Up is Better Than Down, but Prosperity is not Just Around the Corner

As the glee over adding a few million jobs in May gives way to a more measured reaction, the question for a still hard-hit economy becomes whether the green shoots of May will become sturdy plants during the halcyon days of summer. And, as lyricists Alan and Marilyn Bergman would put it, survive summer’s “last caress, [when] it’s time to dress for fall.”

Investors seem to have made their decisions – it’s up, up, and away. Until it wasn’t. The National Bureau of Economic Research, charged with dating recessions, decided that the current downturn began in February, ending the 128-month expansion, the longest since 1854, when records were first kept. That announcement came on the very day, last Monday, that investors – or bored millennials and other tyros who think they know more than fabled billionaire investors such as Warren Buffett and Carl Icahn – drove share prices above levels prevailing at the beginning of the year, before COVID-19 began its global journey from China. Only to witness a vicious sell-off later in the week. We do not know how the newbies survived the shock of learning that markets plunge as well as soar.

There are reasons for thinking May was no false dawn, among them Federal Reserve Board chairman Jay Powell’s expectation that the recovery will start in the second half of the year, a prediction concurred in by 68.4% of the economists recently polled by The Wall Street Journal. Airlines, which reckon they will lose $84 billion this year and not return to profit until 2022 (to admit otherwise would be to risk further government handouts), are at least heading in the right direction. They are booking enough flights to warrant increasing the supply of seats. The housing market is hot: new home sales in May were 21% and mortgage applications 17% above year-earlier levels, and prices paid for existing homes are up by 7%. Macy’s and other retailers report that the return of customers to re-opened stores is exceeding expectations. Consumer sentiment, still below pre-virus levels, rose in early June by the most since 2016. Locked-in consumers have piled up cash, driving the personal saving rate from its less than 8% of income last year to 33%, almost twice the 17% record rate in May 1975.

Most important, executive, legislative and monetary policies all point to sustained support for the recovery. Despite a resurgence of the virus in some states, treasury secretary Steve Mnuchin announced that shutting down the economy again is not an option. “I think we’ve learned that if you shut down the economy, you’re going to create more damage.” Despite the usual bipartisan sniping, congressional Democrats and Republicans are preparing another package of trillion-dollar spending to beef up the recovery. And Powell last week committed the Fed to using its powers “forcefully, proactively and aggressively until we’re confident that we’re solidly on the road to recovery”.

Turn now to the longer-term outlook for the economy. The macroeconomic background is not encouraging. We will face the future with a level of debt that was simply unimaginable a few months ago, and a deficit this year that is already closing in on $2tn, two-and-one-half times last year’s level. That tsunami of red ink is the result not only of fiscal and monetary policies deemed essential to shore up a crumbling, shuttered economy and relieve suffering. It was set to be the norm for years to come before anyone ever heard of the COVID-19. A Republican President aiming for still more tax cuts, and a Democratic opposition moving far beyond John Maynard Keynes’ plan for counter-cyclical spending to Modern Monetary Theory and perpetual deficits, foretell continuing trillion-dollar deficits regardless of who occupies the White House.

Large, enduring deficits portend inflation, which might be one reason the dollar is falling. Faced with a need to rein in deficits by raising taxes and/or cutting spending, or allowing inflation to reduce the real burden of the nation’s debt, politicians prefer the job-preserving latter course. The Lindsey Group points out that the value of lost production will never be recovered even if the economy grows a full percentage point faster than its average past rate for the next ten years, and concludes, “History suggests that the easiest way to camouflage this negative wealth effect (and to some extent to pay for it) is inflation.”

Upward pressure on prices from the trillions of dollars being pumped into the economy will be exacerbated by the inability of the supply side to engineer a smooth output response. The 18.2% year-on-year rise in the prices of beef and veal in May were due less to a demand spurt than to supply constraints. The need to create more inter-worker space slowed processing and raised costs. This is only the first of supply constraints to come.

Restaurants will be operating at 50% of capacity to allow for social spending. Businesses will be paying staff higher wages to lure the five out of six workers the Congressional Budget Office says are now receiving more in benefits than they would receive were they to return to work at their former pay rates. Supply chains have been disrupted by disease and geopolitical considerations.

Then there is the need to disengage from China. Both parties agree that America must reduce its reliance on China for vital supplies of industrial, high-tech and pharmacological products. Easier said than done. The federal government last week approved the state of California’s $1 billion contract for the monthly purchase of 150 million U.S. standard N95 masks from Shenzhen-based BYD Co., a Chinese car and battery maker backed by Warren Buffett. According to The Wall Street Journal, California paid $500 million up front. Washington State has a similar contract, and is paying $177 million for 55 million masks.

Then there is the cost of disengagement. Tariffs, already feeding through to higher prices, will not be the only force driving prices up. The semiconductor industry, its trade association admittedly “accepting a national industrial strategy,” has been first off the blocks with a request for $37 billion in taxpayer funding for building semiconductor factories, research funds and related purposes. A bill to fund that effort has already been introduced by a bipartisan group in the House and Senate.

Big Pharma has yet to reveal the cost of liberating America from dependence on the communist regime for crucial medicines and related supplies. U.S. companies, after all, will be competing with highly subsidized Chinese entities charged with enabling China to dominate world markets in these products by 2025.

Talk about disengagement is easy, marshalling the political will to pay its price will not be.