Whither the Economy?

What’s going on, and where we are headed, isn’t something you can look up on Google.  With the media, including the financial press, complete polarized you get either “What, me worry?” from the mainstream or “The sky is falling has already fallen!” from the right alternative.  Neither with a scrap of decent analysis attached.

Inflation, or not? It’s beyond doubt, except maybe to CNN, that there are widespread price increases out there.  If you’re on one side, it’s evidence of galloping stagflation, if on the other – what increases?

Neither mentions the possibility that some of the increases are legitimate price signals.   That’s the normal market process that simultaneously pushes down demand and encourages more production.

Is there a good reason for multiple, simultaneous price signals across the economy? You bet.  We’re in the midst of the worst supply and distribution chain thrash since World War II.  With production of both raw commodities and intermediate products shut down or curtailed by the pandemic / panic, and transportation disrupted globally, seemingly remote corners of the economy have stalled for lack of components.  (E.g., you can’t have a new SUV because certain silicon chips that drive the dashboard displays have gone in short supply.)  At the same time, ‘stimmy’ money injected bursts of demand in patterns that were not typical.

At the best of times, multi-stage supply and distribution chains are notorious for instability when hit with sharp changes in demand or supply.  There’s a classic educational simulation called the Beer Game that highlights the issue.  Supply chain management systems have been introduced in recent decades to make flow down the chain more transparent, in order to reduce instability.  But instead of taking advantage by improving robustness, it’s been used to create ‘lean’ supply and distribution chains that tie up the minimum of capital in inventory.  Spread those chains out over the globe, introduce the Wuflu and watch chaos erupt.

The thrash is going to continue for some time.  The US is rapidly dumping the lockdowns and masks, but not so in many places that are part of the global economy.  Looked at in this way, higher prices in many cases are a big sign saying “Don’t buy this now unless you REALLY need it” while the thrash dies down.

This is definitely occurring.  While it’s a pain in the rear it will eventually work out, and hopefully some lessons will have been learned about the need for robustness.  But it can also be covering up a couple of less benign reasons for price rises:

The first is price signals reflecting supply changes due to hostile government intervention.  The obvious one right now is energy costs.  It took only a few weeks for the Biden* administration’s attack on the industry, fracking in particular, to put up prices at the pump as the market anticipates less abundance in the future.  Similar is the increase in labor costs as the government pays people more to sit at home than to get back to their entry level jobs.  Both of these are insidious as they are cost components in practically every business.

The second malignant reason is of course monetary inflation.  With the Federal government spending like a drunken sailor with an unlimited credit card, and Fed trying to keep the market liquid during COVID mania, the money supply has ballooned.  But it’s over-simplifying to say “Ah, ha!  Inflation!”  Because what has collapsed at the same time is the velocity of money, in other words how quickly money flows through the economy.  Cash that simply sits on account somewhere is not creating effective demand.

If velocity takes off, then we are indeed at risk of general inflation, but right now it looks more like a liquidity trap.  What we are seeing is asset inflation, as the cash gets parked in equities, speculative cryptocurrencies, or real estate.  The last is also compounded by side-effects of COVID:  Work from home has accelerated the Big Sort of Americans into ideological clusters, skewing regional demands at the same time as construction supply chains and labor were thrashed.

So what might increase velocity and detonate the inflation bomb that is certainly ticking away?  The transient price shifts created by the supply thrash probably won’t do it, unless they persist long and widely enough to create an inflationary psychology (a point on which the right side is not helping at all).  What those shifts are doing is increasing uncertainly, which typically slows investment and growth.

Once the transients die out, what kind of economy is likely?  We have an administration with regulatory and taxation policies as bad or worse than Obama’s, and pursuing foreign policies that are likely to increase global instability.  It seems reasonable to expect, at best, a slow growth environment such as Obama produced after the 2008 crash or at worst, a Carteresque malaise and stagnation.  With many businesses having involuntarily downsized during COVID, it will be very tempting to keep the wallet closed rather than rebuild to the levels of the Trump economy.

(This started as a ‘thinking into the keyboard’ exercise to ponder my own investment strategy, and grew to the level of a post.  What do you think is going on?)

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  1. I hear you. I still wonder where the Obama inflation is. My tentative understanding is that we exported it, largely to China. Or more precisely, that we built a dollar inflation bomb and handed it to China. What could possibly go wrong?
    This COVID disaster may have helped lance the bubble in education and Real Estate which seems to have blown up a bit in recent ZIRP-lite years.
    I’m just sure that whatever I do, it will simply blow up in my face. So — sitting tight.

  2. Gavin Longmuir

    Locke On: “… at worst, a Carteresque malaise and stagnation.”

    Oh, it could get a whole lot worse than that!

    At least in the Carter years the US still had most of its industrial capacity, and was moderately self-sufficient. The suffocating regulatory build-up and resulting offshoring was only in its early years.

    The part of our economic situation which I find puzzling is the implicit assumption in most of the “informed” comment that the US can continue to run a massive & growing Trade Deficit for ever.

    Lots of people who consider themselves experts argue that the exporters need the US market (i.e. freshly printed US IOUs) more than we need their physical goods — Unlikely. And they say they have an equation proving the US has to run a Trade Deficit — as if a little equation based on a lot of assumptions is reliable.

    My take is that the Chinese Communist Party has been waging a successful economic attack on the US for about 20 years or so. I don’t know if this was a deliberate CCP strategy from the beginning, or if the CCP just realized as they went along that US politicians-bureaucrats-academics were easily corruptible and US businessmen were so short-term focused. But the end result is that the CCP can now pull the plug on the US economy at any time of their choosing. The US has offshored the vital manufacturing capacities required to support modern life. We have a Cargo Cult economy, dependent on imports for which we have nothing to trade.

    The Fed and the Biden* Administration think they are in control — they are not. Rough times ahead — or should I say Ruff Times? Plan accordingly.

  3. I’m not crazy about macroeconomics (i.e., it’s bunk) so the money supply balloon & velocity collapse do not impress. Hyperinflation has been just around the corner since before QE2 and yet here we are.* Sure, the numbers are bigger every time but it’s not clear how big they need to get. For reference, gold is trading at about the same price as it was ten years ago.

    As for the Big Sort, my first reaction is if Bill Clinton is against it, I’m probably for it. More substantively, the only way to survive the coming civilizational decline is precisely to separate from the spiteful mutants** that are the causes of the decline. Local governance is important so it makes sense to congregate with like-minded individuals. In spite of the flow of illegal immigrants into California, the state is losing population for a reason.

    Bill Bishop (Big Sort guy) complains about decrease in social trust. We were already becoming a low-trust society, principally because of the dishonesty and corruption rampant in the institutions: government, the courts, universities. The revelations from the recently-released Fauci emails are just the most recent example. Rapid immigration is an accelerant.

    *For perspective, QE1 was 13 years ago, QE2 about 10 years ago. No one bothers to number them anymore.

    **not just an insult, see M.A. Woodley et al., Social Epistasis Amplifies the Fitness Costs of Deleterious Mutations, Engendering Rapid Fitness Decline Among Modernized Populations

  4. Gavin Longmuir: Locke On: “… at worst, a Carteresque malaise and stagnation.”

    Oh, it could get a whole lot worse than that!

    Fair enough. Maybe “a reasonable expectation…” instead of “worst case”.

    I deliberately did not go down the hole(s) of overt war with the CCP, or civil war at home. This was sort of a maximum likelihood guesstimate, not trying to cover hedging requirements. (Still thinking about how to hedge a civil war…)

  5. Gavin Longmuir

    Locke On — I too have lost hours trying to think my way through the potential future.

    The giant uncertainty is timing, but there is no doubt that eventually the rest of the world will lose interest in exchanging their real goods & services for our dubious IOUs. What then?

    Setting aside the war options (economic, civil, external kinetic — in order of decreasing likelihood), the unavoidable truth is that any sustainable economy has to be based on the production of goods & services. Production Precedes Consumption!

    The unfortunate reality today is that many of us are non-productive. Even those of us who are employed are too often functionally Overhead. The good side of that is there will be a large pool of labor to be re-deployed to genuine productive activities once other countries cease subsidizing us through their exports.

    And there will be great opportunities for re-establishing businesses in the US which should never have been offshored in the first place. (Example — US apples are shipped to China to be squeezed into apple juice which is shipped back to the US). Imagine a world where unemployed lawyers can get productive entry-level jobs squeezing juice out of apples instead of unproductively squeezing settlements out of businesses. That is a world I will be happy to live in!

    How to invest for this future world? Invest in yourself! Learn useful skills, such as equipment repair. Invest in quality tools. Build up supplies of critical parts & materials. And if you have time, learn Chinese.

  6. I’ll differ strongly with you here.

    Gavin Longmuir: Imagine a world where unemployed lawyers can get productive entry-level jobs squeezing juice out of apples instead of unproductively squeezing settlements out of businesses.

    Sounds like the Khmer Rouge. Feels good, right? Lawyers may tend toward the scummy, but I’ll submit that they are in the main a necessary component of the rule of law in a Republic. “Imagine” court proceedings tuned to the self-representation of every thug and scam artist.

    Given an even partly functional system, it is the communications majors and _____ studies champions who will squeeze our juice. Nobody needs those “services”.

  7. Gavin Longmuir

    Don’t get too annoyed at my sense of humor. You are of course correct — a functioning republic needs justice, as expressed through a properly functioning Rule of Law.

    Unfortunately, it is now possible to make a credible case that this Republic no longer has a reliable functioning Rule of Law — and the incestuous relationship between lawyers and politicians has to take much of the blame for the effective Rule of Man which has replaced real justice.

    However, the broader economic point is that any society can afford only a certain level of non-productive overhead. Some overhead is always necessary — but we passed that point in the 1970s if not earlier. To echo Phil Gramm, people need to get out the wagon (overhead) and start pushing (producing goods & services which meet human needs).

    Yes, the “Studies” majors leaving accreditation mills with student debts and no marketable skills are part of our Overhead problem — as are those Dark Satanic Mills themselves. How we get back to a society where most people are genuinely productive — that is the challenge!

  8. Gavin Longmuir: it is now possible to make a credible case that this Republic no longer has a reliable functioning Rule of Law

    We are in what I am calling a QROL, or quasi-Rule-of-Law environment — not quite WROL (without), which is a special limited case of SHTF in prepper-speak. It’s somewhere between democracy and tyranny, wherein the law still rules, but only as applied by a powerful and unjust faction. It is a dictatorship held back by what we may politely refer to as modesty.
    All are equal under the law, and some are more equal than others. This is where we are now.
    Be prepared.


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