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Powell Answered the Market’s Three Most Pressing Questions at Jackson Hole Symposium

Federal Reserve Chair Jerome Powell kept his address at Jackson Hole brief and focused. He also gave an intentionally direct message about the current economic environment and his resolve to succeed in changing it.

Powell told his audience, both attendees of the symposium and the broadcast audience, that the monetary policy setting arm of the Fed (FOMC) has as its highest focus to bring inflation back down to its 2% target. Aware that he was speaking to a world audience, he made clear that price stability in the U.S. is the responsibility of the Federal Reserve – and without stable prices, the economy is on shaky ground. He connected low inflation with achieving a sustained period of strong labor markets. Which, alongside inflation, are the mandates of the U.S. central bank. Powell said, “The burdens of high inflation fall heaviest on those who are least able to bear them.”

Is the Fed Okay with a Recession Level Contraction?

He offered that restoring price stability won’t happen in weeks or even months; because it takes time to bring demand and supply into better balance. Is the Fed okay with a recession-level contraction? Powell said, “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.” Powell then explained, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.” The Fed Chair said he believes that failing to calm inflation “would mean far greater pain.”

What is the Current State of the U.S. Economy?

Powell believes the economy is showing strong underlying momentum, despite mixed economic numbers. As an example, he said, “The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.” He added, “Inflation is running well above 2 percent, and high inflation has continued to spread through the economy.” He recognized that July showed an improvement in inflation but said a one-month improvement  “falls far short of what the Committee will need to see.”

What is the Fed Doing to Achieve Balance?

The Fed Chair said they are moving policy to a level that will be restrictive enough to return inflation to 2%. He told listeners that after the last FOMC meeting, they raised the target range for the federal funds rate to 2.25 – 2.5 percent. Powell then offered that with current inflation above 2%, they won’t stop or pause. The estimate is the overnight lending rate, once 2% increases in prices are achieved, is likely to be near the current Fed Funds rate. He recognized that July’s second 75bp increase was large, and under the circumstances, may occur again after the September meeting.

The Fed expects to maintain a restrictive policy stance for some time. He discussed what has happened when the Fed has prematurely eased policy. He offered the FOMC participants’ most recent individual projections from June estimated Fed Funds would run slightly below 4 percent through the end of 2023.

The public’s expectations about future inflation play a role in setting inflation over time. He recognizes that an inflation mentality has not set in, he said, “ But that is not grounds for complacency, with inflation having run well above our goal for some time.”

Powell seemed to want to stress to the markets (bond, stock, real estate), that the Fed plans to do whatever it takes, and it will take a lot. He said he has learned from the mistakes of past Fed chairman, he is being guided by them, and repeatedly expressed his strong resolve to meet the 2% target.

Paul Hoffman

Managing Editor, Channelchek

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Source

https://www.youtube.com/KansasCityFed

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What is the Jackson Hole Symposium and Why it’s Important to Investors?

With almost a month to go before the next FOMC meeting, investors have set their focus on the Jackson Hole Economic Symposium – the conference organized each year by the Kansas City Federal Reserve Bank. Last
year’s symposium (held online for attendees) allowed the Fed Chair to recap the challenges of the previous 12 months of pandemic management. One Powell utterance that was mostly overlooked last year was his comment on inflation when he pointed out that demand was outstripping pandemic-reduced supply. He said it was a big factor in why inflation was running ahead of the Fed’s 2% target. One year later, inflation is likely to be the most discussed topic, and market participants and others interested in the economy will be listening intently to how strongly the U.S. Central Bank will need to squelch growth to bring damaging inflation down.

About the Jackson Hole Event

The Kansas City Fed has been hosting the annual conference to discuss the economy since 1982 at a lodge in Grand Teton National Park. The attendees are central bankers from around the world, economists from the 12 Federal Reserve Districts, academics, influential economic leaders, policymakers, and journalists.

Image: Jackson Hole Symposium attendance (Kansas City Federal Reserve)

Each year there is a theme. For example, “Guided by
the Stars” in 2018 set the tone for the year’s whitepapers and speeches the event is known for. Powell’s 2018 address is considered his most memorable. It outlined how he thinks about critical but unmeasurable variables like the natural rate of interest (R-star) and the natural rate of unemployment (U-star). For 2022 the theme is “Reassessing Constraints on the Economy
and Policy.” To be sure, the world will be listening – so far this decade, Central Banks have seemed to push the barriers of previously believed boundaries and constraints on policy. There will also be a number of whitepapers made public on the subject; these will be released Thursday evening. Powell’s speaking slot is first thing Friday (10 am EDT)

The presentations and discussions are not broadcast (except for Powell’s speech this year), but all of the proceedings in the room are on the record, and economic journalists are on hand to report what they hear. The Kansas City Fed publishes the papers on its website.

Powell’s Words

One of the most powerful market-moving things a Fed Chair can do is talk. Every word of his speech will be scrutinized; they know this, so they choose their words wisely. Traditionally, the Fed chair uses the Jackson Hole speech to deliver a particularly important and long-range message, similar to a president’s State of the Union.

It is highly unlikely he will give any guidance as to what he is doing next month. Instead, he’ll be recognizing paths and cultivating an understanding of changes in the economic climate and policies to foster desired long-term results.  

Is it all Business?

In the early 1980s, the Kansas City Fed leaders learned that the best way to ensure Fed chairman Paul Volcker would accept an invitation was to locate the event somewhere with good fly fishing in late August. Jackson Hole was it!

It also helps that the late summer ski resort setting is gorgeous. The weather is usually great, and the Kansas City Fed has done a commendable job cultivating compelling topics, papers, and guest lists over the years.

The eventgoers are not surrounded by luxury. Rather, it’s at a lodge in a national park that remains open to the public. It features a big grizzly bear trophy in the lobby. The rooms are rustic.

In and around the conference, it is common to see powerful economic policymakers from around the world wandering the hotel lobby, along with American tourists who drove in an RV or a group of motorcycles.

Some symposium attendees adopt Western fashion, wearing cowboy hats, boots, and pearl snap shirts. Others find more traditional business casual more their flavor. After the second day of economic meetings, attendees usually go to a Friday dinner with Western-themed entertainment, such as a horse whisperer.

Take Away

Four decades after the first Jackson Hole Economic Symposium, it is an important event for those in the meetings and an important event for those with a stake in the U.S. economy. History is made at these meetings as subtle shifts have a big impact on the future wealth of the nation. The mountain resort lends itself to a relaxed feel. Behind closed doors at the symposium itself, the small amount of attendees is closer than at many economic conferences.

Beginning at 10 am EDT tomorrow, the markets will have their answer as to what the Fed Chair will say. If it is in line with his more recent comments, he will place inflation as a priority and word it in a way where it is understood but not feared by those with business interests.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.kansascityfed.org/research/jackson-hole-economic-symposium/about-jackson-hole-economic-symposium/

https://www.cnbctv18.com/economy/jackson-hole-symposium-2022-all-eyes-on-us-fed-chair-jerome-powell-expectations-explained-14583021.htm

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Is Quantitative Tightening Impacting the Economy on the QT?

The Fed has begun to reduce the trillions it has added to its balance
sheet. With each dollar it added to the economy over the past two years, there was a new dollar available to provide capital for growth and investment. Or a new dollar to help hold borrowing costs down. Quantitative
tightening (QT) is out of the spotlight relative to overnight bank lending rates. Yet, QT could have a much greater economic impact on all markets, from real estate to stocks, and more directly fixed income.

There is less understanding of QT. The Federal Reserve’s effort to shrink its balance sheet after buying trillions in bonds is somewhat complicated and less visible. But, although QT is on the quieter side of what is shaping tomorrow’s economy, investors need to know how shrinking the balance sheet, the other tightening, impacts investments.

The Fed stopped its bond purchases in May. That is to say, they stopped buying bonds that injected money into the system. This is referred to as quantitative easing (QE).

In June, after a period of tapering its purchases, the central bank began QT> Then it announced it would partially unwind roughly $4.5 trillion that had previously been purchased. The Fed officially said that it would start by letting up to $30 billion in US treasuries and $17.5 billion in mortgage-backed securities (MBS) mature out of its holdings (balance sheet). During the previous months, it would have reinvested the maturing amount and even added to the purchases.  The announcement was, beginning in September, it’s shrinking the balance sheet could increase to $60 billion maturing bonds not rolled in treasuries and 35 billion not reinvested in MBS securities. Fed Chairman Jerome Powell shared a plan lasting 2½ years, which implies the Fed’s $9 trillion balance sheet could shrink by as much as $2.5 trillion. Roughly half of what was added to support the economy during the pandemic.

Lack of Awareness

The financial news likes to keep it simple. And quantitative tightening isn’t simple, so its impact isn’t reported to the extent that an overnight increase, which is easier to understand, is presented. With QT, there is no prior hype asking “what is the Fed going to do?” and there is little certainty to what they have done. It just happens, no fanfare, no commentary.

Historically, this kind of tightening has been attempted only once before, and it was derailed. The transparent Fed is ridiculed and criticized when it removes economic stimulus. So there may not be a strong overall belief that the Fed will actually remove the trillions of extra money now floating around and creating economic opportunity by inflating asset prices.   Also, overnight rate increases are much easier for economists to model and news for mass public consumption to report on.

So, the news of QT is underreported and ignored. What is being reported is a strong doubt that the Fed is following through on its balance-sheet tightening plan, particularly with MBS. For those that have looked at the Federal Reserve’s balance sheet, the doubt is not without cause.

Barron’s spoke with a senior trader on the Fed’s open markets desk. This is what the well-respected investment publication was told. The Fed is conducting QT as it has said it would. The trader said people are confused because it looks like the Fed’s MBS holdings aren’t decreasing and even may be increasing.

The trader told Barrons that the saw-toothed pattern in the Fed’s MBS holdings is the result of accounting issues. First, there is a gap between when MBS purchases settle and when holders of MBS receive payments. Second, the Fed has a three-month window for settling MBS purchases. The Fed is the largest single investor in the MBS market, the Fed has the option of delaying settlements if it thinks that will create a better functioning market.

In effect, this means MBS purchased by the Fed, as it does when it reinvests pay downs, could just be showing up. QE ended, but if there are pay downs in excess of the Feds goal of runoff, the excess is reinvested. The settlement dates differ and cause the appearance of a balance sheet that may have grown. This isn’t the case, and investors need to know that longer-term interest rates are being tightened.

The Fed senior trader warned something is apt to break, not unlike what happened the last time the Fed tried QT, and chaos in the repo market prompted an early end to the return to “normalcy.” But he was more optimistic as he said the Treasury may be more supportive in smoothing the process of reducing liquidity while not disrupting markets.

Take Away

If quantitative easing (QE) mattered, then quantitative tightening should too. It isn’t reported on as prominently as direct interest rate hikes, but the impact is the direct inverse to what allowed so much economic growth. So, the savvy investor will pay attention, which may give them an edge. For the Fed to bring inflation back to 2%, the Federal Reserve would need to shrink its balance sheet by the almost $4 to $5 trillion it increased it a short time ago. This could increase longer-term interest rates by far more than the announced increases in short-term rates.

Paul Hoffman

Managing Editor, Channelchek

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https://en.wikipedia.org/wiki/Quantitative_tightening

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Image(s): Wikimedia.org 

Does Michael Burry Have a Problem with John Maynard Keynes?

There is no doubt that Dr. Michael J. Burry is familiar with Keynesian economics theory. Under the theory, the government should help control aggregate demand by infusing money into a weakening economy to create added demand or withdraw currency to reduce demand. But there is a caveat to this basic tenet of Keynes’ theory, and it seems Michael Burry, famous hedge fund manager at Scion Asset Management, has little patience for it.

Followers, both fans and haters, pay close attention to the tweets the Scion Asset Management founder often uses to share his thoughts. Burry’s tweets are usually deleted by him shortly after he sends to keep BOT benefactors down. So his Twitter account isn’t always the best place to see his thinking that is more than a few hours old.

What is Michael Burry is Saying

Burry’s recent tweets have indicated he believes retailers could cut prices to rid themselves of inventories caused by seasonal delivery inventory mismatches. Also, dwindling savings and soaring debt could spark a recession. He just offered more proof of his theory.

At about 4 am this morning (presumed Pacific time), Burry posted a Bloomberg chart on U.S. consumer credit use. The graph reaches back to 1991 and carries into the recent monetary policy tightening. Along with the chart, Burry tweeted, “Net consumer credit balances are rising at record rates as consumers choose violence rather than cut back on spending in the face of inflation. Remember the savings problem? No more. COVID helicopter cash taught people to spend again, and it’s addictive. Winter coming.

Source: @michaeljburry (Twitter)

When speaking of economic cycles, “winter” is often referred to as the downside of the cycle; there is death and dormancy among businesses in the winter. It’s miserable, but it leads to the spring part of the cycle with new growth.  Translating further, if the consumers continue to buy, despite having an unsustainable ability to continue at the previous pace, a more violent winter may fall upon the economy. 

The chart attached to the tweet shows the net change of consumer debt each month as recorded by the Federal Reserve. The historical average, including negative periods, is $27.5 billion.  The current monthly pace is $27.5 billion.

Burry noted in May that American consumers, faced with rising food, fuel, and housing costs, were pulling from their incomes, racking up credit-card debt, and poised to virtually exhaust their savings by the end of 2022.

What Keynesian Theory Says

Keynesian economic theory says the government should help free markets when they are faltering by injecting cash. The cash will then spur aggregate demand for goods and services. And the government should also pull money from the system to reduce demand in an overheated situation. Having a smoothing hand, in addition to the free market’s invisible hand, could lead to a more balanced outcome and a more even keel.

The theory also recognizes that if additional money is put into consumers’ hands today that it works its way into the economy quickly. The U.S. experienced this a couple of years ago with stimulus checks that began stimulating right after being announced – even before distribution. However, if money is removed from the system, spending continues at the same pace for a while as consumer spending habits don’t back off the consumption gas pedal as quickly.

Most consumers are no longer receiving benefits doled out through the pandemic and are now confronted with rampant inflation. Yet, despite worsening cash flow and higher prices, they are consuming at the same level, making up the difference by pulling from savings and increasing debt. This is right in line with what John Maynard Keynes would expect. At least at the beginning.

Keynes would also expect a turn to more conservative spending eventually, currently, consumer tapering on spending is just beginning. And based on his theory, it will be followed by a reduction in consumption.

Is Burry at Odds with Keynes?

The short answer is what Burry has been bringing to investors’ attention is right in line with what Keynes, in 1936,  said could be expected. Apparently, human nature related to consumption hasn’t evolved.

I am sure Dr. Burry understands that reactions when it comes to cutting back aren’t immediate. But what may frustrate him is that the markets (not the consumer) always take so long to spot what he is seeing. He has a habit of getting into trades much earlier than others. His expectations, more often than most, play out as he expects, with one exception. The exception is timing. Even in his famous “big short” of the mortgage market, he was a couple of years ahead on his credit default swap play. One can presume that he felt a good deal of pain as housing continued on its path for much longer than expected. 

Practical Use

The central bank has to be out ahead of the economy when the pace is heating up because taking the proverbial “punch bowl” away doesn’t cause immediate sobriety. Burry predicted consumer spending would drop as a result of tightening and believes retailers will cut prices to lessen overstocking and badly timed inventories. This would help derail inflation and put pressure on retail and other earnings by Christmas. The tweeted chart of consumer debt above shows the “party” is still raging as the government-supplied punch bowl has been removed, but people are tapering by using their limited stash. When that stash taps out, there will be an abrupt end.

Earlier this week he tweeted about the turnaround in the stock market, specifically Nasdaq. He warned that the big-tech heavy index may be 20% off its low, but history indicates that this doesn’t mean that it can’t fall dramatically as it did seven times after 2000 when the dot-com bubble burst.

Source: @BurryArchive (Twitter)

Frustration is a common theme of his tweets. Some of the frustration is a lack of patience for things like the nuances of Keynesian economics and the overall behavioral patterns of investors across many asset classes.

Burry He also has asserted the pain for investors might not end until they swear off owning tech stocks, cryptocurrencies, and non-fungible tokens (NFTs). Referring to the latest w/streetbets “meme-stock” additions AMTD (HKD) (which rose 21,000%) and Magic Empire (MEGL) (which rose 2,000%) he recently complained that market “silliness” is back after the two IPOs skyrocketed.

Source: @BurryArchive (Twitter)

Take Away

An investor can be consistently right about the future direction of individual stocks or the markets. If they perceive what is going to happen to be timed much sooner than the other players, they will miss other opportunities, or more frustrating, lose patience with the position and get out of it before it becomes profitable.

In the book about Michale Burry’s housing crisis position, it took a long time for what he was certain to happen, to become reality. He lost a lot of investors in his funds while waiting for what he believed to be inevitable, played out. Classic economic theory tells us that we should expect delays in cause and effect. As investors, we need to remind ourselves if we are long-term and willing to ride out the ups and downs to stick to the plan. Or if we are more active, we may try to take advantage of shorter moves that may be against our overall thoughts on the long-term direction.

Follow Channelchek’s Twitter account and let us know under this article your overall thoughts on the market, and favorite small-cap stocks. 

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://twitter.com/BurryArchive/status/1557518533172477952/photo/1

https://twitter.com/BurryArchive/status/1557430160512524288

https://twitter.com/michaeljburry

W.
Carl Biven (1989). Who Killed John Maynard Keynes? Conflicts in The Evolution
of Economic Policy

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Social Security and Pension Cost of Living Increases Next Year Will be Largest Since 1981

A 9.6% COLA increase in wages in 2023? That’s what retirees can expect from Social Security if the inflation rate doesn’t recede in August and September. This would be the highest cost-of-living increase in more than four decades. The increases are based on the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) measured from the third quarter of the last year to the current third quarter. COLA is to ensure that the purchasing power of Social Security and Supplemental Security Income (SSI) benefits is not eroded by inflation.

Here’s How 2022-2023 COLA Works

The CPI-W is determined by the Bureau of Labor Statistics (BLS), which is part of the Department of Labor (DOL). It is the legal measure used by the Social Security Administration to calculate COLAs.

Social Security checks get an inflation adjustment each year based on the index. In determining the cost of living adjustment, the Social Security Administration (SSA) compares the average figures for July, August, and September to the index’s average level over the same annualized monthly average a year earlier.

The July CPI-W data, released Wednesday (August 10), rose 9.1% during the past 12 months. That is slightly higher than the more talked about “headline inflation” number, which is CPI-U or the Consumer Price Index for All Urban Consumers. CPI-U YoY rose 8.5% year-to-date.

If inflation remains at the current level, on average, over August and September, the approximately 70 million retirees and disabled people who receive Social Security benefits will experience payment increases of 9.6% beginning January 2023. With a COLA of 9.6%, the average monthly Social Security check for retired workers would rise by about $160 in 2023, to $1,829 in January from $1,669 this year.

Source: SSA.gov

Compared to 2022

Last October, when the COLA for 2022 was announced, federal retirees received a 5.9% increase in Social Security payments. The Civil Service Retirement System (CSRS) annuities that use the same COLA calculation have been benefitting the same. The Federal Employees Retirement System (FERS) annuities received a 4.9% increase starting in January 2022. At that time, this was the largest COLA increase in 40 years. The 2023 increase is almost certain to surpass 5.9%.

The actual 2023 COLA will be calculated in mid-October. At that time, the average for July, August, and September will have all become official; from there, the actual COLA calculation is easy. In 2022 this led to a combined pay raise of over $68 billion for those receiving Social Security.

The Bureau of Labor Statistics is scheduled to release the August CPI-W on September 13 and September data on October 13. The SSA will issue the official COLA announcement for the following year soon after.

Next year’s COLA increase is likely to speed up the calculated date of insolvency for the Social Security trust fund. The current expectation by the Committee for a Responsible Federal Budget, which predicts insolvency, is 2034. This is a year earlier than it had been previously forecast.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.ssa.gov/cola/

https://www.bls.gov/news.release/pdf/cpi.pdf

https://www.bls.gov/schedule/news_release/cpi.htm

https://www.crfb.org/issue-area/social-security

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Image: Bloomberg TV (August 8, 2022)

Why Cathie Wood Thinks We Will Emerge from A Recession More Quickly than Others

Cathie Wood, the founder, and CIO of Ark Invest, was asked in an interview, “Is the Fed going to continue hiking rates, or are they going to stop and turn around and come back down next year?” Her response was not initially uplifting, but as she explained why her firm has evaluated the current economic growth trajectory and what the future may bring, the fund manager, that focuses on innovative sectors, was actually optimistic.

Are Jobs Strong?

Wood brought up July’s huge unexpected increase in Non-Farm Payroll and contrasted it with the Household Employment numbers (a broader-based survey). She reminded the Bloomberg interviewer that Household Employment “…has been flat to down for the last four months.”  She added, “If you look at [unemployment] claims, we’ve never seen a faster increase.” She thinks people don’t weigh in the fact that we are up 50% off the low in unemployment. Cathie Wood also mentioned that large numbers of people are being laid off, then she referenced a Challenger survey that reported layoffs are up 55-60% year-over-year.

The reason she gave for the layoffs is inventory levels. “We have a massive inventory glut.” She believes the push to hire is ending and unwinding.

Is Inflation a Non-Issue?

Cathie Wood had been on record as previously saying, “deflation is more of a concern than inflation.” She was asked if she still feels this way. “I still think that because the evidence is piling up. Now the CPI and to some measure the PPI, both of those are lagging indicators.” She emphasized, “The Fed is driving policy off lagging indicators.”

What she prefers to look at is the price of commodities used for building and growth like copper. She said that copper took a decisive break to the downside (20%), but the decrease hasn’t yet fed into the inflation indexes. Wood says a better measure of where inflation is headed is gold. “Prices [Gold] peaked August 2020, we’ve been in a trading range, we’re at the low end of the trading range now.” She believes if the Fed continues to tighten, her firm’s expectation is the dollar will turn back up, and commodities will continue
to fall.

The next inflation report is due Wednesday (August 10). An Econoday consensus estimate puts July headline inflation at 8.7%, cooling from 9.1% in June.

Are We in a Recession?

“Yes, we believe we are in a recession.” Wood told the interviewer. She explained that the economy receded for two consecutive quarters, which is the beginning of the definition. Three consecutive declines in leading indicators would suggest the same, she explained. “Our point of view is this is going to be a severe inventory recession, but we don’t have the systemic excesses like we did pre-2008, 2009 in the mortgage market.” She explained that while many economists use the inverted yield curve and say it indicates a recession next year, she believes we will be coming out of our current recession next year.

What’s Going on in China?

Cathie Wood says the big question is what is going on in China? She offered that perhaps the commodity prices unraveling has to do with the Chinese economy, especially their growth-inhibiting policies and real estate problems. She thinks China’s economy is going to be more difficult for them to control than they anticipated.

Why Stay Invested?

She was asked if it makes sense to move to cash since there are possible trouble spots on the horizon. In classic, confident optimism, Cathie Wood responded, “We are going to stay 100% in innovation.” Her reason is innovation is going to be a critical allocation in the years ahead. She explained, “Innovation saves time. Innovation solves problems.” She then listed the current problems, as supply chain, and energy, and food price increases. “Better, cheaper, faster, more productive, more efficient, more creative, is going to win,”  she exclaimed.

Wood thinks most asset allocators are short the innovation categories. Her idea of the sector is not current day high tech Nasdaq 100, but what Nasdaq used to be in the 1990s.

The Federal Reserve will reverse course on interest-rate policy next year by yanking down borrowing rates in the face of weaker activity in the US economy, disruptive-tech investor Cathie Wood told Bloomberg TV.

“We’re getting all kinds of signals that the economy is very weak,” which will prompt the Fed to start rate cuts in 2023, she said Monday.

Take Away

The well-followed manager always has strong convictions, they are often contrary to popular opinion. These forecasts have both served her firm and investors well and have caused disappointment when the volatile innovative sector is giving back gains.

She said that she will stay 100% invested as the industries and companies her funds are most heavily weighted in will be the kind of companies that help resolve issues weighing on consumers and economies today.

Did you know Channelchek has no paywall – and never will? Take the time to sign-up now for regular emails on quality research of innovative companies and insightful articles and ideas.

Paul Hoffman

Managing Editor, Channelchek

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Image Credit: Viv Lynch (Flickr)

Inflation is Spiking Around the World – Not Just in the United States

The 9.1% increase in U.S. consumer prices in the 12 months ending in June 2022, the highest in four decades, has prompted many sobering headlines.

Meanwhile, annual inflation in Germany and the U.K. – countries with comparable economies – ran nearly as high: 7.5% and 8.2%, respectively, for the 12 months ending in June 2022. In Spain, inflation has hit 10%.

It might seem like U.S. policies brought on this predicament, but economists like me doubt it because inflation is spiking everywhere, with few exceptions. Rates averaged 9.65% in the 38 largely wealthy countries that belong to the Organization for Economic Cooperation and Development through May 2022.

What revved up those price increases starting in early 2021?

Scarcity Put Pressure on Prices Everywhere

When the COVID-19 pandemic began, demand for computers and other high-tech goods soared as many people switched from working in offices to clocking in at home.

Computer chip manufacturers struggled to keep up, leading to chip shortages and higher prices for a dizzying array of devices and machines requiring them, including refrigerators, cars and smartphones.

It’s not just chips. Many of the goods Americans consume, such as cars, televisions and prescription drugs, are imported from all corners of the world.

Supply Chain Strains

On top of problems tied to supply and demand changes, there have been major disruptions to how goods move to manufacturers and then onto consumers along what’s known as the supply chain.

Freight disruption, whether by ship, train or truck, has interfered with the delivery of all sorts of goods since 2020. That’s caused the cost of shipping goods to rise sharply.

These massive shipping disruptions have exposed the disadvantages of the popular just-in-time practice for managing inventory.

By keeping as little of the materials needed to make their products on hand, companies become more vulnerable to shortages and transportation snafus. And when manufacturers are unable to make their products quickly, shortages occur and prices surge.

This approach, especially when it involves the reliance on far-flung suppliers, has left businesses much more susceptible to market shocks.

Labor Complications

The beginning of the pandemic also sent shock waves through labor markets with lasting effects.

Many businesses either fired or furloughed large numbers of workers in 2020. When governments began to relax restrictions related to the pandemic, many employers found that significant numbers of their former workers were unwilling to return to work.

Whether those workers had chosen to retire early, seek new jobs offering a better work-life balance or become disabled, the results were the same: labor shortages that required higher wages to recruit replacements and retain other employees.

Again, all of these dynamics are occurring globally, not just in the U.S.

War in Ukraine compounded these woes

Russia’s war on Ukraine, which began officially on Feb. 24, 2022, has also exacerbated inflation by interfering with the global supply of fuels and grains.

The conflict’s effects are reverberating around the globe and fueling inflation.

Russia is the world’s second-largest exporter of crude oil. Sanctions against Russian imports, combined with Russia halting oil shipments to European countries in retaliation, has led to disruptions in the global oil market.

As Europe buys more oil from the Middle East, demand for oil from that region increases, prompting price increases. Crude prices jumped from $101 per barrel in late February 2022, to $123 a month later. Prices stayed high for several months but by late July were around $100 a barrel again.

Food prices have increased substantially in the U.S. and elsewhere, partly due to this conflict. Ukraine possesses some of the most fertile soil in the world and is the third-largest exporter of corn.

Russia’s destruction of Ukrainian crops and its blockade of Ukrainian exports have led to significant price increases worldwide for agricultural commodities.

How Will the World Respond?

Support for globalization and international trade has waned in recent years. Given supply chain disruptions and the war in Ukraine fueling inflation, this trend will likely continue.

However, as an economist, I believe the benefits of free and open trade still outweigh current challenges.

In my view, there isn’t anything fundamentally wrong with the globalization that cannot be fixed. But, like quelling inflation and alleviating supply chain bottlenecks, it will take time.

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Image Credit: John Hritz (Flickr)

Prioritizing Investments at the Expense of Luxuries is Key to Societal Wealth

In a pioneering study, psychologist Walter Mischel demonstrated that delaying gratification in childhood led to success in later life. The experiment entailed placing toddlers in a room with treats and giving them the option of eating them immediately or waiting for fifteen minutes so that they could get a second offering. Follow-up studies found that participants were more successful in adolescence if they exercised self-control by waiting for fifteen minutes before eating the treats.

The observation that self-control is correlated with individual accomplishment is uncontroversial, though its link to national success is underexplored. Building a civilization necessitates the renunciation of present desires for long-term benefits. For society to thrive, citizens must save, invest, and plan. In planning for the future, people will automatically prioritize investments at the expense of acquiring luxuries, thus indicating low time preference.

Invariably, capital accumulation is a consequence of low time preference, and those with lower time preference will be inclined to forfeit current wants for future success because they are future oriented. When an entrepreneur reinvests profits into his venture, this is an outcome of futuristic thinking. Since he is a long-term thinker, the entrepreneur appreciates that capital investments drive value creation and ultimately increase the firm’s competitiveness.

Even contemplating starting a business is indicative of long-term thinking, considering the roadblocks that entrepreneurs frequently encounter. Most people are unlikely to become entrepreneurs, however, sustaining progress requires that characteristics of entrepreneurship like long-term orientation and patience are widely diffused throughout society. Essentially, outlier performers are indeed crucial for national success, but the average quality of the population maintains prosperity.

Many countries boast talented entrepreneurs and intellectuals; however, they remain poor because the population’s average quality is too low to induce economic dynamism. Economists in a 2019 paper state that the reproduction of middle-class traits emphasizing human capital investments and long-term planning might have played a pivotal role in the rise of industrialized England:

We find that the middle class had the highest reproductive success during England’s early industrial development…Hence, the prosperity of England over this period can be attributed to the increase in the prevalence of middle-class traits rather than those of the upper (or lower) class.

Today, saving and investments in human capital are markers of elite status, but originally, aristocratic elites preferred conspicuous consumption and cared little for boosting family wealth through enterprise. Therefore, the assumption that England’s rise was aided by the proliferation of people with bourgeois traits is entirely plausible. Interestingly, there is evidence showing that patience—a proxy for long-term thinking impacts national wealth

In a paper entitled “Patience and the Wealth of Nations,” economists conclude that patience explains “a substantial fraction of development differences across countries.”

Countries with more patient populations have higher incomes, superior levels of human and physical capital accumulation, and better institutions. Such findings are explained by the future-oriented outlook of patient people. People invested in the future will save and work hard in the present to live a better life in the next decade.

Furthermore, more recent research asserts that patience is positively correlated with a country’s external wealth. According to Mika Nieminen, countries inhabited by patient individuals have a positive net foreign asset position, whereas countries populated by impatient people have a negative net foreign asset position. Similarly, economic literature suggests that long-term orientation is also instrumental to development.

A 2021 study by European economists argues that long-term orientation increases economic freedom’s benefits. Using a panel analysis of a sample of sixty-seven countries from 1970 to 2019, Johan Graafland and Eelke de Jong reveal that economic freedom has the greatest effect in countries where people are high in long-term orientation. Discussing these findings, they write:

Economic freedom appears to be particularly effective in raising income per capita in countries in Asia (China, Hong Kong, Singapore, South Korea, Vietnam), because these countries combine low Uncertainty Avoidance with Long Term Orientation…In addition, South American countries and countries in the Middle East and Africa hardly benefit from more economic freedom, because of the combination of a relatively high Uncertainty Avoidance and short-time orientation.

Additionally, countries that score high on long-term orientation are also more innovative. This is unsurprising because inventing is a trial-and-error process that includes failure; therefore, people who exercise patience and think long term are more likely to materialize success, since they refused to quit.

In sum, the latest findings in economics should make policy makers aware that designing policies without accounting for a population’s capacity to think long term won’t yield preferred results. Proposing workable solutions is an exercise in futility when people fail to appreciate their impact.

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