The potential pitfalls of economic growth

0

FT subscribers can click here to receive Swamp Notes by email.

The sentiment pendulum has swung a long way since last spring. The panic we saw in March last year over a yet to unfold pandemic has been replaced by extreme optimism over a long-awaited post-Covid recovery ahead. The front-page of The Washington Post on Sunday touted the US economy’s “best chance in years to break from era of subpar growth” as we emerge from Covid’s stronghold.

Today global business leaders and investors are eagerly looking forward. Since last fall’s vaccine announcements, their mounting enthusiasm has propelled commodity prices and bond yields substantially higher. Lumber and crude oil prices have doubled, and the yield on the 10-year US Treasury note is at its highest level in a year. The “reflation-trade,” as it is now called, is all the rage as one headline after another highlights supply shortages in critical commodities and key manufacturing inputs.

Two weeks ago Kellogg’s announced that it couldn’t make Frosted Flakes fast enough, while on Wednesday the Biden administration met lawmakers to discuss the shortage in semiconductors and chips. In less than a year we’ve gone from worries about vast oversupply to mounting concerns over scarcity in the global supply chain. 

While typically a strong economic outlook is good news for the White House, the current backdrop is likely to pose several challenges for Joe Biden’s new team. 

First, and not surprisingly, it has some economists and policymakers challenging the need for yet another major fiscal stimulus package. Three weeks ago Barack Obama’s economic adviser and Bill Clinton’s Treasury secretary Larry Summers — normally a strong advocate for Democratic policy actions — cautioned that the $1.9tn Biden plan was simply too big. Coming now, it runs the risk of further exacerbating the rising inflation pressures already on display.

If Summers is right, and inflation soars ahead, the Biden administration will be an easy target as consumers pay more to feed their families and government borrowing costs rise. 

At the same time, doing less or too little here could leave those individuals and businesses upended by the panic [OR PANDEMIC?] even further behind as economic growth returns. While approval by the House of Representatives now seems all but certain, the rising divergence in views on the necessary size and scope of the Biden stimulus package could challenge the party unity required by Democrats for Senate passage in the face of Republican opposition.

Second, today’s soaring agricultural and energy prices are a mixed blessing for American voters. We are a nation of suppliers, middlemen and end customers. If cost increases can’t be passed through, business profits will suffer. And unless accompanied by wage growth, rising consumer prices will squeeze main street further at a time when many are already challenged by food scarcity. 

And here it gets complicated for the new administration (as if it wasn’t already). Many of today’s commodity cost increases and supply shortages can be clearly tied to soaring demand from China. Attempts to lower the pace of exports will not only create diplomatic challenges but will play right into partisan politics back home. The burden of lower agricultural and energy prices, for example, would fall disproportionately on red state economies. If the administration intervenes and prices fall, President Biden will be blamed for undoing the Trump-China deal once celebrated across the heartland.

Navigating what is now seen as a red-hot economy ahead won’t be easy. 

At the same time, and admittedly not without its irony, it is the potential for disappointing growth that worries me most. The greatest risk I see here is that with everyone fantasising on what rising vaccination rates and falling Covid cases might mean for the economy, they are overlooking possible pitfalls — and what has already been priced in by investors, especially in corporate debt and US equities. With junk bonds, for example, now yielding less than 4 per cent, and the stock market at all-time highs, it feels as if investors are celebrating the benefits of the stimulus package and strong economic growth ahead, while at the same time looking past the adverse effects of rising inflation on corporate margins and government bond yields. The crowd is now having its cake and eating it too, while ignoring the fact that with wheat prices up almost 60 per cent a lot of growth has already been baked in.

Rana, it feels like a precarious moment for the new team. If they do too much and today’s optimistic forecasts do come true, the new administration will be tarred with fuelling punishing inflation. If they do too little and forecasts disappoint, the team will be left holding the bag on a shrinking economy. 

Edward Luce is on book leave and will return in mid-March

Recommend reading

  • With more signs this week that the “just-in-case economy” has bipartisan appeal, the FT’s Aime Wiliams and Claire Bushey dug into the chip shortage and the weaknesses in the US supply chain.

  • Elon Musk has been at the centre of many of this cycle’s biggest manias — electric vehicles, space exploration, solar energy, cryptocurrency (or at least until Musk threw some doubt on bitcoin’s sky-high value this week), etc. With all of them soaring, the recent reviews of Musk have been glowing. This week that changed with Faiz Siddiqui of The Washington Post raising several questions on whether the tide is now turning.

  • And speaking of manias, Matt Levine’s deep dive for Bloomberg into the lurid details of the Lucid-Churchill Spac tie-up affirms, yet again, that confidence and investor scrutiny are negatively correlated.

  • As a big Daniel Kahneman fan, I thoroughly enjoyed Joe Lemire’s take in The New York Times on how Thinking, Fast and Slow is changing professional baseball.

  • And I know this isn’t a read, but Charlie Munger’s conversation at the Daily Journal annual meeting is filled with much-needed wisdom from someone who is old enough not to dance around how he says things.

Rana Foroohar responds

Peter, you’ve just sketched in a nutshell Biden’s short and long-term problems. If this were only a matter of dealing with the inflation that may understandably come from pent-up demand following a pandemic, it would be OK. But this is about the fact that Covid has come at the end of what I believe is a multi-decade cycle of wealth creation, to a new period of wealth distribution. That’s natural and normal — economic pendulums should shift when they become too far tilted in one direction. The issue is that crafting policy at such a time, particularly when geopolitical forces are so much in flux, is incredibly tricky.

During the past 20 years, Democrats (including Summers) have sometimes talked about policy as if there weren’t people behind it. That’s wrong, and that’s why things such as Buy America, which many economists argue won’t help support manufacturing in the US, are still correct because of the message they send — we see the people whose lives have been destroyed by laissez faire financialised globalisation and we want to help them.

I think Biden’s focus on “work not wealth” is a good way to frame the needed shifts in ways that aren’t zero sum. But this is going to be a rocky few years, even if things go very well. It’s possible that we’ll get a market correction if the pent-up demand causes a quick inflationary spike. But as I’ve argued in past columns, given how upside down and financialised our economy has become, it could be that we’ll know main street reality is improving when wall street tanks. 

Your feedback

And now a word from our Swampians . . .

In response to ‘Race to the bottom’:

“As the tech companies move to low-tax states that are actually less able to cope with climate change, the fact that the tech industry is now represented by a slickly designed computer and not a huge smoking chimney is — ahem — a smokescreen. But I love the fact that you’re a fan of Carl Hiaasen. From your link I have some catching up to do — there are titles I’ve not read that are post-Trump. For the best non-fiction description of the southern states, I’d go for Louisiana and Arlie Russell Hochschild’s Strangers in Their Own Land, from 2016.” — Judith Martin, UK

“As southern states lure businesses with lower taxes and fewer regulations, they also get their employees, many of whom are educated families young enough to relocate and who tend to support Democrats. They are not only sowing the seeds of infrastructure collapse, they are slowly turning their red state blue.” — Robert Hatfield, Portland, Oregon

We’d love to hear from you. You can email the team on swampnotes@ft.com. Follow them on Twitter at @RanaForoohar and @Peter_Atwater. We may feature an excerpt of your response in the next newsletter.

Source

Leave A Reply

Your email address will not be published.