The State of the Economy

Like it or not, these are pretty difficult economic times, with not very good near term prospects for a recovery.  Presumably things will get better, but the path to improved times seems very uncertain.

Right now year over year inflation is over 8 percent, the highest price increases in 40 years, with some key reports coming out later in the week. Although price hikes in food and gasoline, which has now begun to rise again, are probably most rooted in people’s consciousness, the increases are pretty much across the board.

Another obvious manifestation of inflation is in the job market. As The New York Times reports this week, not only has the economy recovered all of the 22 million jobs lost during the pandemic, but it has added another half million positions. The job market remains strong with only minor signs of softening in the last report. Meanwhile, wages are rising substantially, fueling inflation.

But there are numerous other signs of inflation.  The Wall Street Journal reports that even companies that are able to raise prices are falling behind because of rising costs.  Abroad, the Ukraine war and sagging currencies have also added to price pressure.  In addition, OPEC oil producers like Saudi Arabia, as well as Russia and its allies, have decided to cut oil production by two million barrels a day.  

While no single factor can be held responsible for the inflationary wave, either in the United States or globally, it is widely believed that the huge infusions  of government spending during the pandemic, as well as constraints in supplies, have played a significant role, causing the classic problem of too many dollars chasing too few goods and services. Indeed, JP Morgan Chase President Jamie Dimon stated this week that the economy is headed for recession in the next six to nine months. Mr. Dimon cites inflation, quantitative easing and the war in Ukraine as major causes.

The biggest problem is that the most likely cure for inflation, higher interest rates, is very likely to lead to more pain.

Basically, the Federal Reserve Bank has decided that the job market, among other segments in the economy, is excessively strong and inflationary. Accordingly, it has already initiated a series of interest rate increases and has expressed the belief  that a continued series of rate hikes will be  required.

Unfortunately, the higher interest rates will almost certainly slow down the economy in many unhappy ways.  Businesses will have to borrow at much higher rates, which will generally slow down expansion plans and willingness to hire additional workers.  Homeowners will have a more difficult time selling their homes, because potential buyers will have trouble affording the monthly payments.  The stock market will likely decline, both because corporate earnings will probably be depressed, and because high interest bond obligations will compete with stocks.   This will adversely affect millions of people with 401(k) stock accounts.

A series of interest rate increase in the early 1980’s ended the last major wave of inflation and it seems likely that the recent wave of hikes will eventually be effective. 

What we don’t really know is whether the Fed can manage the rarely achieved “soft landing” where the rate hikes will gradually soften the economy, but will not have many serious side effects.  Probably more likely, if the experience of the 1980’s is taken into account, is that there will be a pretty hard crash, with minimal or negative  economic growth and a depressed labor market before the economy finally rights itself.

In the 1980’s example, a recovery did take place in 1983 and 1984, which greatly helped the reelection efforts of President Ronald Reagan.  Of course, the state of the economy in 2024 will matter greatly for both President Biden (if he is the nominee) and the Democrats as well as to the Republicans. However, the crystal ball is far too cloudy at this point to make any realistic forecasts.              

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