Neel Kashkari sees inflation. A lot of it. And he sees it everywhere.
“It’s very concerning, you know,” he told CBS’s John Dickerson Sunday, as though Dickerson were the policymaker and Kashkari the average American. “It’s not just a few categories. It’s spreading out.”
It sure is. Late last week, PCE price gauges accompanying June’s income and spending figures underscored the message from the latest CPI report: Inflation isn’t receding. It’s fanning out and establishing new beachheads.
For many Americans, price growth has never been hotter. Some traders will tell you, anecdotally, that based on their recollection, the situation was much worse in the 70s. Such assessments are basically true, but they sometimes ring hollow due to ambiguity around what’s meant by “the situation.” Societies change and so do expectations. Some things that were tolerable four decades ago likely won’t be now, and vice versa. It’s notable that Larry Summers’s reconstituted inflation series suggests that on an apples-to-apples basis, inflation actually is comparable to levels observed 40 years ago (figure below).
As regular readers are apprised, I’m not generally a Summers fan, nor am I enamored by the extent to which he’s monetizing his criticism of public policy by way of paid speaking engagements for Bloomberg. However, to suggest he hasn’t, in fact, contributed meaningfully to this debate would be wholly disingenuous. The recalculated CPI series (shown above) is one such contribution.
This discussion — the post-pandemic inflation debate — is more robust for Summers’s participation. What began as a simplistic appraisal of the potential pitfalls of the Biden administration’s original fiscal stimulus package has morphed, over 18 months, into a fairly trenchant critique.
Summers gives short shrift to the supply factors which have been shown, mathematically, to be the main drivers of the pandemic inflation (figure below). In many respects that’s an unforgivable lapse, especially considering it’s no lapse at all — in my opinion, it’s intentional.
Still, it’s become mostly impossible to dismiss Summers. He was right, accidentally or not, and he’s willing to go on the record, week after week, with fresh predictions. That’s more than you can say for… well, for pretty much anyone vis-Ã -vis this debate.
Implicit (and in some cases explicit) in Summers’s criticism is the notion that policymakers, both monetary and fiscal, are reluctant to concede reality. I tend to agree with Summers on that point. I put off such concessions for as long as possible, not because I was inclined to policy largesse, but rather because I, like many of you, became accustomed to a macro conjuncture dominated by structural disinflationary factors which have proven mostly impervious to counteracting forces for a meaningful portion of my adult life. It’s not generally a good idea to assume you’re witnessing an epochal shift, even if recognizing such shifts ahead of time is the stuff investing legends are made of. Most of us won’t be legends. Show me someone who sees an epochal macro shift around every corner, and I’ll show you a charlatan peddling tabloids.
At some point, though, it’s incumbent upon all of us (policymakers included) to admit what’s obvious. As Summers (and others) have suggested, the Fed still won’t do that — not wholeheartedly, anyway.
During Sunday’s CBS interview, Dickerson asked Kashkari about last week’s employment cost index, which I called evidence that the Fed is losing control. “Losing control” is, unfortunately, a phrase that’s been stripped of meaning in the context of central banks thanks to years of overuse by the same sort of tabloids I alluded to above. When I used the phrase Friday, I meant it literally. Wages and salaries for private industry workers rose at a 5.7% 12-month rate during the second quarter (figure below).
Another three-month period like that and we’ll be staring at a 90-degree inflection — an almost perfectly vertical line.
The explanation for this is straightforward. Wages are chasing prices higher, and prices are then chasing wages as employers seek to pass along higher labor costs to consumers. As I’m fond of reminding readers, consumers are just laborers on their day off. Today, you’re buying groceries. When the worker who stocked the shelves at the grocery store has a day off, she’ll be buying something you contributed to making or consuming some service you provide.
Currently, everyone in that equation is asking for a raise because last week’s raises are manifesting in higher prices this week. It’s plain as day. Unless you’re Kashkari. “I mean, typically we think about wage-driven inflation, where wages grow quickly and then that leads to higher prices in a self-fulfilling spiral,” he told Dickerson. “That’s not yet happening. High prices and wages are now trying to catch up to those high prices [and] those high prices are being driven by supply chains and the war in Ukraine, among other factors.”
That’s a difference without a distinction, and it may not even be a difference in the first place if “other factors” means wages. Notwithstanding wildly exaggerated allegations of rampant, economy-wide “gouging,” companies don’t generally want to raise prices dramatically to consumers. Most companies aren’t monopolies and for most products and services, there are name brand alternatives. If I’m Nike, I’ll be at least a little bit careful before I decide to raise prices by 30%, because the choice for consumers isn’t binary — it’s not Nike or Payless. There’s Under Armour and Adidas and Reebok and New Balance and so on. I can’t just decide, “Screw these customers, I’m charging 30% more starting tomorrow.” If I do that, I risk market share. Plainly, companies want to protect margins because margins determine profits and shareholders like profits. But if your market share is de minimis, great margins don’t much matter. So, in the presence of higher costs for certain inputs, corporates will generally try to find some kind of happy medium that protects margins without risking market share with draconian price hikes to customers.
What companies can’t so easily do is protect margins without raising prices to consumers when all inputs are more expensive simultaneously. For labor-intensive industries, soaring wage growth is especially problematic. When Kashkari claims that supply chain frictions and higher raw materials costs are what’s behind rising wage demands and higher consumer prices (as opposed to wage demands and higher consumer prices being their own cause), he’s trying to break apart a Venn diagram. You can’t silo these issues. It’s a holistic view or it’s nothing.
Kashkari also addressed deeply negative inflation-adjusted wages, but there again, he seemed unable to conceptualize of the whole — incapable of connecting all the dots. “For most Americans, their wages are going up, but they’re not going up as fast as inflation, so most Americans, real wages, real incomes are going down,” he said. “That’s why families are finding it increasingly hard to make ends meet. When they go to the grocery store, when they buy necessities, they’re not able to buy as much because they’re getting a real wage cut, because inflation is growing so quickly.”
That’s obviously correct, but what’s missing is the admission that in such a scenario, the response function for workers is to push for higher wages. Too many Fed officials (where that may mean all Fed officials), seem to believe that the only way for a wage-price spiral to set in is for wage growth to exceed price growth such that workers are becoming relatively richer every month, leading to voracious demand for goods and services, above and beyond available supply. There was certainly some of that in play post-pandemic as stimulus checks and government transfers juiced demand against a supply-constrained economy, but what’s plainly happening in 2022 is this: Workers are getting poorer in real terms in a hurry, and that’s leading to high levels of job switching and constant upward pressure on wages, which is exacerbating an already onerous input cost burden for corporations, leading to an unprecedented gap between 12-month wage growth and YoY consumer price inflation, as the former chases, but never catches, the latter.
Second quarter earnings, and particularly commentary from Visa and Mastercard, suggested consumers are still willing to absorb price hikes. But they surely aren’t doing so happily. Nobody happily pays more for necessities. And when people unhappily pay more for everything they need, what are they likely to do about it? First they’ll complain at the dinner table, and then, after three or four tense family meals, one of the two adults at the table will say, “Well, if you’re that upset about it, why don’t you ask for a raise?” (“I drive a Dodge Stratus!”)
All of this is as maddeningly circular and self-referential as it is glaringly obvious. I don’t have any answers and neither does anyone else, apparently. This is why quandaries can’t be allowed to become chicken-egg problems. Once a quandary becomes a chicken-egg problem, there are no answers. There are only deus ex machina prayers and nebulous rhetoric.
“We know supply is low because of supply chains, because of the war in Ukraine, because of COVID. I hope we get some help on the supply side,” Kashkari told Dickerson Sunday. “So far, inflation continues to surprise us to the upside, wages continue to grow, the labor market is very, very strong, and that means whether we are technically in a recession or not, doesn’t change the fact that the Federal Reserve has its own work to do and we are committed to doing it.”
The solution is not in the hands of the fomc. They can raise rates even more, it won’t fix supply. What it will do is cause a very sharp economic recession/depression. The cure will be worse than the disease. But it’s even worse, the drug will make the patient sicker. When this happens I will be waiting for the gallery of Larry, Mohammed, and the rest to admit it. But I think I will be waiting for a long time.
Sure they’ll “admit” it. Because ultimately, what do they (and everyone else in the world) care about? Money and fame and headlines and recognition. Summers will be more than happy to cash a check from Bloomberg for going on TV and talking about a recession prompted by Fed tightening. El-Erian will be more than happy to write anything (even if it’s a mea culpa of some sort, which isn’t necessary right now, because he’s generally been proven right just like Summers) because that keeps his brand alive and as I’m sure you’ve noticed, his brand is highly lucrative. This is an entertainment business. Everybody is Jim Cramer.
Incidentally, I’m not suggesting El-Erian gets paid for any articles he writes or TV cameos he makes. He certainly doesn’t need the money. All I’m saying is that given the frequency with which he weighs in across mainstream financial media outlets, it’s reasonable to suggest he believes that keeping his personal “brand” (figuratively speaking) in the news has some utility. He’s a known quantity and being a known quantity is generally conducive to lucrative opportunities in life, however you define “lucrative.”
Remember that paid add that a bunch of luminaries took out in the NY Times telling Bernanke we were going to get massive inflation from his stimulus during and after the global financial crisis. I do, and I never remember seeing any kind of mea culpa from the group. Bernanke was right, and they were wrong. As I recall Summers was in the don’t spend too much back then- absolutely terrible advice and Obama paid for it- more importantly the voters paid and are still paying for it. Maybe I am overconfident, but as day is to night this kind of rapid monetary tightening is a gigantic gamble with the well being of our economy. If the Fed does not pause soon, we are probably going to witness a serious slowdown- and not what we have now- a long and severe recession. The reason is the economy is extremely leveraged and the rapid rate of tightening monetary policy will turn out to force a painful deleveraging. (System is fragile). Then the Summers, Dudleys and El Erian will move on to their next pontification. One thing Dudley is right about is the idea that it is extremely hard to have a soft landing now. What perplexes me is that he advocates a rapid increase in policy rates anyway. Lets just call it Monetary Hari Kari….I guess when you are a GS partner and then President of the NY Fed you are kind of removed from the consequences of your policy advice.
Yeah, my point is just that none of these people care because why would they? They’re all rich. Like, the truth is that people in advanced, developed economies who are fortunate enough to be in the top two income quintiles really don’t care about anything at the end of the day. They argue, debate, etc. from 9 to 5, and then that’s when it stops because what difference does it actually make if you have a nice family, an $800,000 home and you can just turn it all off at dinner time, safe and secure, and flip it back on the next day once you’re rested? What I try to drive home here in these pages on occasion is that for the vast, vast majority of humanity, that isn’t the case. Life is arduous (at best) and pure suffering (at worst) all day, every day, with the only respite coming from sleep. That’s what I mean here. Larry Summers, El-Erian, you, me, every anchor on CNBC, most people who read this site, Fed officials, economists, etc. — we can all just forget about this stuff at 5 PM if we want. It’s easy to forget that for the people we’re actually talking about when we have these debates (i.e., families trying to get by with two or three or four kids on a $70,000 annual income), there is no 5 PM. There’s just worry, worry, worry, sleep, wake up, and worry some more. And that’s in developed economies during peace time. Let’s not forget what life is like for a family in Yemen or Syria. I mean, this is all just such a silly charade. This isn’t real life. The vast majority of people on this planet are struggling to survive. And we’re, you know, debating the impact of last year’s fiscal stimulus on bond yields or something.
It does matter due to the affects on the average person. Inflation is pernicious- I don’t disagree. I part company with those that are advocating slamming on the brakes so quickly, since that will really hurt a lot of people- the kinds of folks you mention above. Obviously some sort of adjustment had to be made in rates- policy rates were clearly too low. But the Fed is caught up in a panicky move to hike rates. I found it extremely telling that Mester dissented for a 50 bp hike in the meeting before last. She is a well known hawk. But she stated something like 75 could be destabilizing and indicate panick on the FOMC’s part. Policy rates are a blunt tool- some rate increase was clearly justified, but it did not have to be radical. Many of the leading indicators point to landmines. Employment, due to supply constraints will be one of the last shoes to drop- but rest assured it will in the fullness of time if the FOMC continues this policy.
George dissented. Not Mester. Your point stands, but … I don’t know, I guess I just feel like Esther and Loretta want to be known as two different people. haha. https://heisenbergreport.com/2022/06/17/esther-george-calls-big-fed-hike-abrupt-unsettling/
Employment is generally a lagging indicator, at best it is coincident. By the time the fomc sees this rollover it will be too late. If they continue rapidly raising rates my over/under u5 unemployment rate is 6.0%.
H-Man, while it may be an entertainment business, it has a side effect of influencing what people will do with their money. It seems that everyone is seeking the financial Messiah to guide them to the proper investment structure – the elixir. So we resort to the roadshow of the digital world to give us that supreme guidance. Information, no matter how it is delivered, is powerful which does not mean it equates with knowledge or that it is accurate. Information is just that – information. How your process it and value it, is your call.
Meanwhile back to more mundane matters. If neutral is 2.5% because the presumed inflation rate is 2%, we can’t be neutral ala Ackman since inflation is +9%. Maybe we call that “future neutral” but not neutral today. Real neutral is closer to 9.6 assuming current inflation rate of 9.1, so it seems we have a ways to go. If that doesn’t make sense, why are we raising rates if we are at neutral right now?
Forgetting the neutral stuff, right now labor and OER inputs account for a ton of inflation. So according to future predictions of inflation, labor costs and OER are going to fall off a cliff by the end of the year. Really. So go long if you believe that or you go short or run to the sidelines if that seems like baloney.
The simple solution is more immigration, but outside of the most liberal districts, advocating for more immigration is political suicide.
Incidentally, the Dodge Stratus skit is one of my all time favorite SNL sketches. I remember watching it live with my girlfriend. The long moments of angry silence where you only hear cutlery on china… perfect.
I’m genuinely happy that at least one reader recognized that reference and got some joy out of it.
Prior to the pandemic, we went through three epochal shifts in the nature of the labor supply in the US, and its relation to the economy: The demise of private-sector unions, the wholesale addition of women to the labor force, and the off-shoring of manufacturing to low-labor-cost parts of the world (globalization). This happened in conjunction with the long bull market in bonds. We have all bemoaned the lack of wage growth (for 50 years) for much of the American labor force, which was a result of these major trends that changed the labor force. One could argue that these trends were just about played out by 2020. Yes, the pandemic and the subsequent war in Ukraine are the immediate causes of our disrupted economy, but we were primed for a disruption. This analysis is of absolutely no use in helping to predict where we go from here, or how best to set policy. But it should be clear to everybody that we shouldn’t be looking for a return to “normal,” if by “normal” we mean the economic regime of the past 50 years.
I think this is a very insightful comment.
You might find this article about shifts in the global supply chains interesting.
https://www.bloomberg.com/news/articles/2022-07-05/us-factory-boom-heats-up-as-ceos-yank-production-out-of-china
Thx. Good article. Foreshadowing what is to come.
An aside: If we’re going to start building huge new manufacturing facilities in Phoenix and other parts of the sun-baked desert Southwest, we need to do a much better job designing them so they don’t worsen our already alarming climate situation.
I agree, but, respectfully, you don’t seem to accept that what we do in the US can’t change the climate situation much when folks in the two largest populated countries with nearly 3 bil people are burning more and more coal every day. People in rural India are lucky to have 8-12 hours of electricity a day. The average GDP per capita there is around 2 grand a year, a month’s apartment rent here. India is looking to get carbon neutral maybe by 2070. Imagine what they will be doing til then. The US can’t fix the climate because a hundred other countries, including the two biggest ones, will do just about anything they can to catch up to the rest of us. Billions of people still live in the dirt with no secure water access, little food, and shelter that wouldn’t protect our garden tools. Even worse than factories in Phoenix is farming in Phoenix.
Rich and enjoyable discussion here. Lots of interesting comments and issues noted. Fun and informative to read.
My 2 cents: As always, there are multiple issues/challenges occurring in parallel as the Fed tap-dances in the face of inflation. I don’t know it for a fact but would venture to guess that, by and large, a large and significant proportion of workers on the lower levels of the economy who need it, and some of whom need it more desperately, are among the folks getting the raises.
The sad irony is it helps little in the face of 8-9% inflation. We can hope the Fed actions diminish the rate of inflation, but that remains to be seen in the months ahead. Federal and state statistics in the weeks and months ahead will tell the story of how it all washes.
I sincerely hope Biden follows through with his stated intention to hasten the return of manufacturing onshore, which may enable Americans to work in roles that enable greater value for the country and the economy in its workers. It cannot be accomplished quickly because of the scale of the problem. But whatever can be done at this stage can be a help.
The Chinese are another problem for another conversation. But they seem to be undermining and spoiling their own economy as we speak.
A couple of thoughts here. On-shoring seems patriotic and all, but our nominal wages are rising fast and making more products here won’t help inflation. And who will work for these new onshore suppliers? We can’t fill the jobs we already have. We block immigration so the companies that might have hired the immigrant workers will move more operations offshore. Deere just moved a big operation to Mexico. Others will follow. Whatever China or India or any other country does is their right. They will do what they want, just as we will do what we want. That’s sovereignty.