Dec 7 A Day That Will Live in Infamy

Early in 1941, the government of resource-poor Japan realized that it needed to seize control of the petroleum and other raw mater sources in the Dutch East Indies (now Indonesia), French Indochina (now Vietnam and Cambodia), and the Malay Peninsula (now Malaysia).  Doing that would require neutralizing the threat posed by the U.S. Navy’s Pacific Fleet based at Pearl Harbor in Hawaii.

The government assigned this task to the Imperial Navy, whose combined fleet was headed by Admiral Isoroku Yamamoto. The Imperial Navy had two strategic alternatives for neutralizing the U.S. Pacific Fleet.  One was to cripple the fleet itself through a direct attack on its warships, or cripple Pearl Harbor’s ability to function as the fleet’s forward base in the Pacific.

Crippling the U.S. fleet would require disabling the eight battleships that made up the fleet’s traditional battle line.  But to be really successful, this alternative would also require disabling the two brand-new U.S. battleships then assigned to its Atlantic Fleet (which could be quickly reassigned to the Pacific), along with the three aircraft carriers in the Atlantic

It was quite a tall order.

The most effective way to cripple Pearl Harbor’s ability to function as a naval base would be to destroy its fuel storage and ship repair facilities.  Without them, the Pacific Fleet would have to return to the U.S., where it could no longer deter Japanese military expansion in the region during the year or so it would take to rebuild Pearl Harbor.

It soon became apparent that the basics of either strategy could be carried out through a surprise air raid launched from the Imperial Navy’s six first-line aircraft carriers.  Admiral Yamamoto had a reputation as an expert poker player, gained during his years of study at Harvard and as an Imperial Navy naval attache in Washington.  He decided to attack the U.S. warships that were moored each weekend in Pearl Harbor.

But in this case the expert poker player picked the wrong target.

The Imperial Navy’s model for everything it thought and did was the British Royal Navy.  Standard histories of the Royal Navy emphasized its victories in spectacular naval battles like Trafalgar, during which Royal Navy warships attacked and destroyed opposing ships.  Thus the Imperial Navy inevitably focused on attacking the U.S. Pacific Fleet’s battleships while at Pearl Harbor.

Lost in the shuffle was any serious consideration of trying to cripple Pearl Harbor’s ability to function as a forward naval base. So it was that, in one of history’s finest displays of tactical management, six of the world’s best aircraft carriers under the command of Vice-Admiral Chuichi Nagumo furtively approached the Hawaiian Islands from the north just before dawn that fateful Sunday, December 7, 1941, launched their planes into the rising sun, caught the U.S. Pacific Fleet with its pants down and wrought havoc in spectacular fashion.  On paper at least, this rivaled the British Royal Navy’s triumph at Trafalgar.

But so what?

The American battleships at Pearl Harbor were slow-moving antiques from the World War I era.  As we know, the U.S. Navy already had two brand new battleships in its Atlantic Fleet that could run rings around them.  And eight new ones the navy was building were even better.

More importantly, the Pacific Fleet’s three aircraft carriers weren’t at Pearl Harbor.  American shipyards were already building 10 modern carriers whose planes would later devastate Imperial Navy forces in the air/sea battles of the Philippine Sea and Leyte Gulf.  Moreover, the Air Force program was moving quickly to produce the B-29 bombers that would burn down 66 Japanese cities and drop nuclear bombs on Hiroshima and Nagasaki.

Most importantly, as the sun set on December 7 and the U.S. Navy gathered the bodies of its 2,117 sailors and Marines killed that day, all-important fuel storage and ship repair facilities remained untouched by Japanese bombs, allowing Pearl Harbor to continue as a forward base for American naval power in the Pacific.

So in reality, December 7 marked the sunset of Japan’s extravagant ambitions to dominate Asia.  Admiral Yamamoto and the Imperial Navy’s other tradition-bound leaders chose the wrong targets at Pearl Harbor.

The dictates of tradition are usually the worst guides to follow when it comes doing anything really important.  After all, if they survived long enough to be venerated, they’re probably obsolete.

Is the Fed Changing Course on Interest Rates?

There is a sliver of good news on the economy: inflation may be moderating.  For October, the consumer price index (CPI), a key inflation barometer, came in below expectations.  Though up 7.7 percent from a year ago, it’s the smallest increase since January.

But members of the Federal Reserve (the Fed) would be wise not to repeat their earlier mistakes by reading to much into a single month of cooling numbers.

You don’t have to be a professional economist to know that inflation is insidious for working Americans, as it erodes purchasing power.  For example, in 1970, the average cup of coffee cost 25 cents, by 2019 it had climbed to $1.59.  That’s inflation and it refers to price increases across the entire economy.

For decades, central bankers led by the Fed have flatlined interest rates and created money out of thin air, first in response to financial emergencies and then to the coronavirus pandemic. What were once emergency measures became totally normal, certainly since 2008. In simple terms, over the first two decades of the 21st century, the Fed engaged in a long love affair with ultra-low interest rates and printing money.

Easy money after the global financial crisis in 2008 produced several ill effects, including the creation of multiple asset price bubbles.  As one market analyst put it, “Never in the field of monetary policy was so much gained by so few at the expense of so many”.

But now Fed officials are walking back Fed Chair Jerome Powell’s hawkish comments in his briefing that followed the November Federal Open Market Committee (FOMC) meeting.  The Fed chair emphasized that it’s “premature” to discuss a pause in rate increases. He said the goal was to get inflation back to 2 percent, as the Fed announced an unprecedented fourth consecutive three-quarter interest rate increase, taking the central bank’s benchmark funds rate to a range of 3.75 to 4 percent.

This is the highest funds rate level since early 2008 and represents the fastest pace of policy tightening since the early 1980s, as the central bank tries to slow consumer and business demand and give supply a chance to catch up.

But multiple members of the Fed are now saying it looks like time to slow the pace of interest rate increases.  For example, the president of the Philadelphia Fed recently said the central bank should “pause when it makes sense”. Then the president of the Boston Fed said: “the risk of overtightening has increased”.

And the vice chair of the Fed says “soon” it would be appropriate to move to a slower pace on rate hikes.  The FOMC gets to see one more CPI report before its next meeting on December 13-14 to decide if it is time to pull back on the level of interest rate hikes.

These dovish comments are coming from the same grand poohbahs who 18 months ago claimed inflation was transitory as they sat on the sidelines and waited for it to abate.  They ignored the alarm bells and missed a crisis in formation.

Then, when inflation got out of control, the Fed finally tightened monetary policy. It was just a year and a half too late doing so.  As history has shown, printing too much money causes inflation.

Still, Fed officials convinced themselves that inflation was a thing of the past. The threat of inflation has faded from public memory. All this was before Russia invaded Ukraine.

The takeaway from all this is that the Fed will likely dial down the pace of interest rate hikes to a 0.5 percentage point increase in December after the recent encouraging signs that October inflation cooled more than expected. If this is the case, then it raises the question of whether the Fed has the minerals to stay the course and crush inflation.

OPEC+ decision to cut oil production will impact gas prices

Earlier this month, the 23-member oil-cartel known as OPEC+ (Organization of the Petroleum Exporting Countries), of which Russia is a member and led by Saudi Arabia, announced it would slash production by 2 million barrels per day.  The production cut is equal to 2% of the world’s daily oil production.  The cut was seen as a slap in the face to President Biden.  The move by OPEC+ drew angry criticism from Washington and the White House accused the Kingdom of taking sides with Russia.

In response the Biden Administration said it plans to re-evaluate the U.S.’s eight-decade old alliance with Saudi Arabia. It is hard to forget that during the Presidential campaign in 2020, the president’s money quote was he promised to make Saudi Arabia a “pariah” state.  He said there is “very little social redeeming value in the present government in Saudi Arabia.” He has criticized the Crown Prince for his role in the killing of Washington Post journalist and political opponent Jamal Khashoggi.  All this while courting Iran, an arch enemy of Saudi Arabia, in the hopes of striking a nuclear deal that would give Tehran billions of dollars to threaten the security of Gulf States.

Still for months the leader of the free world lobbied Saudi Arabia to help ease energy prices by pumping more oil into the market.  These pleas fell on deaf ears. The Administration urged the Saudis to wait for the next meeting of OPEC+ on Dec. 4 before making a decision on production cuts.  The Administration wants to hold down gas prices to advance the Democrats’ chances in the midterm congressional elections. Now the administration has announced it will sell 15 million more barrels of petroleum from the nation’s strategic reserve, aiming to ease gas prices.  The White House said it was prepared for more sales of the $400 million barrels in the strategic petroleum reserve if there are further disruptions in the world markets.

Not only that but the White House is starting to relax some of the sanctions on the authoritarian government in Venezuela which sits atop some of the world’s largest oil reserves to allow Chevron to resume pumping oil and exporting oil to the U.S.  There is an ominous sound of barrel scraping here.

Congressmen from both parties called for retribution against the cartel as well.  Some called for taking direct action against Saudi Arabia such as denying it access to military hardware and passing legislation allowing OPEC+ members to be sued under antitrust laws.

The Saudi’s rejected the accusation that it was getting in bed with Russia. They stated that the decision to cut output was driven purely by economic considerations and in response to future uncertainty about demand for oil.   OPEC+ was doing what it usually does.  They want to regulate the flow of crude oil to world markets in an effort to control prices. That is what the cartel is all about, full stop.. They are seeking to protect their national economic interests as has always been the case. The Saudi’s need money to provide for a decarbonized future and to fund its on-off war in Yemen.

The irony here is that according to the U.S. Energy Information Administration in September 2019, the U.S.  became a net exporter of crude oil and petroleum products for the first time since 1973.  In 2022, the U.S. will again be a net oil importer.  The Administration’s policy has been to ween the American economy off fossil fuels in favor of clean energy.  Quite apart from bans on fracking, bans on drilling, the President’s first act in 2021 was to scrap the cross-border permit for Canada’s XL pipeline which was projected to carry 900,000 barrels of crude oil a day into the U.S.

Events like the coronavirus and the tragic war in Ukraine should have revealed the dangers of being dependent on unreliable regimes and geopolitical adversaries.  These choices have left the U.S. in  an untenable, vulnerable place.

Insider Trading in Congress

A New York Times analysis found that between 2019 and 2021, 97 senators and representatives or their family members bought or sold stocks or other financial assets in industries that could be affected by their legislative committee work, violating a law designed to prevent insider trading and stop conflicts of interest.

Over the three -year period, more than 3,700 trades posed potential conflicts between lawmakers’ public responsibilities and private finances.

For example, 15 lawmakers tasked with shaping US defense policy actively invested in military contractors.  Still further, Senators, House members, and top Capitol Hill staffers who will help decide whether the government regulates cryptocurrency are themselves invested in bitcoins and altcoins.

All this while ordinary Americans are losing their shirts, if not their entire wardrobes, dealing with the pandemic and the rising cost of living while lawmakers ae making hay.  Sure, consumers may be getting some relief at the gas pump, but they are having to dig even deeper to pay for groceries.

The price of eggs is up about 40 percent since this time last year.  They are paying 20 percent more for milk, bread, and a staple in many Americans’ diet—chicken. Many of these working-class individuals risked their lives on the frontline of the COVID-19 crisis to stock grocery shelves, work in hospitals, or deliver food to homes, among other things.

To prevent members of Congress from taking advantage of their positions for personal gain, the U.S. passed the Stop Trading on Congressional Knowledge Act, known as the STOCK Act, signed into law in April 2012, an election year.  At a highly visible signing ceremony, it was said that the legislation would address the “deficit of trust” that divides Washington and the rest of America.

The STOCK Act prohibits members of Congress and senior executive and legislative branch officials from trading based on knowledge obtained as a result of their jobs. It increased transparency by beefing up financial disclosure requirements on stock trades and posting the annual financial disclosure forms federal officials file on a publicly available online database.  A key provision of the law mandates that lawmakers publicly and quickly disclose any stock trades made by themselves, a spouse, or a dependent child.

But transparency only works if people abide by the rules.  Congress and top senior Capitol Hill staff have violated the STOCK Act hundreds of times, but they face minimal penalties that are inconsistently applied and not recorded publicly.  If they file their disclosure more than 30 days after it’s due, they have to pay a fee this being the U.S. Congress of no more than $200.  And Congress has the discretion to waive the fines stipulated in the law.

Is it any wonder that the average American does not understand why elected officials do not play by the same rules as everyone else?  The hard truth is that the American people simply do not trust the federal government.  Only two-in-ten Americans trust leaders in Washington to do what is right, according to the Pew Research Center.

There are a variety of rare bipartisan proposals floating around the House and the Senate to tighten the rules on stock trading, and key details still need to be ironed out.  The only way lawmakers can earn back trust is to hold themselves to a higher standard, starting with an outright ban on the trading of stocks and other financial assets such as cryptocurrencies by members of Congress, their immediate family members and senior congressional staff.

Members of Congress should spend their time working for the American people. But persuading them to start putting the public ahead of their personal financial interests is like asking them to perform surgery on themselves.  And you can take that to the bank.

Russian ruble rebounds as Russia and China work hard at de-dollarization

“Russia’s ruble is reduced to rubble. Their economy will be cut to half. The ruble is crumbling now,” President Biden said during a speech on March 26 while visiting Poland, a country that has been taking in refugees from neighboring Ukraine.

The value of the Russian ruble tumbled 30 percent after the U.S. and its allies, including most of the European Union, Canada, Japan, Australia and almost all other major Western economies imposed sanctions in response to the Russian invasion of Ukraine. But the ruble has bounced back, almost doubling in value from its low point on March 7.

The recent gains mean the currency is now back to its level before broad based, hellish sanctions on the Russian government and its oligarchs were imposed, continuing its streak as the best performing currency in the world this year.  This strong performance once again demonstrates the body politic in the U.S. has become like the other woman, wanting to believe the promises all too many politicians make about the future.  They never change.

Russian energy exports drive ruble rebound

Why has the Russian ruble made large gains in spite of the sanctions?  Reasons for that rebound include, surging energy prices, support from the Russian government putting huge capital controls in place to stabilize the ruble and the Russian Central Bank raised interest rates by as much as 20 percent.

Additionally, Russia required the European Union and other nations guzzling Russian oil and gas, to pay for the energy commodities in rubles since the U.S. and Europe weaponized the dollar denominated financial system.  In effect, Russia has weaponized its energy in response to Western sanctions.  Given super high energy prices, Bloomberg Economics estimates that Russia’s energy exports will increase this year by one-third to $321 billion.

Still further it is hard to ignore the lifeline other nations such as China, India, Brazil, South Africa, NATO member Turkey and others have tossed Russia by purchasing its oil and gas in rubles. Also, Riyadh is in discussions with Beijing to sell its oil to China for yuan in lieu of dollars.   These purchases have given Russia a current account surplus—exporting more than it imports, stabilizing the ruble.

The decision to link oil and gas and other raw materials to the ruble threatens the hegemonic order of the U.S. dollar.  In effect, Russia, the eleventh largest economy in the world by nominal Gross Domestic Product, has accelerated its de-dollarization.  For the last several years, China and Russia have sought to reduce their use of the dollar in an effort to shield their economy from existing and potential future U.S. and other Western nations sanctions and assert global economic leadership.

Dollar dominates global economy, for now

The U.S. government has acknowledged that it can’t stop these purchases because there are no secondary sanctions on countries doing business with Russia.

The U.S. can use sanctions as a weapon and compel allies to go along with it or else because the U.S. dollar is the world’s reserve currency.  For nearly 80 years the dollar has dominated the global economy because it is needed to conduct global trade.  The U.S. dollar controls about four-fifths of all currency operations in the world. It is hard to imagine things being done in a different way.

The U.S. accumulated about two-thirds of the world’s gold reserves at the end of World War II. This was the basis for the Bretton Woods system of monetary management that ensured the U.S. dollar hegemony in the western world for many years.

China and Russia have tried for some time to de-dollarize in trade and investment with limited success but if their de-dollarization efforts gain traction there could be major implications for the U.S. economy, U.S. sanctions, and U.S. global economic leadership.

Revisiting the 2008 Financial Meltdown

This month marks 14 years since the 2008 global financial crisis. The demise of the investment bank Lehman Brothers on September 15th sparked an economic downturn that was felt throughout the world.

The crash led to the worst recession since the Great Depression. It illuminated the dangerous corporate culture that had existed in banking for many years, explaining something as tangled and multi-dimensional as the 2008 financial crisis is fraught with difficulty.

The meltdown was one of the most critical events in American history, and its aftermath saw plenty of hardship. It wiped out some $11 trillion of the nation’s wealth and destroyed more than eight million American jobs by September 2009. It froze up the nation’s vast financial credit system, leaving thousands of firms too short of cash to operate.

It also forced the federal government to spend $2.8 trillion and commit another $8.2 trillion in taxpayer funds to bailing out crippled corporations such as General Motors, Chrysler, Citigroup, Bank of America, AIG, and a host of other “too-big-to-fail” companies run by corporate panjandrums.

It cost millions of Americans their jobs, homes, life savings, and hopes for decent retirements. This was a cataclysm far worse than any natural disaster in the nation’s experience.

The lack of accountability for the banks and other bad actors helped spur social movements from the left (Occupy Wall Street) and the right (the Tea Party), the heirs of which have made themselves heard during elections dating back to 2016. It appeared to many that there were two sets of rules: one for ordinary Americans and another for the rich and well connected.

After the financial crisis, there was no shortage of wannabe Cassandras who supposedly had been warning about this for years. They wrote about “casino capitalism” and “corporate greed” without saying a word about the quite specific causes of this very specific crisis. They have been vindicated only in the way a horoscope might occasionally come true.

In November 2008, just two months after the Lehman Brothers bankruptcy and the Western economy’s descent into the abyss, the Queen of England asked a roomful of academics at the London School of Economics a disarming question: Why had they not seen it coming? They were all caught off guard.

In the years following, many economists and academics have attempted to answer her question, but few have come up with more than citing immediate causes, such as high leverage and a strong appetite for risk and failed to identify the deeper causes.

The Queen’s question resonated with ordinary people, who were baffled at why politicians, bankers, and academics all failed to spot the financial storm on the horizon.

The Financial Crisis Inquiry Commission created by Congress in May 2009 is often cited as the definitive source for information about the causes of the 2008 crisis. The commission was tasked with restoring trust in the banking sector by bringing to light the misdeeds and malfeasance that caused the Great Recession.

But the bipartisan 10-member commission could not agree on the underlying causes of the financial crisis. Instead, it completed its forensic work and produced three conflicting reports in January 2011.

All the members basically agreed on the facts, but disagreements arose over interpretation. For sure, no single narrative or satisfying theory to explain the cause of the financial meltdown emerges from the mother lode of factual information surrounding the crisis, but the variety of conclusions is informative.

It may be decades before anything approaching real perspective about the crisis can be achieved. The situation is similar to the story in the Japanese film “Rashomon,” where different witnesses give conflicting accounts of a crime.

One lesson to be learned is that what can’t be easily understood can’t be easily controlled. So, the question may be when, not whether it will occur again.

The Consequences of Interest Costs on U.S. Debt

Over the next 30 years, the fastest growing category of government spending is projected to be interest on the national debt.  That means the government will be shelling out hundreds of billions of additional dollars each year for interest payments.

The growth in interest costs presents a huge threat to the economy and to Americans’ economic future.  The long-term societal effects will be massive; it will be a painful reckoning when the bill comes due.

According to the Congressional Budget Office’s (CBO’s) 2022 Long-Term Budget Outlook, the cost of interest on the national debt will surpass defense spending in 2029; Medicaid, Medicare and Child Health Insurance in 2046; and Social Security in 2048.

The CBO projected that annual interest costs paid to holders of Treasury securities would total $399 billion in 2022 and nearly triple over the coming decade to $1.2 trillion, growing from 1.6 percent of gross domestic product (GDP) to 3.3 percent in 2032, which would be the highest level ever.

If the Federal Reserve raises interest rates by larger amounts than the CBO has projected, costs may rise even faster than anticipated.  Still further, interest costs are on track to become the federal government’s single largest expenditure in 2054.  By then, interest costs will account for almost 40 percent of tax revenue and become the largest federal expenditure.

Rising interest payments are the result of escalating interest rates and debt levels that have risen like the blade of a hockey stick.  Treasury yields have surged with inflation running hot and the Federal Reserve in an aggressive tightening mode, while the national debt has grown by some $6 trillion since the pandemic began.  Pandemic-driven fiscal and monetary policies changed the debt situation considerably and for the worse.

The latest data show inflation at an 8.5 percent annual rate.  It is reasonable to expect the Fed to keep tightening over a sustained period, trying to reduce aggregate demand, relieve pressure on consumer prices and produce a hoped-for soft landing.  In 2017, the national debt was $20 trillion; now it is approaching $30 trillion.  Ten-year Treasury yields have climbed close to 3 percent, double what they were last December.

Increasing debt and high interest rates can crowd out important federal budget priorities and lead to a vicious cycle of even more debt, deficits, and interest payments.  This means the government will be paying hundreds of billions dollars more each year on interest payments on top of other fixed costs that are also growing, such as health and retirement provisions for an aging population.  This enhances the risk of a fiscal crisis.

As for those who hold on to the hope that folks in Washington will develop a long-term strategy to deal with the debt pile and deficits, it is likely time to label that as wishful thinking.

Congresses and presidents of both parties have long avoided making hard choices about the federal budget and failed to put it on a sustainable path.

In line with time-honored tradition, they prefer to just pop into the national arboretum of magical money trees and grab what they want.  The phrase “often wrong, but never in doubt” is only a slight exaggeration when it comes to their behavior.  The present commands their attention.  The few lawmakers raising issues about the debt, deficits, and rising interest costs are an endangered species.

Of course, crises can provide the necessary cover to make tough, hard decisions. As Stanford Professor Paul Romer said in 2004, a crisis is a terrible thing to waste – a sentiment later echoed by former White House Chief of Staff Rahm Emanuel.  Let’s hope the U.S. doesn’t waste this one.

Technology is Disrupting the Transportation Industry

The increasing pace of change is a defining feature of our times.  This is one of the most discussed topics among consenting adults, right there with the ongoing debate about what exactly constitutes a recession. Far more than those who lived during the Renaissance or the Industrial Revolution, people are self-consciously aware of the transcendent characteristic of this period in history.

Americans truly live in an age of innovation. Even the most conscientious technophobes find it difficult to ignore the waves of technological change that are rolling through the global economy.

One challenge to implementing technological advances is outdated regulatory structures.  The pace of change far outstrips government’s ability to serve the public interest by managing and regulating these new developments. Government at all levels needs to rethink the application of old-style bureaucratic tools to today’s fast changing high tech industries, especially when it comes to transportation.

A healthy transportation system is the lifeblood of American commerce and industry and is central to America’s ability to compete with its economic competitors, particularly China. Indeed, there is a robust link between the level of transportation investment and the nation’s ability to increase its productivity.

Technological innovation is transforming the transportation system.  In addition to the number one trend – the move to electric cars – there is autonomous driving – not just for cars but for low-cost micro-mobility – ride-sharing; in-vehicle connectivity; 5G wireless technology;  companies like Uber and Lyft adding to the concept of on-demand mobility; robotics, such as robo-taxis that are currently operating in Phoenix and San Francisco; and mobility technology, to name just a few salient trends.

Consider mobility as a service the holy grail. Ideally it would offer customers the ability to plan, book, and pay for transportation services by digitally connecting to a variety of public and private transportation options across all transportation modes.

The future of transportation is being shaped by a convergence of these trends – a huge set of disruptive forces to reckon with. While it is extremely difficult to predict when these new technologies will be ready for prime time and their rate of proliferation and adoption, it is important to understand and consider the impact they will have on mobility and the transportation system.

Such improvements could help reduce the costs of traffic congestion, which some experts believe cost the economy over $120 billion per year; road accidents, which killed nearly 43,000 Americans in 2021; air pollution, which contributes to health problems like respiratory ailments; improving mobility for seniors and individuals with disabilities; and other societal benefits.

Underscoring the discussion about the rate of technological change is the major implications advances in mobility will have for urban centers as they determine how to tailor new mobility approaches within each city context.

Just as the Federal Communications Commission manages the airwaves for the public good, so, for example, must cities manage their streets and public transit.  Their challenge is to become mobility managers, leveraging all the new technology to provide better and safer service to their riders.

There are opportunities and threats that cities have never encountered before, presenting a daunting challenge to the current crop of public sector managers. They might not be willing to buck the status quo and reimagine the future of mobility, especially in their quixotic quest to improve mobility, particularly in cities where transportation assets are reaching the end of their expected life span after suffering from decades of benign neglect.

The challenge for providers of transportation services is to leverage current assets while wisely exploring the development and deployment of new technological innovations that indeed may cannibalize existing core assets.  Just how many public sector managers and leaders are capable of being ambidextrous is problematic when operating in a political environment.

But to paraphrase Bob Dylan, when the times, they are a-changing, you must too.



The Shrinking Labor Force

The country is in a fragile state – burnt out from three years of pandemic; social upheaval; the war in Europe; and an economy that is cooling under the weight of high inflation, rising interest rates and the scarcity of labor.  The U.S. may have reached the point where its past is more appealing than its present.

So when good news comes along, you might as well seize it. This could apply to a recent announcement by the Bureau of Labor Statistics that the economy added a seasonally adjusted 372,000 jobs in June, well above the 250,000 economists expected.

But this sliver of good news must be set against the continuing cost of living crisis, or “Bidenflation,” as some call it, which is impoverishing working Americans.  The consumer price index rose 9.1 percent in June on a year over year basis, the worst inflation since December 1981.  It is unclear how the Federal Reserve will put the inflation genie back in the bottle without a creating a whole lot of pain.

Education and health services led job creation, followed by professional and business services, and leisure and hospitality. Meanwhile, the unemployment rate remained at 3.6 percent, a touch above the 50-year low reached before the pandemic hit in early 2020. Job growth continues, although fewer people are looking for work.

The Covid-19 pandemic turned the labor market upside down, and it is currently drum tight.  There were more than 11 million job openings at the end of June – up substantially from 9.3 million open jobs in April 2021 and seven million prior to the pandemic.

The pandemic led many people to reevaluate what they want from a job and from life, and it prompted a wave of early retirements.  Others left to start their own businesses.  Still others left to care for children, elders or themselves.  Some people simply threw in the towel and decided to stay at home, courtesy of the taxpayers.

The demand for workers far exceeds the number of unemployed people looking for work.  The labor participation rate – the share of adults working or looking for a job – was 62.2 percent in June, down from 63.4 percent before Covid.

Workers are taking advantage of the tight labor market by switching jobs for better pay, which represents a new source of inflation for many American companies.

Average hourly earning rose 5.1 percent over the last year.  Rising wages could make it harder for the Federal Reserve to tame inflation.  Nearly 79 percent of American workers are in the service sector, where higher labor costs are a large burden.

In addition to a shrinking labor force driving up wages, a steady decline in birth rates is expected in the U.S. and many advanced economies, which will sharply reduce the growth of the labor force.

For example, life expectancy in the U.S. has increased from 1980-2019 and improvements in morbidity and mortality rates will lead to a rapid increase in the number of people who are over 65 and retired.  As a result, dependency ratios – the ratio of the number of dependents to the total working age population – are set to rise sharply.

Put simply, deteriorating U.S. dependency ratios in the U.S. and globally means dependents who consume but do not produce will outweigh those who are working.  In effect, too few people carrying the load.

This translates to lower productivity per capita, an ever-intensifying war for talent and skills, and upward pressure on inflation.

As the supply of labor contracts, their bargaining power will increase and wages will continue to rise.  The growing leverage of labor may have beneficial effects on inequality, but it may manifest an increasing risk of structural inflation.

The Fed Fighting Inflation

Prices at the gas pump and in the grocery store are climbing at the fastest pace since 1981.  As inflation spreads throughout the economy, it is proving painful for working families.

The Federal Reserve has raised interest rates three times so far this year and has signaled it plans to keep doing so in coming months.  The country is in the eye of the storm; the price spiral is nowhere close to over.

The Fed is passing off these interest rate increases, in bits and bobs as the British say, as a coherent strategy organized around a defining theme: to fight inflation and put the beast back in its cage without tipping the economy into a recession.

The American public has been told with monotony by various media outlets that the central bank has a laser-like focus on cooling the economy and limiting demand for goods and services, noting that the Fed has not hiked interest rates by 0.75 percentage points in one go since 1994.

The media was so transfixed with this figure that if you had a frequent flyer mile for every time it was mentioned you would have enough miles to circumvent the globe by now.

What is absent from this reporting is that the funds rate is now in the 1.5 to 1.75 percent range.  The Fed plans on the rate reaching a relatively modest 3.4 percent by year’s end.

Meanwhile, inflation hit 8.6 percent in May, the fastest rise in 40 years, with more pain to come.  Interest rates are still way below the rate of inflation.  It is crucial that the Fed take the cost of borrowing well above the inflation rate for price pressures to cool.

The reasons behind the current inflation are not hard to fathom, from the global pandemic to supply chain issues and the war in Ukraine.  The expansionary monetary and fiscal policies of 2020 and 2021 surely put a fire under the economy, driving up consumer demand and putting upward pressure on prices.

While it might not quite be true that, as Milton Friedman memorably put it, “inflation is always and everywhere a monetary phenomenon,” it is still a large part of the explanation.  Skip over blaming Putin.  To believe that is to think in political cliché.  Inflation was high before the Russian invasion of Ukraine.

By any normal reckoning, the Fed and others steering the economic ship remained conspicuously in the wrong for a long time when it came to dealing with the rise in prices.  By to-ing and fro-ing and insisting that inflation was transitory last year and hoping it just went away as though it didn’t exist, inflation got out of hand.

For the U.S. to defeat inflation, it will take real leadership.  To put it crassly, the Fed needs leadership like that provided by its former Chair Paul Volcker, the consummate public servant, a rarity on par with Halley’s comet.

As Volker understood it, inflation can be defeated, but it takes a willingness to make tough choices and the minerals to face down critics.  He did everything except kick extra points to deal with runaway inflation, explaining to the public the tough road ahead, the sacrifices to be made and the fact that there was no alternative.

For example, when inflation reached 15 percent in 1980, Volcker understood the need to go for inflation’s jugular and ratchet up interest rates above the rate of inflation.  He raised interest rates to over 20 percent to crush raging inflation.

That gives a foretaste of what the U.S. will experience in the coming years if the Fed does not move more aggressively and quickly to combat inflation.

While predicting the future is beyond difficult, if the Federal Reserve is to get inflation under control, it has a long way to go when it comes to raising interest rates.