F. Scott Fitzgerald wrote that “the test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.” George Orwell labeled the ability doublethink or indoctrination. Psychologists call it cognitive dissonance. I call it the current economy.
There are mixed signals everywhere. Inflation is running hot at an 8.5% annual rate—subtract food and energy and it’s 5.9%. Despite a string of long-overdue Federal Reserve rate hikes, credit is still loose and will be until short-term rates rise above inflation. At 2.25% to 2.5%, we have a way to go.
Prices are popping. Restaurants everywhere seem to have New York prices. Haircuts are more. Same for doctor’s bills, furniture and Uber rides. There’s still $5 rotisserie chicken, and the $1.50 hot-dog special, but it sure feels like Costco added a couple of bucks to every other item.
More heat: The U.S. economy added 315,000 jobs in August, and unemployment is 3.7% as workers are hard to find for the 11.2 million available jobs. Stores are closing or limiting hours owing to a lack of workers. And unionization is back, burdening Amazon, Starbucks and even Google’s cafeteria. A national railroad strike might hit soon.
Once wage hikes start, they are hard to stop. John Deere increased workers’ pay by 10% last November. Lowe’s is giving out $55 million in bonuses this quarter. I expect more pay increases of 10% to 15% over the next year. The new- and used-car market is still tight because of chip shortages, but that’s almost over. Container ships now are idling outside East Coast ports, as I observed flying into New York recently. Hot, hot, hot.
Policy makers keep pouring gasoline on the inflation bonfire. California Gov. Gavin Newsom signed a law that would increase fast-food worker wages up to $22 an hour next year from $15. Expect 20% price increases, even for In-N-Out Burger’s “Animal Style” fries. After trillion-dollar spending binges in 2020 and 2021, Congress has piled on spending with the Inflation Reduction Act, a misnomer for a green pork bill, plus the unnecessary Chips+ Act with even more green goodies. And the Biden administration’s wave-of-the-hand student-loan forgiveness will have the same effect as sending out $10,000 and $20,000 stimulus checks. Fire in the hole.
But there are plenty of signs that the economy is weakening, most visibly at gas pumps. To whip inflation, rate hikes are becoming common. Chairman Jerome Powell said last month the Fed would take “forceful and rapid steps to moderate demand,” which might “bring some pain to households and businesses.” Ouch.
Beyond interest-rate bumps, the Fed is sitting on $9 trillion in reserves and running off $95 billion a month in Treasurys and mortgages. You can do the math: It will take five to seven years of quantitative tightening to return to more “normal” reserves. Continuous pain.
The average 30-year fixed-rate mortgage is now 5.9%, up from 2.9% a year ago. No wonder housing prices are dropping in many markets. Worse, new housing starts are headed south as mortgage payments become unaffordable for new buyers. This means construction job losses and lower demand for lumber, pipes, etc.
From Walmart to Target to Nordstom, retailers over-ordered and now face a glut of product. They are slashing prices to move it, even renting shipping containers to store their overstuffed inventory.
The pandemic and working from home pumped PC and laptop demand, but that is now cratering. Same for Peloton. Zoom usage is weakening. Chipmaker Nvidia announced a 17% shortfall in its sales outlook. Even Google had an earnings miss. Re/Max, Snap, Netflix, JPMorgan and many others are laying off employees.
Europe is a mess, with 10% or higher inflation in some countries. U.K. pub owners complain that their electricity bills are tripling. The Nord Stream pipeline is shut down, and winter is coming. China may be a bigger mess, with its flat-lining economy. While zero-Covid lockdowns are partly to blame, real estate may be in a death spiral, with Evergrande-like defaults and loss of customer prepayments that could require massive bailouts.
Won’t all these weak economic signs douse the hot economy, killing inflation and allowing the Fed to stop raising interest rates? That mythical “soft landing”? I’m skeptical. Not to be a gloomy Gus, but here’s another scenario: Inflation persists. Rates rise. Credit tightens. Housing values drop. Corporate earnings miss. Recession continues. Earnings multiples contract. Layoffs accelerate. Wages stagnate. Then and only then will the Fed start lowering rates. That could happen in 2023, but it’s more likely to happen closer to the 2024 election.
Maybe understanding the economy’s mixed signals doesn’t require Fitzgeraldian intelligence or Orwellian indoctrination. The signals cause psychological dread, like walking a tightrope across Niagara Falls (slowly I turned . . .). Cognitive dissonance makes decision-making difficult. The stock market might continue to yo-yo up and down thousands of points, maybe for years, as investors hold two competing thoughts, boom or bust, in their heads—until one thought prevails.