Economists study individual and group human behavior as we try to satisfy our needs. Sometimes the sum of the quests for individual satisfaction produces an outcome that is unexpected or contradictory to the aims of each individual’s choices. People may synchronize their behavior to a point that their accumulated actions overload a system, causing it to become dangerously unbalanced and lead to a collapse. Our modern communication systems may introduce more frequent panics, more opportunities for reactionary zeal and anger.
During the Great Depression, the economist John Maynard Keynes proposed a Paradox of Thrift. Saving money is a prudent choice for each person but if too many people decide to save money at the same time, economic activity declines. An extreme example is the 2008 financial crisis and recession when millions of people decided to curtail their current spending, the blue line in the graph below, and increase their savings. This is the power of uncoordinated expectations. We act sometimes as if our actions were being choreographed.
These paradoxes introduce contradictions that challenge our assumptions and ideologies and cause a lot of disagreement among economists and the public. In an EconTalk (2009) podcast, economist Steve Fazzari explained the immediate consequences of the Paradox of Thrift. In an effort to save money for college, a family foregoes their weekly meal out at a nearby restaurant. At the first occurrence, the family saves money which they deposit in a bank savings account. The next day the restaurant owner must withdraw that same amount from the restaurant’s savings to make up for the lost revenue. In that immediate time frame, there is no increase in savings/investment and this violates the ideologies of some listeners. As the pattern continues, the restaurant owner will adjust her expectations for revenue and lay off some workers. The podcast listeners interpreted Fazzari’s analogy in several different ways. They could not agree on what a short time frame is or the scope of the story.
We see and hear words and events differently yet sometimes respond in a seemingly coordinated fashion. Our panicked response may cause or amplify the very thing we fear. In September 2008, banks and investment firms lost trust in the soundness of each other’s assets. The loss of confidence caused the value of those assets to plummet, actualizing the fear. The Fed and central banks around the world struggled to contain the panic as the global financial system seized up like an engine without oil. In March 2020, central banks were better prepared, flooding the markets with liquidity at the onset of the Covid-19 pandemic. Still we swarmed onto the streets, emptying shelves of merchandise ahead of lockdowns.
Every culture has its account of the consequences of humankind’s hubris, a lesson in the perils of our own arrogance. The Bible accounted for the variety of languages with the story of the Tower of Babel. Our phones connect us to the information hive, instantly relaying breaking news in our language of choice. The internet brings us together and drives us apart. As our communications become more rapid and extensive, we increase the likelihood of global panics, an unplanned reaction to some event. Fringe groups become more adept at coordinating their anger and actions like they did at the Capitol on January 6th. Our culture evolves with our technology but our laws are slow to adapt. Our mechanism of lawmaking, adapted to a horse and buggy age of communication, will have to be redesigned before it breaks apart our society, our culture and our union.
This week I’ll look at the week’s events within a broad context of several centuries so make sure your seat belt is secure! Two weeks ago I wrote about two reliable indicators of recession, the annual acceleration in unemployment and in real retail sales. Since World War 2, an upward tick in unemployment and a downward movement in real retail sales has always preceded a recession. The unemployment report came out last week ending July 10th. The acceleration in the unemployed has remained negative, not confirming a high likelihood of a recession in the presence of weak retail sales.
The latest reports on inflation and retail sales were released this week. Although retail sales showed an increase, inflation adjusted retail sales decreased from last year. The deceleration in real retail sales is severe at -26%, indicating the dramatic consumer response to inflation and higher interest rates. Whether economists declare an official recession or not, consumers are feeling the pain and uncertainty. Here is an update on a graph I showed two weeks ago.
(FED, BLS, 2022)
In 2011, we saw a similar pattern – a plunge in retail sales but not an annual rise in the unemployment rate. There was a budget battle, a looming government shutdown and the stock market dropped 20% in anticipation of a recession that did not materialize. In the first quarter of 2012, the stock market began another historic climb, rising 60% in 30 months.
Each week we are reminded of rising food and energy prices but the rise in the cost of housing has been the most dramatic. According to Redfin (2022), a national real estate brokerage, a townhome in LA had a typical mortgage of almost $2400 in February 2021. In June 2022, they estimate a monthly mortgage cost of $4000, making it more expensive to own a townhome than to rent.
In David Hackett Fischer’s (1996) book The Great Wave he wrote about four centuries where prices continued to rise even during economic downturns. He dubbed these periods of sustained inflation “price revolutions.” The approximate dates are the 1200s, 1500s, 1700s, and 1900s (p. 6). The current price revolution began after World War 2, with prices falling only three times. Despite the severe recessions of 1974 and 1982, prices continued to rise.
Price revolutions create class conflict. The prices of life sustaining commodities like food, basic commodities, energy and shelter go up, having a greater impact on people with lower incomes. There are higher returns to property and capital owners. The price movements of manufactured goods are more tame but these benefit those with higher incomes, exacerbating class tensions (p. 86).
According to the Dept of Agriculture (USDA, 2022), the cost of food at home has fallen in only two of the last fifty years – in 2016 and 2017. There have been nine recessions since WW2, but the cost of shelter has fallen in only one year – 2010 (BLS, 2022). In a period of sustained price increase, people need more money. Since 1960, the per person quantity of a broad measure of money called M2 has declined in only two years – 1993 and 1995 (BOG, BEA, 2022).
Fischer identified seven causes of inflation (p. 279-280). Let’s review these in light of the rise in the cost of shelter. The first is an expansion of the money supply. A textbook example is the 1920s in Weimar Germany when people carted money in wheelbarrows to buy groceries. Today the Federal Reserve increases the money supply by lowering interest rates. People demand more credit and the banks increase the money supply. Low mortgage rates increase housing debt and the demand for housing.
A second cause of inflation is an increase in aggregate demand. An extreme example is the surge in military spending during WW2. In this case we are focused on one sector – housing. According to the Case-Shiller Home Price Index (S&P, 2022), home prices have risen at last 5% each year in the past decade. China’s rapid industrialization since 2000 has elevated global demand for building supplies. A third cause of inflation is a contraction in supply. The pandemic caused supply bottlenecks in the supply of lumber and other building materials. A fourth cause is rising input costs, or “cost push inflation.” This is sometimes associated with rising wages as happened in the 1960s, but real wages in the decade before the pandemic rose only 5%, according to the BLS (2022). In that same ten year period, the costs of building materials rose 26% and jumped 50% in the second quarter of 2021 (BLS, 2022).
A fifth cause of inflation are administered prices, or oligopolies and monopolies created by government action or as part of an international pact. A good example is the alliance of oil exporting countries known as OPEC. This has not been a factor in the latest rise in home prices. A sixth cause is “bubble inflation” like the tulip mania of 1634 or the more recent surge in home prices during the 2000s. People bought homes in the expectation of a rapid rise in home asset values and they paid little attention to the home’s affordability.
The seventh cause of inflation is more applicable to the recent surge in home prices and current Fed policy – inflationary expectations. Anticipating higher prices of goods and services, people buy now, increasing demand and prices. The expectation starts a chain of events that fulfills the expectation. The late 1970s is a good example of this. Anticipating a 25% increase in the price of stereo in the coming year, a consumer would buy now on an installment plan, paying 15-20% interest. They were saving money and getting to use the stereo free for a year! It is that kind of thinking that the Fed wants to contain because those expectations continue to fuel inflation. Each of these inflationary factors adds to the persistence of inflation. Five of the seven causes are clearly present in this latest bout of inflation but the pandemic is the culminating event of decades of inflation.
In previous price revolutions, a crisis event led to a fundamental transformation of society, attitudes and thinking. The plague of 1348 ended the price revolution of the 1200s and early 1300s. In its aftermath, humanism emerged and the serfdom of the Middle Ages declined. The price revolution of the 1500s was followed by the Thirty Years War and the founding of the nation state that persists to this day. The Age of Enlightenment accompanied the price revolution of the 1700s. Napoleon’s defeat at Waterloo in 1815 marked the beginning of the Modern Age, a revolution in travel, communications and industrial production. Will historians mark this pandemic as the end of the price revolution of the 1900s and the start of a new age?
Federal Reserve Bank of St. Louis, Advance Real Retail and Food Services Sales [RRSFS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/RRSFS, July 15, 2022.
Fischer, D.H. (1996). The Great Wave. Oxford University Press, NY.
Redfin. (2022, June). Data center. Redfin Real Estate News. Retrieved July 15, 2022, from https://www.redfin.com/news/data-center/. Note: at the bottom of the page is Redfin Monthly Rental Market Data. Enter the market and type of housing you are interested in.
U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIAUCSL, July 15, 2022.
U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Shelter in U.S. City Average [CUSR0000SAH1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CUSR0000SAH1, July 15, 2022.
U.S. Bureau of Labor Statistics, Producer Price Index by Industry: Building Material and Supplies Dealers [PCU44414441], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PCU44414441, July 15, 2022.
U.S. Bureau of Labor Statistics, Employed full time: Median usual weekly real earnings: Wage and salary workers: 16 years and over [LES1252881600Q], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/LES1252881600Q, July 15, 2022.
The jobs report this past Friday surprised to the upside, showing a monthly gain of 372,000 jobs, far above the 250,000 expected gain. This is one of three indicators I wrote about last week. The positive job gains lowers the chances of a coming recession but the Atlanta Fed is now projecting a 2nd quarter decline of 2% in real GDP. As some economists have noted, it is unusual to have strong positive employment growth and negative GDP growth. In the graph below is the percent change in employment (blue line) and real GDP (red line). Since labor accounts for the majority of production costs, the two series move closely together.
Historically, employment growth (blue line) is declining before recessions. Here is a look at the period before the 2008-9 recession.
Let’s turn to another prominent concern – inflation. When the price of oil declined below $100 this past week, some economists interpreted that as a sign of decreased demand and a greater likelihood of recession. The price of oil factors into the production of most goods, even the electricity that comes into our homes. In the graph below I’ve charted the acceleration in the price of oil and prices in general. The magnitude is less important than the direction. Most of the time, the direction of each is the same.
Now I want to focus on recent years. As the economy recovered from pandemic restrictions in 2021, the changes in both series shot higher as expected. In the past year, the acceleration in oil prices (blue line) has declined while the acceleration in general prices has gone up.
The divergence is unusual and indicates that inflation is grounded more in supply disruptions and pent up demand than in the price of oil. I’m guessing that the Fed has noticed a similar trend. To appreciate how unusual this divergence is, let’s go back to the 1970s when the price of a barrel of oil went from $3 to $34. Even though the price movement was extreme, the acceleration in oil prices and the general price level moved in the same direction.
There is no shortage of opinions about Fed monetary policy and the Biden administration’s fiscal policy. The second stimulus payments went out in the first two weeks of 2021 under the Trump administration. Retail sales rose 5% that month, but fell 2% in February. Inflation in February was 1.7%, below the Fed’s target of 2%. On March 11, 2021, six weeks after taking the oath of office, Joe Biden signed the American Rescue Plan and in late March a third round of stimulus payments went out. Retail sales rose 11% in March but most of that increase happened before people received their payment. The odd thing is that there was little change in retail sales in the following months. This is one of many oddities surrounding this pandemic.
The general adult population received vaccines in April, May and June. Inflation rose above 5% by June 2021, then leveled off through September. In the graph above, the acceleration in oil prices and the general price level began to show a divergence. In the last three months of 2021, inflation started climbing while the acceleration in oil started falling. Why? It had never happened before.
Russia’s invasion of Ukraine has aggravated the situation and no one is happy. Xcel Energy, the public utility in my area, has raised electricity prices by 42% over last year; natural gas prices by 14%. The Fed’s next FOMC meeting is July 26-27 and the market is pricing in a 97% chance that the Fed will raise interest rates by another .75%, moving the federal funds effective rate near 2%. From 1954-2008, the average rate was 5.65%. From 1988-2008, the rate averaged 4.71%. Since 2008, the rate has averaged .62%. Near zero interest rates are abnormal.
Can the Fed retrain investors and consumers expectations toward a 3-4% federal funds rate in line with historical averages? The Fed conducts a lot of research but the current circumstances are unusual and the data shows conflicting trends. In a few years with the benefit of hindsight and firm, revised data, an economist can devote a few chapters if not an entire book to the past two years.
The Atlanta branch of the Federal Reserve maintains a running estimate of current output and other economic indicators updated sometimes daily as reports are released. The app is called EconomyNow and includes GDP, unemployment (UE), retail sales, and inflation. Recent data has caused them to revise their forecast for GDP growth in the 2nd quarter to a -2.1% annualized rate from 0% earlier in the week. Just a month ago, the model was forecasting 2% growth. If there was actually negative growth in the 2nd quarter, that would be two consecutive quarters of negative growth, increasing the likelihood that the Bureau of Economic Analysis (BEA) would call this a recession. However, the BEA does not rely on a single number to call a recession. Let’s look a bit deeper at past recessions.
Out of the many economic reports released each month, the unemployment (UE), inflation and retail sales reports have been reliable predictors of recession. The inflation report is used to adjust retail sales for inflation and produce what are called real retail sales. The combination of positive growth in UE and negative growth in real retail sales is a clear indicator of a weakening economy. The UE report for June will be released this coming Friday, the inflation report on July 13th and retail sales on July 15th.
Before each recession, the quarterly average of the unemployment rate rises above that of the previous year. Because the same quarter is compared in both years, the seasonal adjustments and economic flows are similar, an “apples-to-apples” comparison. Look at the rise in UE just before the 1990 and 2001 recessions, shaded gray in the graph below. (I will leave the series identifiers in the footnotes at the end of this post). Notice the hint of a recession in the first quarter of 1996. The Fed had raised interest rates by 3% in the previous year to curb growing inflation, then began lowering them at the end of 1995, averting what might have been a shallow recession.
Before the 2007-2009 recession, the growth of UE turned positive.
At the start of 2020, the UE was about the same as it was the previous year, an indication that the economy was susceptible to a shock. The pandemic was the shock of the century.
Let’s add in another indicator, real retail sales, and revisit these periods. When UE growth is positive, state unemployment benefits are rising while income tax revenues are falling. If retail sales are falling, then sales tax revenues are falling as well, putting additional budget pressures on states and localities. 1996:Q1 UE growth had barely turned positive but the growth in real retail sales was still positive and did not confirm the weakness in UE. In 2001, UE growth was positive and real retail growth was negative, confirming the economy’s weakness as investors became disillusioned with the heady promises of the new internet economy.
Before the 2008 recession, UE growth turned positive as real retail sales growth turned negative.
Let’s turn from that historical perspective to our current situation. In the 1st quarter of 2020, these two indicators turned positive and negative because of the pandemic, not in advance of it. At the end of 2019, UE growth was at zero, indicating a weakening economy. However, real retail sales growth was 1.6%.
There is a lot of talk about recession but these two indicators are not confirming that prediction. Growth in real retail sales is still positive and UE growth is negative. The reports in the next two weeks will give us a better picture of recession probabilities. The retail report comes out on July 15th, which is a Friday. The market will react to this report as it does most months. I will update the graph to include both of these indicators in my blog post for July 17th. Have a good 4th celebration and be careful if you live in a western state where it has been dry this year.
In the past two decades the Roberts’ court has overturned several long standing court precedents and laws. In Heller and Citizens United, the court has favored the greatest degree of individual freedom in their reading of the 1st and 2nd Amendment. In this week’s 5-4 decision to overturn Roe, the court has chosen the least amount of individual freedom in their interpretation of the 14th Amendment. In his concurring opinion, Justice Clarence Thomas stated a desire to overturn other court precedents based on the 14th Amendment. In 2013, the court’s Shelby decision overthrew portion of the Voting Rights Act based on the 14th Amendment.
Before overturning the “separate but equal” doctrine that had been in place for five decades, newly appointed Chief Justice Earl Warren delayed the Brown v. Board of Education decision by six months to try and convince two of the justices to change their vote and make the decision unanimous. Warren demonstrated a respect for the principle of stare decisis that the Roberts court does not have. This week’s decision overturned five decades of legal precedent on a 5-4 vote. At Scotusblog, Amy Howe (2022) notes the disagreement among the justices as to what their decision means going forward.
The six conservative members of the Supreme Court are members of the Federalist Society. Each working day of the session they gather in a candle lit chamber in the basement of the Supreme Court Building and kneel down before the Grand Jurist of the Federalist Society.
“Do you believe in the sanctity of the text?” they are asked and each affirms their belief. “Do you swear to only write opinions and never write law?” the Grand Jurist asks and they each swear an oath.
Around each neck, an acolyte drapes a necklace adorned with eyes of newt, the claw of an eagle, the eye of a falcon. Each jurist will deftly weave through the jungle of legal texts like a newt. Each jurist will grasp the text’s relevant truth like an eagle. Each jurist will have the wide vision but narrow focus of a falcon.
Each jurist puts their thumbs and forefingers together to form the letter “O.” “Do you swear to observe the commandments of Originalism?” the Grand Jurist asks and each affirms obedience. Each justice stands and is wrapped in the black robe of objective jurisprudence based on the meaning of the original text as the lawmakers understood it. They bow to the Grand Jurist and are escorted to their individual chambers.
Their law clerks bring each justice the finger bones of dead lawmakers and jurists – the 18th century jurist Blackstone, the forefingers of Jefferson, Adams, the signers of the Constitution and the Amendments. Into a bowl go the bony digits and the justice gives the bowl three shakes, and no more. Two law clerks tie the dark bandana of Originalism around the justice’s eyes. In a ritual called “throwing the bones,” the justice withdraws a bone from the bowl, and lays it at a random spot on the unfurled scroll of sacred text. Twice more the ritual is performed, then the bowl is put aside and the bandana untied.
Jefferson’s finger may point to the “privileges and immunities” clause in the 14th Amendment and a clerk solemnly records the historical precedent. The thumb of John Bingham, the author of the first section of the 14th Amendment, may point to the “life, liberty, or property” phrase in that same Amendment. The pinky digit of Thurgood Marshall might point to the “due process” phrase in the 5th Amendment. These will be the foundations of the justice’s opinion. The bones are returned to their vessels, the scrolls rolled up and secured. The bones and their placement are different for each justice.
The clerks begin a scan of the databases containing all the sacred texts, searching for the occurrence of each phrase and an indication of how the lawmaker or previous justice understood those phrases. In the course of several months, each justice assembles these perspectives into an opinion which they hand first to the Grand Jurist of the Federalist Society. The Grand Jurist selects that opinion that most faithfully follows the principles of Originalism, secures that opinion with a wax seal, then imprints the wax seal with his ring. An acolyte then delivers the opinion to the Chief Justice, John Roberts and the opinion is made public.
The Grand Jurist was 22 and in law school when Roe v. Wade was decided fifty years ago. He never liked that decision. This Friday, the Grand Jurist smiled as he closed the heavy door to the underground chamber below the Supreme Court.
There are several series of inflation and each offers a different perspective on annual price changes. Each month the Bureau of Labor Statistics publishes a headline number CPI-U, or Urban index, which estimates the annualized price change for urban dwellers of all ages. It also publishes a CPI-W or Worker index, which is focused on the spending priorities of working families. Yet another series is an index that the Federal Reserve uses to establish a longer term trend for price changes. This week the Fed enacted a rate increase of .75%, its strongest response to inflation since 1994, to counter the acceleration in price changes.
Working families and the general urban population differ in their spending priorities in transportation costs, household expenses and health insurance (BLS, 2021). Out of every $100 of income, working families spend about $2.40 less on maintaining a household, but $3.80 more on transportation. Being younger, they spend less on health insurance, about $1.50. The difference between the two series indicates which part of the population is bearing the weight of price changes. When transportation costs rise more than housing costs, the difference between the Workers and Urban index is positive.
In 2015-16, increases in senior housing costs caused the difference to go deeply negative. Starting in mid-2021, rising costs for new and used cars produced a positive difference, the highest since WW2. The Russian attack on Ukraine in February accelerated increases in gas prices and working families have borne more of that burden. Rising food costs have an almost equal impact, although working families tend to spend more eating out.
Just as we feel changes in our car speed, we feel changes in inflation. We expect some variation up and down around an average, but expect a balance of up and down. We are sensitive to acceleration, the change in speed, and become alert to too much up or down. Since mid-2021, the monthly acceleration in price changes have been mostly up.
Because pandemics only come along once a century and strangle the global economy, it was hard to tease out the underlying trend. Look at the negative drop in inflation in April 2022 on the far right side of the graph. The acceleration in price changes seemed to be easing up. In May 2022, the acceleration turned positive again and that prompted the Fed’s strong move this week.
Price changes in energy and food are both seasonal and volatile. To understand the trend, the Fed looks at yet another CPI index that excludes food and energy. Before the pandemic, the variation around the trend was small.
After the pandemic the variation in inflation was as severe as the early 1980s. Supply chains had been shut down, goods were stacking up at US ports, people were getting vaccinated and were spending money. With a shortage of new cars because of a chip shortage, used car prices increased a historic 45% in June 2021. Veterans in the industry shook their heads in disbelief. What should the Fed do? It has a double mandate of full employment and stable prices. Unemployment was still high at 6% in the spring of 2021. They maintained a zero-interest rate policy. As unemployment fell below 5% in September 2021, they probably should have increased interest rates a little.
Russia’s invasion of Ukraine and China’s month-long shutdown of Shanghai factories this spring threw yet another wrench in the forecast. Families abruptly switched their spending from household to more social spending, services and travel. Airline fares increased 38% in May. The change in spending patterns caught the buying managers at Target, Home Depot and Wal-Mart by surprise and these retail outlets now have excess inventory.
The housing market is experiencing declines as people respond to rising interest rates. The real estate giant Redfin just reported that home sales fell 10% y-o-y in May 2022, down 3% in one month from April (Ellis, 2022). Rising rates will curb the volatility in price changes but they usually cause a recession. Investment spending, both commercial and residential, responds first and that causes a decline in economic activity. Over the past few months the Atlanta Fed has revised their 2022 GDP forecast from over 2% annualized growth to 0%. Each revision has been negative.
During the pandemic, households reduced their spending and have stored up a lot of spending power. There is a lot of untapped equity in homes as well. Higher interest rates will slow residential and commercial investment spending. Inflation may stay elevated if consumption spending remains strong and offsets that decline.
Economics students learn that money is a complex function, a multi-tool that plays three roles in our lives. Lawyers study the role of money in contracts. Psychologists study how our beliefs and personal history shape our distinct attitude to money. Our use of money embodies our expectations of the future and our perceptions of risk. The financial crisis demonstrated that money connects us and separates us. The struggle between cooperation and distrust is the foundation of our experiment in democracy.
Money is the Swiss army knife of most societies. As a medium of exchange, it saves us the cost of matching our needs. We can store our labor in a unit of money, then trade it for the things we want. The law regards an exchange of money as a “consideration” that distinguishes a contract from a gift. Current Supreme Court precedent has held that money is speech. Because we use money to store purchasing power, we want it to be a reliable container that doesn’t leak value. Money’s role as a unit of account requires legal institutions to administer the rules of that accounting.
We buy insurance to mitigate risk but to do so we are herded into risk pools based on age, sex or occupation. Those under age 25 pay higher car insurance premiums but lower health insurance premiums. Because they make less money as a group, they have a higher loan default rate and must pay higher borrowing costs. Roofers pay higher workmen’s compensation premiums than police. Heights are more dangerous than criminals. Before Obamacare, health insurance companies charged women of childbearing age higher premiums for individual policies (Pear, 2008). The premiums reflected the higher expected costs of pregnancy regardless of whether a woman had any intention of getting pregnant. We are Borg.
Companies may classify our risk profile but we have a unique relationship with money, a composite of personal experience and inclination. “Me” and “my” are appropriately contained in the word “money” because our attitude toward money is as unique as our fingerprints. In 1984, British psychologist Adrian Furman (1984) led a study to assess people’s attitudes toward money. The questionnaire included 150 questions grouped into five areas that probed the subjects’ beliefs, their political attitudes and affiliations, their sense of autonomy and personal power. An argument about money can be as complex as that questionnaire.
Many political debates involve money. Each party tries to gain control of the public purse to fund its priorities. After 9-11, the debate over money intensified. The hijackers had attacked a money center as a symbol of American hegemony. While Americans debated the justification for an invasion of Iraq, the budget surplus of the late Clinton years evaporated. For some voters, the choice was a stark one – spend money to blow up people in a foreign land or spend it to strengthen American communities. To calm his critics, Mr. Bush promised that Iraq would repay American war expenses with its oil revenues. This was one of several follies that turned voter sentiment toward Democrats in 2008.
The financial crisis showed us the complex nature of money and tested the values that we attach to money. In the last months of a flailing Bush Presidency, the crisis exposed the corruption, greed and stupidity of the country’s largest financial institutions. Billions of taxpayer money had created and fed a thicket of regulatory agencies that were either corrupt or incompetent. The crisis ignited a strong moral outrage that intensified when Democrats fought to pass Obamacare.
The debate may have ebbed during the decade that followed but the Republican tax cuts of 2017 reignited public disdain and distrust. While many American families struggled to recover from the crisis, the politicians and their rich patrons fattened their fortunes.
Money is the heart of the American experience. The American confederacy of colonies that had won independence from Britain could not pay its debts or borrow money. The writing of the Constitution was sparked by the urgent desire to resolve that crisis or risk becoming subjects again of a colonial power. To reach consensus, the colonies had to overcome their distrust of a central government with the power to levy taxes. The colonies distrusted each other and the regional coalitions that might take the reins of that central government. The founders built their distrust into the Constitution and its governing institutions. In grade school we learn them as “checks and balances,” a euphemistic phrase for distrust.
On social media we argue about the many aspects of money. Our experiment in democracy will be over when Americans stop having spirited discussions about money.
This week Janet Yellen, the current Secretary of the Treasury and former Fed Chair, admitted that she had not understood the path inflation would take. Such honesty from an administration official is refreshing. Ms. Yellen joins a long list of smart and experienced money managers who did not forecast this inflation trend. Global pandemics happen once a century, producing economic shocks that are unpredictable.
The economist Milton Friedman attributed inflation to money growth. Who grows money? Banks. The central bank (Fed) may increase the base money it makes available to its member banks but it is the banks who multiply that base money when they make consumer and business loans. In the past decade, the annual percent change in household debt has tracked closely the rate of inflation. As long as banks were reluctant to extend credit, inflation remained low. The CARES act transferred billions to consumers and banks followed the money, extending more credit and shifting consumer demand higher.
For more than a decade sales of consumer durables excluding cars (ADXTNO) had waned. Pandemic restrictions forced us to alter our consumption habits and we bought durable goods for a new stay-at-home lifestyle. These included computers, dishwashers, refrigerators, and workout equipment. Our collective actions produced positive and negative effects. There is no one individual responsible for the negative impacts so we have blamed government policies or politicians.
Our collective actions change our physical and economic environment. Like a forest fire, we create our own weather and that feedback process can amplify the destructive forces of our actions. Adam Smith, the first economist, lived at a time when people were clustering in communities to trade with each other and engage in collective production. He was the first to note the dynamics of labor specialization where the productivity of individual effort is magnified and the entire community benefits from the assembly of coordinated effort.
As our population grows and concentrates in larger communities, group dynamics have a greater influence in our individual lives. Fashionable ideas and perspectives sweep through our society as easily as new product innovations. Social media speeds the introduction and adoption of trends. Under normal circumstances, the global supply chain adapts to these demand shifts rather quickly. However, the supply chain relies on a continuous flow of goods and services. The pandemic interrupted that flow, inducing a supply shock into the economy.
As economic activity returned to normal during 2021, investors and policymakers thought that supply chain disruptions would ease. Market prices increased about 20%. In January 2022, companies reporting 4th quarter results indicated that supply chain problems were slow to resolve and anticipated higher prices in 2022. Thousands of very smart people revised their earlier forecasts and adjusted their portfolio positions.
One of our favorite pastimes is armchair quarterbacking. We do it with ourselves as much as we do it with others. Reviewing a test score, we are sometimes surprised by a dumb mistake we made. Many of us gravitate toward jobs with a greater degree of familiarity and predictability. There is less stress and less likelihood of making mistakes. Some jobs are like daily tests with multiple selection choices and the answers are not certain. The lessons emerge as events unfold and lack what statisticians call external validity. The lessons learned or principles identified cannot be generalized to other situations because of important differences. Top administration officials and those in upper company management have those kinds of jobs.
It is fitting that the Memorial Day holiday weekend should follow this week’s shooting of nineteen fourth-graders in Uvalde, Texas. As we honor those who died in war, we should acknowledge the schoolchildren and two teachers who died on the killing field of our American hostility. Respect the parents whose hearts lie in the grave with their child.
In 2020, 55% of gunshot deaths in this country were suicides (CDC, 2022a). 53% of 46,000 suicides were committed with a gun (CDC, 2022b). Most mass shooters use an AR-15 style weapon designed for military assault in war. Since the assault weapon ban expired in 2004, the Congress has been unable to pass legislation restricting the sale and carry of these weapons. The children in Uvalde died on that battlefield.
In 1863, President Lincoln spoke on the Gettysburg battlefield, calling us to “highly resolve that these dead shall not have died in vain; that this nation shall have a new birth of freedom” (Library of Congress, 1995). Let us stop listening to the sound of our thoughts and listen to the wind as it blows over their graves.
CDC. (2022b, March 25). FastStats – suicide and self-inflicted injury. Centers for Disease Control and Prevention. Retrieved May 28, 2022, from https://www.cdc.gov/nchs/fastats/suicide.htm. Out of 46,000 suicides in 2020, 24,000 were committed with a gun.
Consumer spending during the pandemic and in the post-pandemic recovery has been strong. Inflation adjusted retail sales have averaged 5.6% annual growth since December 2019 (FRED, 2022a). However, the disruptions caused by the once-in-a-century pandemic have made the annual growth rates erratic, particularly those in the spring months when the pandemic hit. In spring 2021, retail sales numbers showed an annual increase of 48% over the previous year. Older Americans had been getting vaccines in the first months of 2021, shops were reopening and people were spending money. The economy was recovering but the size of the recovery was a “base effect.” Retail figures in 2021 were compared to retail sales in March and April 2020 when the economy was largely shut down. The American economy is so large that it is not capable of producing 50% annual growth in real sales.
Because the spring 2021 numbers were so strong, the numbers this spring look shaky. When the April retail numbers were released this week, traders began to mention the word recession and the market sank several percent. When people swarmed into stores in the spring of 2021, Target (Symbol: TGT) reported an increase of 22% in same store sales. A realistic portrayal of a customer behavior trend? No, it was an artifact of the pandemic disruption. In the first quarter of this year, the company reported a slight decline compared to those year-ago numbers. The reaction? The company’s stock fell 25%, an overreaction in a thinly traded market, and its worse loss since October 1987 when the broader stock market fell more than 20% in one day.
The stock market gets all the headlines each day but it is small in size relative to the bond market where the world’s lifeblood of debt and credit is traded. Over time the differences in interest rates between various debt products indicate trends in investor sentiment. These differences are called spreads. A common spread is a “term spread” between a long-term Treasury bond – say ten years – and a short-term Treasury of three months (FRED, 2022b). Short-term interest rates are usually lower than long-term rates because there is less that can go wrong in the short-term. When that relationship is turned upside down, it indicates a recession is likely in the near-term like a year or so. Why? Financial institutions are now expecting the opposite – that there is more that can go wrong in the short term than in the long term. They will be less likely to extend credit for new investments, business or residential.
For the past forty years, this spread has been a reliable predictor of recessions and it does not confirm the market’s recent concern about a recession. There are a few shortcomings with this indicator. With a wide range of several percent over five years, it has a lot of data “noise” that might obscure an understanding of the stresses building in the bond market and economy. Secondly, Treasury bonds are a small part of the bond market and carry no risk of default. We would like a risk spread between the rates on corporate bonds and those on Treasury bonds. Thirdly, the Federal Reserve has much less influence over corporate bond rates than it does on Treasury bond rates. Comparing corporates and Treasuries would give us a better sense of the broader market sentiment.
Moody’s Investors Service, a large financial rating company, computes the yield, or annualized interest rate, of an index of highly rated corporate bonds in good standing with a term longer than one year. The yield spread between corporate and long-term Treasury bonds usually lie in a range or channel of 1-1.5%. Like the lane markings on a highway, channels help us navigate data. The upper bound of 1.5% indicates a stress point. Let’s call that the long spread (FRED 2022c).
The Fed Funds rate is an average of rates that banks charge each other for overnight loans and the Federal Reserve tightly manages the range of this rate. For most of the past decade it has been below 1% and has often been close to zero. Let’s call the difference between the yield on corporate debt and the overnight rate the short spread (FRED, 2022d). Most of the time, the short spread is larger than the long spread. Just as with our first indicator of term spread, this relationship flips in the near term preceding a recession. Importantly, they continue to move in opposite directions for a while. The short spread keeps getting smaller while the long spread goes higher. In the graph below is the short recession after the dot-com bust.
In the right side of the graph the pattern will telegraph the coming recession in 2008. The graph below highlights the years after the financial crisis. The short term spread remained elevated above 1.5%, an indication of the persistent stress in the bond market. During Obama’s two terms in office, the short spread fell only once into the “everything is OK” range. Helped by the prospect of tax cuts in 2017, the spread declined to a lasting lull.
In the last half of 2019, the conjunction of these two time-risk spreads indicated a coming recession. The term spread we saw in the first graph also indicated a recession. They suggest that a 2020 recession was likely even if there was no pandemic. The Fed had been raising rates through mid-2019 to curb inflationary trends, then eased back a bit in the final months of that year. Were they seeing signs of economic stress as well?
How would the 2020 Presidential campaign have evolved if there had been no pandemic but a short recession lasting six to nine months? The Republican tax cuts enacted at the end of 2017 would have been shown to be a bust, doing little more than transferring wealth to the already wealthy. Mr. Trump would have certainly blamed the recession on Jerome Powell, the Chairman of the Fed, whom he had appointed. Powell would have been characterized as a Democratic stooge, part of an underground political plot to get Donald Trump out of the White House. The stories of what could have happened are entertainment for a summer’s campfire.
FRED. 2022a. Federal Reserve Bank of St. Louis, Advance Real Retail and Food Services Sales [RRSFS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/RRSFS, May 18, 2022.
FRED. 2022b. Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity [T10Y3M], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/T10Y3M, May 19, 2022.
FRED. 2022c. Federal Reserve Bank of St. Louis, Moody’s Seasoned Aaa Corporate Bond Yield Relative to Yield on 10-Year Treasury Constant Maturity [AAA10Y], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AAA10Y, May 19, 2022. The “long” spread.
FRED. 2022d. Federal Reserve Bank of St. Louis, Moody’s Seasoned Aaa Corporate Bond Minus Federal Funds Rate [AAAFF], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AAAFF, May 19, 2022. The “short” spread.