As I explained last week, President Trump was entirely correct back in the spring when he predicted a V-shaped recovery for the U.S. economy. I also noted that we now have more evidence that the stimulus checks and unemployment bonuses blew out far more cash in the economy than was necessary under the artificial economic shutdown.
Now, though, it is time to issue another inflation warning. There are two mechanisms at work fueling the inflation fire. Both are caused by Congressional overspending, therefore both can be turned off with swift, responsible action by Congress.
If Congress doesn’t act, we are in for a rough ride in 2021.
In my second article on the V-shaped recovery I explained that this cash blowout
reinforces my previously expressed inflation concerns. We could be looking at a food-based surge in prices, which in turn could spread throughout the economy. It has been suggested that the artificial economic shutdown, with its disruptive effects on some supply chains, can be the origin of inflation. This is true only in theory: if we were to have permanent supply disruptions, such as in a centrally planned economy, there would be upward pressure on prices. At the same time, a centrally planned economy does not allow for market prices in the first place, so there is de facto no inflation there. Furthermore, the disruptive effects of the artificial economic shutdown in Q2 were almost entirely gone in Q3, suggesting that the rise in farmers’ earnings could be a sign of monetarily driven food-price inflation (transmitted by the aforementioned sharp rise in entitlement spending). Again, I am not suggesting that we are witnessing monetarily driven inflation. However, I see enough hints that it could be underway to suggest that the next Congress will have to make de-monetization of the economy its highest domestic-policy priority.
A closer look at the national-accounts data for the third quarter add more fuel to the inflation worries. My previous review was of annualized, seasonally adjusted numbers, which are good for analyzing long-term trends in the economy. However, they are not good for closer examination of short-term swings, especially when it comes to such extreme economic episodes as this year’s artificial economic shutdown.
For that purpose, the Bureau of Economic Analysis offers NIPA Tables 8.1.5 and 8.1.6, with quarterly GDP numbers that are not seasonally adjusted. These figures are as raw as they come, giving us one of the best street-level pictures of what is happening out there in the American economy (only surpassed by employment numbers from the Bureau of Labor Statistics).
Using these tables, we can see in closer detail what the V-shaped recovery actually looks like. We also get a not-so-happy picture of inflation numbers, one that we will return to in a moment. First, the recovery itself.
In current prices, third-quarter GDP was $5,318.3 billion. This is total spending in the economy in the three months July, August and September. It was a solid rebound from the $4,901.8 billion in Q2, but even more noteworthy is that it exceeded Q1 GDP by almost $73 billion. That may not seem to be much of a number to write home about – and it could change when the adjusted numbers are released in a few weeks – but it does show that the recovery is strong and our economy is resilient.
As I noticed in my first article on the recovery, we saw a strong come-back for American businesses. Capital formation – investments – rose sharply. In current prices,
- Equipment purchases increased 12 percent from Q2 to Q3 and are only eight billion dollars away from where they were in Q3 of 2019;
- Residential investments – home construction – increased by 16 percent from Q2 to Q3 and were 11.6 percent over their level from Q3 of 2019.
It is also important to note that businesses were back to increasing their inventories. In Q2 they reduced their inventories by more than $88 billion, the largest quarterly inventory decline on record. In Q3, they were back to increasing them again.
Changes in inventories are important. An expansion in inventories during a surge in economic activity is a sign of economic optimism. By contrast, inventory depletion in economic downturns (as we saw in 2009 during the Great Recession) is a way for businesses to liquidate future sales and stem losses.
The artificial economic shutdown was to some degree different. Many businesses were forced by government to cease operations. Albeit temporarily, they nevertheless had limited ability to respond to the demand they had from buyers. Depleting inventories was a way to bridge the shutdown gap.
By doing this, they could essentially keep supply flowing. To again dispel the suggestion that supply disruptions have caused inflation, Table 1 shows that inventory depletion actually correlates with a decline in prices. In short: thanks to inventories there were no significant supply disruptions in the U.S. economy in Q2. Using the two aforementioned tables from the BEA, we can get an inflation estimate for the second and third quarters and see where the inflation pressure is emerging. The “Q to Q” columns report price changes from, respectively, Q1 to Q2 and Q2 to Q3. The “Y to Y” columns report the same numbers for a full year, i.e., from Q2 and Q3 2019 to Q2 and Q3 2020. The picture is quite telling:
Table 1: Inflation estimates
Starting with the quarter-to-quarter numbers, there was an almost universal decline in prices from Q1 to Q2. The decline in prices on consumer goods – which covers everything from groceries to automobiles – of almost a full percent contrasts sharply to the 1.28-percent increase during Q3. Since Q3 was the quarter when the economy opened up, we can conclude that this increase is related to the cash blowout in the economy – and to access to cheap credit.
The low cost of credit is noteworthy. It is a spin-off effect of the massive monetary printing that the Federal Reserve has engaged in for almost a year now. In other words, this money injects inflation into the economy through at least two venues: monetized deficit spending in the form of the stimulus cash blowout; and cheap consumer credit.
We see the price push even more clearly if we disaggregate consumer goods spending into so-called durables and perishables. The former are goods that last for more than one economic period, such as lawn mowers, computers and furniture. Here, prices increased by 2.31 percent in one quarter.
Looking at the year-to-year numbers, the rise in prices of consumer durables in Q3 was enough to wipe out the decline that took place in Q2.
There is another interesting source of inflation, one that will probably be even more important going forward. Prices on consumer services essentially stood still in Q2 and increased by less than one percent in Q3. However, the year-to-year numbers tell us that prices are rising by as much as 1.76 percent here.
Access to cheap consumer credit is less of a driving factor here. More than likely, what we are seeing here is instead a price effect from the labor market: thanks to the unemployment bonus that Congress created in the spring, when the economy opened back up again it was more profitable for people with low-to-moderate income to stay at home than to go back to work. In response, employers have had to significantly raise wages.
I predicted this a bit over a month ago. The numbers we see here are a reflection of how this cost-push inflation is now working its way into consumer prices.
This means, bluntly, that we have two different inflation forces at work: one monetary and one from cost increases. Interestingly, both originate with government. The monetary inflation originates with exorbitant Congressional overspending on stimulus bills; the cost-push inflation originates with exorbitant Congressional overspending on unemployment bonuses.
As of today, inflation is not an imminent threat to the U.S. economy. However, I maintain my warning of more inflation to come: with two sources of inflation at work we will very likely see higher rates in 2021. The only way to quell the drive in prices is for Congress to end its highly irresponsible spending spree.
Again: Never Bark at the Big Dog. The Big Dog Is Always Right.
There are some very important numbers on personal income in the data that the Bureau of Economic Analysis (BEA) released yesterday. These numbers confirm two points I made weeks ago:
- The crazy stimulus checks that Congress doled out in the spring and the summer were highly unnecessary. A compensation for forcefully lost income was perfectly reasonable, but not this cash bonanza.
- People respond to windfall income just as economic theory suggests. Therefore, we do not need crazy economic adventures like Steve Moore’s proposal to suspend the federal personal income tax for 2021 (only to return it to full force in 2022). It would do a lot of harm to, and not much good for the economy.
Before we get back to the see-I-told-you-so part of this article, here are the numbers on personal income for the third quarter this year. Saving the bad news for later, the good news is that work-based earnings are almost back to normal. In Q3, calculated at annualized rates, wages and salaries earned by American workers were only 0.3 percent below where they were in Q3 of 2019. They were only 2.5 percent below their Q1 2020 levels.*
The big concern is with transfer income, or entitlements. Or the extra money that Congress threw after households under the guise of its stimulus bills. If we look at the so-called “other” category under entitlements, we find an increase, in quarterly numbers, of $330 billion from Q1 to Q2 this year. During the same period of time households lost $170 billion worth of wages and salaries (again in quarterly numbers). If we assume – as is reasonable – that the $330 billion represent stimulus checks, then households got $194 from government for every $100 they lost because they could not work.
To add yet more perspective to this, the total increase in payouts of unemployment benefits vastly exceeded the loss of work-based income. In Q2, Americans received $260 billion more in unemployment benefits than they did in Q1. That increase is 52 percent larger than the $170 billion loss in wages and salaries.
All in all, the increase in tax-paid (or deficit-paid) transfers from government to households was 3.4 times higher than the wage-and-salary loss.
Absurdly, this enormous extra cash flow to U.S. households contributed to a 7.6-percent rise in personal income during the shutdown. Now that these payments are tapering off, it looks like personal income is in decline!
It is not, of course. As of Q3, total personal income is 6.8 percent higher than a year earlier and 4.8 percent above where it was in Q1 of this year. That, again, is almost entirely due to stimulus checks (some of which went out in the third quarter) and the absurd unemployment bonus. However, there has also been an uptick in equity-based income, primarily in the proprietor category. Farm-based income, which belongs under this headline, is up 7.3 percent in Q3 2020 over Q3 2019, and 12.1 percent over Q1 this year.
This income boost, which comes on the heels of a noticeable decline in Q2, reinforces my previously expressed inflation concerns. We could be looking at a food-based surge in prices, which in turn could spread throughout the economy.
It has been suggested that the artificial economic shutdown, with its disruptive effects on some supply chains, can be the origin of inflation. This is true only in theory: if we were to have permanent supply disruptions, such as in a centrally planned economy, there would be upward pressure on prices. At the same time, a centrally planned economy does not allow for market prices in the first place, so there is de facto no inflation there. Furthermore, the disruptive effects of the artificial economic shutdown in Q2 were almost entirely gone in Q3, suggesting that the rise in farmers’ earnings could be a sign of monetarily driven food-price inflation (transmitted by the aforementioned sharp rise in entitlement spending).
Again, I am not suggesting that we are witnessing monetarily driven inflation. However, I see enough hints that it could be underway to suggest that the next Congress will have to make de-monetization of the economy its highest domestic-policy priority.
Finally, it is time to get back to my gloating about where I have been right… In both my previous blog articles and my InsideSources piece on a federal tax holiday, I have referred to what economic theory says about windfall income: it goes toward savings. The stimulus spending we now have on record is a great experiment of precisely that kind. It helicoptered money into the economy, far more than was needed to cover paycheck losses, and people responded precisely as theory says:
–In Q2 of 2019 households saved 7.2 percent of their disposable income;
–In Q2 of 2020 they saved 25.7 percent of their disposable income.
In quarterly numbers, Americans increased their savings by $779 billion in Q2 compared to Q1. Now: if Americans could afford to stow away that kind of money in the midst of an economic disruption, what need was there – really – for all the stimulus checks and the unemployment bonuses?
Overall, the new numbers on personal income tell us that in general, households around the country have done comparatively well through this year. The numbers also confirm the recovery we saw in the GDP numbers, but even more so they confirm that Congress was downright reckless in its stimulus spending.
Let us not have any more experiments like this in the future; from now on, let us focus all our fiscal policy efforts on structural reforms to spending at all levels of government.
*) Normally, it is not recommendable to use annualized numbers in any economic analysis. They are not good for the analysis of longer trends, and they are not to be confused with annual numbers (an otherwise often-seen mistake). However, if the annualized figures are used with this caveat in mind, they can be informative in exceptional economic conditions such as the coronavirus shutdown.