Elon Musk has a “super bad feeling” about the economy. JPMorgan’s Jaime Diamond forecasts an “economic hurricane.” Both claims are counterfactual. The economy’s super hot, inflation’s temporary, the Fed’s not slamming on the breaks and reversing QE, to the extent that happens, will surely be benign. Larry Kotlikoff is a Professor of Economics at Boston University and the founder and president of Economic Security Planning, Inc.
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My second cynical reaction: Maybe Musk has shorted the market? Nothing wrong with doing so. But when market-movers discuss the economy, they should disclose whether or not they have conflicts of interests. This goes for JPMorgan’s Jaime Diamond who just forecasted an “economic hurricane,” if not necessarily a level 5.
Cynicism aside, are Musk and Dimon right?
Not unless they and other big-time influencers panic the economy into recession.
Come again?
The economy can fail if everyone suddenly thinks that everyone else thinks the economy will fail. Thus, employer A will fire their workers, who are employer B’s customers, because A thinks B will fire B’s workers, who are A’s customers, and vice versa.
Economists call this multiple equilibrium. Anther terms is coordination failure. President Roosevelt summed it up brilliantly in eight words: The only fear to fear is fear itself. Unfortunately, explaining that everyone is panicking doesn’t stop panic, which can kill an otherwise very healthy the economy. Panic was surely the cause of the Great Recession.”none of the “culprits” the Federal Financial Crisis Commission fingered were guilty. Given that our economy can scare itself to death, Musk and Dimon should discuss the facts and vent their anxieties off-mic.
Here’s what’s going on. The economy is red hot. The unemployment rate is 3.6 percent. This is among the lowest rates we’ve seen in 70 years. Even better, the employed share of the working-age population is 80.0 percent. This is close to a 70-year high. Job growth slowed a bit in May. But job growth has to slow. There aren’t that many people left to hire. Meanwhile, companies aren’t seeing Dimon’s “hurricane Sandy.” They aren’t laying off workers. They are trying to hire another 11 million.
Yes, gas prices, adjusted for inflation, have risen 75 percent over the past six months. But they were 20 percent higher in 2012 and the economy didn’t collapse. Dimon says oil (and thus gas) prices could rise by 50 percent — to $175 per barrel. They could also drop by 50 percent. If Dimon’s “could” were “will,” a barrel of oil would already cost $175.
Dimon knows this, so presumably he was just saying that economic risk is high. No question. But the market has already discounted this fact, which is why it’s fallen 13 percent since January. But this doesn’t mean it will predictably continue to fall. As a matter of Finance 101, the price of a financial asset, be it a barrel of oil or the value of the S&P, isn’t predictable. And 13 percent is a modest adjustment. The market fell 86 percent in the Great Depression, 50 percent when the dot com bubble burst, and 53 percent in the Great Recession.
What about inflation? Based on May data, it ran at 5.0 percent over the last year. But that’s down substantially from the 8.3 percent rate recorded in April. And core inflation was just 3.8 percent over the past 12 months. Core inflation leaves out food and energy prices, which are particularly volatile. Everyone is talking about high grain prices. But the inflation-adjusted price of wheat is lower today than in most of the past 40 years. Here, again, if the market was sure the price of wheat was going to soar further due to Putin’s war, it would already have done so.
Based on nominal and real Treasury yields, the market estimates inflation over the next five years at less than 4 percent. The market makes huge mistakes, but it reflects millions of assessments, not just those of Musk and Dimon. And the consensus is that temporary supply-chain bottlenecks will continue to ease, bringing down inflation. Clearly, there are lots of oil producers around the world who can make up for any reduced supply of oil from Russia. Same for wheat. Ukraine is the eighth largest wheat producer. The top seven have plenty of additional capacity. Yes, the extra wheat will take time to grow, but its supply will rise and its price will fall.
What about the Fed’s rate hikes — another concern of Dimon. So far, the Fed’s actions have been cosmetic. Just look at short real rates. They’re still negative. The Fed’s recent 50 basis-point move is one fortieth of the rate hike Paul Volker engineered when he fought inflation back in the late 70’s.
The Fed’s not into dramatically raising rates, as Larry Summers appears to advocate, to reduce inflation — for good reason. It believes inflation will come down on its own — something we’re starting to see.
Finally, consider Dimon’s concern about the Fed’s reversing Quantitative Easing (QE). First, there’s no reason the Fed has to quickly alter its balance sheet. It can do so slowly as it collects interest and principal on its private asset holdings. And if it decides to accelerate the swap of private assets for Treasuries or reserves, there’s no reason this should impact bond prices or interest rates. It’s the threat of cutting off credit to the economy that leads to abrupt interest rate increases, not swapping one asset for another that’s very similar in nature. In this regard, it’s worth noting that when Paul Volker announced he was going to target monetary aggregates, the credit market instantly went nuts. It’s not clear that the Fed engaged in any open market operations that raised rates. It simply didn’t intervene to keep them stable. As for doing what he said he’d do, Volker missed each of his targets. Volker, as I see it, leveraged panic, not monetary policy, to raise rates, engineer a recession, and lower inflation. Jerome Powell is not Paul Volker. He sees current inflation as short-term price increases that will shortly be reversed. And the market thinks he’s right.