Inside this Issue:
- Price Skating: Prices Popping, but Fed Storms Ahead
- An Inflation Situation? The Debate Intensifies
- Retail Fail: Sales Data Adds to Recovery Concerns
- Shocks to Stocks: Markets Fall as Data Points Disappoint
- Kick to the Coin: Bitcoin Buckles on Elon’s Edict; Dogecoin Too
- Fexit: How Does the Fed Tighten Its Sheet but Not Frighten the Street
- Bankless Banking: A New World of Finance
- After the Plague: Hospitals Returning to Normalcy Post-Covid
- Care Where? Health Sector: Expect More Healing in Homes
- What Befalls the Malls? A Rebound, Simon Says
- The Great Estate Inflate: Monetary Stim Plus Supply Crunch Means Prices Soar
- And This Week’s Featured Place: Gary, Indiana, How to Heal from the Ghosts of Steel
Quote of the Week
“The people that I listen to most are the people who from time to time will say: ‘I don’t know.’”
-Former U.K. central bank governor Mervyn King (speaking on the “Capitalisn’t” podcast)
First, a disappointing April jobs report. Next, a worrisome inflation report. Then, signs of tepid retail sales. Adding to the unease: A survey showing heightened inflation concerns among U.S. consumers.
It was an uncomfortable week for the U.S. economy, unnerved by a sharp jump in the Labor Department’s consumer price index (CPI). Inflation, after all, is the great fear associated with the economy’s reopening, a fear amplified by unusually large doses of fiscal and monetary amphetamines. The index was almost a full point higher in April than it was in March, and up 4.2% from this time last year. Comparisons versus last year, of course, are only so useful—this time last year, businesses were shutting down; now they’re opening up. In addition, the index was heavily influenced by a few specific categories experiencing unique supply shocks—used cars, for example (affected by a shortage of new cars due to semiconductor issues) and utilities (affected by disruptive weather in Texas). Gasoline prices also rose sharply, but from extremely low levels a year ago. Other categories pushing the index upward included several linked to travel, like airfares, hotels and rental cars. Here too, the increase was from abnormally depressed levels.
Housing, by far the weightiest category in the index, showed a more modest increase. Yes, housing prices are soaring across the U.S., but mortgage rates remain low and in some big markets, rental costs have dropped. Food, the second weightiest category, saw a more pronounced monthly jump linked to a broader global rise in commodity prices. In the meantime, government data showed other signals of rising prices, i.e., for producer inputs and imports.
As for retail sales, non-auto purchases unexpectedly declined from March to April. Recall, however, that March figures were exceptionally strong. The biggest drops were for things like clothing, sporting goods and department store purchases. Spending on autos, restaurants and electronics was solidly up month to month. Separately, a University of Michigan survey of consumer sentiment revealed concerns about the recovery’s impact on prices.
Some investors aren’t reacting well to the string of disappointing data. Stock markets dropped last week. Tech and other growth stocks dropped even more. Bond markets, on the other hand, took things in stride, with Treasury rates momentarily jumping a bit but ultimately ending the week largely unmoved. Also unmoved: The Federal Reserve, insisting again that today’s rising prices are just temporary. Weighing more heavily on its mind is the discouraging jobs report from a week earlier. Also lodged in its mind: Memories of a lethargic recovery after the last crisis, accompanied by too little inflation. So no easing its foot off the stimulative breaks just yet.
Eventually, the Fed will have to taper. And when it does, some worry a frothy stock market won’t handle it well. A stock bubble pop, or a pop in asset prices more broadly, is another risk alongside inflation. Some are separately worried about the crypto hype, pointing to episodes like last week’s reaction to the tweets and comedy routines of Elon Musk. He’s apparently less enamored of Dogecoin and Bitcoin than you thought.
The crypto space is nevertheless still burning with potential for disruptive change. The Ethereum blockchain in particular is winning more attention as a platform for new crypto applications. Its developers are now working to make it faster and more energy-efficient, two major shortcomings right now. As a reminder, blockchain technology allows a network of computers to do things that once required trusted third parties—like undertaking a financial transaction. The technology is young and immature. But it’s attracting lots of minds and money.
Will more money attract more workers? Companies like Mcdonald’s are raising pay. Amazon, meanwhile, is hiring another 75k people, with average stating pay exceeding $17 per hour. It’s also incidentally giving $100 bonuses to new hires that show proof they’ve received the Covid vaccine. This comes as the Centers for Disease Control relax the rules on mask-wearing. The darkest days of Covid, for the U.S. anyway, seem finally past.
On the earnings front, there weren’t too many superstar firms reporting last week. Marriott and Airbnb chronicled the burgeoning return—finally—of tourism. Disney is seeing it too, at its theme parks. Less happily for Mickey Mouse, people are watching less television as they emerge from their homes. The newly public Coinbase talked more about crypto. Occidental Petroleum celebrated the rebound in energy prices. The energy market, though, saw disruptions last week following a ransomware attack on a major pipeline.
This week, retail takes center stage, with Walmart leading the way.
Recent monthly CPI readings:
- HCA Health: As Warren Buffet recently said about his company’s attempts to control health care costs: “We were fighting a tapeworm in the American economy. And the tapeworm won.” Health accounts for close to a fifth of U.S. GDP now, which by itself isn’t a bad thing. The health sector, after all, includes lots of high-paying jobs. But it’s also an area of the economy where basic tenets of the free market often don’t apply. Can you really shop around for the best price and quality while undergoing an emergency procedure? Can you put a price on a life-saving device or drug? It’s also a difficult sector to achieve productivity gains, the secret sauce to making an economy wealthier. You’re not just trying to produce more outputs with your labor, capital and technology. The characteristics of U.S. health care, meanwhile, are enormously influenced by government policies, with government indeed paying for a large share of the care undertaken.
- Somewhere near the center of this cauldron is HCA Health, America’s largest hospital chain. Based in Nashville, it operates 184 hospitals across the country (many in Texas and Florida). It runs many outpatient health facilities as well, offering everything from radiology services to urgent care to physical therapy. During 2020, HCA’s hospital beds were filled with Covid patients. This was true in the first quarter of this year as well, when it treated nearly 50k Covid patients, accounting for 10% of total admissions. By March, however, the figure was down to just 5%. Now, HCA’s facilities are starting to see a rebound in demand for non-urgent services that people deferred during the pandemic (knee replacement surgeries, for example). For that matter, it saw a big drop (almost 20%) in emergency room visits last year too. Also down sharply in the past year but now coming back: medical procedures for children, who suffered fewer accidents while schools were closed and sporting events suspended.
- HCA’s earnings have been remarkably consistent over time, even through the pandemic. Its pretax profit last year was $5.4b, almost identical to what it earned in 2018 and 2019. Its $51b in revenue last year was also largely unchanged from the year prior. In general, inpatient revenues (from people with overnight stays in hospitals) increased last year, while outpatient revenues decreased. How does HCA get paid? Rarely from patients themselves. Instead, a little more than half of revenues come via private sector insurance companies like Anthem, United, Cigna, etc. Another third or so comes from Medicare reimbursements (that’s the federal-state plan covering seniors). Medicaid, the government plan covering low-income Americans, is responsible for about a tenth of revenues.
- Looking ahead, HCA expects the home to become a more important setting for health care. As such, it’s making acquisitions of home health providers. It separately bought a 40% stake in a telemedicine company last year, something Walmart incidentally is doing as well. Can Walmart successfully compete in the health care space? It’s a question with giant implications not just for HCA but the entire economy. HCA, for its part, controls costs through large economies of scale. Much of its business, however, is shaped by public policies, including the Affordable Health Act better known as Obamacare. Tax policy is crucial too, with HCA competing against many hospitals with tax-exempt non-profit status. HCA itself last year paid more than $1b in income taxes.
- Cigna, the Connecticut-based health insurer, identifies three key trends changing health care. One is pharmacological innovation. Two is the connection between mental and physical health. And three involves changing preferences in how people access care, with care via video or in the home increasingly favored. Separately, at a Bank of America investor event last week, CFO Brian Evanko said costs for Covid care started coming down substantially toward the end of Q1, though non-Covid care costs simultaneously rose ahead of expectations. About 60% of Cigna’s business is with companies buying insurance for their employees. It also participates in the Affordable Care Act exchanges for individuals, plus the Medicare Advantage program.
- Simon Properties: E-commerce transactions skyrocketed during the pandemic. The question always was: How much shopping would revert to in-person stores once the crisis ended? Well, the crisis is now ending, and shopping malls for their part are seeing a strong demand revival. Simon Properties, an Indianapolis-based operator of shopping malls, speaks of a ““resurgence across the board.” That includes even the restaurants that lease space in its malls. Clothing and footwear tenants are seeing strong demand as well. In some cases though, Simon faces tough negotiations with tenants, some of whom want substantial discounts post-pandemic.
- Banking: “A world without banks may sound to many like a dream. But it could turn out to be more like a nightmare.” The Economist, in a survey on the “Future of Banking,” looks at how new technology, capital markets and even central banks are disrupting the banking sector’s traditional role in the economy. For centuries, banks have provided safe storage for people’s money. And to make money themselves, they take some of those funds held for safekeeping and lend it out, charging interest. In doing so, they’re creating new money—that $1 deposited by Joe the Saver is now also $1 in the pockets of Jane the Borrower. As long as all the savers don’t ask for their money back at the same time, there’s no problem. If they do, well, that’s a bank run, which government central banks were designed to address by providing the bank emergency funds. Today, however, according to the survey, nearly 40% of all loans and securities are held by non-banks. And that percentage is growing. In 2007 global assets of non-bank financial firms stood at $100 trillion. They now stand at $200 trillion. Total assets of the world’s 1,000 largest banks, by comparison, are worth about $128 trillion. “The banking system is smaller, as a share of finance, than it was before,” said JP Morgan chief Jamie Dimon. Why?
- One reason is new technology, and the many startups it’s encouraging. Advances in data science mean collateral isn’t quite as necessary anymore when lending out money. You can simply use algorithms to predict who’s capable of repaying and who’s not (just like Facebook can predict what products people are likely to buy, hence their billion-dollar advertising empire). Princeton’s Markus Brunnermeier describes “an inverse of the information asymmetry.” Now, lenders can predict whether borrowers will repay, often better than borrowers themselves.
- To the extent that collateral does matter—and to be sure it still very much does—many of the modern-day economy’s largest firms don’t really have that much. We’re living, after all, in the “intangible economy,” dominated by companies that don’t hold many physical assets a lender can repossess. For companies like Microsoft and Google, the most valuable thing they own is their intellectual property. Can you repossess that? The result is that such companies, especially when young, rely less on bank debt than they do on equity capital. There’s a reason why the venture capital industry has grown so important in tandem with the rise of Silicon Valley.
- Banks are also finding that many fintech startups are avoiding lending altogether, to avoid the need for a banking license. Instead, they’re “cream-skimming,” or going after the most profitable activities of the banking sector, like managing payments. Also, to their advantage, startups and other non-bank financial institutions don’t have to abide by the same regulations as banks.
- Another threat to the banking business: the ultra-low interest rates prevailing for many years now. In theory, low interest rates, pushed down by central banks, encourage people to borrow, leading to more economic activity and money creation. But according to some scholars, as rates approached zero, banks rebalanced away from deposit-taking and lending, which are interest-generating, to intermediation activities that produce fee income. So the economy sees less bank lending with low interest rates, not more.
- Importantly, The Economist survey discusses what might happen if central banks adopt their own digital currencies, as China is now doing. Already, the declining role of banks is posing challenges for central bankers because financial regulation and monetary policy have traditionally operated through banks. With a digital dollar, people could theoretically keep their savings in a digital wallet for safekeeping, rather than a bank. If banks saw all their deposits sucked away, how could they fund new lending? Would the central bank have to decide who gets to loan out its digital dollars?
- In the same way a government’s digital currency could complicate monetary policy, so could private digital currencies. “Facebook Libra Diem was a wake-up call for monetary authorities,” the survey notes. Because it raised the prospect of citizens using currencies over which central banks had no control. “Parallel payment systems, especially supra-sovereign ones, threaten the usual channels for monetary policy, which run through the banks.”
- The survey makes clear that banks have major shortcomings that technology, non-bank competition and digital currencies could help countries address. In the U.S., 7m households are unbanked, relying on check-cashing firms, pawnshops and payday lenders. Banks can be slow and expensive. They often make more money from trading and fees, not normal banking. Negligent banks can create boom-and-bust cycles that inflict economic hardship. But banks also play a vital role in the economy. And that role is diminishing, leaving big questions.
- Housing: Ed Pinto, director of the AEI Housing Center, says the Fed is focusing on the wrong measurements of inflation. The personal consumption expenditures (PCE) index, he said on a Housing News podcast, has risen 16% since 2012. But housing prices, even at the lower end of the market, have risen more like 100% since then. He thinks it’s inappropriate in other words, to maintain a stimulative monetary policy in the face of so much housing inflation. The result: First-time home buyers are squeezed out of the market, total homeownership rates fall and people have to settle for lower-quality houses. The central problem, according to Pinto, is that the “United States has a massive problem with lack of supply.” It likely has the lowest housing supply ever, in fact, relative to demand. Credit easing, he insists, only makes things worse in such a market. Put another way, the Fed is stoking additional demand in a market already short of supply, turbocharging prices. During the 2008 housing crisis, he explains, people would “drive until they qualify,” referring to the practice of moving farther and farther out into the exurbs until land was cheap enough to get a mortgage and afford a home. That’s harder to do today for various reasons. But also today, there’s the new phenomenon of remote working, where people from Silicon Valley are bringing their $130,000 median salaries to places like Phoenix, driving up prices there. Wages, in other words, are still tied to specific geographies but incomes are increasingly not.
- Autos.com, based near Los Angeles, made an interesting point during its Q1 earnings call. “As both the used and new car market become less affordable,” said CEO Lev Peker, “drivers are keeping their cars longer, which results in increased maintenance and repairs.” The company separately estimates that less than 5% of Americans buy their car parts online.
- Interest Rates: It’s the question everyone is asking: With prices on the rise, when will the Fed start raising rates again, or at least start winding down (“tapering”) its monthly purchases of government and government-backed securities? Economist Phil Suttle, speaking on the Macro Hive Conversations podcast, expects something to be announced at the Kansas City Fed’s annual Jackson Hole event this summer. It will likely start in Q4, he guesses, with reducing or ending the purchase of mortgage-backed securities; It’s quite irresponsible, Suttle thinks, to be buying such assets while the housing market is so hot.
- On the big inflation question, he seems mostly unworried—goods prices will rise, yes, but prices in the service sector should remain stable. He does highlight one inflationary trend that The Wall Street Journal and others have identified: The shift away from just-in-time (JIT) inventory management, which is cost-efficient but vulnerable to the sort of supply shocks now rampant. It’s also harder to run a JIT operation with ships and containers in short supply. So businesses will likely hold more inventory than in the past.
- The supply side will also be constrained by China’s increasing propensity to not just produce but consume as well. Its shrinking and aging demographic trend is another factor affecting its future ability to provide labor and output.
- Suttle is separately hopeful of an end to a decade in which corporate boards felt compelled to buy back equity, paranoid about underperforming their peers in the stock market. This behavior was influenced, he said, by the troubles of GE, which invested in real assets and wound up dramatically underperforming other stocks. The 2020s might look more like the 1990s though, meaning more investment in assets other than mere financial securities. With demand throughout the economy rising, companies are increasingly rewarded for growing their businesses rather than just promises to return cash to shareholders.
- Interest Rates: One common way to measure inflation expectations: Look at the path of Treasury rates that the market expects to prevail over time (the forward curve) and compare them to the path for inflation-protected Treasuries. At the moment, the comparison implies that people do expect higher inflation for the next two years but a more stable outlook five and ten years into the future.
- Labor: The big jobs report everyone talks about each month concerns just non-farm jobs. Which is fine because today, fewer than 3m Americans are employed in agriculture. In 1950, when the total U.S. population was much smaller, the figure was 7m, according to the St. Louis Fed. In 1930, a full 30% of the entire American workforce was in agriculture. In 1880 it was 50%.
- Monetary Policy: All eyes were on Richard Clarida as he spoke last week. The Vice Chair of the Fed’s Board of Governors was a guest speaker at a virtual event hosted by the National Association of Business Economists (NABE). He did express surprise that last week’s CPI inflation numbers were as high as they were. But just as with the surprisingly dull employment numbers from the week prior, he downplayed the significance of any individual monthly reading. Clarida didn’t veer from the Fed’s central messages, most importantly that 1) the current rise in prices should be temporary and 2) that the job market remains far from recovered. In fact, he said, at the current pace of job gains, it would take until August of 2022 to restore employment to pre-pandemic levels. The current unemployment rate adjusted for participation, he added, is closer to 9% than 6%. The Fed, it’s clear, is heavily influenced by the experience of the late 2010s, when employment, wages and participation kept rising without any meaningful impact on inflation. As for inflation expectations, Clarida doesn’t put too much stock in any individual measure, but he does monitor a variety of gauges. And nothing in any of his data worries him right now. If anything, he’s encouraged by the sharp gains in worker productivity seen during the pandemic—rates about twice what they were pre-pandemic. If that persists (a big if), prices will fall, not rise. In any case, Clarida cautioned that reopening a $20 trillion economy after abruptly closing it takes time. Matching workers with companies, in other words, could take longer than some expect.
- Monetary Policy: Not outlooks. It used to be that the Fed adjusted its policies based heavily on future forecasts. Now, under its new policy framework announced last year, it intends to react after the fact—after, in other words, it sees the goals it set reflected in actual data. It won’t start tapering bond purchases, for example, until it actually sees the labor market recover substantially. For Cambridge University Queens’ College President Mohamed El-Erian, that’s a concern. He emphasized the heightened uncertainty amidst major structural changes in the economy. And this uncertainty demands flexibility to “course correct” when necessary, even if its outcomes aren’t quite achieved. He says the Fed’s current framework stems from a psychology formed pre-pandemic, when chronic shortages of demand, coupled with stable supply, merited an outcome-based approach. In this new world of seemingly strong demand and structural changes to supply, “you cannot be pinned in a corner that says ‘I will make up my mind after I see many months of data.’” He goes on: “By that time, if you’re wrong, playing catch-up is really problematic.”
- Monetary Policy: Back on the Fed side, governor Lael Brainard also spoke publicly last week, at an online event hosted by the Society for Advancing Business Editing and Writing. She of course spoke in favor of the Fed’s new approach, stating: “The latest jobs report is a reminder that the path of reopening and recovery—like the shutdown—is likely to be uneven and difficult to predict, so basing monetary policy on outcomes rather than the outlook will serve us well.”
Eds, Meds and Fun
In the Philadelphia metro, nearly a quarter of all jobs are in the education and health care sectors. In Las Vegas, nearly a quarter work in leisure and hospitality. Here’s a look at percentages for a selected group of other U.S. metros.
source: Bureau of Labor Statistics, March 2021 data
- Gary, Indiana: Let’s be frank: The story of Gary, Indiana isn’t a happy one. The city didn’t even exist in the 1800s. Only in the early 1900s did it appear on maps, after US Steel built a factory there. But that was like getting a new Amazon headquarters. It meant plentiful middle-class jobs and an influx of wealth. US Steel, after all, was for a time one of the world’s largest and richest corporations, with links to some of America’s most famous business magnates, most importantly Andrew Carnegie and JP Morgan. Just how important was steel to America’s economy in the first half of the 20th century? It was essential to making cars, planes, railroads, skyscrapers and weapons. Just how important was it to the U.S. Midwest specifically? Pittsburgh has a football team named the Steelers. Gary itself is named for none other than Elbert Henry Gary, a founder of U.S. Steel. The point is, Gary was a Silicon Valley or Austin of its time, its steelmaking essential to running the American economy and winning both world wars. It’s not long after the second world war, however, that the story starts to sadden. Like the textile mills of New England before, the steel mills of the Midwest began losing out to lower-cost foreign competition. At the same time, racial tensions simmered amid an influx of blacks escaping the South for factory jobs in the North; many of these jobs were also filled by eastern European immigrants. As Gary’s black population grew, what followed was a textbook example of white flight to surrounding suburbs, incentivized by laws, regulations and practices affecting the real estate market. Nearby suburbs, furthermore, won state exemptions to incorporate, assuring Gary wouldn’t have access to their tax base. People left. Companies left. Jobs left. Today, African Americans account for nearly 80% of Gary’s 75k people. That 75k is 7% below what it was just ten years ago and about 100k below its peak in the 1960s. As for US Steel, it’s sure enough still the city’s largest employer. But where it once provided more than 30,000 jobs, it now has more like 7,000. The jobs, furthermore, don’t provide the same compensation and social protections they once did. Today, just 2% of the population is foreign-born. Just half of residents own their homes. More than 30% fall below the poverty line. Less than two-thirds of homes have broadband internet. Perhaps nothing captures Gary’s decline than a comparison of downtown photos from the 1950s and today. The city, it seems, will never be the hub of prosperity it once was. But it can be better than it is today. Hope for a turnaround was on display last week, as Gary opened a new $300m Hard Rock casino. On hand for the ceremony: members of the original Jackson Five, brothers of Gary’s most famous if controversial son, the late Michael Jackson. Smartphone manufacturer Akyumen Industries is moving its California-based headquarters to Gary, creating more than 2,000 jobs. Trucking and logistics companies, enjoying the ecommerce boom, are investing in the area given its proximity to Chicago (the downtown loop is just a 40-minute drive away). There’s even good news on the steel front, with Alliance Steel moving its headquarters and processing plant to Gary. Officials in the meantime are prioritizing the removal of the city’s many abandoned and blighted buildings and houses, hoping to attract new residents and businesses. Another priority is developing Gary’s seven miles of Lake Michigan shoreline. The local airport, though it never caught on as an alternative gateway for Chicagoland, has at times attracted some scheduled service to places like Orlando. Much grander hopes lie with the Biden Administration’s plans for infrastructure and family aid, many designed to address the problems of hard-hit places like Gary. Will they make it through Congress? That question aside, Gary simply wants to get past being a metaphor for deindustrialization. As its local government slogan makes clear, it wants to reimagine the city.
- Gary: An update on Gary: In the same week it celebrated its new casino, the city’s government suffered something increasingly and frighteningly familiar: A ransomware attack. It’s where hackers hijack a network of computers and refuse to let anyone back in unless they pay a ransom.
- A Wall Street Journal report highlighted Greenville, South Carolina; Des Moines, Iowa; and Provo, Utah as “rising stars” among U.S. cities. It mentioned Madison, Wisconsin; Fort Myers, Florida; and Columbus, Ohio as well. All have below-average unemployment and lots of incoming residents and businesses attracted by lowish costs and in some cases proximity to larger cities.
- Global Demographics: It’s not just the U.S., Europe and Japan facing a major slowdown in population growth. China is feeling it too. Consider this headline from Reuters last week: “China demographic crisis looms as population growth slips to slowest ever.” Despite a relaxed one-child policy, the country’s population grew just 5% in the 2010s, to about 1.4b. That still makes it the world’s most populous country ahead of India, but probably not for long given a fertility rate of 1.3 children per woman. Indeed, the population might already be shrinking. It’s certainly getting older: The Reuters report says citizens 65 and up accounted for almost 14% of all people, up from 9% in 2010. On the bright side, older societies tend to have less political instability. But the economic risks are daunting. How to fund health care and pensions for so many seniors? How to ensure robust demand given the tendency for seniors to spend less than younger groups? How to ensure sufficient funding for schools when seniors—whose children are finished with school—have outsized political influence (even in non-democratic societies)? China by the way, just like the U.S., Europe and Japan, have particular areas where such problems are already severe. They have, in other words, their own Gary, Indianas (minus the complicated racial relations). China’s rust belt equivalent is its northeast. Southeastern cities like Shenzhen, by contrast, are growing faster both economically and demographically.
- U.K.: With the country still in Covid lockdown during much of Q1, Britain’s economy shrank almost 2%. That’s a big contrast with the 6% growth in GDP that America managed last quarter. According to The Economist, U.K. GDP shrank in January and February but began growing again in March. It added that GDP is still 6% smaller now than it was just before the pandemic.
- Evolution of the mortgage market: One can’t possibly have a good grasp of the U.S. economy without understanding the intricacies of its housing market, worth some $33 trillion today when counting just single-family homes. Almost $12 trillion of this $33 trillion is held as debt, about 80% of that in the form of 30-year fixed-rate mortgages, prepayable anytime. More than 50% of all U.S. bank assets, meanwhile, are mortgage loans. The data comes via Judge Glock of the Cicero Institute, in a discussion on David Beckworth’s Macro Musings podcast. Glock is also the author of a new book called “The Dead Pledge: The Origins of the Mortgage Market and Federal Bailouts, 1913-1939.” It argues that federal programs to support mortgage lending during this period—financial guarantees and the creation of semi-public banks—were even more impactful on the economy than the more widely known New Deal programs like Social Security. For most of the 1800s, it was illegal for commercial banks to provide mortgage loans—it was seen as too risky. In 1916, this started to change as farmers successfully pushed for new federal land banks which were non-profit cooperative associations issuing mortgage loans to local members. These loans were packaged into bonds that were highly popular among investors thanks to their tax exemptions and even more importantly, the implicit guarantee that Washington would repay in the event of defaults. These new banks incidentally became the country’s biggest banks by the end of the 1920s. When many small banks failed in the Great Depression, new home loan banks were created, followed by the birth of the Federal Housing Administration (FHA). Another New Deal era change allowed regular commercial banks to issue mortgages, and the Federal Reserve to buy them to ensure demand. The result, Glock says, was “layer upon layer” of federal support for the housing market. Such measures also created a national market for mortgages and made today’s 30-year fixed-rate product feasible—it almost surely wouldn’t be (they’re very risky) without all the government backing. Today, the private-sector-owned but government-sponsored Fannie Mae is the country’s largest provider of mortgage finance. Glock adds another striking data point from the Richmond Fed, which estimated a few years ago that roughly 60% of the entire U.S. financial market was in some way guaranteed by Uncle Sam. This includes all the mortgage support but also FDIC deposit insurance and other programs. Naturally, all these lending guarantees have led to a big increase in borrowing by Americans. And they contribute to what Glock and others call the “financialization” of the U.S. economy. (For more on U.S. government credit guarantees and their impact, see Econ Weekly’s Jan. 11 discussion on Sarah Quinn’s book “American Bonds: How Credit Markets Shaped a Nation”).
- Crypto Risks: Does cryptomania pose a systematic financial risk? Viktor Shvets of Macquarie thinks it might. Speaking on the Bloomberg Odd Lots podcast, he notes how many of the same people buying Bitcoin and NFTs are also buying Tesla and SPACs and other financial assets that have soared in value over the past year, recent pullbacks notwithstanding. They’ve been buying, furthermore, with lots of leverage, and the size of such investments is starting to look very large. “Those digital assets,” says Shvets, “will be the next crisis.” He more broadly warns about how “financialized” the world economy has become (see mortgage discussion above), characterized by enormous leverage. That makes it more difficult for the Fed to tolerate much volatility, especially with everything in the economy so interconnected.
- What does Viktor Shvets have to say about inflation? He’s not an inflationista. Current concerns about rising prices, he says, stem from outdated “industrial age” models and frameworks. Today, intangible assets account for 60% of U.S. private sector GDP. And intangible assets aren’t as subject to price-inflating capacity constraints. For one, they tend to easily spill over from one industry to another (think of a patent for some artificial intelligence software, which by the way won’t get stuck on a boat in the Suez Canal). Labor too is less rigid than it was, with gig workers and people able to do multiple jobs and tasks thanks to technology. No one’s just a plumber or a carpenter anymore. Capacity constraints, indeed, just “melt away.” Shvets also cites Fed research showing that only 27% of the Covid stimulus money was actually spent, implying a low fiscal multiplier. Government investments, meanwhile, can push prices both up or “If you invest in oil, that’s inflationary. If you invest in lithium, that’s disinflationary.”
- A shift is coming: From around 2000 to 2020, he says, the economy was dominated by companies he calls “digit manipulators.” In the next 20 years, these firms will give way to those manipulating atoms and physical matter, which will be more capital intensive. Reasons include the shift to green energy, the development of robotics, improvements to logistics and the emerging space economy (think Elon Musk sending rockets to outer space). But to Shvets, all of this means the Fed will need to update its economic and forecasting models.
Consumer Price Index (CPI) for selected categories
(source: Bureau of Labor Statistics)