America’s Economic Future

America can’t be experiencing inflation, stagflation, recession, deflation and modest growth all at the same time. Which will predominate depends on who you ask.” – The Lonely Realist

TLR last discussed the economy with Cassandra in early June 2021 when she predicted that inflation would spiral and that the Federal Reserve thereafter would bring it under control. Although we have yet to see whether the latter part of her prediction will be proven correct – she is sticking with it –, the predictions she made in September 2020 were spot-on.

A few weeks after Cassandra made her June predictions, TLR received a rebuttal from The Delphic Oracle, who foresaw cascading inflation that would lead to Dollar debasement and economic turmoil. The Oracle concluded that America would be faced with a weakening stock market in 2022 but that, ultimately, a high rate of inflation coupled with America’s remarkably resilient economy would allow it to repay its enormous debt with deflated Dollars and, after a difficult period, emerge economically stronger.

What do Cassandra and The Oracle now think? TLR decided to find out, cautioning (as TLR has in the past) that the contents of The Lonely Realist, including (and most especially) the opinions expressed by Cassandra and The Delphic Oracle, should never, ever be treated as investment, legal or tax advice.

Realist:                 Good morning Cassandra … and good morning Oracle. It’s been a full year since we last spoke and much has transpired. TLR’s readers are wondering whether the events of this past year have altered your thinking. Global events, particularly in China and Ukraine, have led telegenic analysts and media-finfluencers to reboot their previously-forecasted economic predictions. Their views have waffled … and their opinions – as well as those of some of the most reputable economists – today range from stagflation to raging inflation to deep recession to deflation to everything in between. Each of you has a history of predicting the future with a degree of exactitude that far exceeds modern pundits. What Americans long for today is someone who can point them in the right direction. I’m confident that you are the visionaries who can do that. Let’s begin today with where you see America’s economy at year-end 2022. Oracle – what do you think?

The Oracle:         Thank you, Mr. Realist. The sad fact is that a recession already has begun. Don’t look so surprised! The task of labeling an economic downturn in America falls on the National Bureau of Economic Research’s Business Cycle Dating Committee. Because it’s rarely apparent that a recession has begun until well past the top of a business cycle, the NBEC doesn’t call recessions quickly. 2022 will be no exception. Q2 is likely to see further GDP weakness (following Q1’s negative growth of -1.4%). The economy will weaken measurably after Summer begins. That’s when the stock market again will take notice … and crack … and investors will regret not having sold in May and, as they say, gone away. The trends are clear, Mr. Realist. Inflationary forces are waxing in a self-reinforcing wage-price spiral. By year-end, America will be suffering from an inflation rate well above 8.5% and will have just experienced two successive quarters of negative growth. At least one more quarter of negative growth and high inflation await in 2023. But, as I explained last year, on a long-term basis that will be good for America’s financial health because it will allow the country to satisfy its currently unrepayable debt.

Realist:                 Despite the long-term caveat, Oracle, that is quite a discouraging forecast! Cassandra – you are shaking your head. I gather you disagree with The Oracle.

Cassandra:          Yes, in almost every way. In addition to assuming that current trends necessarily will persist, the Oracle places no weight on the abilities of Jay Powell and America’s Federal Reserve. They have proven themselves most capable economic generals. The Fed’s creative policies avoided depression following the Global Financial Crisis and the Fed thereafter successfully navigated the world economy to a 12-year period of consistent growth. Those are extraordinary accomplishments that few thought possible in 2009. And it did so again in 2020, avoiding economic calamity during the global COVID pandemic. The Fed has utilized a flexible set of financial tools, tested them out, and honed them to a fine point. It now is in the optimal position to once again fine-tune America’s economy and achieve a soft landing … and that’s exactly what it will do. By year-end, America’s economy will be experiencing fading inflation – less than 5% – and the same modest GDP growth it experienced over the teen decade – ~2%.

Realist:                 Yours is one of the more optimistic forecasts I’ve heard, Cassandra. Could you explain the bases for your optimism?

Cassandra:         Of course. Many have criticized the Fed’s wanton quantitative easing(QE) and now criticize its quantitative tightening (QT) plan. Both criticisms are misplaced. Under QT, the Fed will be running down its $8.9 trillion bond portfolio, initially at the rate of $47.5 billion/month for June, July and August (with more (or less) to come thereafter), and raising interest rates in half-point increments. Those are hefty, unprecedented numbers. They will measurably impact the economy … and they will do so roughly as the Fed has planned. Remember that the Fed receives and analyzes more economic data than anyone else on Earth. It has the advanced technology and more than 400 PhDs to do so. Some believe that the Fed’s tightening plan will be too little and too late. The Fed’s track record proves otherwise. Moreover, the Fed can easily adjust its QT, or revert to further QE, to fit economic needs. Consumers already have begun to reduce their purchases and have increased their credit card debt. The economic slowdown is going according to the Fed’s plan and the way Fed Governors provide a little hint here and another there has proven to be an effective method for nudging the markets’ and businesses’ expectations and actions. QT plus higher interest rates are just what the economy needs to check inflation without strangling economic growth. By early Fall, just in time for election season, the Fed will be able to relax its tightening and allow the economy to bob back to a slow and steady growth path.

Realist:                 You put a great deal of trust in the Fed, Cassandra. The Oracle does not. Oracle, what facts are you relying on in reaching the conclusion that the country is headed towards, well, what? Would that be a period of potent stagflation?

The Oracle:          Precisely, Mr. Realist, and the explanation is simple. Although historically I found my inspiration in vapors – which apparently is what most pundits now do – , I take a technician’s approach by relying on data. Everywhere one looks essentials, including labor, are in short supply. That will not easily or quickly change. The economic realities cannot be wished away by America’s Federal Reserve. The squeeze on supply is not due solely to supply chain constraints. It’s also not a temporary phenomenon caused by the latest COVID wave. It’s a pervasive trend. For example, it’s not only about agricultural goods but the fertilizers to grow them. These are global problems that take years to reverse. It’s also about raw materials shortages that are exacerbated by the shortage of capital, labor and energy to produce them … and by the will to do so. Oil and gas are prime examples of the problem, and a confounding factor is that they also are being constrained by green policy and the Ukraine War. These fundamental supply problems will not be solved in 2022. Or in 2023. In addition, China has been pursuing a zero-COVID policy that creates periodic shutdowns. The result is a slowing economy, the second largest in the world. China will continue to slow and continue to shelter itself against foreign connections as a defense against Russia-like sanctions. That will negatively impact global trade and global GDP. The reality is that the problem is not about any single thing. It’s about everything. It includes irreversible trends, a global pandemic that isn’t about to disappear, manufacturing nationalism, and macroeconomic realities. And labor markets are following the same path. There’s a pervasive shortage of skilled workers. Wages are reflective of a decline in available labor because workforces are in permanent decline. It indeed is true that “demographics is destiny.”  Businesses recognize this and are drawing in their horns. There currently are 11.4 million unfiled jobs nationwide. Although many businesses continue to look in vain for workers, others have stopped trying. The latest CNBC Small Business Survey found that 80% of small business owners expect a recession in 2022 and are managing their businesses accordingly. This will create ripple effects. Not to be even more of an alarmist, but Jamie Dimon said he is expecting “a hurricane“!

Realist (smiling):       If nothing else, the one clear conclusion that can be drawn from your statements this morning, Oracle, is that you have become a proverbial Cassandra! The second take-away from your and Cassandra’s highly-contrasted predictions is that since the two of you, blessed with gods-given powers, cannot agree on the direction this complex world will be taking, mere mortal pundits who attempt to predict our future certainly cannot do so. Since both of you cannot be right, however, readers of TLR will have to wait and see what the future actually brings. I trust that we will catch-up later this year to determine which, if either, of your predictions has come to pass.

Many thanks to each of you for expressing yourselves so forcefully. TLR looks forward to future discussions.

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