The week of August 8, 2022: The inflation debates, ESG, climate, taxation, and much, much, more.
The week of August 8, 2022: The inflation debates, ESG, climate, taxation, and much, much, more.
S ome may scoff, but I, for one, am impressed that President Biden’s campaign against those wicked gas-station proprietors has paid off so well.
This week’s inflation report finally delivered some good news, and a falling gas price had quite a bit to do with it. July’s CPI rose by 8.5 percent year-on-year, down from June’s 9.1 percent, and lower than the expected 8.7 percent.
Core CPI (which strips out food and energy) rose by a relatively modest 0.3 percent in July, as compared to 0.7 percent in June, but its overall year-over-year level remained unchanged at 5.9 percent, a number said by some to be a more “normal” level, although it’s worth reading Larry Summers’ comments below on that interpretation.
CNN tweeted what was expected of it:
US inflation took a breather in July, thanks to the falling cost of food and gas, as consumer prices grew at a slower pace than in previous months
A closer look at the story revealed that that wasn’t quite right.
CNN:
However, food costs continue to jump sharply, increasing by 1.1% over the month and rising 10.9% on a year-over-year basis, the largest increase since May 1979. Food at home spiked by 13.1% on a year-over-year basis. The run-up in food prices was a surprise, as lower energy prices were expected to help ease the sticker shock Americans have experienced at the supermarket over the past several months.
Oh.
Some villains of the post-pandemic price surge are improving their behavior. The prices of plane tickets, hotel rooms, and used cars fell. Shelter (i.e., rent and, indirectly, house prices) which accounts for about 30 percent of the CPI and some 40 percent of core CPI, continues to move up, although by less than last month. This will remain an area of concern for a while.
Not enough new housing has been built in recent years, but homebuilders (who have picked up activity considerably in recent months) will be watching the impact of higher mortgage rates with concern. Even after the recent easing in those rates, they are still far higher than, say, a year ago, adding to the pressure on potential buyers already wrestling with affordability. New listings had been picking up (although that may now be going into reverse) but overall, inventory is still (CNBC reports) at about half pre-Covid levels. Moreover, despite signs of weakness here and there (including falling sales), the cost of buying a home (the median price of an existing home hit a record in June) is keeping people renting, increasing the upward pressure on rents.
On more positive notes, PPI numbers (a fall of 0.5 percent versus an expected 0.3 percent increase) eased, and supply-chain pressures seem to be relaxing. So far as the latter is concerned, spot prices have to be treated with some care, but, the New York Times reported:
An index of global supply chain pressures created by the Federal Reserve Bank of New York also shows that pressures have trended down since December. Importers are now paying about $6,632 on the spot market to move a 40-foot container from China to the West Coast of the United States, compared with $18,346 a year ago, according to data from Freightos Group. Average monthly delivery times on the same route are about 74 days, down from a peak of 99 days in January.
“It’s a massive traffic jam that is now unclogging,” said Phil Levy, the chief economist at Flexport, a freight-logistics company.
Please keep an eye our articles by Dominic Pino, Capital Matters’ Mr. Supply Chain, for further details, not always cheery.
Last week, Larry Summers, someone who is also not always cheery, offered his now traditional message of caution, worrying ahead of the CPI release that “some good news on non-core inflation,” might be on the way thanks to the falling gas price. Add some signs of a slowdown, and the Fed might think that things were under control and relax too soon even though the economy remained, in Summers’ view, “overheated.” In particular, Bloomberg reported, Summers believes that the labor market remains “red hot” and that would mean “constant or even accelerating inflation.”
Our Kevin Hassett read something different into the job market’s strength than Summers. Writing for Capital Matters, he explained:
Inflationary recessions are reliably different from normal recessions, and their key attribute is that the labor data continue to look bullish throughout the first half of the recession. This happens for a simple and intuitive reason. When employers start to lose money at the beginning of a recession, they need to cut their costs as demand falls. With real incomes down more than 4 percent this year, and real GDP down two quarters in a row, demand is clearly falling. Wages tend to be hard to adjust downward, so in a normal recession, firms begin to adjust their costs by laying off workers.
But in an inflationary recession, firms’ prices are going up faster than their wages, so real labor costs fall without the need for layoffs. With inflation running at about 10 percent, and wage increases up about half that, firms have already dramatically reduced their wage bill, relative to the rest of the economy. And if you add that wage increases tend to be focused on job switchers, firms that are hunkered down and not adjusting wages at all can cut their real wage bill right now by almost 10 percent just by treading water. Add to that the post-Covid difficulty in finding workers, and it is natural that this recession would see stronger labor-market data for now.
It’s also worth paying attention to data that suggest that all is not as well as first appears. Certainly the recent job numbers were strong, and unemployment (3.5 percent) is low, but labor-force-participation rates remain some way below their pre-Covid level. Average wage growth has recently been running at annualized rates of 5 percent per year, but wages have eroded in real terms (job-switchers and lower earners have done better) although, month-on-month, the numbers were positive in real terms for July. Throw in recent hiring freezes in the tech sector and rising unemployment claims (albeit from a low number), and the narrative of a red-hot labor market begins to lose some of its force.
There have also been signs that the economy is weakening: most notably, of course, two consecutive quarters of GDP decline. Those numbers are subject to revision (and note the positive noise emanating from the Atlanta Fed’s GDPNow), but normally they would constitute a recession, even if that politically inconvenient definition has come under rather more scrutiny than would normally be the case. How odd.
Beyond signs of a faltering housing market, there have been other signs of weakness, or weakness to come, ranging from an inverted yield curve to the fall in the price of some commodities (perhaps tellingly, the copper price, traditionally seen as an excellent economic leading indicator, has taken quite a hit), to signs that, hard-pressed by inflation, some consumers are cutting back on their spending (others, however, are simply switching more of their spending away from goods and to services).
Make of surveys what you will, but in June the University of Michigan’s index of consumer sentiment hit its lowest point since being established in the 1970s and only made a minor recovery in July, although the preliminary numbers for August jumped some above expectations. It will be interesting to see the Conference Board’s Consumer Confidence Survey for August. It fell for the third consecutive month in July.
There is little in the international picture to inspire much joy, especially as what may be an energy-constrained winter in Europe draws closer, although that may put upward pressure on the oil price as the continent struggles to replace shortfalls in Russian natural gas. And it’ll be worth keeping an eye on what looks like a developing emerging-markets debt crisis, as well as what may flow from China’s housing mess. Monetarists meanwhile will note that the growth in M2 has collapsed.
So, there is gloom, but not enough of it to cheer Summers.
Back to Bloomberg (last week, my emphasis added):
Stripping out food and commodities such as energy, “we have by every reasonable measure of core inflation running somewhere plus-or-minus 5%,” Summers said. “That is more than when Richard Nixon put price controls in place. That is not acceptable by any dimension.”
The former Treasury chief reiterated his criticism of Fed Chair Jerome Powell’s assessment last month that, with the latest interest-rate hike, the central bank had already reached a “neutral” setting — where it’s neither stoking nor restraining consumer prices.
“I don’t think the Fed has the thread right now,” Summers said. Without significantly boosting real interest rates — which are adjusted for some gauge of inflation — “then we’re just setting the stage for stagflation,” he said.
This matters: Real rates are negative (even if we add in the effective additional squeeze provided by quantitative tightening). That’s hardly evidence of Volcker 2.0.
Writing over at his blog at the end of July, so also before the CPI release, John Cochrane observed that:
The Fed thinks that interest rates are already “neutral,” meaning that a 2.25-2.5% interest rate and 9% inflation does not push inflation up any more. How can they believe this?
Markets also believe that inflation will largely go away on its own, with no period of interest rates substantially above inflation.
Something to ponder.
That said, today’s higher rates will have come as a shock to many of those accustomed to ultra-low interest rates (on some measures, the lowest for four thousand years). The consequences of those years of extraordinarily cheap money will, I suspect, be with us for some time.
When the inflation numbers were released, Summers thought they were “pretty good”, but (via the Hill):
“We knew gas prices were way down and that was going to have a large effect on headline [inflation]. The core number was a bit better than we expected, than people expected. That was largely driven by components like hotels, like airlines, like used cars that are volatile month-to-month, that are hard to seasonally adjust especially coming out of the pandemic, and that aren’t so easy to measure,” he said.
However, Summers cautioned that it would be a mistake for anyone to radically revise their view of the situation based on the July figures.
“This report is a lot like the report in March, which was followed by very discouraging reports afterwards, making the optimists from March look wrong,” he said.
Writing in Bloomberg on August 11, John Authers echoed Summers’ caution:
Different research groups within the Fed monitor measures of a “core” of inflation to look at underlying price pressures, and these are still rising. It’s possible that we’re at or near the peak, but we haven’t passed it.
Two widely followed measures come from the Cleveland Fed, which publishes a trimmed mean (excluding the biggest outliers in either direction and taking the average) and the median. These measures were never moved by rental cars or gasoline in the first place. And unfortunately, both continued to rise, and both are at their highest since the series started in 1984.
The Atlanta Fed monitors prices that are “sticky” (which require lengthy planning to change and are hard to reduce), against flexible prices that can rise or fall swiftly with little difficulty. The early months of the inflation scare were dominated by flexible prices, for which inflation is beginning to drop a little. What matters for the Fed is whether expectations have become so dislodged that sticky prices are moving. And again, the year-on-year rate of sticky price inflation rose last month, to a new 40-year high. This is a big problem that implies a need for extreme central bank vigilance. The good news is that sticky prices didn’t inflate as much last month as they did the month before — but this is still strong evidence that as far as the Fed is concerned, the peak is not yet in.
Markets are already looking forward to declines in interest rates as growth eases, because they are trying to discount future events — but this is all on the assumption that the Fed does what it says it will do, raise rates further, and leave them there for at least a matter of months. Unless it actually goes through with these actions, there is no reason to believe that inflation will come under control. And while it doesn’t want to crash the economy, the horrible example of the early 1970s, when the Fed under Arthur Burns correctly hiked aggressively as the oil spike hit, but crucially started easing before inflation had been totally beaten, will be on central bankers’ minds.
Authers quotes TS Lombard’s chief U.S. economist Steven Blitz:
“CPI appears to have begun decelerating, giving, to some, a sense that disinflation back to 2% is under way. It is not. This price deceleration simply reflects the unwinding of the Covid boom – reversing, for example, the price surge from reopening (hotels, airline tickets, rental car prices). First half GDP data similarly gave a false indication of recession when the data were only reflecting an unwind from the unsustainable real 6% growth pace set last year. Any current price deceleration runs in concert with the slowing of the economy from Covid to something closer to trend. In other words, any disinflationary trend from 9% is not signaling a shift in the economy’s fundamental supply/demand imbalance that is underpinning a base inflation rate below 9% but well above the Fed’s 2% target . . . The NY Fed puts trend underlying CPI inflation in a 4.7% to 5.9% range. The economy is a long way from returning to 2% inflation.”
Meanwhile, the New York Fed’s survey of consumer expectations for the next year dropped sharply, albeit to a level (from 6.8 percent in June to 6.2 percent in July) far above the Fed’s 2 percent target.
Put all this together (while you are at it throw in the wealth effect created by a partly recovered stock market) and it’s clear that there are good reasons for Summers’ caution, a caution that the Fed appears to share. Loretta Mester, president of the Cleveland Fed, has warned against crying victory too early, words echoed by both Fed chairman Jerome Powell and the Minneapolis Fed’s Neel Kashkari, among others. Powell has also said that he wants to see “compelling” evidence that inflation was headed towards that 2 percent, words that suggest that he hasn’t seen it yet. That’s fair enough, indeed if I had to guess, even if the current tightening is maintained, I’d be surprised if we get much below 4 percent any time soon.
Alert readers will notice that I have not mentioned the Inflation Reduction Act. That’s because, if there’s one thing it won’t do, it’s reduce inflation to any material degree. It might even increase it.
So, what should the Fed do when it considers the size of its next rate hike in September? Markets are currently divided: Some expect a 50 basis-point increase, others 75. We’ll see, but the dangers of overshooting strike me as being less than those of undershooting. Assuming current conditions persist, the Fed should opt for 75 basis points, not least for the message that will send — a message that, after the last year, still needs to be heard.
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 the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 79th episode David is joined by Steven Teles of the Niskanen Center, also a professor of political science at Johns Hopkins, and a well-known author in the domain of political economy. David and Dr. Teles go all over the map discussing rent-seeking, the role cronyism plays in feeding wealth inequality, and what policy solutions and trade-offs need to be on the table.
The Capital Matters week that was . . .
ESG
Does the “g” in ESG stand for genocide? Because that is what is taking place in Xinjiang. Regardless of climate change, investors who believe that ESG (a variant of “socially responsible” investing in which actual or prospective portfolio companies are scored against a series of environmental, social or governance — the real “g”, in case you wondered — benchmarks) is in some sense ethical surely should find it unacceptable to take a stake in any firm manufacturing (or using) solar-panel materials (notably solar-grade polysilicon) processed in Xinjiang by forced labor.
But should that be the end of the matter? . . .
Managers of public pension funds have been notable advocates of switching to an investment approach that incorporates the disciplines of ESG or something akin to it (ESG is a variant of “socially responsible” investment under which potential or actual portfolio companies are measured against various environmental, social, and governance guidelines). Yes, there was a green bubble for a while, and there may well be others in the future, but it’s by no means clear (I’m being polite) that ESG will help deliver superior returns over the long term . . .
Climate
Writing in the Daily Telegraph, Daniel Hannan looks at the deeper philosophical and cultural forces currently driving the “race” to net zero greenhouse-gas emissions and doesn’t much like what he sees. The background to his article is the energy crunch now being faced by the U.K. (and the rest of Europe), a fiasco that American climate policymakers seem only too keen to emulate . . .
Energy
A number of perverse Beltway ideas never seem to die despite their underlying fallacies. The latest such nostrum is the argument that a renewed ban on the export of crude oil and refined products would reduce domestic fossil-energy prices, as asserted in a recent letter to President Biden from four U.S. senators urging Biden to “preserve petroleum supplies for the U.S. and our allies.”
Supply Chains
If China were to go to war with Taiwan, one of the many negative consequences would be an immediate and severe disruption to ocean shipping. The waters around Taiwan are some of the busiest in the world for commercial vessels, and the Port of Kaohsiung, Taiwan’s busiest, is a top-20 port globally.
As such, shipping lines have a lot to lose if China’s aggressive rhetoric turns into aggressive action. Wars that affect ocean trade are not as common as they used to be (thanks largely to the global peacekeeping presence of the U.S. Navy), but they still do happen from time to time.
To mitigate risk, the maritime insurance industry designates areas of the sea according to the likelihood of war.
Taxation
All that said, I’ve never been a great fan of share buybacks. To me, they represent too much of a bet by the company’s management on where a firm’s share price is going. I’d rather that decision was left to investors as they weigh whether to buy, sell, or hold. I prefer dividends. But yes, it is certainly true that share buybacks are more tax-efficient for shareholders who pay tax on dividends, a category that excludes, incidentally, investors who hold their shares or mutual funds in their 401(k)s.
And all that said, I am not a fan of either banning or taxing share buybacks.
The centerpiece of IRS spending would be for tax-law enforcement. The bill promises $45.638 billion for this purpose, to include enhanced audits and collection, legal and litigation support, criminal investigations, digital asset monitoring and compliance, and the general enforcement of tax laws and other financial crimes.
And while the administration has repeatedly assured us that the targets of this increased enforcement action will be only high-income earners, I have shown clearly that the targets will likely be self-employed persons, along with those who claim the benefits of the laundry-list of refundable tax credits — lower-income taxpayers . . .
Treasury Secretary Janet Yellen sent a letter to the IRS commissioner earlier this week about the new funding the tax-collection agency will receive under the Democrats’ reconciliation bill. But her numbers don’t seem to add up when she talks about the goal of using that windfall to squeeze high-income households . . .
Pharmaceuticals
Congressional Republicans defeated a proposal by congressional Democrats to mandate that private insurance companies cap out-of-pocket spending on insulin by their enrollees at $35 per month. This follows years of reporting on the high cost of insulin and nearly two dozen states that have imposed similar co-payment price caps for insulin. Yet this proposal neglects to address the way the government drives up the cost of insulin. Further intervention would make matters worse.
In January 1922, a Canadian boy hospitalized and dying from diabetes . . .
Bahnsenomics!
The much-anticipated Bahnsen Economics Course has been unleashed and is now awaiting curious and parched minds keen on understanding the means to human flourishing, as presented by our paisan, David Bahnsen (host of NR’s popular Capital Record and Radio Free California podcasts).
This is not unserious stuff . . .
The Economy
And so, that said, looking at the state of the economy and of the markets today, where do we stand? The U.S. stock market is down 12 percent year-to-date, but it was down 22 percent YTD in mid-June. Oil and gasoline are up 20 and 36 percent YTD, but they were up 74 and 94 percent YTD two months ago. (All performance figures are as of midday on August 10.) The Fed has started to tighten, but real interest rates remain solidly negative. Official inflation is near a 40-year record per the CPI, but other indicators have rolled over, suggesting that CPI itself will soon break decisively on the downside . . .
The partisan recession deniers — that is, the Biden administration and congressional Democrats — have just passed a fiscal-policy bill that no rational economist would recommend enacting during a recession. The bill subsidizes inefficient energy production and pays for it with a slew of tax hikes. Indeed, even President Obama, in 2009, argued that “you don’t raise taxes in a recession.” The reason you don’t raise taxes in a recession is that doing so makes the recession deeper.
If the Federal Reserve were confident that we are in a recession, then it would continue to lift interest rates to fight inflation, but it would do so with the gentle touch of a brain surgeon’s scalpel. Instead, comforted by low unemployment, it runs the risk of feeding the negative momentum from inflation and fiscal policy with harsh monetary policy. This also makes the recession deeper. In other words, the depression risks are higher than they have been in our lifetimes.
Student Loans
Major changes in federal policy toward student debt have been in the news recently, chiefly with the Biden administration considering some amount of student-loan forgiveness. Meanwhile, very quietly, a more innovative, free-market solution to the student-debt crisis is being attacked. The Biden Consumer Financial Protection Bureau (CFPB) has been cracking down on income-share agreements (ISAs), an innovative solution popularized by Milton Friedman in a 1955 essay titled “The Role of Government in Education” that ultimately made its way into Friedman’s 1962 classic, Capitalism and Freedom. With income-share agreements, students have to pay back a fraction of their future earnings over a fixed amount of time, as opposed to the case with traditional student debt where students often have to pay back a fixed amount of debt payments . . .
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