Immaculate Disinflation?

A Soft Landing Indeed!” – Cassandra

TLR recently described the reasons why America may be in the midst of a soft economic landing, acknowledging Cassandra’s February 18th prediction that America’s economy would prove more resilient than doomsayers had forecast. In response, Cassandra wrote TLR the following letter presenting a thought-provoking supplemental analysis.

“Dear Mr. Realist:

I read with interest your recent economic analysis in “A Soft Landing?”. You reference our interview of June 4, 2022 in which I reiterated my earlier observation that Jay Powell and America’s Federal Reserve had proven themselves the most capable of economic managers. I noted that the Fed’s creative policy execution had avoided depression following the Global Financial Crisis of 2008-09 and that the Fed has successfully navigated the world economy that now has recorded a 13-year period of consistent growth. These were extraordinary accomplishments that few thought possible. The Fed repeated that feat in 2020, preventing economic calamity during the COVID pandemic. The Fed has utilized a flexible set of financial tools, tested them out, and honed them to a fine point. I noted that the Fed continues to be in the optimal position to once again fine-tune America’s economy and achieve a soft landing … and that’s precisely what it is doing.

In our more recent February 18th conversation, I emphasized the extent to which supply chain problems had been easing, commodity prices had been declining, global energy prices had been falling, global food prices had been declining, inflation expectations had been easing, and wage growth had been decelerating. These non-transitory downward trends in inflationary pressures all resulted from Fed actions. Most of these downward trends will persist. Wage growth, however, will continue to outstrip inflation.

The Fed is charged with maintaining economic growth by ensuring stable prices and maximal employment. Two factors drive growth: the relative size of a country’s workforce – that is, its demography –, and the productivity of its workforce. Despite a slowing birthrate and restrictions on immigration, America’s demographic profile is the developed world’s most robust. Of equal significance is America’s contest with China – that is, the backlash resulting from decades of globalization as outsourcing is replaced by local production and just-in-time international delivery is replaced by localized sourcing. The fact is that deglobalization is accelerating America’s manufacturing capabilities and, consequently, America’s productivity growth.

You have highlighted Cycle Theory, Mr. Realist, where boom and bust cycles alternate. Globalization and deglobalization are two additional sides of the economic cycle, and the current round of deglobalization is ushering in an American manufacturing renaissance, a reality few have recognized. The CHIPS Act, for example, is providing funding and incentives for semiconductor production and the Inflation Reduction Act is providing Federal subsidies for green energy production. Their effects already have triggered a surge in construction – and in construction jobs – that, in turn, will create further jobs in manufacturing and services. Coupled with the surge in labor-saving technologies – of which AI is the most notable –, fewer worker hours will be needed to produce the same output. That means that America will see improving productivity and slower workforce growth with rising demand for workers. Although wage inflation is slowing, wage growth hereafter will exceed the rate of inflation …, which is a very good thing. America is a better place when people’s incomes rise faster than inflation. While the last 30 years have seen inflation outstripping wage growth, the next number of years will see worker earnings exceeding inflation, which will translate into a higher standard of living for a majority of Americans. The period of rising absolute returns on capital will be replaced by a period of rising absolute returns for labor.

There is little doubt that the trend in inflation is downward. Easing supply chain pressures, commodity price declines, stable energy and housing prices, declining food prices, and lower consumer prices and inflation expectations will persist. When combined with increasing wage expectations, the result will be Immaculate Disinflation. [ED NOTE: Paul Krugman coined the term “immaculate disinflation” to mean disinflation without an increase in unemployment.] Inflation will slowly, though jaggedly, decrease with little collateral damage …, and despite the fact that the Fed will hike interest rates by 0.25% on July 26th. The Fed will suspend interest rate increases after this month and embrace a wait-and-see approach. The Fed nevertheless is committed to monetary hawkishness and will remain a hawk until it sees negative growth. Before renewing Quantitative Easing, it will ensure that inflation is under control and wage earnings are outstripping cost-of-living increases. This will restore a balance between return-on-capital and the value-of-labor.

In short, Mr. Realist, the Fed’s ongoing actions will ensure that inflation indeed proves itself to have been transitory and that recessionary fears are overblown. America experienced its recession in 2022 (primarily in H1 and on a rolling profits basis thereafter). That indeed was “immaculate.” With the strong tailwind of Federal subsidies and spending, the Fed has all the tools it needs to continue successfully managing America’s economy.”

[ED NOTE: The opinions expressed by Cassandra in today’s TLR are not investment advice and should not be treated as reflecting the views of The Lonely Realist.]

TLR Index

An index of TLR titles can be found here.

Finally (from a good friend)

No Comments

Post A Comment