the Blog Papers of Dr. Michael Sakbani; Economics, Finance and Politics

Dr. Michael Sakbani is a professor of economics and Finance at the Geneva campus of Webster-Europe. He is a senior international consultant to the UN system, European Union and Swiss banks. His career began at the State university of NY at Stoney Brook,then the Federal Reserve Bank of New York followed by UNCTAD where he was Director of the divisions of Economic Cooperation, Poverty Alleviation, and UNCTAD`s Special Programs. Published over 100 professional papers.

Saturday, November 12, 2022

Inflation and a Likely Recession; the Return of the Old Maladie

The Blog Papers of Dr. Michael Sakbani; Economics, Finance and Politics

Dr. Michael Sakbani is a professor of economics and Finance at the Geneva campus of Webster-Europe. He is a senior international consultant to the UN system, European Union and Swiss banks. His career began at the State university of NY at Stoney Brook, then the Federal Reserve Bank of New York followed by UNCTAD where he was Director of the divisions of Economic Cooperation, Poverty Alleviation, and UNCTAD`s Special Programs. Published over 125 professional papersand coaurhored 6 books. The Intelligent Economist selected Dr. Sakbani`s blog michaelsakbani.blogspot.com as one of the top 100 blogs in the world in 2020, and 2022.

SATURDAY, NOVEMBER 12, 2022

Inflation and a Likely Recession; the Return of an Old Malady

 

Inflation and a Likely Recession ; the Return of an Old Malady

  by

 Dr. Michael Sakbani

The things we forgot

Over the past four decades, the world has forgotten about the old malady: inflation. That is because China and other developing countries learned how to export and attract developed  country profit- seeking enterprises to locate therein in order to produce products at lower costs.  The advantage of low cost was due to cheap labor as well as escaping international labor, environmental and public-health standards. This great transfer of jobs built an efficient global supply- chain. It brought down consumer prices, vastly increased company profits, created international economic dependence and equally plighted many old industrial areas in the US and Europe. The globalization of supply escaped national state control and the resultant uncontrolled international business greatly favored globalization participants and markedly contributed to severe income inequalities. This was globalization as we experienced it for the three decades since the nineties.

The industrial globalization was also followed by a similar financial globalization which brought to the whole world the recession of 2008. The public treasuries paid out billions to save the financial system which caused the recession. And ironically, the financial system rewarded the guilty doers who scandalously escaped any accountability.

In this apparent, but surface well-being, Central Banks did very well their job of keeping the economies growing but hardly thought about the impact of their quantitative expansion on their job of guarding against future inflation. And when the time came to act, they acted late, but with vengeance.

In 2019, the world was hit by COVID, an extraordinary global epidemy. Nobody seemed to have been well-prepared for this global event. In the world leading economies:  the USA and China, the reaction differed. In China the remedy was a lock-down to achieve zero covid and in the US, President Trump was more interested in his reelection than in  combatting the epidemy. The global aggregate supply and demand were simultaneously destroyed and a far reaching slump took hold with massive labor furloughs and pent- up demand, especially for services.

At the end of 2020 and throughout 2021, global expansionary fiscal policies were vigorously pursued with accommodative monetary policies in almost all the developed economies. These policies protected the economic well-being of the public, saved many jobs from disappearing and kept small and medium businesses out of bankruptcy. In 2022, most economies were recovering from the devastation of COVID 2019. But the recovery was asymmetrical, being largely on the aggregate demand side, while the aggregate supply side was hampered by supply-chain dislocations that included China`s zero-covid policy, bottlenecks in the structure of  supply chain as well as shifts in planned business investments.  All of that resulted in a skewed recovery: recovery in aggregate demand but a  hampered one in aggregate supply.

Adding to this, President Putin unclenched in February 2022 his attack on Ukraine. The US lead the West in imposing draconian all-encompassing sanctions on the Russian economy to cut its exports.  So far, the sanctions have  resulted in harming the Western economies and increasing President Putin oil and gas revenuesby more than $100 billion  despite a 20 percent reduction in his sales of oil and gas. The war shot- off also 30 percent of the global supply of wheat and fertilizers and the bulk of Russia `s supply of gas  and oil to Western Europe. 

Inflation: a Statistical Picture:

 Figure one USA



                       Figure two

Euro- area inflation



Figure three

                           Global Inflation



 The statistical data in figures 1, 2 and 3 clearly lead to four main conclusions.
First, even though the severity and composition of inflationary pressures differ among countries, inflation is now global and transmissible by international trade and international capital markets. Thus, no individual-country action is likely to succeed in taming it without some international coordination.

Second, the composition of inflation is wide ranging covering, energy, transportation costs, food, fertilizers, consumer credit, borrowing cost and housing mortgage rates. Thus, it is quite comprehensive and by the consequent interactions is self- sustaining.

                    Table 1 

         Composition of inflation

Top of Form

PEW RESEARCH CENTERJANUARY 21, 2022

 What goes into the consumer price index?


Third, many developing countries face physical shortages in aggregate supply, while developed countries face, on the whole, bottlenecks in the aggregate supply.

Fourth, the prices of the major components of inflation; namely, food, energy and fertilizers are determined in the international market and not in the local markets. Hence, international traders such as the oil companies stand to reap windful profits, quite unearned by their local operations, because of this off-limits revaluation of their inventories. Indeed, the data in table 2 show historical records of profits of all US`oil and energy companies.

                                     Table 2

               The windful profits US oil companies

 Oil company profits: Net income (excluding exceptionals) $bnJan - Sep 2021

Jan - Sep 2022 reported

Forecast

$0bn

10

      20

30

40

Shell

$12.8bn

$30.1bn

BP

8.7

20.7

ExxonMobil

14.3

42.7

Chevron

10.7

27.3

TotalEnergies

11.3

28.7

Eni

2.6

10.3

ConocoPhillips

5

13.8

Guardian graphic.

Source: S&P Global Market Intelligence; Guardian Analysis

 

 

 Inflation Causes; Real and Financial

There are real and financial causes for the present inflation. The real factors are headed by the Covid 19 epidemy, which wiped out aggregate supply from February 2020 till the wide roll- out of the vaccines in the spring of 2021, close to 16 months of large-scale closures. This destruction of aggregate supply was global. Hence, the global supply- chain which has been built and widely scattered in the heydays of globalization was very affected. China, which accounts for about one fourth of world exports and dominated the supply- chain pursued a policy of zero covid which meant continued closure of its productive factories when the Western economies were beginning to recover.

To this list of aggregate supply problems, President Putin added an ace: he unclenched in February 2022, his attack on Ukraine.  The war and the Western unified  reaction to it, resulted in severe energy shortages, especially in Europe; oil prices nearly doubled  and gas prices increased four folds.  The situation is dissimilar in the US, because while the country is self-sufficient in energy supply, it is deficient in refining capacity. The US energy companies using off-limit international pricing  did not cap their prices and reaped the huge windful profits shown in table 2.

It should be recalled that  Russia and Ukraine are in the top five  global exporters of food, commodities and fertilizers.,The two of them account for 30 percent of wheat exports. Ukrain, by itsself has 10 % of the world market in wheat, 15 % of corn and 13% of barley (Eisele/DW)[i]The interruption of these exports caused price increases everywhere. This price escalation masked the significant decline in global commodity prices in 2022.

The financial causes were precisely the vigorous fiscal policies pursued by all countries and the accommodative monetary policies accompanying them.  In the USA, fiscal measures during President Trump`s term and the first two years of President Biden added $ 5.5 trillion to planned expenditures over several years. About half of that was pumped into circulation over two and a half years; a massive and unprecedented monetary stimulus.

President Biden`s budget stipulated raising taxes to finance one third of his expenditures, and assumed a growth scenario of the economy, and thus of tax revenues, to finance a second third. In reality however, the proposed tax increases failed to pass the US` Senate and the supply problems did not allow the forecast growth in revenues. Hence, the excess supply of money was not about $800 billion , rather the entire amount pumped in in the last two years, i.e. three timesas much.   

The Evolution of Inflation in the US, Japan and Europe

                        figure  4                            

           Diagram of US inflation pace

figure 4 shows that the US` CPI (consumer price  index) attained the highest level in the past forty years. It rose from 2.2 percent in 2016 to 9.2 percent last August. Thereafter it has declined in September and October to 8.6 percent. The forecast is for a  more slow decline in the months ahead. The most notable inflationary parts of the CPI basket are food, borrowing cost, and mortgage rates. Energy prices have declined for several months through September and have levelled off thereafter.

In the Euro area, the picture as shown in figure 5 is even worse. Inflation has risen from virtually zero in 2016 to 9.5 in October 2022 and a consensus forecast of 10 percent early in 2023. Energy remains the biggest contributors to the index` basket.

                        Figure Five

                   EU inflation pace



 The UK provides the grimmest picture with inflation climbing to 11.1 in November 2022 from 10.1 in October. Both food and energy are the biggest contributors. it is now officially recognized that the UK economy is already in recession (Pictet Banque, September 2022, )[ii]

Japan is an outlier in that its inflation rate went up from - 0 .4 percent in 2012 to 2.9 percent in September 2022 (Ibid,) [iii].

The US ‘Policy Response and the likely Recession

The US ‘policy response is in many ways similar to the policy responses of other developed economies, with the possible exception of the UK. It stays its hands on fiscal policy but assigns to monetary policy the task of wrenching out inflation.

Monetary policy impacts directly aggregate demand with a lag of that extends to 9 months. It  affects aggregate supply only indirectly and after a more extended lag. The US` Federal Reserve has so far raised its rate by four points in less than a year. The question raised by financial commentators is whether the Fed will refrain from further hikes once it reaches a plateau of 4.5 percent, which it is  expected to attain by the end of this year. A quantum jump of interest rate of 400 paces- points has historically brought down recession.

The US economy still faces a strong labor market with unemployment around 3.6 percent.  the Biden Administration has added 10 million jobs to employment through October 2022 and is expected to add more in November. This level of unemployment is historically full employment. However, there are more job offers than job seekers. Three factors might shed some light on this riddle. The participation of able white workers in the active labor force has declined in the last three decades. Nobody has come up with a satisfactory explanation of that. The second factor is the difficulties President Trump put on students and foreign workers visas and  immigration which has affected the Tech. Sector in particular. The third factor is the decline in female participation in active job seeking. Female participation rate has declined since the onslaught of COVID 19. This is the case in minority female workers and low paying jobs laborers. It is perhaps not surprising that the lack of public support in the US for children care of working mothers is responsible for that.

This muddy and somewhat complex picture poses difficulties for monetary policy making. The other major difficulty is that aggregate supply is somewhat missing in this policy picture. There is evidence that the supply-chain problem is easing. But China`s zero Covid policy is still keeping China`s factories away from supplying the required accessories and intermediate products.

Thus, the Fed will have to continue pressing down aggregate demand to a level well below the economy`s capacity in order to equal aggregate supply. This  is indeed a harbinger of recession in 2023. In this respect however, there are several factors that should moderate the Fed`s action. The first one is the decline in inflation pace shown in the figures above. It can be reasonably predicted that by mid-december the CPI would be around 7 percent and core iinflation bellow 5 percent. The second is the decline in employment shown in the most recent data exhibited in table three bellow.

                                   Table Three

               US` Employment Statistics                   

 

Employment Rate in the United States decreased to 59.90 percent in November from 60 percent in October of 2022. 

source: U.S. Bureau of Labor Statistics

Related

Last

Previous

Unit

Reference

Unemployment Rate

3.70

3.70

Percent

Nov 2022

Non Farm Payrolls

263.00

284.00

Thousand

Nov 2022

Employed Persons

158470.00

158608.00

Thousand

Nov 2022

Average Hourly Earnings

0.60

0.50

Percent

Nov 2022

Labor Force Participation Rate

62.10

62.20

Percent

Nov 2022

Job Offers

10334.00

10687.00

Thousand

Oct 2022

Employment Cost Index

1.20

1.30

Percent

Sep 2022

Employment Rate

59.90

60.00

Percent

Nov 2022

Part Time Employment

26394.00

26230.00

Thousand

Oct 2022

Full Time Employment

132228.00

132661.00

Thousand

Oct 2022

                                    ---------------------------------------------------------

 

United States Employment Rate

In United States, the employment rate measures the number of people who have a job as a percentage of the working age population.

Actual

Previous

Highest

Lowest

Dates

Unit

Frequency

59.90

60.00

64.70

51.30

1948 – 2022

Percent

Monthly

SA

 

   

The third factor is the decline in aggregate demand. There are many signs of that. One such an indicator is the decline in business investment orders, a leading indicator. The other one is the steep decline in new housing construction.Figure six bellow documents this factor

                                                   Figure Six

                      Decline in New Housing Starts

  The University of Michigan Survey points to recession expectations of consumers. Moreover, job creation is beginning to dip because real wages which were positive till March 2022 have turned negative thereafter. However, these three factors are counteracted by the stickiness of consumer expectation shown in figure seven bellow

                                   Figure Seven

    Stickiness of Consumer Expectation

     


Nonetheless, the Conference Board tracking several leading indicators has concluded that the US will dip into a mild recession in 2023 (Author`s  note)[iv].

                          Figure Eight

          Conference Board Leading indicators

Geneva (Octobe2022)

                    Notes

[1] Ines Isele in DW, 11/1/2022

[ii]According to Bank Pictet WM CIO Office & Macro Research, , fact set, September 29, 2022,  the UK inflation rate of the CPI went up from 2 percent in 2002 to 11  percent. The core inflation rate went up from 2 percent to 6.5 percent.

 [iii] Pictet Bank OP. Cit.

[iv] The  Peter Peterson Institute estimated that the US Administration can shave off 1 percent of the CPI inflation rate by cancelling President Trump import duties on China. President Biden indicated that this step is under consideration.  Furthermore, the Inflation Control  Act of 2022, would cut off over 2023 the cost of drugs and health care support by another 1 percent.   

The US Bureau of Labor Statistics reported that US`  employment increased in November 2022 by 265 thousand,a figure signinficantly larger than what was expected.  Therefore, it looks that the US labor market is still strong and the US economy might avoid a severe recession if the Federal Reserve moderates its stance in light of all the data marshalled above..

posted by Dr. Michael Sakbani | 12:38 AM 

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