The government just reported that third quarter gross domestic product (GDP) growth was revised upward to 2.9%. That’s solid growth and good news. Today, though, that’s bad news. It was also reported that the economy added 263,000 jobs last month. That’s usually good news, except, today, that’s bad news. Consumer spending and retail sales are both increasing rapidly. That’s good news, except, today, it’s bad news.
Because we are in a period of high inflation and generally stagnant growth, news that shows the economy growing is generally good. But with the economy overheated due to massive government spending policies of the last three years, and shockingly irresponsible monetary policy in 2021 and early 2022, high growth is bad news, because it is inflationary.
Because the U.S. economy is experiencing a severe labor shortage, adding 263,000 jobs last month, means the demand for labor is increasing. That’s normally good news. But increased labor demand today just means higher wages. That’s good for the workers, but it is bad for the economy because it increases labor cost for business. That will push inflation higher.
Consumer spending accounts for about 70% of GDP. Most retailers do up to 40% of their annual sales in the fourth quarter. So strong consumer spending overall and strong retail sales are normally very good. But in an overheated, supply challenged economy, that will lead to more inflation. That’s bad news.
Since March and more specifically since June, the Federal Reserve finally realized that the primary goal of monetary policy is price stability. For some reason, through all of 2021 and the first quarter of 2022, the Fed abandoned the price stability goal.
That policy coupled with government budget deficits that totaled $7.5 trillion in 2020, 2021 and 2022, led to most of the inflation.
The Fed did raise interest rates aggressively from June to November this year. Next week the monthly consumer price index (CPI) number will be released. The number will probably be in the 0.5% range. That should result in the 12-month inflation rate rising to the 8% range.
A day or so later, the Fed meets to discuss the level of interest rates. Prior to the release of the latest data, it was believed the Fed would raise rates 50 rather than 75 basis points. It looks like a 75 basis point increase is most likely.
Right now, the Fed’s biggest fear is that a wage/price spiral is developing. Last month, wage increases averaged 0.6%. That translates into a more than 7% annual increase. Workers are demanding that much because they say they need it just to keep up with inflation.
But the resulting increase in labor cost for business means they will have to raise prices more than that to maintain profitability. That raises inflation. Then workers demand even higher wages, and we end up in a wage/price spiral. Historically this is very difficult to break. Usually, a recession is necessary.
That seems to be the most likely outcome today. The Fed will continue to raise interest rates until it is convinced that the rates are high enough to reduce demand enough to bring the inflation rate down to the 2% range. The large increase in interest rates will bring on a recession.
Although the unemployment rate remains at 3.7%, there are signs of a slowing economy. The first two quarters of this year had negative GDP growth.
Some large companies, particularly in the high-growth tech sector, have already begun layoffs. Also, the number of job openings is starting to fall as employers no longer seek to add to their current workforce even if they are operating with smaller than usual crews.
The “good news is bad news and bad news is good news” scenario that we have today will last well into next year. The hope is that consumers start to cut back on spending which reduces demand. Based on the large increase in credit card debt, that doesn’t appear to be happening.
Since the Biden administration will deficit spend another $1.5 trillion this fiscal year, excess demand will continue to build. The high interest rates should eventually reduce consumer spending, although that may take most of next year. And will bring on a recession.
After that, good news will be good news.
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