March 10, 2022
Situational awareness: How volatile are financial markets in a time of warfare in Eastern Europe? There have been five trading sessions since the start of February in which the S&P 500 moved more than 2% in either direction — compared to seven in all of 2021.
- This week in Capital, we look at the gloomy economic possibilities for the wartime economy, New Jersey's weird gas stations, a bond king's masterful financial crisis maneuvering, and the lobster (or price inflation thereof). All in 1,435 words, a 5-minute read. 📈🦞
1 big thing: The economic abyss
Just a couple of short weeks ago, the economic outlook seemed to be coming into focus. Supply crunches were starting to un-crunch. The Federal Reserve was starting monetary tightening, taking away the economy's pandemic-era training wheels. The private sector was booming anyway.
- Now, things look a great deal more perilous. The commodity price spike caused by the war in Ukraine has increased the risks of a recession, sustained high inflation, or both.
Why it matters: The range of possibilities for what the economy looks like a year from now has widened considerably in just a few short days, in ways that leave policymakers with a higher degree of difficulty in trying to attain benign economic conditions.
The big picture: The latest Consumer Price Index numbers — 7.9% over the 12 months ended in February — show just how widely inflation pressures have spread over the last year. But there has been a plausible rosy story to tell about the outlook, at least until recently:
- Pandemic fiscal stimulus is done. The Federal Reserve will start raising interest rates next week, tightening financial conditions. Supply chain managers worldwide are starting to overcome logjams.
Now, things are more complicated. Prices are surging for energy and food commodities, and those are going to flow through to what American consumers must pay for staples over the months ahead.
- Price spikes in metals produced in Russia like palladium and nickel will filter out into U.S. inflation more slowly, as shortages of key materials amount to a new source of supply chain snarls for cars and other durable goods.
- It would have been simpler if the war-driven commodity price spike had happened a few years ago, when inflation was low and it would have been easy to chalk up a war-induced price spike as an aberration for policymakers to ignore.
What's next: Given shifts in commodity markets, it's pretty much a mathematical certainty that inflation rates will be higher in the months ahead rather than lower.
Will year-over-year headline inflation hit double digits? Quite plausibly. That leaves the Fed between a rock and a hard place.
- If the Fed accelerates its monetary tightening campaign, it would rock already-jittery financial markets and slow the labor market expansion at the same time Americans are feeling the pinch of higher prices. Depending on how entrenched inflationary behavior has become, it may even take a recession to break it.
- But conversely, if the Fed sticks to a slow, gradualist approach of rate hikes, it will make it that much more likely that high inflation becomes entrenched, eventually requiring an even more severe economic downturn to undo.
The bottom line: The gyrations in markets in recent days are only the beginning. The potential results for the economy involve some gloomy possibilities.
2. Energy intensity, down
If there is a saving grace in this new world of $110 per barrel oil (or wherever it has swung to by the time you read this), it is that petroleum products play a less significant role in the U.S. economy than they did during the oil shocks of the 1970s, or even the price spikes of 2008.
- Indeed, energy represented 4.2% of Americans' personal consumption expenditures in January, before the recent price surge. It was nearly 7% in the summer of 2008.
Why it matters: As frustrating as expensive gasoline fill-ups and heating bills may be, they should do less damage to the overall economy than they would have in earlier eras.
That reflects a rise in energy efficiency of cars, houses and more, and a shift of consumption toward services over physical goods.
What they're saying: The Biden administration is pitching its clean energy initiatives as a longer-term way to insulate American families from the geopolitics of oil.
- "We have to make sure that we get that kind of clean energy independence because that's going to create real economic security for families in the decades to come," Heather Boushey, a member of the White House Council of Economic Advisers, told me in an Axios Events conversation this week.
Yes but: The price spikes tied to the Ukraine conflict are hardly limited to oil and other energy products. They are affecting many agricultural commodities, as well as metals needed for high-end manufacturing that could cause a broader set of inflationary problems than an oil shock alone.
3. Gas station productivity
For decades, New Jersey has held steadfast to a law prohibiting gas station customers from pumping their own tank. That may be about to change, in ways that contain a surprising insight about how the economy works.
Why it matters: If New Jersey backs off its gas pumping rules, it will show the power of "endogenous productivity growth," the idea that tight labor markets can create powerful incentives to deploy workers in ways that generate the most economic value.
It's hard to argue that legally required gas station attendants create a lot of economic value, given that in most of the U.S. customers happily pump gas themselves.
- If the law were changed, and people pumping gas in New Jersey went to work in jobs more highly valued by the marketplace, that would amount to higher wages for them and higher economic output for the state.
The labor shortage has made state legislators more receptive to relaxing the rules, Politico reports. That's how the issue connects to a broader economic idea.
- In effect, when labor is scarce, it forces employers to find ways to get more economic benefit from each hour of labor — which ultimately fuels higher wages and standards of living.
The bottom line: If New Jersey deals with the current economic situation by loosening its gas-pumping rules, it will show a different way tight labor markets can generate productivity gains — through political action.
4. How Pimco won the Global Financial Crisis
When the world economy creaked and nearly collapsed in 2008, one of the biggest winners was the asset manager Pimco, and its larger-than-life chief, Bill Gross.
- That is one subplot in Mary Childs' vivid tale of the bond manager and his empire, "The Bond King," out next week.
As early as 2006, Pimco's leaders saw the problems emerging in subprime lending and the housing price bubble — and positioned their portfolio accordingly. But things got really interesting as the bubble started to pop.
What happened: Over the course of 2008, its leaders argued in TV appearances and elsewhere that the Treasury would need to backstop debt of Fannie Mae and Freddie Mac.
- Not coincidentally, Gross had put 60% of his signature fund in those securities. In September 2008 the Treasury did what the Pimco team had advocated.
- Following the September 2008 bankruptcy of Lehman Brothers, Pimco drew a line between assets that were inside the "umbrella" of federal support, including the big banks, and those that were not. It bought up debt of the former and avoided that of the latter.
Then, when the federal government went to implement its bank bailout program, Pimco was one of the few firms with the manpower and know-how to carry it out. So the government hired Pimco to administer the programs.
The bottom line: "Whatever the government touched was becoming gold," Childs writes. "So, whenever Pimco got visibility on what the government might need to buy, it could easily pick up the spread between not-gold and gold."
To understand the economy, consider the lobster.
- Prices of the crustacean have soared so much that restaurants are either giving their customers sticker shock, or taking them off the menu entirely.
Why it matters: The lobster price shock isn't just a supply problem or just a demand problem. It reflects both — and is a microcosm of the U.S. economy.
By the numbers: Maine lobstermen were able to sell their catch straight off the boat for $6.71 a pound in 2021, according to the Maine Department of Marine Resources. That was up 59% over the pandemic-depressed 2020 level — and up 39% over 2019.
- That price increase coincided with rising supply — the problem was just that supply didn't rise enough to keep up with high demand.
- The 108 million pounds of lobster that landed in Maine last year was comfortably higher than the 102 million pounds in 2019 — though well below levels of earlier in the 2010s.
Restaurants are being forced to adapt. Washingtonian magazine reports that this means $100 for a two-pound lobster at D.C. steakhouse The Prime Rib. Others are going further.
- The Salt Line restaurant has cut lobster rolls from the menu and replaced them with shrimp and clam rolls. "Lobster rolls just aren't meant to be that expensive. It's almost embarrassing to pass that cost to our guest," partner Jeremy Carman told Washingtonian.
Have a good weekend and enjoy your clam rolls, everybody.