Albert Edwards: The Ice Age Is Finally Over

Albert Edwards: The Ice Age Is Finally Over

The US is likely headed into a proper recession, but according to one erstwhile deflationist, the “secular theme of lower lows and lower highs in Fed Funds and bond yields has been broken in this cycle.”

That, you’ll immediately note, sounds like a recipe for stagflation.

According to SocGen’s Albert Edwards, an oncoming downturn in the US will “bring temporary cyclical relief to the secular tightening cycle,” as the combination of recession and an energy-driven decline in headline inflation gives the Fed plausible deniability to cut rates despite stubborn core inflation, which he said could remain “well above target.”

In the US, corporates, still shellshocked by the acute labor shortage that defined the post-pandemic macro environment, will hoard workers headed into the recession, which means that although consumption will “hold up better” during the downturn, profits will “strain and collapse as labor becomes more of a fixed cost.”

Earlier this week, Walmart CEO Doug McMillon told CNBC that in his view, “wage inflation is going to be with us forever,” and because “pricing has to be adjusted to reflect” that reality, “there’s some level of inflation that’s going to be with us basically forever” as well.

Edwards said this is “key” to the depth of any coming downturn. Recessions, he wrote, are typically the result of large oscillations in the business investment cycle “as companies react to both falling profits and margins.”

Usually, business investment (so, fixed investment and inventories) chips in 1-2 percentage points to annual GDP growth. In recessions, though, declining business investment drags the economy into the abyss. “Where the dotted line falls to or below zero, the red line totally overlays it,” Edwards wrote Thursday, referencing the figure on the left (below). “In an accounting sense the recession is entirely ‘caused’ by business investment.”

SocGen

He went on to say that America’s inventory problem (underlined again this week by retailers reporting Q2 results, with Target as the poster child) is the next shoe to drop.

Although Q2 earnings season was generally better than expected in the US, energy did quite a bit of the heavy lifting. Edwards cited colleague Andrew Lapthorne in noting that excluding energy, profit growth is perilously close to turning negative.

That’s the recession thesis. The short version anyway. But notwithstanding the downturn and any associated decline in yields and policy rates, Edwards said the “Ice Age” (his long-running macro framework) is at an end. He mentioned remarks from Bridgewater CIO Bob Prince.

“I agree with Prince that we have now entered a multi-year tightening cycle,” Edwards said, before noting that in his view, “we are set for a very lengthy secular rise in rates and that despite a collapse in headline inflation in the coming recession, core inflation will likely rise through many cycles rather than be tamed.” It won’t be one tightening cycle “and done,” Albert said. “There is much more to come.”

In “Transitioning to Stagflation,” Prince wrote that “As central banks pursue their dual mandate of maximum employment and stable prices, they will not be able to achieve both at the same time and will be forced to choose between too-low growth in order to achieve their desired inflation rate, or too-high inflation in order to achieve their desired employment conditions.”

That, Prince suggested, will result in erratic policy (he didn’t use the word “erratic.”) “In managing through this, we see them toggling back and forth in their prioritization, trying to avoid both an unacceptably deep economic contraction and an unacceptably high inflation rate, culminating in a long period of too-high inflation and too-low growth,” he said.

In other words: Stagflation.


6 thoughts on “Albert Edwards: The Ice Age Is Finally Over

  1. Walt – Thank you for your work here on the Heisenberg Report, which consistently proves itself to be a practical resource to guys like me.

    My days necessarily focus on the tasks of my job and responsibilities at home. Investment is an indulgence, an aside, enabled by greater than average income, though mine is not at all extraordinary. My background in finance and investment is limited to practical experience (long-ago losses from bad decisions that imposed painful, necessary learning), from which I have definitely benefited.

    Your writing provides clear, beneficial value to guys like me. My experience of economic cycles and downturns is not unlike the business of prairie dogs, which must prepare for the inevitable rains by making tunnels deep enough and mounds high enough to withstand flooding that may drown their babies. Your neat and accurate delivery of financial and investment perspective informs and shapes my ongoing understanding and learning, helping me to navigate the economic landscape and take the measure current risks.

    I imagine that what I’m saying here is nothing new, and you know well the audience that you serve. But I want to thank you directly for this practical and useful service, and your engagement with us in this community. Your work here is meaningful, and it has an impact.

    I like to write, as you may have noticed. I do it for a living. My work, which is technical, requires intellectual engagement at a minimum. But for me, engagement is the jazz of it. Guess I’m a bit of a writer-geek. But I enjoy being useful and engaged.

    You had mentioned at some point how much you enjoy doing this, and I believe it. You are mighty and prolific. Good show!

  2. A multi-year tightening cycle is a very scary proposition for the global economy. I’m not saying I don’t agree with the proposition, in fact, I whole heartily believe it is a necessary evil. I just wish we had been able to recognize the perils of continuous stimulus induced growth before it got us to this unsavory point

  3. I don’t see this happening at all.

    US corporations will keep business investment going as they make subtle shifts in their supply chains with the goal of reducing their current risk from solely relying on China. Costs may go up, but the US might see the tides turn with regard to the middle class- which could actually grow, as a result. A price worth paying.
    Hybrid and electric vehicles will continue to reduce demand for oil and at some point, we will have SMR’s in place- this is a game changer for humanity, which will provide the energy needed for global growth. If the US can figure out how to provide clean energy and water to the third world population (the majority of the population), consumption will explode.
    The US holds the Ace of Spades in the game of growing GDP/taking an even bigger percentage of global wealth-“intelligent immigration”. We also need universal and portable healthcare- as most other developed countries already have and revamp our public education system – everything from what students actually learn (RRR + logic) to who goes to college and how borrowing to go to college works. This is all solvable with different politicians in place.
    Where else would one invest? The US still looks great to me.

  4. I do not believe we’re looking at a multi-year tightening cycle. I do believe we may well experience ongoing, refined, small adjustments by the Fed in the new year. That’s my opinion. But we’re in a unique economic kerfuffle. It differs from past downturns, and it’s more complicated. We will not have a clearer view of how it plays out for a while.

    In parallel, the United States of America has larger challenges for the longer term. While we recently passed the Chips Act, it will take time to yield the desired results of improving US chip-making and its associated infrastructure. In recent years we have been far too slow to act in regard to chip manufacturing. Forty-five, moored in blissful ignorance, and in awe of the power he held as the most powerful man in the world, sought to show off rather than do anything constructive, beyond cutting the taxes of the wealthiest Americans, and providing token cuts to everyone else.

    In the midst of our fascination with political idiots, our attention fails to focus on genuine needs for our country. The discord in American politics has been the most destructive distraction I can recall in my lifetime, beyond the Vietnam War. While we all ogled in rapt fascination the Trump show in the White House (and beyond) for six years, China has been playing its investment cards well in the semiconductor manufacturing space. They have shown us how to play the long game.

    A piece from a few weeks ago in the New York Times (July 28th – https://www.nytimes.com/2022/07/28/us/politics/us-china-semiconductors.html) tells the story in greater detail. China has apparently “leapfrogged ahead in its effort to manufacture a semiconductor whose circuits are of such tiny dimensions — about 10,000 times thinner than a human hair — that they rival those made in Taiwan, which supplies both China and the West.”

    Whether they have actually leapfrogged the US in chips may be a stretch. But their activities during recent years to enable chip-building infrastructure, and the huge levels of investment they’ve committed to it must be a cause for great concern.

    Our political leaders must ensure that our actions in regard to chip manufacturing are successful and serve their expected purpose. Today, the US and other western chip-making companies need to be enabled to achieve parity with TSMC, the most noteworthy producer of chips in the world.

    US politicians must fully exercise their rhetoric to encourage American competitiveness. We cannot take it for granted.

    1. Outside of oil, a huge portion of the US right has fought against any government intervention to support a specific industry. When China looked to take over the solar panel business, cries for help from US producers was countered with “We don’t pick winners!” followed by “Don’t you remember Solyndra?” Look at the result.

      Essential items such as chips and rare earth minerals faced the same wall of opposition, until recently.

    2. Thanks Derek. Good comment. I like your mention of oil, which helped to form for our modern economy, and has impacted our politics ever since. Having a set place at the table, big oil naturally tends to want to elbow the competition at the feeding trough when budgets are made. Understandably, they do not abide well with the idea of being shoved aside by a new form of energy. But the truth is that no other forms of energy today, or combination thereof has evolved sufficiently to enable bypassing oil.

      Now, though we have known all along that we eventually need to set aside oil, we are quickly arriving at the point where we must consider alternative energy sources. Unfortunately, we are not far from Square 1. Not only must we understand how to innovate and develop non-polluting energy sources. We also must understand how to sort out the candidate energy sources and develop the infrastructure for integrating them and making them available. This definitely will be a problem.

      As for the Chinese, it’s okay if they can make solar cells more cheaply. I am anxious for real innovations on a broader scale, like hydrogen, fusion, nuclear, and innovations in battery technology that may make a difference. But none of these are ready for prime time.

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