The Trade-off Between Economic Stability and Economic Growth

 

The Trade-off Between Economic Stability and Economic Growth

Economics Without The B.S.**: 

[**  Double entendre intended.]

 

https://www.wsj.com/articles/rising-interest-rates-hit-landlords-who-cant-afford-hedging-costs-11673900169?st=8bw3rzwf8t6pbf0&reflink=desktopwebshare_permalink

This is a good article in the Wall Street Journal that illustrates what I see as a problem in our economy -- financing long-term investments with short-term loans. It is a way of showing we have an investment community that is more situated in what is called "rentier capitalism", earning income on the cash flows of an asset/investment rather than an emphasis on increasing the productive output of a capital investment that grows an economic opportunity that is new, what was more likely in an industrial economy.

 

It makes the investors constantly vulnerable to the fluctuations of short-term interest rates; in effect the viability of their investment is subject not only to the productiveness of the asset but also the constant variability of the short-term financing.  When enough businesses operate this way, dependence on short-term financing of long-term investments, it puts pressure on our Fed and government policy for encouraging low interest rates, which in my opinion offsets higher rates of economic growth.

 

In other words there is a trade-off between lower interest rates, more moderate growth rates, in effect economic stability, with higher rates of growth which can result in a tolerance for more speculative ventures.  It is a trade-off between stability and growth, in effect between stability and societal change -- trying to find the sweet spot between the two at any point in time subject to change.

 

Another way of looking at it is how much vitality in a society -- acceptance of change -- is related to more vitality in economic activity by encouraging higher rates of growth? And since the U.S. provides the economic leadership in the world and the dollar is the primary reserve currency for international financial transactions and commerce, how much effect does U.S. policy have on other less developed nations and the rest of the world?

 

 The importance that finance has played in making investments and structuring the financial aspects of the investment, something that has become more prominent since World War II, has, along with changes in the tax code, made the finance discipline even more important in business and society than it previously was.  This is one reason why we have had the growth of the Financial Sector and Service Sector and the decline of the Industrial Sector since the 1960s when we were more of an industrial society. And we have had lower rates of economic growth since the 1960s, even in our good years like the 1990s.  So how do we get the change our society needs to stay creative and innovative in meeting the wants and needs that arise as we go from generation to generation?

Mare Liberum; Mare Nostrum; Mundus Nostrum

 

Inflation and Monetary Policy

 

Inflation and Monetary Policy

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

 

How effective has Monetary Policy been in fighting inflation and promoting good economic growth?

Inflation and the Price of Oil

Inflation and the Price of Oil

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

 

What is the relationship between the price of oil and the Consumer Price Index?...especially as we become more and more a Service Sector economy?

https://fred.stlouisfed.org/graph/?g=M6eO

https://fred.stlouisfed.org/graph/?g=M78M

Ukraine -- What now?

 Ukraine -- What now?

I’m reading several news accounts today of how the U.S. is to blame for Russia/Putin’s action with Ukraine.  They say it started with the U.S. attempt to expand NATO when the Soviet Union collapsed.  Oh really?

 

As I recall almost thirty years ago – the mid-1990s – as we were dealing with a newly created Russia and the questioning if NATO was still needed, what shall we do with NATO?  Some of the idealistic talk was that if a new free Russia could liberalize it could join with the rest of Europe economically and a cooperative military arrangement could be made that would work with NATO.

 

This talk was not that all idealistic; it was acted on.  While Russia was not ready to join the European Union (EU) economically, it was invited and did become a participating member of the G-7, making it the G-8 in 1997.  With upgrades to its economy, it could be ready to join the EU.

 

Of the former East Bloc of the Soviet Union, all of those countries started their application to the EU between 1993 and 1996 and got their membership after 2000.  Russia never applied or started an initiative to join the EU. 

 

In 1999 the Czech Republic, Hungary, and Poland became members of NATO – none of them border on Russia proper; Poland borders on Kaliningrad which is part of Russia but separate from the main territory because it is wedged between Poland and Lithuania.  So no NATO nation was on the Russian border when Putin came to power in August 1999 and became President of Russia in May 2000.  The Baltic States and other nations on Russia’s border joined NATO 2004 and after.

 

My point is this:  Russia, in the mid-1990s, had two paths to follow.  It could liberalize and join Western Europe, or it could remain as it has historically, an East European power.  It choose the later, not the former; and when Putin came to power, he doubled down on this.  Putin had an opportunity to truly revolutionize Russia’s outlook for the future; but choose otherwise.  Germany had a similar opportunity after WWII in the 1950s – to take its traditional role of a Central European power, counter-balancing its interests East and West; or turn to the West and join in an alliance.  Konrad Adenauer, the leader of West Germany in 1949, choose a new path for Germany’s future.

 

Russia lost its G-8 membership when it invaded the Crimea in 2014.  History has no subjunctive case.  Here we are.  Now what?

More on the current inflation

 

More on the current inflation

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

 

The world community experienced a shock to the economy when the pandemic hit in March/April of 2020 – a major contraction of economic activity.  Had central banks, around the world along with our Fed, not intervened, there would have been a large deflation across the international economy, to include the United States.  That would have affected asset prices, probably on a broad category – physical and financial assets.  One can only speculate what that impact would have been, remembering that asset prices underlie the foundation for credit, as collateral, and the importance of credit to keep liquidity flowing to support economic activity/behavior.  Not to mention that a prolonged deflation could result in cuts to income – derived from wages and salaries – something Americans have not experienced in many generations.

 

Instead of dealing with a deflation, and the possibility of a deflationary spiral, central banks did intervene; and, in the case of the United States, where we also had a very large fiscal intervention, we were able to stabilize the price level to some extent where we are dealing with some degree of inflation at present without knowing its severity.  The broad category of asset prices has held firm or have even risen substantially.  Credit markets were disrupted, but the Fed has intervened to support specific sectors of the credit market.

 

Only to that extent can this inflation be considered a monetary phenomenon.  When the international economy shutdown, that caused physical harm to the economy – unemployment, a substantial reduction in the output of goods and services, and business closures.  In other words, greatly reduced economic activity of actual physical/real people and structures (businesses, equipment), and the flow of goods through the vast distribution system.

 

The injection of monetary and fiscal stimulus bolstered segments of the economy.  But it has been uneven.  This has resulted in imbalances among the sectors of the economy and especially between the demand for goods and services and the ability of the broad economy to respond, to fulfill that demand.  The supply is lagging the demand.

 

That gap between supply and demand is affecting prices.  You see this gap in the uneven recovery by comparing Personal Consumption Expenditures (PCE) with the broad Industrial Output. 

https://fred.stlouisfed.org/graph/?g=JACK

Industrial Production and PCE

https://fred.stlouisfed.org/graph/?g=Jm29

Capacity Utilization

And you see the effect on price when you compare the Consumer Price Index (CPI) to the Producer Price Index (PPI) – it is the PPI with the wild swings that tells the story.  In the post-2008 Financial Crisis years, the PPI took wild swings while the CPI remained steady; the price increases in the wholesale system were absorbed within the economy and not passed on to consumer, as reflected in the gradual increases in the CPI.  This time the price increases in the PPI are not being absorbed within the economy, they are being passed on to consumers, as reflected in the CPI.  The PPI leads the CPI and is driving the CPI.

https://fred.stlouisfed.org/graph/?g=JvxR

PPI and CPI

The inflation behavior now is due to the PPI swings and the behavior in the productive sectors and the supply chain/distribution system that services the productive sectors.

 

That we are in an inflationary time period, and not a deflationary time period, is a monetary phenomenon.  But that is a one-time event.  The inflation we are now experiencing is due to imbalances within the physical economy – namely the recovery of the production and distribution sectors lagging, failing to satisfy, the demand for goods and services.

 

In this current inflation Aggregate Demand is leading Aggregate Supply, and the lag in production and distribution results in the PPI leading the CPI.  This inflationary cycle is not due to monetary factors, but due to the real, physical economic structure and process – the flow of goods and services have been disrupted.  There is little the Fed can do about that; and probably little Central Planning by the government can do.

 

Take care of the Big Picture – dealing with the pandemic and restoring an operational framework – and let the individual agents (big businesses and small businesses, and the folks who make up the labor force) figure things out for themselves.  Sooner or later order shall be restored, and we will probably be operating at a higher price level, but without the inflationary pressures and back to some sense of stability.

 

Inflation in the future?

Economics Without The B.S.**: 

[**  Double entendre intended.]

An economy is not just goods and services, but also people.  We seem to have lost all proportion in what a shock to our economy we experienced this past year.  Without delving into details, let me be descriptive.

 

Just in April 2020 alone, near the beginning of the pandemic when we had a national lockdown, we lost [net] over 20 million jobs, and over 6 million people dropped out of the labor force of near 165 million (about 8 million total dropped out of the labor force and we have recovered around 5 million of that), and the unemployment rate rose, just in that month, over 10% (from 4.4% to 14.7%), for the worst month in U.S. history, even nothing during the Great Depression came close to that.

The month before, March 2020, when the international economy shut down, there was a sell-off of U.S. treasuries to raise cash.  The Fed stepped in to the tune of over $1 trillion per day; described by the NY Fed’s John Williams “a staggering amount” to provide liquidity to support the market activity.

 

Now if that alone does not impress you for what a shock we experienced, let me relate this: during that lockdown of about three weeks, the complete Los Angeles freeway system was wide open without any hitch, and I have lived in Southern California for over forty years.

 

May I digress into a little detail now?  Our logistics system, the supply chain, is not just national in scope but international.  While we were experiencing the lockdown, so was the rest of the world.  Container ships were taken out of service and temporarily put in mothball status at a variety of secondary ports around the world.

 

You can think of our international/national logistics system as queuing theory -- waiting/processing lines, or queues.  One line is for processing (moving goods -- from Asia to Europe and the USA; and for moving goods across the USA) -- and also for moving empty containers once they are off-loaded back to Asia; and one line is a waiting line for reserve capacity (extra containers, trucks, storage space, etc.) that is needed to fill gaps in the processing line or take capacity out of the processing line when it is not needed and thereby make the processing line flow more efficiently.  The whole system operates on flow -- keep the processing line flowing. In normal operation the processing line capacity (the movement of goods) far exceeds the waiting/reserve line capacity.

 

When the pandemic hit in February 2020, economic activity was halted, greatly reduced.  So the processing line had to be shrunk -- back in Asia, and in Europe, and in the USA.  Container ships were taken out of service and put in temporary "mothball storage". When they are put in storage (idled at smaller ports), they require a certain amount of processing to avoid the marine corrosion that can deteriorate them in a short matter of time (90 days).  Rail cars and trucks are taken out of service and put in storage on lots. Empty containers and chasses are taken out of service and put in storage on any lots they can find.

 

All of the companies that are part of this network -- big companies, international companies, but also a lot of small operators who operate on a small margin -- in various forms of transportation (rail, truck), storage (warehouses, lots, small dirt lots [and we have them in Greater LA in low-income neighborhoods]), brokers and freight forwarders and packing & crating companies, etc. -- had to reduce their operations or in some cases close down. Employees were laid off.

 

The waiting/reserve queue does not have the capacity to hold all the trucks, trailers, containers, chasses, and especially the container ships that were taken out of service.

 

In the case of the empty trailers/containers/chasses -- these items are probably stored anywhere in the country where the owners (shipping companies in most cases; but could also be freight brokers) could find cheap storage rates. 

 

So, as economic activity picks up, it will take a little time to put all the pieces back together in order to get good flow moving again.

 

It takes time to deprocess the container ships that were "mothballed" for several months.  And who knows where some folks put all those empty trailers/containers/chasses?

 

Two things need to happen to rid the economy of inflation.

(1) The shock to the economy was due to the pandemic. We have to either conquer the pandemic, or learn to live with it. Then we will return to some sense of normalcy.

(2) And then, the economy will normalize along with prices, and we will probably be at a new and higher price level for our large economy and without the inflationary pressures.

 

The analogy you could make to understand a shock to the economy would be when we came out of war time periods into post-war, more normal, periods – like after World War I when we experienced a short (18-month) depression or the short, but sharp, recession we had in 1946/1947 right after World War II.  1946 was the second worse calendar year in our entire history, right after 1932 during the Great Depression.

 

Normally when we have a big shock to our economy after coming out of a big war we can have a deflation (1921 and 1922) or inflation (1946 and 1947).  When we shutdown the economies world-wide from February to April 2020, our Federal Reserve along with the fiscal stimulus of the federal government, pumped enormous amounts of money (well into the trillions of dollars) into various aspects of the economy to keep it somewhat afloat, putting a bottom on the recession, in order to avoid a deflation.  We perceive a deflation to be worse than an inflation, because of the negative consequences on investing for the future.  One moral hazard of that is that asset prices have not corrected and have spiraled upward.

 

Whether all that funding that went into the economy to keep it afloat will result in long-lasting inflation will depend on raising our productivity levels as we go forward.  We have had very poor rates of productivity, as measured by the Real GDP, since 2001, skipping the pandemic year of 2020 – yearly averaging 1.98%; and only 2.41% if you leave out the recession years, well below our historic yearly averages of well over 3% per year (3.77% since 1790 and 3.03% since 1947; and 4.53% during the ten years of the 1960s).  This is also true for labor productivity (output per hour), in which the rate of labor productivity has been in a downward trend since 2005.  So what it will take to turn things around, we will just have to see; but, there is plenty of room for corrective action.  There is no need for us to return to the inflation of the 1970s – this is not a similar situation.