The whining has begun, Krugman vs. Powell

Investment Analysis Clubs Macro Economic Trends and Risks
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Fed Chair Jerome Powell said clearly, in so many words, that reducing inflation would require pain.

Paul Krugman, who was enthusiastically “Team Transitory” before spiking inflation forced him to finally see reality, is already whining that the Fed should back off despite little evidence that inflation has receded.

Tracking the Coming Economic Storm

by Paul Krugman, The New York Times Oct. 6, 2022

…
Recently I wrote about the growing buzz from economists and businesspeople to the effect that the Federal Reserve, which has been trying to slow the economy to fight inflation, is braking too hard. Since then the buzz has intensified. And I’m increasingly convinced that, despite a disappointing inflation report and what still looks by some measures like a robust job market, the Fed is getting behind the curve.

We are, I’d now argue, just starting to see the effects of the interest rate hikes the Fed has been making since early this year. Never mind what inflation and jobs data are saying right now; there’s a lot of reduction in inflationary pressures — and a lot of drag on output and employment — already in the pipeline. The economy, as some business analysts like to say, may well be “rolling over.”… [end quote]

What are inflation and jobs data saying right now? That “sticky inflation” is still rising and the job market, though slightly weakening, is still strong. Average hourly earnings climbed 5 percent from a year earlier, the Labor Department reported.

Looking ahead, Krugman sees clouds gathering, so he wants to “evacuate before the storm” by telling the Fed to pull back on its tightening policy. That’s exactly what Fed Chair Arthur Burns did in the 1970s when inflation kept roaring back.

We can expect lots of whining from Krugman. The screams of pain from Wall Street haven’t even begun in earnest. When zombie companies start defaulting when they can’t roll over their low-interest debts. When profits begin to drop even in solid companies.

Yes, there will be a recession. No, the recent bottom in stocks is not a true bottom – it’s only noise, not based on Macroeconomic trends.

My brother-in-law thinks that Powell will cave to the pressure, as he has before. But I think that Powell is fully aware of the spotlight of history on his legacy. He’ll hold firm, like Volcker.

I don’t intend to put money into the stock market until the “mungofitch 99 day rule” triggers – 99 trading days of new highs. The market of the 1970s had many violent head fakes that failed. The market didn’t reach bottom until 1982.

The whining has begun but it’s far from ending. The storm clouds are moving in. It’s not Hurricane Covid – people won’t die – but it will be nasty.
Be careful out there.
Wendy

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In 2023 the pressures on economic decision making are going to look very different.

The American public supports much higher taxes on the wealthy and corporations.

The deficits have to come down. The debt has to be paid in part. The country feels they have been badly cheated by the wealthy. We get there are tons of bull arguments to keep cheating the country. None of those arguments were more than “disinformation”.

Dont listen to the press right now for what is going to happen. There is a pocket of the public that will show up at the last minute a few weeks from now and 'oh me oh my how did we miss this"? The pollsters got it wrong again.

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I am still in “team transitory”. The employment numbers have not relaxed, yet. Put a few million people out of work, and the “JCs” will cut pay rates. Pay is the only thing the “JCs” will cut. They won’t cut their prices, because that would take money out of the “JCs” pocket. The only place to push is employment, and fewer employees have their wages protected by collective bargaining agreements, so wages will not be as sticky as in the 70s.

Steve

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I’m trying to figure out the motivation for those who keep calling for Powell to end the Fed rate increases. And it’s troubling to me, because I don’t like the answer I’ve come up with. Not that I think the answer is wrong, but that the answer doesn’t bode well for society as a whole.

Here goes:

So why are some people pushing so hard to stop the interest rate increases and, in some cases, actually call for their reversal? Well, what happens if the rate increases never happened, or are kept small? Inflation, that’s what. And who cares about inflation? Or more correctly, who isn’t impacted all that much by consumer price inflation? The very wealthy - whether measured by income or assets - aren’t all that impacted. They have more than enough to deal with a bit of inflation. Plus their income and/or assets are likely to keep up with inflation. So inflation isn’t that big a deal to them.

But what are those folks scared of? Recession. Recession will drop the prices of most investment assets - stocks, bonds, real estate. And those working wealthy could see things like performance bonuses (which can be a significant portion of their income) fall or disappear completely.

That leads me to believe that the wealthy prefer inflation over recession. It’s better for them.

How about everyone else? Looking at the polar opposite - the working (and non-working) poor - they see things much differently. Inflation is hardest on the poor. When prices of food, housing, and transportation increase, they don’t have a cushion to cover the price increases. Their income is likely to lag inflation, so they get squeezed by rising prices. Union contracts need to be renegotiated before wage increases happen. Non-union workers see a similar lag, with wages staying the same until they (or enough of their peers) leave for better pay. Or recession hits and they lose their job. But we are often optimists about our job. The other guy will lose their job before I do. So ordinary, non-wealthy folks fear inflation far more than they fear recession. And rightfully so. Not every worker will lose their job in a recession. But every worker will be negatively impacted by inflation.

And that’s what I don’t like about my answer. It boils down to class warfare. It puts us back in the same place as the dark ages. The wealthy controlled government and did what was best for themselves and not for the society as a whole. And if what was best for the wealthy wasn’t good at all for the poor, too bad. The poor suffer and the wealthy don’t. At least not until the pitch forks come out. Eventually, the wealthy learned to give the poor enough to prevent revolt. But those lessons don’t stick for more than a couple of generations. So the cycle repeats.

In US history, we had to have open warfare to end slavery. That took about 80 years from the inception of the country (which I take as the Constitution rather than the Declaration of Independence or the Articles of Confederation). Another 60 years later, the excesses of the 1920s lead to the Great Depression. While not open warfare, the wealthy suffered quite a bit during then. The lessons of then stuck around a bit longer, but seem to have been mostly forgotten.

So we find ourselves again on the precipice of class warfare. The early battles play out in things like the Krugman article, arguing to end the economic policies needed to control inflation before they’ve done their job.

The macroeconomics of our current situation are remarkably simple. Supply has been (and is likely still) constrained. That causes inflation. The solution to the problem is two fold. Monetary policy needs to constrict demand until supply begins to increase again. Fiscal policy needs to work to increase supply sooner than it would increase on it’s own. The correct monetary policy without the proper fiscal policy means there will be prolonged economic pain for everyone as we wait for supply to slowly drag itself out of it’s doldrums.

But the wrong monetary policy (or the premature end of the correct policy) means the economic pain can be avoided by some, but will be higher for the rest. And that is not sound domestic policy.

–Peter

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Meanwhile, many retail employees are signing up for union representation. And a lagging factor is that union workers see the need for higher pay but must wait for contract negotiations to get those increases. Hence we see news of strikes and threatened strikes. Those may continue for some time after interest rates peak and unemployment begins to rise. Wage pressures will likely continue. Will formal cost of living adjustments be in those contracts?

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Investors like to think interest will peak soon and begin to decline. This will make for better performance in the stock market.

The economic arguments are contrived. It’s investors. And wishful thinking. Always in a hurry for rising stock prices and more business.

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Fiscal policy needs to work to increase supply sooner than it would increase on it’s own

Supply of what?

Bear in mind that as the economy slows state and local govt spending will decrease.

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Look, anybody can look over the railing and see where the ocean liner is, the Fed is supposed to be bright enough to look ahead. They’re not supposed to react, they need to Pre-act to do the job.

They already failed to get in front of it by dithering, but now they are about to fail to read the tea leaves and risk pushing the country, and perhaps the world, into a nasty global recession.

There are plenty of signs of easing inflation, but if all you look at is the same after-the-fact reports as everybody you’re going to come to the same conclusion.

Like poker, you have to read the tells before the hand is played, not after. A few months ago getting a cargo container cost north of $20,000, now it’s $2,000. The transit costs have dropped similarly. That tells me that the supply chain problems are being worked out, and that shortage of that kind are receding.

Housing starts have dropped like a stone, but the inflation stats look at house selling prices. Well those are trailing stats, based on houses started over a year ago in most cases. The seller’s market in pre-owned housing has flipped on its head in most areas, it’s suddenly a buyer’s market, albeit at an increased price point than where it might have been had the sit of inflation this past year not happened.

Gas prices are coming down, although admittedly that could be short term depending on Ukraine, Russia, Saudi Arabia and others, But prices are already off by 30%.

Lumber prices are off by half on many products, they went through the roof (pun not intended) at the beginning of the pandemic but they have moderated dramatically.

Shipping and fertilizer prices are down, chips are less expensive than just a few months ago thanks to 1) lower demand and 2) supply chain issues working out.

I note that everything I’ve mentioned: Energy, lumber, shipping, containers, housing, fertilizer, chips are “inputs”, those costs take longer to work into the public sphere than, say, detergent and potato chips. Housing moves usually mean lots of fix-up by sellers, and home decorating by buyers. It spurs furniture purchases, contractor bids, new appliances and all sort of direct spending, the indirect effects take longer to see. When housing slows down, all the rest does too.

And that’s my point. You and the Fed are complaining about price increases at the retail level, when they should have a better telescope and see them at the input level. If they carry on with another 75bp increase I will understand that they are setting the table for a deep recession, hard impact, rather than the soft-landing that they keep talking about. That may be a pipe dream anyway, but in flying there’s a perfect landing, a hard landing, and a crash landing.

I think team Fed - and those yelling for even more severe measures are setting us up for the last option. That ain’t good.

I never thought “transitory” meant prices would return to previous. Who wants to tell their employees that you’re talking away their raises? I thought it meant “we’d have a bout of it and then increases would moderate back to normal-ish. If you’re looking to put prices back to 2019, good luck. Even the horrible recessions of 1980 and 1982 didn’t do that. Neither did the Great Recession of 2009, so far as I remember.

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Supply in general. You know, the supply part of supply and demand.

Specifically at the moment, it would the things like oil and gas, computer chips, wheat and other grains. Of course, the government isn’t going to produce these things, but they can encourage more production with various incentives: tax breaks, grants, subsidies.

Classic economics say that is exactly when government spending should INcrease. That’s part of the fiscal policy I’m talking about. But since the current problem is not a lack of demand but a lack of supply, spending willy-nilly isn’t the answer. The spending needs to be highly targeted at increasing the supply of the goods that are currently in short supply. That could be incentives to bring production back to the US, or for the production of certain specific products that are causing bottlenecks. Going too far down that road is going to get somewhat political, so I’m not going to go further.

–Peter

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Goofy,

The failure in the global economy was in 2020 March. My take the FED is making the economy whole for the last 2.5 years. The “soft landing” is a place where things are okay again but real values for equities, bonds, and commodities are realized. We are no where near that yet.

We can take away the classical definitions of killing inflation 1981 and replace them with 1950s reasonable values for the middle class. It will look and taste differently.

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Peter,

The fiscal policy has to come from the federal side. State and local budgets are more reliant on middle class incomes. Federal spending is reliant on corporate taxes and higher earners’ incomes.

The piece I am missing is when do the tax hikes kick in on the wealthy and corporations.

Looking earlier today here at TMFMurph’s effective earned income taxes, I am of a mind that a roughly 5% hike in the corporate and top income bracket earned income taxes would do a world of wonder.

If the tax cuts are kicking in from the recent federal legislation in 2023 that will help more than anything else to dampen inflation. Note who is getting that done and who is not getting that done.

But honestly I was not paying attention to the legislation for those details. And I have not been paying attention to 2022 for tax hikes.

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Bear in mind that as the economy slows many people will lose their jobs. State and local gov’t spending in the form of unemployment insurance and other entitlements (e.g. Medicaid) increase.

Wendy

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The employment market will take a ding but unemployment is not going to be the real problem this go around. It will recover in 2024 quickly.

This is all about normalizing valuations after March 2022. This is about equity and bond portfolios and the commodity values.

add bears saying this is a crisis for the baby boomers not the millennials.

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Another element of this discussion, which I’ve read here before, but not in this thread, is that inflation may be good for the government / treasury. With all of the deficit spending that has happened over the past 2.5 years, the government can inflate that debt down to something more manageable by paying with inflated dollars. How does that element of the economy fit into this discussion? (I’m asking cause I’m not that smart to know).

'38Packard

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I think I qualify as “wealthy”, as do many of the participants here. I certainly don’t want inflation; every million dollars (cash) in the bank is only worth $900,000 a year later, give or take. Put it in something ultra-safe and you ~3% against a 10% loss, and you get to pay taxes on the 3%.

No, I don’t want recession either, although there’s money to be made in any market, all I want is a nice even-keel economy. We’ve had a bowling ball thrown at us in the form of the pandemic and related supply chain issues which led to shortages which led to entirely predictable price volatility. Add to that the $$$ response and drastic changes in society (WFH for one, buying of goods over services for another) and you have a chaotic environment which is slowly evening out.

What I also do not want is Powell over-reacting now to compensate for under-reacting before. I don’t think that wish is going to be fulfilled.

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38 that is true if balanced against a much longer time horizon.

This inflation is much steeper and in a shorter period of time. Meaning it is politically and economically unstable. The idea is for some of this inflation over a ten year period.

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Goofy,

I do not think we are getting the choices you imagine in your response.

I am seeing this all as a great reset for the middle class. Normalized returns after that where those who make 10% yearly are hugely successful and not all that common.

What will mark this common period is several years per decade with 5% plus real GDP growth. The country is going to get rich.

The 1981 to 2020 period was marked by very slow real GDP growth and a roaring stock market. That is not what we are getting. Instead the country is going to get wealthy without the transfer of our national debt growing to buoy the stock market. Best summed up as the lying is not going to work.

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" What I also do not want is Powell over-reacting now to compensate for under-reacting before"

Can you imagine the blowback if Powell and the Fed had tried to raise rates under the previous administration? They would have been attacked mercilessly thru social media, and would have had their lives threatened if they dared follow thru on rate increases.

I think Powell and the Fed are going to take advantage of the current administration’s sanity and level-headedness, and err on the side of raising rates too much, because they know that the window of sanity could close soon.

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Actually we’re approaching it incredibly quickly. A year ago the market was overvalued by 75-80%. By historical measures it’s now about 35% overvalued. You don’t wait until it’s 0% to stop applying the brakes, or you slam directly into the wall (recession.) You ease off. You still apply the brakes, but less and less firmly until you achieve a smooth stop, else your passengers fly through the windshield.

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I think it’s pretty clear he’s not over-reacting. Not yet. Unemployment is staying historically low. There are more job openings than unemployed people to fill those openings. That overhang of unfilled jobs is one factor that is contributing to inflation. It’s another constraint on supply and a bit of a vicious cycle.

Business would produce more if they had more workers. Because of the shortage of goods/services, they can get higher prices for the limited supply of goods/services they do have. But to produce more, they need to poach workers that are already employed or attract workers into the workforce that aren’t already there. That means higher wages and/or benefits. But those higher wages also translate into higher prices.

The only way out of the vicious cycle is to reduce the actual demand for goods/services. Reduced demand means a lower GDP and higher unemployment. And that is basically the definition of a recession.

So yes, a recession is in the cards. If we don’t have a recession, we are going to have a persistent inflation problem, and that will eventually lead to higher unemployment in a much harder to fix way. (See 1980)

Better to have a smaller, controlled recession now that have to generate a bad recession a few years from now.

–Peter

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