During the second quarter, we discussed a pivot. A pivot from where the economy was to where the economy is. We refer to this as “The Ailment & The Cure.” We know what the ailment is. The ailment is inflation and inflation is a nasty thing. Why is it a nasty thing? Because the prices are going up and your wages may not. We may not be able to afford the same standard of living as we once had.
As inflation continues to increase, it becomes more painful. This is particularly painful for the bottom half of the economic spectrum, where most of the money is actually earned and spent. The economy is really driven, not by the top 10%, 20%, 30%, but it’s really driven by the majority of us. It is the majority of us that will be hurt by inflation. That is the ailment.
How did we get here? Even before COVID, the economy was actually slowing. The economy was slowing down to 1.8% of real GDP (Gross Domestic Product) inflation adjusted. That means that is the total services and goods in the society produced by the United States. That’s very low. Then COVID hits and the economy closed down all commerce, so the GDP went down even more.
Then the government dumped in all this money, COVID stimulus payments, in an attempt to revive the economy and put a safety net in place. Since then, COVID diminished over time with the introduction of the vaccine and the roll of COVID minimized. Today, people are living with it a lot less severely than 2020. So, there is all this money from the stimulus and people are ready to go spend it with the economy re-opening.
At the same time, we have a supply chain issue that is also COVID-driven:
- There are not enough truck drivers
- There are not enough ships
- There are not enough harbors open
This created a bottleneck of everyone spending extra money and not able to get the goods they have purchased. Classic situation, increased demand, lower supply, guess what? The price of whatever you need goes up.
So, inflation came around and is staying with us. But we are changing to service as the economy opens. Service is having its own challenge as there are more job openings than people willing to fill:
- Some people don’t want to fill it
- Some people may not have the skills to fill it
- Some people who used to fill it have moved on to other jobs
Inflation is going to be with us on those fronts for a little bit because it takes time to get back to normal, whatever normal means.
The other problem is that the world is going through an energy transition. From what we call carbon-based: petroleum oil, gas, coal to new green energy: EVs, electric vehicles, hydrogen, solar, wind. Green energy received large investments but not a lot of money was reinvested in the carbon-based technology to get a new refinery or what have you. We have abandoned the old infrastructure and spent all the money on the new infrastructure.
The problem is in the handoff, or the lack thereof. We have a supply shock on the carbon-based production side because we’re not producing as much, but on the other side, we are creating green tech but not enough and not fast enough. Thus, we are going to have an energy transition without equilibrium and prices will remain high.
Then we add Russia to the equation. That continued to exacerbate the supply chain. Now included with increased energy prices, is increased food prices. Russia and Ukraine are big food producers, often referred to as the food basket of Europe, contributing to global food sources.
What we anticipate going forward is more inflation, may not be increasing inflation, but sustained higher inflation for much longer.
What is the cure? The cure is less, reduced demand. How do we do that? The federal reserve and the central banks of the world can do is tighten financial condition. What does that entail? Increasing interest rates, making borrowing cost more, so we won’t go and buy as much. We are going to dampen the economic enthusiasm, thus dampening the demand, thus dampening growth, thus possibly recession.
The cure is going to get us to a place that we don’t like. It’s a different place, but if we don’t have a cure, we’re at a place we don’t like because we can’t afford anything that we want. So, therein lies this ailment and the cure, they all have problems. The question is which set of problems do we want?
The final analysis:
It’s probably better if we have an economic slowdown, get price under control, and then recover. That is a much healthier way to do it. How long is the recession and how deep is the recession? The common wisdom right now tells us it’s a shallow and short recession; however, our position is that it’s going to be longer and deeper.
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