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.