Over the last several blogs, we have opined that the pandemic hasn’t changed the economy’s potential growth path. The chart shows GDP growth rates beginning in the mid-1990s (with the Atlanta Fed’s +1.3% Q3/2021 forecast). The horizontal line shows a 2% growth level. Note that the left-hand side of the chart shows much higher growth than the right-hand side. In the 1990s, growth was in the 4%-5% range, and in the 3%-4% range in the first decade of this century. But post-Great Recession, the economy settled into a 2% growth mode and that lasted for a decade until the onset of the pandemic.
This blog attempts to look at the impacts the pandemic has had, including its impact on inflation, whether those impacts are permanent, and how they will impact short- and long-term economic growth.
The biggest complaint of businesses appears to be a lack of qualified applicants. It should be remembered that pre-pandemic, labor markets were already tight (unemployment rate of 3.5%), and such a complaint was already a major issue.
- Throughout 2021, until early September when the federal programs ended, industries requiring low skilled/low wage workers (leisure/hospitality, retail…) were competing with very generous federal unemployment subsidies. While September employment data appeared to disappoint markets, we believe the survey week (week of September 12) was too early in the month to show any marked improvement from the shutdown of the federal programs. We still think the October and November jobs report will show significant job creation.
- We have been following the Continuing Unemployment Claims (CCs) data on a state-by-state basis for several months, separating the states into those that opted-out of the federal $300/week supplemental unemployment benefits (the Opt-Outs) and those that didn’t (the Opt-Ins). Excluding CA (where CCs in early October had only fallen -8.2% from their May 15 level), as of mid-September, the Opt-Ins had reduced their CCs by -27% from their May 15 level, while the Opt-Outs had reduced their CC counts by -45%. Since then, however, the Opt-In states showed an 8-percentage point improvement, almost matching that of the 9-percentage point fall in the Opt-Outs. While other may disagree, it is our conclusion that those federal programs were holding back re-employment in the Opt-In states, and now that they have ended, re-employment has accelerated.
- The chart shows that, with the end of the special federal unemployment programs, the CCs are now rapidly approaching their pre-pandemic levels. (Compare the left and right-hand sides of the chart.)
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- Also impacting the labor force has been the pandemic’s influence on the retirement of a significant number of employees both over the age of 65 and those approaching retirement age. This has been a contributing factor in employee shortages as has the dearth of women returning to re-employment. Because of remote learning (i.e., school via Zoom), many women, especially those that couldn’t work from home, left the labor force. Today, we hear of employee shortages in the child-care industry, and not all schools have returned to pre-pandemic “normal.”. This has prevented many young mothers from returning to the labor force. Until the pandemic is long behind us, this looks to be a continuing employment issue.
The labor shortage has also stoked non-residential fixed investment.
- Businesses have responded to the dearth of labor applicants by investing in labor saving technologies. As shown in the first chart below, after an initial spike in labor costs due to Covid related work rules, unit labor costs have fallen. Some of this spike down in the Unit Labor Cost chart is due to base effects, but much of the spike up in the Non-Residential Fixed Income chart is due to businesses trying to substitute technology for employees. We think that a continuation of the tight labor market will continue that fixed investment uptrend (especially in technology) going forward.
During the lockdowns, there was a shift in consumer spending from services to goods.
- We all know what happened to the leisure/hospitality and retail industries. Airlines, hotels, live entertainment venues, restaurants…. During the first half of 2021 when there were lockdowns or a hesitancy to frequent service businesses, consumers spent on goods, especially since the federal government was giving money away. During this time, big-ticket items (like autos) set records. Was that just pulling consumption forward? That seems to be the case in the auto industry, as sales have plummeted since – although a good argument can be made to blame the lack of inventories (due to chip shortages) on the fall in sales.
- The demand for goods set off a chain reaction. Demand rapidly rose. Supply, on the other hand, was hampered by factory closures and other Covid related issues in manufacturing countries (mainly in Asia) and then by a lack of available transportation capacity. We all have read stories about the number of ships waiting to be unloaded at west coast ports. Recent reports have indicated that, after significant reduction in the number of anchored ships and wait times for unloading, the problem has worsened. To be fair, one must consider seasonality. It is the time of year when retailers order inventory for the upcoming holiday spending season. Thus, the rise in ships waiting to be unloaded.
How much of the current inflation is “transient” (pandemic related) and how much is due to other sources?
- Will consumers shift back to their pre-pandemic goods/services ratios? Likely there will be a shift back – we’ve already seen some of it (restaurants, airlines, hotels, casinos) – but, perhaps, not all the way back. Many small businesses (like restaurants) have permanently closed, and consumers have spent tons of money on home remodeling and have spent 1.7 years limiting their consumption of services. Some of those new habits may have become permanent. Many, for example, have found joy in cooking at home.
- The port back-up issue and the rise in the cost of shipping goods will continue to be an issue until the private sector adjusts. Note that it may take several months or even years for the private sector to build ships and containers. We do see that shipping company profits have soared to record levels which, in a capitalist economy, will attract new capital investment. So, while prices have risen due to the cost of transportation, we do think the private sector will eventually solve the issue. Meanwhile, prices can only rise so high before consumers revolt by not purchasing (i.e., high prices are a cure for high prices). This part of the inflation does appear to be “transitory.” The conclusion here is that supply chain related inflation isn’t systemic, i.e., it doesn’t have a life of its own and will stop or even partially reverse when the supply chain heals.
- However, some isn’t “transitory.” Because the media hasn’t distinguished between different inflation sources, the pandemic is being unfairly blamed for all the rise in the price of energy when that isn’t the entire story. Some of the blame for the initial spike in energy prices, especially fuel, certainly lies with the port, shipping and transportation issues discussed above. Thus, there is a “transitory” component here, especially in the price of gasoline at the pump. But there is a very significant component to energy inflation that lies elsewhere. Federal government policies, beginning at the turn of the year, that have emphasized green energy and de-emphasized fossil fuels have played a large role in the run-up in energy prices. In addition, the fossil fuel industries have suffered from a lack of investment, not only from the recent change in government policies and fossil fuel mandates, but, over the past few years, from a move of investors to ESG investing which eschews such fuels. The U.S. was moving away from its energy independence prior to Covid, and the recent government mandates and policies have significantly sped up that process. The conclusion here is that much of the inflation we see in energy prices is not “transitory.” It is not pandemic related and it will continue long after the pandemic has subsided.
- The scenario is similar in other countries. China, for example, has restricted electricity usage in its heavy industries. It is hard to know why since that economy is not completely transparent.
- Europe has such low levels of natural gas inventories that there are fears that there won’t be enough for winter heating requirements. Thus, rising prices. Again, some of the price increases are likely due to the supply chain issues caused by the pandemic. However, the region’s zealous move toward green energy has likely prematurely removed traditional fossil fuel capacity.
- Many pundits would have you believe that wages are rising everywhere and the that we are now in a new 1970s wage/price spiral. Not so! Wages are rising in those areas where there are significant labor shortages – leisure/hospitality, and retail. The latest data (September) show that wages rose 0.6% M/M (7.4% annual rate) for those two sectors. That’s 30% of the employment arena. The other 70% saw wages rise 0.3% M/M (3.7% annualized), not a scary number given that rising productivity has held down unit labor costs.
- In fact, the latest (September) CPI data saw a 0.4% M/M rise, much of it due to a 1.3% M/M spike in energy prices. Excluding food and energy, core CPI prices rose 0.2% M/M after a 0.1% August increase. “Systemic,” you say? Compare that to the increases in core CPI in April (+0.9%), May (+0.7%) and June (+0.9%). In September, apparel prices went down -1.1% (-2.7% for women’s clothing – women not returning to the labor market?), used car prices fell -0.7% after a -1.5% August decline (still up 25% for the year, but now moving in the right direction), rents declined -2.9% (you would never know that from media coverage), but home improvement, furniture and appliance prices continued to rise (likely due to continuing supply chain issues).
- We’ve written extensively about the impacts of excess government stimulus and over-generous unemployment programs. They’ve ended and those households didn’t receive weekly checks after September 4. Yet, we still saw a rise in September’s retail sales (+0.7%). Part of the reason was the rapid rise in fuel prices (not pandemic related). Those coming off of the unemployment programs still had a recent check or two in their accounts. In addition, given the media hysteria about supply chain issues, there may have been some early holiday buying on the worry that retailers would run short of inventory during the holiday shopping season. Thus, we still foresee soft consumptions data as Q4 unfolds.
- The EU has a brewing energy crisis. Slower growth there will have a worldwide impact. Same is true in China with the rationing of electricity. This is certain to cause a contraction in their industrial production. China also has huge issues in its real estate sector (accounting for nearly 30% of its GDP). In addition to Evergrande, several other large property developers have either defaulted on their debt payments or are now on the verge of such. Buyers of apartments (their major housing unit), which were at record levels a couple quarters ago, are simply non-existent. Certainly, economic growth in China will slow with a high probability of GDP contraction. This, too, will have worldwide consequences.
- We do think that much of today’s inflation is “transient,” although the media appears to have made that a “dirty” word. By “transient,” we mean that the inflation process is not self-sustaining, and that prices will stop rising (maybe even fall slightly). Nevertheless, we don’t think we can apply the “transient” term to a significant portion of the rise in energy prices because government policies, mandates, and investment themes have restricted investment in traditional energy sources. The “green” energy industries are just not far enough along to fill the gap those policies, mandates, and investment themes have created. Energy prices are going to continue to rise. In the U.S., consumers have only felt this issue via their pocketbooks. Not so in China where rationing is occurring, and that is soon to be the case in the EU.
- In our view, the best case (optimistic) scenario for the U.S. is a return to the pre-pandemic 2% slow growth economy of the post-Great Recession, pre-pandemic years. The demographics say so (population growing older), as does the rise in indebtedness on the federal level and in the corporate sector. The shortage of labor only compounds the growth issue. As we said, the 2% growth scenario is the optimistic one. We don’t rule out an approaching period of much weaker or even negative growth (i.e., recession).
- Central banks do not have the tools to deal with supply side induced inflation, changes in policies or mandates impacting supply, or changing investment preferences. It isn’t like the Fed can raise interest rates and cause an increase in the supply of energy. The Fed knows this. As a result, while they will soon begin their “taper” process (a reduction in the amount of money printing each month), we do not see them raising rates anytime in the foreseeable future.
(Joshua Barone contributed to this blog.)