Production Before Consumption - How Stimulus Checks May Hinder The Recovery

Forecasting is a complex art, they say, especially when it means projecting the future. This is also true these days, mainly because we are facing 1) times of extreme economic upheaval and 2) a public health crisis. Those are very hard to predict for me as an economist but significantly influence the economy.

How will markets and economies develop shortly? Is everything going to be alright in 2022, and have financial markets just anticipated this? After we have seen a strong rotation back into tech this Tuesday, which continued on Wednesday after US-CPI data matched estimates. Maybe it has had to do with the 10y US-treasury yield consolidation, although they are rising again this Friday morning. 

At first sight, there are no surprises about the CPI data, but the devil is in the details. I do not want to leave out that the Bureau of Labor Statistics has estimated many prices because they were not observable because of business closures and other policy measures to combat the virus (actually, the same is happening with the European HCPI).

But if many prices are just estimates - are the CPI numbers meaningful at all? Well, my guess is that the numbers are somewhat over than underestimated. Nevertheless, looking at CPI development, we notice that even with this notion in mind, inflation is picking up again. 

European inflation is lower but accelerating as well after last year's substantial decline. I expect CPI numbers to rise continually this year because of inflationary pressures of 'the big reopening'.

The Biden administration is doing everything to make this reopening a solid success (at least in their opinion) and therefore brought the 1.9 trillion dollar stimulus package on its' way. Although everybody talks about the stimulus checks (to support low- and medium-income groups), it is worth noticing that just approximately one-quarter of this money will be stimulus payments. 

Last week I wrote about the Cantillon effect, and this stimulus package is nearly a perfect example of how certain lobby groups are provided with new money which they can use to spend on the market at old prices. 

And the stimulus will not be the only thing the Biden administration is using. Recently, Janet Yellen talked about how the US treasury wants to run down its TGA account that Mnuchin has run-up last March. 

Thus we can expect that a lot of liquidity will enter the real economy at reopening. This (artificially) created demand is supposed to restart the US economy. Because of that, analysts have revised expectations of economic growth in the US in Q2 upwards. 

To satisfy higher demand, firms have to increase production capacity to avoid rising demand, resulting in a higher general price level. Therefore they have to hire people.

Currently, US unemployment is about 6.3 %, according to the BLS. 10.1 million Americans are officially unemployed, but a recently published article by the Washington Post suggests that the real rate is much higher:

"But there’s another government data source that indicates a much higher number of unemployed. Every Thursday, the Labor Department reports how many people are receiving jobless aid from the government. The latest data indicates 18.3 million people were receiving weekly unemployment payments through Jan. 30. That figure fluctuates a bit week to week, but it has hovered close to 20 million for the past few months. Top White House officials often cite this number when they talk about the economic pain the country is still facing and make the case for another round of aid, including more stimulus payments to individuals."

To generate growth, firms need to create jobs for those people, and I am not convinced that more stimulus will accomplish that goal. More extra-unemployment benefits will create an incentive for some unemployed (who were working in low-paying jobs) and make it hard for firms to hire people.

We know that people in low-paying jobs were hurt disproportionally harder of the pandemic than people in high-paying jobs.  People in higher-paying positions just switched and started to work from home, which is impossible for some low-paying jobs. Indeed jobs grew for people who make more than 20 dollars/hour while the number of low-paying jobs decreased dramatically.

Further, extra unemployment benefits made it less attractive to low-skilled workers to return to their pre-pandemic jobs. The NFIB Small Business Job Openings Hard to Fill Index shows that small businesses are experiencing labor shortages. The Index has reached an all-time high this year.

Because firms cannot find workers for those jobs, but demand for goods and services is increased artificially, they have to raise prices because they cannot increase production. This is precisely what happens:

Retail trading now accounts for almost as much volume as mutual funds and hedge funds combined. And there may be a simple cause of that. Many of those who lost their job in March of last year seems to have come to terms that they may search for their luck as day-traders.

Further, last years' bull run may have paid off for many of those and decreased their incentive to return to their old jobs even further. But if they do not return, who will produce all the goods? One thing for sure, they will not be produced domestically...

The United States is already reopening; for example, Texas has lifted all restrictions related to the pandemic. The government has guaranteed that enough money is available to support the unemployed and make sure consumption is high. Additionally, many dollars which were saved during the pandemic will also run into consumer markets. 

Meanwhile, Europe is still fully engaged with the virus because there is still not enough vaccine available. After all, Ursula von der Leyen and her European Commission staff have failed entirely and still have not taken responsibility for their failure.

The lack of vaccines is delaying the European reopening. In fact, we are still far away from it. Because rising US treasury yields are also pushing European yields higher, the ECB stated that they will increase their bond purchase speed to ensure that rising yields will not hurt the recovery. 

According to this, we can be sure that Europe will grow more slowly compared to the US. Sustainable economic growth will not develop in the US either, though, precisely because of the stimulus. Contrary to the belief of MMTers and Keynesians, it is not spending that creates growth but growth that makes spending.

These programs create incentives for people not to look for a job and take the extra unemployment benefits instead because they are at least equally or only slightly worse off than working full-time. However, as a result, firms cannot find additional workers who they need to increase production.

Prices determine costs, not the other way around. On the one hand, small businesses primarily work with thin margins and cannot keep prices constant if costs increase. On the other hand, they can not raise prices endlessly because demand will decline at some point. As a result, firms may end up offering higher wages for those jobs to find at least some workers, but only to a certain degree.

We see that there is still a long way to go until we reach that point that financial markets have already anticipated. Growth will be substantial compared to 2020 but will it return to its' pre-pandemic path? Markets already have priced that in, and many analysts expect US companies to beat estimates this year.

Maybe I have to apologize to you: Neither I can predict the future. On the one hand, I see that growth will return strongly this year (compared to last). Many businesses will close, others will try to find workers. However, If the stimulus continues indefinitely and people use those to bid up stock prices instead of working, they are missing at the production of goods and services. But production is necessary for economic growth, and there may be a rude awakening at some point. In the second half of the year, we will know more.

Andy Kessler wrote some valid words for the Wall Street Journal:

"Bull markets need fuel. When the marginal buyer is done, there are no more greater fools to buy in, no matter how well companies actually perform. The dream is priced in, and firms can only meet, not beat, expectations."

Have a great weekend, everyone!
Fabian Wintersberger

Disclaimer: This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the blog owner, and do not represent those of people, institutions, or organizations that the owner may or may not be associated with in professional or personal capacity.