Who Do You Believe? The Fed Or Your Lying Eyes?

“Inflation Is Back at Highest In Over A Decade,” The Wall Street Journal. “New Price Spike Poses Challenge To White House,” The New York Times. “O my prophetic soul,” Hamlet.

You don’t have to be pushing a shopping cart, or trying to hire staff, or worrying if the goods you ordered from China or Vietnam will arrive in time for the holiday season, or watching rising interest rates on US treasuries to know that inflation is here. And that it isn’t transitory.

A survey by the New York Fed revealed that medium- and long-term inflationary expectations are at their highest level since the first such survey in 2013. If you agree with Jeremy Rudd, a staff economist at the Federal Reserve Bank of New York, who pooh-poohs his colleagues’  notion that inflationary expectations drive consumer behavior, you can ask the cart-pushers.

Consumers trust the reality they confront when shopping. And that reality is a price explosion. Which has them stripping shop shelves bare as they stock up on stuff in anticipation of future shortages and price increases, and demanding higher wages – 100,000 workers are on strike this “Striketober”. Stocking-up drives up prices, which drive up wages as workers play catch-up, which drives up costs, which drive up prices in what is called an inflationary spiral that converts consumers’ fears into reality.

Up Go Prices

Consumer prices rose 5.4 per cent in September from a year ago, to a 13-year high, topping the 4.6 per cent increase in wages. Prices are not only rising, but setting the stage for further increases:

  • Skyrocketing crude oil prices about doubled over the past year, with OPEC looking for more, and are feeding into gasoline prices (+49 percent) and into trucking rates (+56 per cent with more driver-wage increases likely).
  • Natural gas prices, already 150 percent above last year, will drive up heating bills, the cost of fertilizers and food, and the price of coal, while restrictions on fracking here and in Europe strengthen Putin’s hand.
  • Recent wage increases will have had their full effect on costs and prices by year-end and in 2022, with more to come as wages chase prices.
  • A nationwide restaurant chain is incorporating a 5 percent price increase in the menus being printed for 2022.
  • Almost half of small businesses plan to raise prices in the next three months. So do some larger ones. Fed Ex and United Parcel have announced higher-than-usual 5.9 percent boosts in average prices, effective in 2022.
  • Wholesale prices have risen more rapidly than consumer prices every month this year, suggesting that retailers are under pressure to raise prices more than they already have.
  • Rents have already jumped, and as leases expire over the next months, new ones are likely to incorporate increases on the order of 10 percent, driving inflation indexes upwards.

Fortunately for 70 million retiree-recipients of social security benefits, administrators of the government’s retiree benefits program do not share the Federal Reserve’s belief that this inflationary spurt is transient. Next year, benefits to all aged retirees will increase by 5.9 percent to offset the impact of inflation on blue-collar workers, the Labor Department’s measuring rod. That is the largest increase in 40 years.

Rapid Recovery Surprises The Supply Side

We are learning that the supply side of the American economy is less flexible than in the past. The economy’s quick and robust emergence from the effects of China’s export of Covid-19, and the shut-downs inflicted on the economy by US policymakers not particularly sensitive to the costs of such a move, took businesses by surprise. Workers had been laid off, inventories drained, orders for materials reduced in anticipation of a drawn-out recession that, in the event, was limited to a few months, thanks in part to the decision of the previous administration to finance the development of vaccines, shortening a process that often takes years.

The unexpectedly rapid recovery ran into supply chains that proved to be more fragile than globalization fans anticipated. A Covid outbreak in Vietnam shut the ports at which goods are loaded for shipment to the US. Coal shortages in China are forcing reduced operation of factories making microchips needed by American manufacturers. A shortage of truck drivers here in America, one of the final links in the supply chain, has vessels lolling in the Pacific calm off Los Angeles and Long Beach, and off Charleston on the East Coast. Forging new links quickly and without cost has proved impossible, encouraging deglobalization that is reversing the cost savings of recent years.

Transportation secretary Pete Buttigieg, regarded by some as preparing a challenge to Kamala Harris for his party’s 2024 nomination if Biden decides to end his battle with Father Time, conceded supply-chain problems will “take years and years to address,” not a working definition of “transitory”.

Consumers Open Their Wallets

Meanwhile, consumers continue to spend. Retail sales in September rose 13.9 percent last month compared with a year earlier, and are up another 8 percent early this month. Knock off a few percentage points for inflation, and the real increase in goods snapped up by consumers remains substantial. No surprise: consumers are sitting on $1.6 trillion in savings, 9.4 percent of their disposable income, well above the 7.2 percent in the October before the pandemic. Whether this sales level is depressed by the lack of goods to buy, or inflated by panic buying in anticipation of shortages and higher prices to come, is a story for another day.

Also, economists did not fully realize how a post-pandemic labor market would operate, especially after millions of workers had the delicious experience of work from home, no commuting, attire beyond casual, pets to provide adoration, minimal close supervision, while what Marx called the reserve army of the unemployed received benefits that made a return to work unattractive or unnecessary. Five million fewer Americans are at work than before the pandemic, at a time when more than 10 million job openings remain unfilled.

Where Did All The Workers Go?

The labor market might now be creating inflationary pressures. Poverty rates among seniors have declined sharply, removing reasons other than boredom for retirees who left the work force to return to work and for others to continue the daily grind; some 3 million women dropped out of the labor force in the past year; the skills of many of the unemployed do not match those in demand; younger workers seek something called life-work balance. Meanwhile, on the demand side, cash-rich consumers and inventory-rebuilding businesses have sellers hunting for workers, often fruitlessly.

What’s A Poor Fed To Do?

Fed chairman Jay Powell & Co. are taking notice, but still believe inflation is “transitory”, worthy of only the limited response of tapering asset purchases soon and raising interest rates by one percentage point by the end of  2023. To do more would, fears the Fed, interfere with its new goal of an economy so “hot” that it reduces wage inequality. For such comfort as it might provide the Fed, the International Monetary Fund agrees that inflation is set “to peak in the final months of 2021, with inflation back to pre-pandemic levels by mid-2022…”.

The problem is compounded by the Fed’s expansion of its historic macroeconomic obligation to maintain full employment to include a duty to boost wages of specific groups. Which Harvard’s Larry Summers, a Democrat and former Secretary of the Treasury, believes undermines the Fed’s inflation-fighting ability. At a conference organized by the Institute of International Finance, Summers gave voice to thoughts that remain unspoken in the minds of less candid commentators. “We have a generation of central bankers who are defining themselves by their wokeness … by how socially concerned they are. … We’re more in danger than we’ve been during my career of losing control of inflation.” If and when the Fed does take action, added Summers, “those actions … are going to be very shocking and very painful in financial markets.”

Inflation Or Stagflation

Adding the Fed’s probable one percentage point to interest rates that in real terms now are negative, would be like bailing flood waters with a thimble. The Fed will instead be forced to choose between the risks of letting inflation run, which has the attraction to some of reducing the real burden of national and corporate debt, or administering a meaningful interest-rate increase that might do more than merely slow the economy to a sustainable, non-inflationary rate. That risk is called stagflation.