Connect with us

Economy

It’s The Demand Curve, Stupid…

Published

on

It’s The Demand Curve, Stupid…

By Christopher Thornberg

The biggest obstacle to slowing inflation is that the real causes of it—excessive consumer demand and rapidly rising wages—are too politically toxic to acknowledge.

The August CPI report showed prices in the United States continuing to increase, contrary to the predictions of most Blue-Chip forecasts and the Federal Reserve. This has spooked the markets and caused a sharp decline in the various indexes—the S&P 500 dropped over 4%. The decline in the markets doesn’t surprise me—they are the ultimate drama queens of the economy, overreacting to everything. They will likely bounce back soon enough.

What does perplex me is how we collectively continue to be surprised when the official inflation forecasts fall well below reality. This same kabuki dance has been repeated almost monthly for more than a year now, with expert economists assuring us that price growth will soon decelerate and maybe even reverse, followed by a gnashing of teeth and predictions of doom when it turns out the data is not living up to the optimism.

I am certainly not suggesting that inflation is easy to forecast—especially on a month-to-month basis. But the problem I see here is different. The major forecasts and official prognostications aren’t just missing the mark, they have consistently predicted lower inflation rates than have been occurring. In statistical parlance the forecasts have bias. And this bias stems from the fact that the cause of inflation has been misinterpreted as primarily a supply chain issue, when in fact it is an excess demand and labor cost issue.

Consider the various explanations for inflation over the last year. They have typically attributed the problem to parts shortages (e.g., empty car dealer lots and high used-car prices), energy markets (the high cost of gasoline), the war in Ukraine and grain markets (food prices) among other issues. The following quote is from a Wall Street Journal reporter discussing her interviews with various economists prior to the summer CPI estimates:

“[June] will probably prove to be the peak for the annual measure of CPI. That’s because pretty much all of the major drivers of the inflation surge this year and last year are fading or outright reversing. Energy prices are on the downswing, most obviously gasoline prices. Upstream, energy and food commodity prices have come down a lot in recent weeks too, which suggests that there’s more easing to feed through to consumers in store, particularly on the grocery front. Supply-chain pressures seem to be gradually improving.”[1]

If we think about inflation as being strictly driven by limitations in inputs, then any relief in those supply pressures should cause prices to fall. But this is not the case today, as the August number clearly demonstrates. The supply-chain theory of inflation is wrong. And the reason many experts continue to get it wrong is because the true causes of today’s inflation—excess consumer demand and rapidly rising labor costs—are politically toxic and difficult to acknowledge in these terse populist times.

Excess consumer demand has been caused by an overstimulation of the economy on the part of the Feds. As I have written many times, the pandemic hit to the economy was never the crisis it was portrayed to be, and the $6.5 trillion in fiscal stimulus, largely funded by $5 trillion in new money created through the Fed’s quantitative easing program, was vastly more than necessary. It set financial markets to new (unsustainable) highs and ultimately generated a 25% bump in household net worth ($30 trillion in new wealth) in just 2 years. This new “wealth” has driven consumer spending to new highs, and that is what is causing inflation. As Milton Friedman famously quipped: “Inflation is caused by too much money chasing after too few goods.”

Looking at the supply side only mistakes the symptoms for the disease. Gasoline prices shot up because the minor issues with supply were magnified by the major jump in demand. Estimates of short-run demand elasticity for gasoline suggest the market is inelastic, but still, an increase in price will lead to a decrease in consumption if those prices are only being driven by supply constraints. Yet, the Bureau of Economic Analysis’ GDP data shows that in the last 18 months, even as energy prices rose 97%, consumption of energy products increased by 7%. Prices rose so dramatically because of the surge in demand, not the limitations on supply.

And now that energy prices are falling as supply catches up, money not spent on energy is simply flowing to other spending—healthcare, housing, restaurants, travel—and causing more inflation in those categories. And those sectors also have supply shortages—driven by labor shortages rather than supply chain issues. Just as excess demand drove up energy prices, excess demand is also causing a rapid increase in worker earnings, which is another important contributor to business costs and output prices. According to the Atlanta Fed’s wage tracker, U.S. worker earnings are now growing at a 6.7% annual pace—the highest rate ever recorded in the 40 years of data they have created.

And therein lies the political problem. If we acknowledge that inflation is being driven by excessive consumer demand, then we must admit that Americans are overconsuming. That’s an idea that doesn’t fit the miserabilist narrative that underpins political debate today. Both parties consistently tell their supporters how terrible they have it and then immediately blame the other party’s policies. Apparently, in the political world, most U.S. households are living hand to mouth, workers are highly underpaid, and we’re all just one paycheck away from financial disaster. To suggest otherwise would be gauche.

For the record, U.S. consumers are overconsuming. Consumer spending as a share of nation’s GDP is the highest it’s ever been, except during the runup to the Great Recession—not a comfortable comparison. This overconsumption is one of the root causes of the growing U.S. trade deficit, currently at almost 5% of GDP, again the widest it’s ever been except for the 2005 and 2006 period. As for the idea that real earnings growth is negative, you only get this result if you use the CPI estimate of inflation, which overstates the situation for technical reasons we won’t dive into here.[2] The appropriate deflator is the PCE deflator from the Bureau of Economic Analysis, and if we use that, real earnings growth is positive, albeit not at a 40-year high pace.

Of course, this story is only explaining the mechanisms within basic monetary theory. If you want to predict how much prices will increase, you only need to look at money supply. The Federal Reserve’s quantitative easing program expanded the money supply of the United States by 40%. Therefore, holding all else constant, prices need to go up by 40% to equilibrate the size of the economy to the size of the money supply.

While the Fed’s quantitative easing caused inflation, oddly their response to the problem has been primarily to push up the Federal Funds rate, the old tool that Ben Bernanke had largely moved past during his tenure. The big hikes in the Federal Funds rate have done very little to reduce the money supply; it has only stopped growing. If the Fed is serious about slowing inflation, they need to engage in quantitative tightening—which they say they will be starting this month.

By tightening of course, they will, by definition, cool consumer demand and weaken labor markets, as these are the ultimate sources of inflation. Given that policymakers are seemingly unwilling to acknowledge that the problem is excessive spending as well as wage growth, it unfortunately suggests they will be unwilling to do what is necessary to slow inflation.

The only question then is how much longer will we continue to be surprised by it.

[1] https://economics.cmail19.com/t/ViewEmail/d/A6E3C20BCF922DDB2540EF23F30FEDED/DE3F8A096023AA9114399806BE9B4083?alternativeLink=False

2 For more about the CPI’s inflation estimate see: https://www.clevelandfed.org/newsroom-and-events/publications/economic-trends/2014-economic-trends/et-20140417-pce-and-cpi-inflation-whats-the-difference.aspx

Christopher Thornberg founded Beacon Economics LLC in 2006. Under his leadership the firm has become one of the most respected research organizations in California serving public and private sector clients across the United States. In 2015, Dr. Thornberg also became Director of the UC Riverside School of Business Center for Economic Forecasting and Development and an Adjunct Professor at the School. An expert in economic and revenue forecasting, regional economics, economic policy, and labor and real estate markets, Dr. Thornberg has consulted for private industry, cities, counties, and public agencies. He became nationally known for forecasting the subprime mortgage market crash that began in 2007, and was one of the few economists on record to predict the global economic recession that followed. Dr. Thornberg holds a Ph.D in Business Economics from The Anderson School at UCLA, and a B.S. degree in Business Administration from the State University of New York at Buffalo.

Economy

Slow Growth Forecasted for California’s Major Metros…But No Recession; Consumer Spending Expected to Keep Local Economies Humming

Published

on

Modest Price Declines Expected In State’s Famously Expensive Housing Markets

California’s major metropolitan regions will weather any national headwinds caused by the recent banking crisis and are all expected to see employment grow and consumer spending continue for the rest of the year, according to new regional outlooks released today by Beacon Economics. Almost without exception, consumer and business sales tax receipts have grown significantly compared to pre-pandemic levels in the state’s largest urban areas.

“We expect consumer and business spending to carry the day in the near term for these local economies,” said Taner Osman, Research Manager at Beacon Economics and one of the outlook authors. “Despite bearish headlines about bank runs and tech industry layoffs, spending continues to trend above pre-pandemic levels in California’s metro areas.”

Since the 1st quarter of 2020, sales tax receipts have jumped in San Diego (+32.3%), the South Bay (+29% in San Benito County, +17.6% in Santa Clara County), the East Bay (+26.1% in Alameda County, 23.6% in Contra Costa County), and Los Angeles (+25.1%). Statewide, receipts have increased nearly 30%. Only San Francisco has seen a decline (-1.5%) in its business and consumer spending, albeit a minimal one. The new outlooks note that the fall off in San Francisco aligns with weak tourism and air travel data, which indicate that passenger counts through San Francisco International are down nearly 30% from pre-pandemic levels.

The ongoing spending spree across the state’s metros is being driven and bolstered by steady gains in payrolls, according to the new outlook. Indeed, in each of the five regions analyzed, the local unemployment rate has fallen back to a low pre-pandemic level and employment is inching towards an all-time high. Moreover, the forecast has job growth increasing by between 1% and 2.5% in all five metros throughout the remainder of 2023. “Overall, we’re expecting to see slow but steady employment growth across the state’s metros this year… and no recession,” said Osman.

In other findings, the new outlooks are forecasting only modest price declines in the housing markets of California’s major metropolitan areas over the rest of this year. While rising interest rates have taken a toll on the local markets, making mortgages more expensive and sidelining would-be homeowners, there has been little relief in terms of badly needed housing production. “The extremely limited inventory of homes for sale restricts how much prices will fall, with some areas only seeing a deceleration in price growth, not actual drops,” said Osman.

As of February 2023, on an annual basis, only in exorbitantly high-priced San Francisco did the median home price fall markedly, by 10.7%. In the other Bay Area metros, price decreases were more moderate, including a 3.5% decrease in the East Bay and a 0.3% and 5% decrease in the two counties of the South Bay. In Los Angeles and San Diego, price growth decelerated but prices continued to rise year-over-year (+1.8% in San Diego, +0.8% in Los Angeles).

This edition of The Regional Outlook was authored by Osman and Senior Research Associate Justin Niakamal.

View full outlooks for the East Bay, Los Angeles, San Diego, San Francisco, and South Bay.

Continue Reading

Banking & Financial Services

All Eyes On The Fed… But Will It Change The US Forecast?

Published

on

Federal Reserve Policies At The Root Of Recent Bank Collapses; California: A Better Recovery Than We Thought!

The recession forecasted by so many still hasn’t shown up and is looking less and less likely to anytime soon, according to Beacon Economics‘ latest outlook for the United States and California. Moreover, the recent bank failures that have been capturing headlines are being ‘wrongly viewed’ as heralding a coming downturn, something that misses the actual drivers behind the collapses and that key economic data refutes.

“These bank failures are not a reflection of an unhealthy U.S. economy, they are all about Federal Reserve policy,” said Christopher Thornberg, Founding Partner of Beacon Economics and one of the forecast authors. “Sad by true; the body that is supposed to be the wise shepherd of the nation’s banking system is largely responsible for creating the very stressors that caused Silicon Valley Bank to fail, and the run on others to begin.”

According to the outlook, the U.S. banking system, overall, is the victim of quixotic and rapid changes in Fed policy over the last three years as they have tried to maintain both full employment and price stability – which can be mutually exclusive. “In their existential panic over full employment during the pandemic, the Fed destabilized prices by injecting historic amounts of cash into the economy; in their existential panic over price instability, they destabilized the banking system through interest rate increases,” said Thornberg.

The new outlook acknowledges that the sudden crosscurrents from the bank failures have made the forecast fuzzier because stress in the banking system will eventually show up in the broader economy in the form of tightening credit. However, the new forecast does not believe those stressors, on their own, will rise to the level of a recession. “Cash is still king in the U.S. economy,” said Thornberg. “But if the Fed decides to continue raising interest rates in its quest to slow inflation, it will do more damage to the bank credit industry and that will trigger negative consequences for the overall economy.”

Assuming the Fed slows their roll, which they’ve shown some signs of doing, Beacon Economics is expecting slow growth and no recession in the near-term future. The forecast has real U.S. GDP growth in the first quarter coming in between 1% and 2%, although the margin of error has increased given the policy uncertainty.

In terms of the macro economy, the new outlook points to copious evidence of its health: unemployment in the nation remains rock bottom, consumer spending continues despite inflation, earnings growth is still running above 6% for the median worker, U.S. household net worth remains 30% ($30 trillion) higher than it was pre-pandemic, banks are not experiencing an increase in problem loans, and interest rates have started to stabilize causing asset markets to do the same.

In California, the news grew rosier this month after the state released its annual employment revisions, although a declining workforce continues to hamper economic growth. The revision shows that California recovered more and faster from the pandemic’s job losses than previously estimated: There are 197,000 more people employed in the state today than there were pre-pandemic. The original estimates had the gain at a mere 70,000.

However, in terms of the percentage increase, California’s job growth has been about five times slower than states such as Florida and Texas. “The underperformance we’ve seen is certainly not due to any unwillingness on the part of the state’s employers to hire workers,” said Taner Osman, Research Manager at Beacon Economics and one of the forecast authors. “Rather, California’s labor force contracted during the pandemic and there are well over 300,000 fewer workers in the state today than there were before COVID hit; there are simply not enough workers to fill the number of job openings.”

Deeply linked to its declining workforce is California’s famously expensive housing market, where prices surged an astounding 41% during the early days of the pandemic. Today, higher interest rates have led to a collapse in demand and home sales have returned to their pre-pandemic trough. However, home prices remain 27% above where they were pre-pandemic and the new forecast only expects them to fall by 6.3% in 2023. “Given California’s acute long-term housing shortage, it’s not surprising that price drops will be limited,” said Osman. “And this isn’t anything like the Great Recession because consumer balance sheets are so much stronger today and unemployment rates are at all-time lows.”

Continue Reading

Career & Workplace

Annual Employment Revision Changes Our Understanding of California’s Recovery From the Pandemic

Published

on

State Recovery Has NOT Lagged The Nation; California Recovered More And Faster Than Originally Estimated

The annual benchmark revision released today by the California EDD has significantly changed our understanding of California’s recovery from the pandemic, according to an analysis by Beacon Economics. While employment figures from 2022 were revised downwards, 2021’s figures were revised upwards, and in total, the state added far more jobs than originally estimated.

“The revisions have painted a rosier picture of California’s labor market recovery than previous estimates suggested,” said Taner Osman, Research Manager at Beacon Economics. “Importantly, given the contraction in the state’s labor force since the start of the pandemic, the job growth that has occurred is partly due to an expansion in labor force participation.”

Overall, employment growth in the state from December 2021 to December 2022 was revised from 3.6% down to 3.1%, while growth from December 2020 to December 2021 was revised from 6.5% up to 7.7%.

Previous estimates suggested that California had only added 70,000 jobs compared to its pre-pandemic level, while the revisions reveal the state has actually added 197,000 jobs. This means that payrolls as of December 2022 are 1.1% above their pre-pandemic peak, compared to the 0.4% originally estimated. While previous estimates showed the recovery in California as lagging the nation overall, today’s revisions reveal that the state has recovered at roughly the same pace.

The revisions also mean that California recovered the nearly 2.8 million jobs it lost due to the pandemic in June 2022, rather than October 2022, as originally estimated.

Growth in the state’s 2022 labor force was also revised downwards significantly. From December 2021 to December 2022, only 128,700 workers joined the labor force in California, far fewer than the 276,800 originally estimated. This translates into a 2022 labor force growth rate of 0.7% rather than the original estimate of 1.5%. However, at the same time, 2021’s labor force growth rate (from December 2020 to December 2021) was revised from 1.5% up to 2.2%.

At the industry level, the annual benchmark revision was mixed, with growth rates in some sectors were revised upwards, while others were revised downwards. The biggest upward revisions to year-over-year growth rates (December 2021 to December 2022) were in Mining and Logging (revised from 0% to 3.6%), Real Estate (revised from 2.8% to 3.2%), Health Care (revised from 4.7% to 5.0%), and Professional, Scientific, and Technical Services (revised from 4.1% to 4.2%).

The biggest downward revisions in year-over-year growth rates were in Finance and Insurance (revised from 1.0% to -0.9%), Construction (revised from 4.6% to 2.7%), Government (revised from 1.8% to 0.4%), Transportation, Warehousing, and Utilities (revised from 3.8% to 2.9%), Wholesale Trade (revised from 2.2% to 1.3%), Education (revised from 7.0% to 6.4%), Retail Trade (revised from 0.8% to 0.2%), and Leisure and Hospitality (revised from 7.7% to 7.2%).

California’s annual benchmark revision was also mixed at the regional level, with growth rates revised up in some areas and down in others. The largest upward revisions in year-over-year growth rates were in Yuba (revised from -0.6% to 4.1%), Napa (revised from 1.8% to 5.8%), El Centro (revised from 1.8% to 4.9%), Madera (revised from 2.4 to 4.6%), San Rafael (MD) (revised from -1.0% to 1.1%), and Modesto (revised from 0.9% to 3.1%). Downward revisions occurred in Santa Barbara (revised from 4.0% to 1.0%), the Inland Empire (revised from 4.9% to 2.7%), Ventura (revised from 4.1% to 1.9%), Merced (revised from 3.3% to 1.7%), San Francisco (MD) (revised from 5.3% to 3.8%), and Chico (revised from 2.6% to 1.6%).

 

January Numbers

California’s labor market expanded in January, with total nonfarm employment in the state growing by 96,700 positions over the month. “Despite all the headline gloom about the state of the economy at present, California’s economy added more jobs in January than it has in any month since February 2021,” said Osman.

As of January 2023, California has recovered all of the jobs that were lost in March and April 2020, and there are now 293,900 more people employed in the state compared to February 2020. Total nonfarm employment has grown 1.7% over this time compared to a 1.8% increase nationally. California also increased payrolls by 3.5% from January 2022 to January 2023, outpacing the 3.3% increase nationally over the same period.

California’s unemployment rate increased by 0.1 percentage point, to 4.2% in January 2023. While this rate is near historic lows, it remains elevated relative to the 3.4% unemployment rate in the United States overall. California is continuing to struggle with its lack of labor supply, although the workforce did grow by 44,700 in January. Since February 2020, the state’s labor force has fallen by 283,600 workers, a 1.4% decline.

Industry Profile  

  • While employment levels in nearly half of the sectors in California now exceed their pre-pandemic peaks, employment levels in the hardest hit sectors remain below their pre-pandemic levels.
  • The Government sector led gains in January, with payrolls expanding by 46,000. However, Government payrolls are still 2.3% below their pre-pandemic peak.
  • Other sectors posting strong gains during the month were Leisure and Hospitality (20,800), Retail Trade (10,200), Health Care (9,600), Professional, Scientific, and Technical Services (9,400), Transportation, Warehousing, and Utilities (6,700), and Wholesale Trade (3,000).
  • Payrolls decreased in a handful of sectors in January. Construction posted the largest decline, where payrolls fell by 7,300. However, the decline in Construction payrolls was largely weather related. Other sectors with significant job losses were Information (-5,000), Real Estate (-4,600), and Administrative Support (-700).

Regional Profile

  • Regionally, job gains were led by Southern California. Los Angeles (MD) experienced the largest increase, where payrolls grew by 37,300 (0.8%) during the month. San Diego (8,700 or 0.6%), Orange County (5,300 or 0.3%), and the Inland Empire (5,300 or 0.3%) also saw their payrolls jump during the month. Over the past year, El Centro (4.4%) saw the fastest job growth in the region, followed by San Diego (4.2%), Orange County (3.5%), Los Angeles (MD) (3.4%), the Inland Empire (2.8%), and Ventura (1.6%).
  • In the Bay Area, the San Francisco (MD) experienced the largest increase, with payrolls expanding by 8,900 (0.7%) positions in January. The East Bay (7,900 or 0.7%), San Jose (5,100 or 0.4%), Santa Rosa (1,100 or 0.5%), Napa (300 or 0.4%), and Vallejo (100 or 0.1%) also saw payrolls expand during the month. Over the past 12 months, Napa (5.5%) saw the fastest job growth in the region, followed by San Francisco (MD) (4.3%), San Jose (4.2%), Santa Rosa (3.6%), Vallejo (2.5%), and the East Bay (2.1%).
  • In the Central Valley, Sacramento experienced the largest monthly increase as payrolls expanded by 3,900 (0.4%) positions in January. Payrolls in Merced (1,000 or 1.4%), Chico (500 or 0.6%), Fresno (500 or 0.1%), Modesto (500 or 0.3%), Stockton (400 or 0.1%), and Madera (200 or 0.5%) increased as well. Over the past year, Madera (4.5%) saw the fastest growth, followed by Yuba (4.3%), Hanford (4.2%), Fresno (4.0%), Visalia (3.6%), Stockton (3.4%), and Sacramento (3.0%).
  • On California’s Central Coast, Santa Barbara added the largest number of jobs, with payrolls increasing by 2,200 (1.1%) during the month. Salinas (900 or 0.6%) and Santa Cruz (600 or 0.6%) saw payrolls decline during the month. From January 2022 to January 2023, San Luis Obispo (3.1%) added jobs at the fastest rate, followed by Santa Cruz (2.9%), Salinas (2.5%), and Santa Barbara (2.3%).
Continue Reading

Business Journal Newsletter



Advertisement

Trending