is appalling on its own, but actually was completed this year, five years late. Well, not actually completed, either: The article says only 16 of the 24 miles are ready for faster service. “The other eight miles are expected to be ready in 2024, a mere seven years late on a project expected to take six,” it says . . .
Energy
The “Do Something!” imperative so common in the Beltway as a response to the headlines of the day yields economic or policy improvement only rarely if at all. This cannot be surprising in that this imperative by its very nature does not lend itself to thoughtfulness, even by the standards of federal policy-making. One of the latest manifestations of this is the current effort to enact “NOPEC” legislation — No Oil Producing and Exporting Cartels Act — that would empower the Department of Justice to sue the Organization of the Petroleum Exporting Countries on antitrust grounds, as a purported response to high fuel prices . . .
Industrial Policy
As far as industrial policies go, however, the Minitel wasn’t a total failure. After all, until its launch in 1983, it was fairly innovative, and it survived for several decades while enjoying a high adoption rate. But nor was it a success. And here the story of the Minitel, even though not a resounding failure, offers a great illustration of one of the problems with industrial policy. When thinking of the Minitel story, we are lucky to have a perfect product to compare it to: The iPhone. As Mercatus Center’s Dan Rothchild reminded me, the iPhone came out 15 years ago, and its evolution offers a sharp contrast with the Minitel. While the iPhone has changed and improved dramatically over the years, thanks to Apple investment and innovation, the Minitel pretty much stagnated. The difference couldn’t be more stark.
So there you have it. Even when industrial policy doesn’t fail, it doesn’t adapt. It stagnates. It often hinders innovation. The result is a mediocre product that’s unnecessarily costly. So think about the Minitel if you are tempted to argue for industrial policy as a solution to some of our problems, in particular in the area of technology . . .
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