The State of the US Economy
A discussion of some current and pontential economic problems that are affecting every american
I may be stating the obvious, however, our economy is not in excellent shape. We are still being affected by covid in terms of supply shocks and the potential for renewed lockdowns. We are seeing high inflation and lower-than-expected economic growth. The stagflation of the 1970s may be back; but let's get specific.
Inflation
We've seen the highest inflation that has occurred in generations. The CPI is currently at 8.6% as of Friday, however, these numbers are deceptive. The CPI has become politicized. Since the Clinton days, hedonic adjustments have been added to the CPI number. Hedonic adjustments are defined as "a method of adjusting prices whenever the characteristics of the products included in the CPI change due to innovation or the introduction of completely new products" by the Bureau of Labor Statistics (BLS).
Beyond this, it's entirely fair to question whether the CPI is even an adequate measure of inflation. Beyond the government incentives to keep CPI low, due partially to the number of public policy programs the benchmark is tied to, it is more than reasonable to question its accuracy. To understand this, we need to begin by looking at how the CPI is calculated. Economists track about 80,000 consumer products each month, which in laymen's terms is the market basket of goods. They then plug this into a formula and evaluate consumer spending patterns.
The first problem arises from hedonic adjustments; where the government replaces an item in the basket with a different item due to quality changes or new technology. However, the item they replace it with always seems to be lower in price.[i]
But let's ignore this for a minute. The Bureau of Labor Statistics says, inflation is " a process of continually rising prices or, equivalently, a continuing falling value of money." Or, in laymen’s terms, too much money chasing too little value. This is a problem for the BLS because the CPI is not a measurement of rising prices or the decrease in the dollar's value. It's a measurement of consumer spending patterns due to price change. This means the CPI doesn't even inspect the idea that the dollars losing value.[ii] This means the CPI is probably inaccurate; inflation isn't 8.6% year-over-year and might be double that.
The Supply Chain Crisis
Beyond high inflation, we also have a supply chain crisis. This is predominantly caused by covid. Our supply chain used to be much easier to secure. Pre covid, the largest problem people had regarding our supply chain was tariffs on China. While this was an issue and did cause problems for companies' supply chains, it pales in comparison to the issue their now dealing with. We have global turmoil due to things like Russia's invasion of Ukraine and the geopolitical threat of China invading Taiwan.[iii] It has gotten to the point where the C-Suite executives now have to be focused on their company's supply chain, and McKinsey's survey of top executives ranked supply chain issues as the number one greatest threat to the growth of their companies and the country.[iv]
Even with this additional focus, the pain hasn't been alleviated for any of these companies, as the cost of doing business or producing things has tremendously increased. Labor shortages are also ravaging our market due to many people not wanting to go back to work after covid.[v]
We've also had shipping and trucking shortages where shippers are unable to find containers, and companies are unable to book with carriers. As the CEO of Nissan put it, “the inventory playbook has been ripped up; the just-in-time model is designed for supply-chain efficiencies and economies of scale.”[vi] These problems are only exacerbated when there are renewed lockdowns, like recently in China.[vii] This supply chain crisis is a significant issue, and there are no quick or easy solutions to fix it.
Gas Shortages
Beyond this, there's a gas shortage—specifically, diesel. Gas shortages cause significant economic issues. If there's not enough gas, people and industries, like trucking, will be unable to fulfill their jobs, and the economy will grind to a halt. This cannot be allowed to occur. The question of solving high gas prices is very complicated. In the United States today, we have record-high gas prices, with a national average of $5 a gallon.[viii] Additionally, the summer months are approaching when gas prices always increase due to increased travel. We have two problems involving gas, and both are related. The first and obvious one is gas prices. The simplest way to describe how this happened is that gas was super cheap during covid because no one was driving. After covid, gas prices began to rise but stabilized. At that point, the US government became more ecologically friendly. This includes policy decisions like canceling the Keystone XL pipeline, changing rules and regulations surrounding: offshore drilling, fracking, EPA standards, etc. This caused prices to rise since the estimated future supply of oil affects current gas prices. Inflation also then began to influence and raise gas prices.
Then in February, Russia invaded Ukraine, at which point the United States and EU banned Imports of Russian oil. This fun cocktail of circumstances has caused gas prices to rise precipitously.
High gas prices, however, should not be our greatest gas-related concern. Our biggest concern is a diesel shortage. Diesel fuel is essential as most United States items are trucked to their final destination. If there were to be a diesel shortage, the price of diesel would shoot up, so precipitously that the prices at the pump, on the shelf, and everywhere else would become utterly unaffordable. Now there is enough oil in the world to supply our needs. However, the additional supply will not be coming from the United States, as we are currently in no position and are unwilling to pull it out of our soil.
Russia could make up for this production gap and would be more than willing to; however, we are unwilling to do business with them due to actions they've taken in Ukraine.
OPEC could also fulfill gas needs; however, due to US policy on Iran, the Saudis are not in any mood to cooperate with us.
The other place the US could have gone to fulfill this need would be the Strategic Oil Reserve (US SPR). The US SPR was established after the 1970s when there were significant gas shortages in the United States. The SPR was established so that if oil-producing countries ever cut us off or we needed oil to wage war, we would have an ample supply to cover our basic oil consumption needs for a period of time. At the beginning of the Biden presidency, thanks to Donald Trump, the US SPR was at its highest level. Due to slow and minor releases by the Biden Administration in an attempt to lower gas prices, the US SPR is at the lowest level since it became fully operational in the later 1980s.[ix] This could become a major problem and go down as a massive blunder in history.
Gas price predictions show no sign of improvement. JPMorgan predicts gas prices will hit $6.20 this summer.[x] I personally think gas prices will increase much more. I predict closer to, if not, $10 diesel, but either way, prolonged prices like these will cause economic turmoil and crisis.
The Slowing US Economy
Due to covid, the economy struggled and experienced one of its largest crashes ever. Everything ground to a halt, but the expectation was that in the wake of covid, our economy would make a v-shaped recovery. This, however, never happened. Whether it was because of renewed lockdowns, not going back to work, a lack of government support for businesses, our supply chain problems, etc., our economy never fully recovered. Even more concerning is that the US economy is slowing. We were supposed to be in a massive boom post covid, in which the economy would fully recover and then some, but we did not hit our expected GDP growth of close to 6%.[xi] Further than this, our economy was expected to go from very rapid growth to somewhat stagnated growth below 2% for each of the following years.[xii] This means that inflation will most likely outpace GDP growth if inflation continues at anywhere near the rate it's been at.[xiii] It seems very likely that we are in a recession.
Concerningly, this looks very similar to Japan’s Lost Decade. In the 1980s, Japan embarked on a period of loose monetary policy, increasing speculation, sending the stock market in real estate values soaring. The Japanese government engaged in repeated rounds of expansionary monetary policy and deficit spending, even when they knew the bubble was about to burst. This problem is created by propping up existing firms and financial institutions rather than letting them fail and allowing entrepreneurs to re-organize them and rebuild. Does this sound familiar? It should.
What’s The Fed Done
This heavily relates to exactly what the Fed has done. The Fed engaged in quantitative easing. Quantitative easing is an experimental way to inject money into the financial system by creating “new money.” 2008 was the largest government intervention in US history. This caused a host of problems, including but not limited to; the largest wealth divide, American companies being addicted to free money, the bloating of corporate debt sheets, and a massive increase in venture capital and shadow banking. However, this is nothing compared with what the Fed did in 2019 during Covid. The Fed bought hundreds of billions in debt from financial institutions to make trillions of dollars available to these “shadow banks.”
Further, the Fed lowered the interest rates again to nearly 0. They cut the reserve requirements for many banks, sent the overnight repo rate to below zero, and for the first time in US history, gave half a trillion dollars to securities dealers, invested half a trillion dollars in foreign central banks, bought two billion in US securities, and bought another one trillion in mortgage back securities. And those are just the highlights.[xiv] Now, this may have been done to save the economy during Covid. In unprecedented times, unprecedented measures, etc. However, the Fed is currently carrying a debt sheet of 8918254.00 millions. (8.9 Trillion and change) [xv]
Potential Costs
This course of action has essentially stripped the fed of any power in our current crisis.
A Soft Landings Not Happening
This left Jerome Powell, the federal reserve chairman, in an impossible situation. The Fed's job is to balance unemployment and inflation. Today that is an impossible task. Whatever Jerome Powell in the US government chooses to do will not have a soft landing.[xvi] Further, whatever they do, and the longer they wait to do it, the more pain will come. The faster the US government acts in order to assist the oncoming crisis, the better off the American people will be on the other side. However, that means inflicting pain now but avoiding further stagflation.[xvii]
Policy That Could Pull Money Out of the Economy
Policy decisions could be made to pull money out of the economy and prevent further stagflation. These policies would include but are not limited to: raising interest rates, raising the fed funds rate, stopping QE, cutting government spending, hiking reserve requirements, increasing swap line rates, decreasing tariffs, and changing the OIS.
Policy Likely To Be Pursued
While these policies would assist in alleviating our problems, I do not necessarily see all these policies being pursued. Some of these policies are very difficult to explain politically, and whether or not we want to admit it, the people in charge of running our economy are all politicians. The policies I think will be pursued are as follows:
I believe the Fed will minimally and incrementally raise interest rates. I believe this will cause a taper tantrum and that due to this, the Fed will not be able to reduce its balance sheet. This will marginally slow the rate of increase in inflation.[xviii] I think the feds will continue to inject money to pump the DJIA. I think the White House will cut tariffs on China to decrease inflation temporarily. I think the government will increase taxes and the government will attempt to create price controls as was tried in the 1970s.
Things To Watch Out For
Our current situation could potentially lead to other problems down the road, especially if the government does not take action to fix existing issues quickly. While these are highly unlikely, they are things to watch out for especially if our government is slow to act.
The most obvious would be the debasement of US currency. This would most likely be due to high inflation that eventually leads to hyperinflation caused by continuing to perpetrate mass spending efforts and mass printing, which will not take money out of the US economy. This could be furthered by people shifting to cryptocurrency or foreign currencies based on boolean.
We could also see a bond crisis. Since 2008, corporations have been taking on more and more debt due to moral hazard perpetrated by the government. The government has been rewarding risk-taking. Do not mistake this risk-taking with making good bets. The government has been bailing out companies that make bad bets, and corporations have responded to this incentive structure by ballooning their debt sheets.[xix]
We could also see a housing market correction. Mortgage rates are rising, and house prices have been increasing but are beginning to taper off. This is expected to be a hot market cooling off, but we could end up seeing much worse than that, especially if inflation continues and spirals out of control. This could result in people holding mortgages that are greater than the value of their home, sparking a second subprime mortgage crisis.[xx]
We could also see a food crisis. Due to the war between Russia and Ukraine, we have been unable to import fertilizer from Russia. This is a problem because a lot of the world's fertilizer supply comes from Russia due to some of the dangerous and harmful chemicals used to create it. Due to the United States degrading its topsoil, it is vitally important that we are able to import and utilize fertilizer. We have not been able to import the necessary amount of fertilizer, which is why fertilizer prices spiked. This means that come the fall, when we attempt to harvest all the food for the country during the coming winter, we could see a global food crisis that causes the price of food to become unaffordable.[xxi]
A situation that could also come to bear would be QE6, most likely brought on by a housing bubble or the bond market's collapse, both of which would expose the entire economy.
Either way, we will likely see inflation rise, as people view this as the number 1 issue, and the current economic mood is not great.[xxii]
Profile
Given the current climate, I was assigned for educational purposes by a professor to attempt to come up with a mock investment portfolio to “weather the storm.” Again, this did not constitute investment advice and was purely an educational activity; however, the results are below. The idea was that the profile would not be actively managed and would protect the principal investment. I said 30% of this profile should be made up of SPDR Portfolio S&P 500 High Dividend ETF ticker, SPYD. This ETF exposes investors to the style box large-cap value market segment. 25% of this profile would be in The First Water Trust ETF ticker, FIW. This is an exchange-traded fund that seeks investment results to correspond generally to the price in yield of the ISE Clean Water Index. 20% of this profile would be in the United States 12-Month Natural Gas Fund LP ticker, UNL. This ETF is designed to track the daily price movements of natural gas. 20% of this profile would be in GraniteShares Hips US High Income ETF ticker, HIPS. This ETF provides diversified exposure to four alternative income categories - MLPs, REITs, BDCs, and Closed-end funds. I said the final 5% of this profile should be in crypto, specifically split up between Bitcoin and Ethereum. I said 3.5% should be in bitcoin while 1.5% should be in Ethereum. However, the restrictions this professor gave me require that I need the entire value of the account to be held in one brokerage account. At that point, I revised this 5% to be put into the Grayscale Bitcoin Trust ticker, GBTC. This trust enables investors to gain exposure to the price movement of bitcoin through a traditional investment vehicle.
[i] https://www.epsilontheory.com/im- trying-to-understand-hedonic- adjustments/
[ii] https://www.forbes.com/sites/perianneboring/2014/02/03/if-you-want-to-know-the-real-rate-of-inflation-dont-bother-with-the-cpi/amp/
[iii] https://www.weforum.org/agenda/ 2022/01/5-ways-the-covid-19- pandemic-has-changed-the-supply-chain/
[iv] https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-coronavirus-effect-on-global-economic-sentiment
[v] https://www.cnn.com/2021/06/29/economy/global-worker-shortage-pandemic-brexit/index.html
[vi] https://www.cmtc.com/blog/how-small-manufacturers-can-develop-risk-management-strategies-for-supply-chains
[vii] https://fortune.com/2022/04/23/china- lockdowns-inflation-supply-chain- nightmare-shanghai/
[viii] https://gasprices.aaa.com/
[ix] https://www.eia.gov/dnav/pet/pet_stoc_typ_d_nus_SAS_mbbl_m.htm
[x] https://www.cbsnews.com/news/gas-prices-could-reach-6-a-gallon-by-summer-jpmorgan/
[xi] https://www.whitehouse.gov/briefing-room/speeches-remarks/2022/05/04/remarks-by-president-biden-on-economic-growth-jobs-and-deficit-reduction/
[xii] https://www.imf.org/en/Publications/WEO/Issues/2022/04/19/world-economic-outlook-april-2022
[xiii] https://www.cbo.gov/publication/56965
[xiv] David Sheffet Power of the Fed
[xv] https://tradingeconomics.com/united-states/repo-rate
[xvi] https://www.dlacalle.com/en/powells-soft-landing-is-impossible/
[xvii] https://mishtalk.com/economics/an-official-denial-suggests-stagflation-is-now-the-base-case-for-europe
[xviii] https://internationalman.com/articles/david-stockman-on-the-monetary-madness-among-the-central-bankers/
[xix] https://tradingeconomics.com/united-states/repo-rate
[xx] https://www.thestreet.com/investing/will-the-housing-market-crash-may-2022
[xxi] https://www.reuters.com/business/sanctions-bite-russia-fertilizer-shortage-imperils-world-food-supply-2022-03-23/
[xxii] https://www.hedgefundtips.com/march-2022-bank-of-america-global-fund-manager-survey-results-summary/