It’s been a while since I stopped writing Econ Weekly. But just wanted everyone to know that I’ve repackaged some of the material in a new book I just published. It’s a detailed look at more than 70 local economies across the U.S. You can read a sample and purchase a copy with Amazon or any other major bookseller. Thanks as always for your support, -Jay Shabat

photo courtesy of www.VisitFayettevilleNC.com

Inside this Issue:

• Are We There Yet? Might the U.S. Economy Already Be in Recession?

• If So, It Doesn’t Show: Ever See a Recession with 3.6% Unemployment?

• Stocks and Bonds Up, Oil Down: A Welcome Break from the Recent Ache

• Cooling Housing: But Some Geographies Faring Better than Others

• A Means to Avert Climate Despair? Removing Carbon from the Air

• Appalachian Calculation: Hoping Prison Jobs Can Replace Coal Jobs?

• 20th Century Fox: How Taiwan’s Foxconn Became Vital to U.S. Manufacturing

• 20th Century Box: How Containers Changed Everything (and Nearly Killed New York)

• And This Week’s Featured Place: Cumberland County, NC, Pentagon South

Quote of the Week

“While the market has cooled, it has clearly not stopped.”

-Lennar executive chairman Stuart Miller, on the current state of the housing market  

Market QuickLook

The Latest

Will there be a recession? Might we already be in one? The gloom is growing.

Fed chief Jay Powell himself, speaking to Congress last week, presented a long list of demons, including high energy prices, ongoing supply chain problems, slowing business investment, a softening housing market, tightening financial conditions, a slumping stock market and of course, intolerably high consumer price inflation. But he also said forcefully: “The American economy is very strong and well positioned to handle tighter monetary policy.” The extremely tight job market attests to that. So do resilient industrial production and consumer spending, even if softening a bit.

The next big clue on where the economy is headed? This week’s release of May inflation data based on personal consumption expenditures (the PCE index). If it reveals signs of inflation cooling, then perhaps the Fed’s next policy move will lean more dovish. If alternatively, May’s PCE inflation figure comes in high, Mr. Powell and his colleagues might feel compelled to squeeze the economy tighter.

Markets for the moment seem to think that future rate hikes could be less aggressive, not more. Last week, stock prices were up, and so were bond prices. Housing prices, meanwhile, are softening in many markets as nationwide sales volumes decline (see the Companies section below). The latest Census data for May showed a 6% y/y decline in new home sales (seasonally adjusted), with severe drops in the Northeast and Midwest balanced by small gains in the West and South. Keep an eye on The National Association of Realtors, which will publish its May data on pending home sales this week (on Monday). They’ve been declining for six consecutive months now. 

Also declining were oil prices, at least last week. The WTI price per barrel fell as low as $104 before ending at $108. They reached as high as $122 earlier this month. A shortage of refining capacity, though, is a separate reason why Americans are paying so much at the gas pump. The Biden administration met with oil producers and refiners last week, seeking ways to boost output.

A few notes from Corporate America: FedEx said it’s ready and able to quickly cut capacity if the economy sours. The battle to buy Spirit Airlines continues, with Frontier upping the ante in a bid to curtail a hostile attempt by JetBlue. Citadel Securities became the latest company to move its headquarters out of Illinois, following Caterpillar and Boeing. Chevron, for its part, is moving more of its operations from California to Texas. CarMax, the auto dealer, spoke of growing demand uncertainty tied to higher borrowing costs, vehicle affordability and overall inflation. Kellogg’s, best known for breakfast cereals like Froot Loops and snacks like Pringles, will split into three separate companies. Carnival, a leading victim of the pandemic, is now seeing strong sales for “close-to-home” cruises, buttressed by “tremendous pent-up demand.” Netflix, a leading beneficiary of the pandemic, is now laying off workers. The large Minneapolis-based adhesives manufacturer H.B. Fuller expressed the sentiment of many American companies right now: “Looking ahead, our planning assumptions and guidance are built on an expectation that demand will weaken, although we have yet to see signs of any meaningful slowdown in our underlying demand from customers.”

The latest read from purchasing managers, as surveyed by S&P Global, shows slowing momentum in manufacturing output: “Weaker demand conditions, often linked to the rising cost of living and falling confidence, led to the first contraction in new orders since July 2020.” The report also noted a sharp drop in exports as a strong U.S. dollar makes American products more expensive abroad.

We’ve almost reached the halfway point of 2022. It’s been quite an adventurous first half for the U.S. economy, characterized chiefly by ongoing supply-side difficulties but solid if somewhat softening demand. A first-quarter GDP contraction surprised many, though its true representation of the economy’s health is suspect. A shrinking economy, after all, isn’t typically associated with an unemployment rate below 4%. If there was a single defining characteristic of the year’s first half, however, it was the scourge of inflation, and the Fed’s determined effort to defeat it. This entailed a sharp reversal in monetary policy, headlined by three consecutive interest rate hikes, each one greater than the last. Markets reacted forcefully—stocks plummeted, borrowing costs spiked (especially for home mortgages) and speculative Covid-era excesses imploded (crypto-coins, NFTs, SPACs, meme stocks, electric vehicle IPOs and stay-at-home beneficiaries like Peloton, a latter-day Pets.com). Any list of top developments in the first half of the year, of course, must include what happened in the oil market, with prices racing from below zero early in the pandemic to well above $100 currently. That alone is cause for alarm, and concern that the second half of 2022 might be even more turbulent than the first.

Companies

·   Lennar and KB Home: Two of the country’s largest homebuilders reported earnings last week, providing an update on the state of the always-crucial housing market. Their general sense was that it’s cooling in response to sharply higher mortgage rates and pressure on household finances from consumer price inflation. But “while the market has cooled,” said Lennar, “it has clearly not stopped.” Demand, it explained, “remains reasonably strong,” supported by rising household formation. Home prices, to be sure, remain high on a y/y basis. And “supply remains limited across the country,” with the need for affordable workforce housing at “crisis levels.” Indeed, “production of dwellings over the past decade has lagged prior decades by as many as 5m homes.” Lennar detailed which specific markets continue to be strong, namely Florida, New Jersey, Maryland, Charlotte, Indianapolis, Chicago, Dallas, Houston, San Antonio, Phoenix, San Diego, Orange County and the Inland Empire (the latter three in California). “All of these markets are benefiting from extremely low inventory, and many are benefiting from a strong local economy, employment growth and in-migration.” Seeing more of a slowdown are Atlanta, Colorado, Charleston, Myrtle Beach, Nashville, Philadelphia, Virginia, the San Francisco Bay Area, Reno and Salt Lake City. “While inventory is limited in each of these markets, we’ve had to offer more aggressive financing programs and targeted price reductions.” Finally, there’s more “significant market softening and correction” underway in Raleigh-Durham, Minnesota, Austin, Los Angeles, California’s Central Valley, Sacramento and Seattle.

Tweet of the Week

Sectors

·   Software: Tech and venture fund billionaire Marc Andreessen, a recent guest on the Econ Talk podcast, highlighted one of the most important realities about the modern U.S. economy—that software really has eaten the world, to use his phrase, but in some sectors much more than others. By just typing into a keyboard, he marvels, things suddenly change in the real world, like when using an app to hail an Uber, or ordering something on Amazon. But while software has brought dramatic change to media, entertainment, communications, advertising and retail, it’s done much less for health care, education, housing, government administration and law. Unfortunately, these categories—where software hasn’t done much to boost productivity—account for the lion’s share of U.S. GDP. These categories, furthermore, are heavily influenced by supply distortions and demand distortions alike. On the supply side, Andreesen mentions “monopolized cartels” like the system that credentials universities. And with respect to demand, the federal government subsidizes or insures home mortgages, student loans and health care. Rana Foroohar of the Financial Times made a related point on the Ezra Klein podcast, warning that just because consumer prices have dropped for four decades, not everything was fine. “The problem is that a cheaper TV doesn’t make up for the fact that all the things that make us middle class—education, health care, housing—are rising at multiple times core inflation rates for decades now.”

·   The Prison Economy: If Kentucky were its own country, writes Judah Schept, it would have the seventh highest incarceration rate in the world. Schept is the author of “Coal, Cages, Crisis: The Rise of the Prison Economy in Central Appalachia.” Speaking on the New Books Network podcast, he explains how rural communities have turned to prisons as an economic development tool in the wake of lost coal mining jobs. At its height around 1950, coal mining employed more than 70,000 Kentuckians. Today, the number is more like 3,000, the lowest it’s been since the 1890s. In Eastern Kentucky alone, there are eight prisons (not counting local jails), most of them built in the 1990s and 2000s. Prison jobs statewide amount to about 6,500 today, which is more than double what coal miners employ but still a shadow of coal employment during its heyday. By building more prisons, local communities in central Appalachia also qualify for more state and federal dollars directed to roads, water projects, health care facilities, and so on.   

Government

·   Defense: In April, the Brookings Institution hosted a talk on defense spending in the U.S., and how it affects local economies. Though spending could reach nearly $850b next year, that would still be just 3.5% or so of total U.S. GDP. That compares to 9% of GDP at the height of the Vietnam War during the 1960s, and 7% during President Reagan’s Cold War arms buildup in the early 1980s. A sizeable portion of federal money for defense is spent at bases, including Fort Bragg as described in the “Places” section below. Other giant bases include Fort Hood north of Austin, Fort Campbell northwest of Nashville, the Lewis-McChord base south of Seattle and Fort Benning near Columbus, Georgia. Naval yards like those in Connecticut and coastal Virginia get a lot of defense dollars as well. Of the money not spent for salaries and health care for military personnel, much goes to contractors led by Lockheed Martin, General Dynamics, Boeing and Raytheon. As panelist John Ferrari explained, the U.S. Army, Navy and Air Force are actually shrinking even as the defense budget increases. That increase is mostly because of nuclear weapons modernization, and also because of inflation. There’s also a shift underway from spending on procurement to spending on research and development, with lots of defense-relevant innovation happening outside of the defense sector (at Silicon Valley tech firms, for example). There’s been a big increase in military construction spending, for building shipyards, barracks, depots and arsenals, etc. Waste and inefficiency are undoubtedly issues. So is difficulty recruiting new soldiers and sailors in the current job market. Texas, by the way, is now the number one state for federal defense spending, in part because of its contracts related to the F-35 jet program. As a percentage of state GDP, Virginia ranks first at 11% (it’s home to both the Pentagon and the Norfolk Navy base), followed by Hawaii (9%), Connecticut (8%) and Maryland (7%). Oregon is at the opposite end with only 0.7% of its GDP liked to defense dollars from Washington.

Places

·   Cumberland County, North Carolina: When you’ve got an emergency, call 9-1-1. When the President of the United States has an emergency, he calls 9-1-0. That’s the area code for Fayetteville, North Carolina, home to the U.S. military’s XVIII Airborne Corps, along with the 82nd Airborne Division. At any moment, when duty calls, teams of highly trained soldiers are ready to deploy anywhere on earth within hours, by land, air or sea. They’re based at Fort Bragg, which happens to be the largest military base in the world, housing not just the Airborne Corp but also U.S. Army Special Forces Command—think Green Berets and the Delta Force. Fort Bragg is in fact headquarters for the entire U.S. Army Force. The Air Force has a presence there as well and, all told, some 50,000 active-duty military personnel are stationed at Fort Bragg. Include family members, along with Defense Department officials, military retirees and military contractors, and Fort Bragg’s population reaches something like a quarter of a million people. No wonder why some call it “Pentagon South.” Naturally, the fort shapes the economy of Fayetteville and the surrounding areas of Cumberland County. The federal dollars paying for military wages alone is enough to support service businesses throughout the county, to speak nothing of the area’s 850-plus military contractors. According to the Fayetteville-Cumberland County Economic Development agency, the community benefits from roughly $1.5b to $2b worth of military contracts per year. That makes for less cyclicality. The giant military footprint, furthermore, makes Cumberland the fifth most populous county in North Carolina, itself the ninth most populous state in the U.S. The base first opened in 1918, at the end of World War I. It grew sharply during the subsequent World War, followed by the wars in Vietnam and Korea. The pace of growth slowed in later decades. But periodic base realignments mostly resulted in more responsibility for Fort Bragg, not less. A 2005 realignment put Pope Air Force Base within its command. That’s also when the U.S. Army Forces Command and the U.S. Army Reserve Command were relocated there. More recent Pentagon moves have added new units, while concentrating more of the Army’s leadership and special forces there. That has Cumberland County forecasting healthy population increases for the coming decade, having grown about 5% last decade. Unsurprisingly, Cumberland County has more veteran-owned businesses than almost anywhere in the country. But it also has—according to economic development officials—the highest percentage of Black-owned businesses anywhere in the country. Black home ownership is relatively high as well. That’s consistent with the military’s history of being an important force for black economic and social empowerment, dating back to President Truman’s integration of the military after World War II, a move deeply unpopular in much of North Carolina at the time. Today, roughly 40% of Cumberland County’s residents identify as Black or African American. More than 12% identify as Hispanic. And while only 6% are foreign born (compared to 14% nationwide), the area has an international feel given the military’s global responsibilities—there are 85 languages spoken in the local school system, including mother tongues from places like Afghanistan and Iraq where the Army has had extensive deployments. There remains, however, high levels of economic distress around Fayetteville despite all the Pentagon dollars pouring in. The county’s poverty rate is close to 20%, compared to 13% nationally. College attainment is below the national average. The area, to be sure, hasn’t seen the same sort of explosive economic growth taking place in North Carolina metros like Charlotte (with its banking), Raleigh-Durham (with its elite universities and booming IT sector) and Asheville (with its tourism and retirees). But at least it’s adding people, which is more than you can say for about half of North Carolina’s 50 counties. Fort Bragg aside, Cumberland County’s health care and education sectors employ about a quarter of the local workforce. Amazon is building two distribution facilities, lured by Fayetteville’s location along busy Interstate 95, midway between New York and Miami. The Norfolk Southern and CSX railroads run through. The deepwater port of Wilmington is not far. Goodyear Tire, Campbell’s Soup and Cargill are among the manufacturers with production or distribution facilities in the county. Booming Raleigh is about a 1.5-hour’s drive north, close enough for about 4,000 Cumberland residents to commute to jobs there each day (efforts are underway to establish an Amtrak link). The Fayetteville airport, meanwhile, though small, actually gained new flights during the pandemic, a testament to the economy’s relative resilience during the pandemic, aided by the steady flow of Pentagon dollars. To be clear though, the pandemic did hit hard, especially in the service sector. Another challenge for local businesses is competition with the military base, which features its own entertainment and other facilities catering to troops and their families. In addition, the base, along with other big employers like hospitals and colleges, are exempt from taxation, straining local government resources. A challenge for the housing market is the transient nature of military personnel, who often remain at a given base for only a temporary period. On the other hand, a large nearby military base implies a young demographic overall, and many retirees with unique skills. Robert Van Geons, President and CEO of Fayetteville-Cumberland County Economic Development, is leading the charge to recruit more residents and businesses to the area. Golfing and nearby parks help with attracting retirees—the mild winter weather doesn’t hurt either. Efforts are underway to improve broadband infrastructure. Downtown Fayetteville is seeing more investment. Crypto mining, notwithstanding the sector’s current troubles, is prevalent in the county. It’s the Pentagon though, that dominates the economy. (Sources: Fayetteville-Cumberland County Economic Development, HUD, U.S. Census, Department of Defense, US Army).

·   Corpus Christi: Los Angeles and Long Beach in southern California constitute America’s busiest container port complex. It’s not even close. But that’s just containers. Looking at overall revenue tonnage for all goods and commodities shipped, the nation’s busiest port (in 2020) was in Corpus Christi, Texas. Why is it so busy? In large part because of energy shipments. In 2015, the U.S. lifted its ban on exporting crude oil, much of which has since flowed out of Corpus Christi. The city, located along the Gulf of Mexico, separately attracts a lot of tourists to its beaches. There’s a Naval Station and Army Depot there as well.   

Abroad

·   Foxconn: A recent episode of the Bloomberg “OddLots” podcast talked about the Taiwanese company Hon Hai, better known as Foxconn. It’s one of the most important companies in the world as far as the U.S. economy is concerned, second perhaps only to Taiwan’s semicon powerhouse TSMC. “If Foxconn or TSMC were to disappear from the face of the earth overnight,” said Bloomberg Opinion columnist Tim Culpan, “we’d be in a lot of trouble because nobody can do what these companies can do.” Host Joe Weisenthal adds: “It’s hard to understand the world over the last decades without understanding the trajectory of Foxconn.” The company was founded in the mid-1970s by entrepreneur Terry Goh, one of the first to recognize the potential of manufacturing in China—Shenzhen more specifically—with its huge pools of cheap labor. Goh began producing low-cost plastic items and moved into connector cables linking, for example, PCs to printers. The “conn” in Foxconn refers to these connectors. Next came components for personal computers, winning clients like Dell and HP in the U.S.—this was the 1990s, when American firms began outsourcing production to Asia. One of these firms was Apple, which was producing its Mac computers in California at the time. When returning CEO Steve Jobs and his chief operating officer Tim Cook were ready to produce the iPod, however, Apple too was looking to Asia. Foxconn would be its key iPod supplier, later providing components and assembly for iPhones and iPads. By 2010, Foxconn had about 1m employees, many working on Apple products. Even today, 70% of all Apple iPhones are made by Foxconn, creating a mutual dependence—an “unhealthy co-dependence,” Culpan suggests. About half of Foxconn’s $215b in annual revenue comes from Apple. Now, the Taiwanese company wants to enter the electric vehicle space, hoping to turn EVs into something like PCs on wheels.

Looking Back

·   Container Ships: A Wall Street Journal article about the Russian military’s use of railroads featured a reference to the U.S. military’s use of container ships during the Vietnam War. In 1965, a buildup of U.S. troops in the Asian nation came with the challenge of having to supply all those troops. “Supplies piled up on the shores of the embattled country, and ships were waiting weeks to unload.” Along came American shipping entrepreneur Malcolm McLean, who had led development of the standardized shipping container almost a decade earlier. As the article explains, McLean persuaded the Defense Department to adopt his innovation, risking his own money to build a container terminal at Cam Ranh Bay. Said Marc Levinson, author of “The Box”: “In pretty short order, containers solved the military’s problems. It really transformed the ability to fight the war.” It also sparked demand for use of containers in the private sector, revolutionizing world trade by dramatically lowering costs. Containerization, as “The Box” recounts, also revolutionized urban economies, wiping out the labor-intensive dockworker trade in cities like New York and San Francisco. Indeed, the loss of huge numbers of low-wage dockworker jobs was a major reason for New York’s financial troubles in the 1970s. Before container ports, linked to highways and rail lines, most factories needed to be close to the seaport, which is why so many of them were in New York City. In 1964, according to Levinson, the city’s five boroughs were home to some 30,000 factories employing 900,000 workers. But between 1967 and 1976, New York lost a fourth of its factories and a third of its manufacturing jobs. The shipping container is not entirely to blame, of course. Nor was it the only reason for the port’s demise—it also suffered from aging docks, labor strife, corruption, the opening of the St. Lawrence Seaway and the shift of America’s industrial base away from places like Buffalo to places in the Sun Belt.

Looking Ahead

·   Carbon Removal: Getting off fossil fuels is proving more difficult than some imagined. Despite untold billions in research into alternatives, it’s still hard to beat the economics of oil and natural gas when it comes to making everyday fuels and products that power the modern economy. The effort, however, continues. A recent Wall Street Journal article looked at one potential solution to climate change that doesn’t involve a substitution for fossil fuels, but rather a means to remove carbon pollutants from the air and store them permanently underground. As the Journal describes, some are calling carbon removal technology the “hottest sector in climate finance.” Indeed, billions in commitments are pouring in, “turning carbon removal into a hotbed of technical and financial innovation.” Google and Meta are among firms that have promised to purchase energy whose emissions are removed from the atmosphere, creating a big incentive to devise technology that works. The idea borrows from vaccine development, where companies that produce a successful one are rewarded heavily with guaranteed sales. Carbon removal is distinct from carbon capture, which involves grabbing the carbon not from the air but at the site of its production, i.e., a factory smokestack. Carbon removal is tougher because the pollutants are dispersed throughout the atmosphere. It’s also at this stage still an immature and cost-prohibitive process. Occidental Petroleum has one of the most ambitious carbon-removal plans, with an intent to spend up to $1b on a direct-air-capture facility with Canadian startup Carbon Engineering. The facility would bury some of the carbon underground and use some to produce oil. Airbus agreed to purchase carbon credits linked to the project, and United Airlines is among its investors.

·   Geoengineering: Looking for ideas even bolder and more speculative than carbon removal? One is an attempt to cool the earth by reflecting more sunlight back to space. It’s called geoengineering. A website called “Futurism,” meanwhile, ran this headline last week: “MIT Scientists Want to Put a Barrier Between Earth and Sun to Fight Climate Change.” Included was a sub-headline: “What, Like You Have a Better Idea?”   

Dear Reader,

I regret having to write this but sadly, I’ll be ending publication of Econ Weekly after the next issue is published this weekend. Ultimately, EW didn’t generate as much interest as I hoped. In addition, I was unable to find a good partner with digital marketing skills to help me promote it. I’ve decided to allocate more time to my Railroad Weekly newsletter, while also returning to my earlier profession of writing about the airline industry.

To paid subscribers of Econ Weekly on an annual plan: First of all, I greatly thank you for your support and readership. I hope you enjoyed reading the newsletter as much as I enjoyed writing it. Be assured that I’ve already issued refunds for the remainder of your annual subscriptions. Please check your credit card statements in the next week or two and be sure to inform me if you don’t see the refund. Auto-renew for monthly subscribers has been deactivated.   

Thanks also to non-subscribers who’ve taken the time to trial Econ Weekly. I hope I was able to provide some useful and interesting insights into the U.S. economy during the past year and a half. I certainly learned a ton while writing it, and especially enjoyed researching the Places section, where I profiled a different local economy each week. It was great talking to economic developers and other local leaders to learn about all the amazing things going on across the U.S.

I will leave the Econ Weekly site active on Substack if anyone wishes to access old issues and podcast episodes. I may periodically add new content to the site as well. A special thanks to Andrew Young who graciously agreed to do the weekly podcast with me. We haven’t decided yet whether we’ll keep going with that but there will be at least one more episode so stay tuned!

Thanks again to everyone and email me with any questions or issues with refunds. I always love to chat about the economy (and railroads and airlines) so don’t hesitate to reach out at jay@railroadweekly.com. Also be in touch if you’ve got digital marketing skills (or a railroad background) and are looking for work! -Jay

Inside this Issue:

• Quarters of Magnitude: Fed Dials Rates Up with Three-Quarter Jump

• Muskerade: A History of Tesla’s Turbulent Rise

• A New Era? A Four-Decade Trend Comes to an End. Maybe

• Up In Claims: What to Do About Sunshine State’s Insurance Rates

• Ivy Leaks: College Endowments and Offshore Tax Havens 

• Pension Apprehension: Economists Discuss Fiscal Future of Social Security

• And This Week’s Featured City: Detroit, Michigan, The Rise, The Fall, The Attempted Revival   

Quote of the Week

“If you want to get inflation under control, while minimizing the impact on growth, what you need to do is get Saudi Arabia to increase oil production, get Russia to allow wheat out of Ukraine and get Taiwan to produce more semiconductors so we can get auto production back online. And the last time I checked, chair Powell, powerful though he is, doesn’t have instruments to do any of these things.”

-Bloomberg’s Tom Orlik, speaking on the Bloomberg Stephanomics podcast

Market QuickLook

The Latest

“The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points.”

Wait a minute, the Fed lowered rates by 75 basis points? The statement is not from last week but from 14 years ago. It was the spring of 2008. Financial markets were increasingly stressed. The economy was clearly slowing. And “the inflation news,” as one committee member said, “has also been disturbing.” Another observed: “Household survey measures of expectations for year-ahead inflation jumped in March to their highest levels in about two years.” By August that year, oil prices had reached far above the $100 mark, lifting the consumer price index to a 5.6% annual increase. So much for the Fed’s 2% target. Alarm bells rang.  But the Fed’s chairman at the time, Ben Bernanke, resisted calls to raise rates.

He made the right call. Five months later, annual CPI inflation was down to 0.1%. The economy had crashed, and oil prices along with it.

Fast forward to June 2022. Faced again with stressed financial markets, a weakening economy and discomforting levels of inflation, chairman Jay Powell and his FOMC colleagues voted to raise rates by 75 basis points. The economic backdrop, to be sure, is very different now. The economy is much healthier than it was in mid-2008, and inflation much worse. There is no housing bubble and no consumer credit crunch—just the opposite, in fact, with home equity at record highs and household balance sheets strong. Will Powell—like Bernanke 14 years earlier—be proved right?

Clearly, the Fed was spooked by the May CPI figures released a week earlier. It was hoping for signs that inflation was easing and got just the opposite. The latest read on inflation expectations, meanwhile, was similarly unsettling. And so, the Fed went with the three-quarter point hike, following a half-point hike at its previous meeting, and a quarter-point hike at the meeting before that. The FOMC will next meet again in late July, and Powell says another half- or three-quarter point hike is most likely. On the other hand, he said: “Clearly, today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common.”

Make no mistake, the Fed’s tighter monetary policy—the three successive hikes alongside balance sheet contraction—is working as intended. Perhaps most importantly, borrowing to buy a home has become significantly more expensive, with 30-year mortgage rates now approaching 6%—they were below 3% a year ago. Housing sales, if not prices, have thus plummeted. It’s become more expensive for the U.S. government to borrow as well—the 10-year Treasury note now offers lenders a 3.25% yield—that was 1.45% a year ago. The Fed’s moves, furthermore, have sent a chill through stock markets, sending the S&P 500 index down 12% from where it was this time last year. The crypto bubble popped. Labor markets are cooling. Corporate earnings are starting to show signs of strain. Ford, for one, says auto loan delinquencies are on the rise. And the latest retail sales report last week showed a 0.3% decline from April to May. Exclude spending at gas stations and the decline was 0.7%. Powell, by the way, said this was one of the most important reports he looks at.

There’s no ambiguity. The economy is slowing. But enough to cool inflation? Maybe, but not necessarily. The strong job market, healthy household balance sheets and still-solid corporate profits (including those from the booming commodity sector) might just be enough to sustain upward price momentum. In the meantime, the Fed’s aggressive tightening hasn’t been enough—at least not yet—to break the oil market. Prices did drop last week, to $110 per barrel from $121 the week before. But severe shortages of refinery capacity have gas prices still dangerously elevated. The Fed’s actions, furthermore, have done little to ease the semiconductor shortage (especially hurtful to the auto sector). They’ve done little to ease infrastructure bottlenecks (moving goods by rail, for example). They’ve done little to stem rising rents. If however, the Fed measures do continue to weaken demand throughout the economy, markets of all types could quickly reset.

In fact, this was a point Powell made. Supply didn’t or couldn’t react to last year’s sharply higher demand, causing the current price surge. But conversely, supply might not react to this year’s falling demand, which could make prices fall just as fast as they dropped. Oil prices, of course, have a habit of plummeting unexpectedly, as events from 2008 (not to mention 2014) made clear. Remember too that the last bout with inflation in the 1970s lasted so long because the Fed didn’t do anything about it until Paul Volcker came along a decade later. Mr. Powell might be a bit behind the curve, but not that far behind.

The point is, the Fed is determined to stop inflation with whatever it takes. That’s hopefully a soft landing, perhaps aided by declining oil prices but—if necessary—a recession. Its own forecasts, by the way, expect GDP growth of just 1.7% this year, down from the 2.8% growth it forecasted in March. It sees 1.7% growth next year too. Powell insists the economy remains healthy, with consumers in good shape and lowly consumer confidence mostly tied to rising gas prices.

Looking longer term, more economists are talking about the end of an era. For four decades, stock prices, bond prices and housing prices marched steadily upward, while goods prices steadily declined. Some ascribe the trend to easy money, loose Fed policy and macroeconomic forces like globalization, a positive Chinese labor supply shock, faster communications and cheaper container shipping. Now, it’s asset prices that are falling and goods prices that are rising, amid tighter Fed policy and a rash of negative supply-side shocks. The start of a new longterm trend?

As the answer to that question slowly unfolds, pay attention to a parade of Fed speeches this week. Chair Powell himself will testify before Congress, taking questions from legislators. This week also brings a few notable earnings calls, from FedEx, Accenture, Darden Restaurants, CarMax and the homebuilders Lennar and KB Home. Chrysler’s European parent company reports as well.  

Companies

·   Ford and General Motors: Detroit’s two largest automakers, both earning solid profits these days, each presented at the Deutsche Bank Global Auto Industry conference last week. Both companies said demand continues to be robust, though Ford did mention that payment delinquencies at its credit division are starting to increase, perhaps a leading indicator of some demand distress. But as Ford points out, if a recession were to come, it would enter from a position of strength, characterized by low inventories and minimal need for incentive pricing. Both manufacturers, meanwhile, continue to see cost pressures and production challenges, including higher commodity prices, disruptions at Chinese suppliers and a shortage of semiconductors.  Interestingly, Ford said its new Mustang Mach-E electric car was profitable until commodity costs spiked. More importantly though, it expects a new generation of EVs to be solidly profitable once they start arriving in about four years. Not only will they be more cost-efficient, especially when produced at scale. But they’ll also generate more software and service revenues (subscriptions to in-car entertainment, for example, or upgrades to better driving features). GM said it’s taking lots of new orders for EVs but doesn’t want to lock in prices given the uncertainty of its future costs. It plans to produce 400,000 EVs in North America this year and next, and 1m by 2025. Ford insists it has all the supplies and materials it needs to build 600,000 EVs through the end of 2023 (for context, it delivered nearly 3m total vehicles in 2019). One big question is the future role of dealerships—Ford for its part sees them as an asset, providing important customer support that Tesla lacks (GM likely feels the same). Nevertheless, it’s being “very selective” in choosing which dealers can sell its Mach-E. Another question is EV advertising, where Ford is taking a more Tesla-like approach—Tesla basically doesn’t advertise at all, relying on its software to communicate and engage with customers. Unlike Ford, GM doesn’t have plans to split its company into two divisions, one for EVs and one for internal combustion vehicles (Ford will rely on profits from the latter to fund development of the former). In other matters of interest, Ford is considering equity stakes in even mining companies to secure its supply chain. Both firms are evaluating different battery chemistries. And both are developing EVs for the business market, as well as EVs with autonomous driving capability.

·   Commercial Metals Company (CMC) is the largest North American manufacturer of steel reinforcing bar (“rebar”), a critical input for construction. Based in the Dallas-Fort Worth Metroplex, CMC sees no signs of a demand slowdown. On the contrary, it expects demand to remain strong and even grow in the years ahead, for three reasons. First is the new infrastructure bill. Second is the boom in Sun Belt single-family residential communities, which will boost the need for nearby roads, wastewater treatment, water supply, schools and shopping centers. The pace of single-family housing starts has slowed, it admits, but in the South, they’re still up more than 30% from 2019 and early 2020 levels. Finally, there’s the tailwind from industrial reshoring. CMC points to the “massive scale and pace of construction of new semiconductor facilities.” There are five such projects now underway in the U.S., including two each in Arizona and Texas. Management sees other industries growing domestic facilities as well in response to ongoing supply chain disruptions. “We have all learned over the last three years that global supply chains are more fragile than previously believed, and the loss of a few critical inputs can have a significant cascading effect throughout the economy.” CMC also mentioned that “offices and hotels are two market sectors that many had assumed would take years to recover if ever, but both are now making a comeback.”

·   Kroger, the country’s largest supermarket (with 420,000 employees), said rising inflation has customers “rethinking their shopping and eating habits.” Americans, for one, are cooking more of their meals at home, after briefly returning to restaurants after the pandemic eased. More budget-conscious customers, Kroger said, “are actively looking for ways to save.” One random fact that came up in the company’s earnings call: Kroger is the nation’s largest florist. Remember that when Valentine’s Day comes around.

Tweet of the Week

Sectors

·   Higher Education: It’s one of the notorious “Three H’s”—along with health care and housing—where market distortions and failures are rife. And it’s the topic of Charlie Eaton’s book: “Bankers in the Ivory Tower: The Troubling Rise of Financiers in U.S. Higher Education.” Appearing on the New Books Network podcast, Eaton explains how student loans were not always a significant factor in financing college. In the 1970s, he said, only one in eight graduates had any student debt. But things started to change after the harsh recession of the early 1980s. With jobs in short supply, college enrollment jumped, swelling federal expenditure on Pell grants. Congress subsequently slashed Pell grant spending, opening a door for bankers. By the early 1990s, banks were selling the idea of borrowing money to pay for school. And by 2010, student loan borrowing had quadrupled. Eaton separately spoke about the role of university endowments, which are pools of donated money, typically by alumni. For top schools these endowments have become enormously large thanks to successful investments and—according to an investigative report by The New York Times—controversial use of offshore tax havens. More specifically, the Times revealed that dozens of wealthy college endowments use Caribbean islands to cut their tax bills. Eaton explained that while college endowments are already tax exempt, they’ve increasingly worked with private equity and hedge funds, borrowing additional money to invest. And profits from these investments are in fact taxable because they’re not directly related to education. So there’s incentive to hide those profits in tax havens. Eaton says: “Private colleges and universities have increased their endowments spectacularly through aggressive fund-raising and these kinds of investment and tax-avoidance techniques.” He cites the example of California’s Stanford University, which used offshoring to help boost its endowment from $2b in 1977 to $18b in 2012. Over the same period, Harvard’s endowment grew from $6b to $32b. What’s the problem, besides depriving the public of tax dollars? Eaton says most of this endowment money benefits just a tiny elite. In Stanford’s case, it still only enrolls about 1,600 new freshmen every year, approximately the same number it enrolled annually in the 1970s. According to Stanford economist Raj Chetty, the top 38 private U.S. colleges today enroll more students from the top 1% of the nation’s income spectrum than from the bottom 60%. The point: That America’s best universities have become ultra-elite institutions, using their enormous wealth to educate just a tiny fraction of Americans. Here again is another manifestation of America’s shortage economy: too few workers, too few houses, too few port facilities, too few competitors in many industries, too few alternatives to fossil fuels … and yes, too few enrollments at top universities.

Markets  

·   Property Insurance: “Florida’s property insurance market is collapsing.” So says Mark Friedlander of the Insurance Information Institute, echoing many others as state residents see a surge in the cost of insuring their homes against damage. In the past three months, according to the “Sunshine Economy” podcast episode that aired in May, three Florida insurance companies have declared insolvency, another is canceling tens of thousands of policies and others are increasing monthly premiums by as much as 50%. Florida is by nature an expensive place to insure property because of its exposure to floods and hurricanes, risks that are escalating with climate change. The state even has its own taxpayer-backed insurer called Citizens to act as an insurer of last resort. Often, it’s the only insurer willing to take a risk on a property. Making matters worse recently is a surge in reinsurance rates—reinsurance is essentially insurance for the insurance companies; what they pay, in other words, to protect themselves against catastrophic losses. Another recent problem is inflation, driving up the cost of repairing a house when it’s damaged. Some blame excessive litigation—three quarters of all U.S. lawsuits involving home insurance claims are in Florida. One common practice is a contractor threatening to sue an insurance company unless it agrees to pay for a new roof after a storm—the insurance company often decides it’s better to just accept the claim than engage in a costly court battle. The state’s legislature recently passed some measures intended to address the situation, including more public money to help with reinsurance and new steps to curb frivolous lawsuits against insurers. But the problem could get worse, not better, as storms intensify. Miami, for one, is considered one of America’s most vulnerable cities to climate change.

Government

·   Infrastructure: The U.S. government identifies 16 critical sectors “whose assets, systems, and networks, whether physical or virtual, are considered so vital to the United States that their incapacitation or destruction would have a debilitating effect on security, national economic security, national public health or safety, or any combination thereof.” What are these 16 sectors? Chemicals, commercial facilities (like shopping malls that draw large crowds), communications, critical manufacturing, dams, defense, emergency services, energy, financial services, food/agriculture, government facilities, health care, information technology, nuclear reactors, transportation systems and water systems. These are sectors that must continue to operate even during times of crisis, whether it be a pandemic or a war or a weather disaster.

Places:

·   Detroit: He could have chosen 1913, when Detroit was fast becoming an economic superstar—thank the auto industry boom for that. He could have chosen 2013, when Detroit filed for bankruptcy—blame (in part) the auto industry gloom for that. Instead, journalist David Maraniss chose to write about Detroit at the midpoint of those two years: 1963. His book “Once in a Great City” depicts the Motor City at its pinnacle. GM, Ford and Chrysler were selling more cars than ever. Motown music was all the rage. The Civil Rights movement was advancing. The United Autoworkers union was gaining strength. And Detroit was America’s fifth-largest city, surpassed in population only by New York, Los Angeles, Chicago and Philadelphia. But even as its star shined brightest, the Motor City’s vulnerabilities began to show. Maraniss chronicles Detroit’s boiling racial tensions in the 1960s, culminating in severe riots during 1967. Wealthier white residents and manufacturing facilities began to flee for the suburbs. Inadequate housing was a major issue. Union battles with the automakers intensified (and grew costlier). Presaging the despair to come, Detroit narrowly lost its bid to host the 1968 summer Olympics, which instead went to Mexico City. The New Yorker magazine, reviewing the Maraniss book, likened Detroit in the early 1960s to “Humpty Dumpty’s most poignant moment being just before he toppled over.” As late as the final decade of the 1800s, nobody could have imagined the industrial colossus Detroit would become. It was always destined to have some commercial significance given its location along the Great Lakes, something its first settlers recognized in the 1700s. The Erie Canal boosted the town’s fortunes in the 1820s. Railroads turned it into a manufacturing center, large enough to become America’s 13th most populous city by 1900. Then along came Henry Ford, born on a farm in what’s today part of Detroit. In 1903, he incorporated the Ford Motor Company, selling a car he called the Model A. Five years later came the immensely successful Model T, produced in mass quantities at affordable prices thanks to Ford’s pioneering use of assembly lines. Though notorious for his bigotry, Henry Ford staffed his giant, vertically-integrated factories with European and Arab immigrants, farmers from Appalachia and—for the most menial jobs—African Americans escaping the Jim Crow South. In 1910, according to historian Ken Coleman speaking on NBC News, Detroit’s black population was less than 6,000 in 1910 but 120,000 by 1930, and 300,000 by 1950. Migration, indeed, both domestic and international, helped Detroit become the fourth largest city in America. The Great Depression, to be sure, was painful—GM cut half of its workers between 1929 and 1932, notes the Michigan League for Public Policy. But the 1930s gave way to a triumphant 1940s, when Detroit’s auto factories helped build the tanks, jeeps and planes America needed to win the second World War. The 1950s brought cheap gasoline, a big increase in female drivers, the construction of new highways, the onset of suburbanization and a golden era for the Big Three. In 1963, as Maraniss recounts in his book, Ford and its marketing chief Lee Iacocca was hard at work developing the Mustang, which would become one of the best-selling vehicles ever. During the 1970s, however, Detroit’s fortunes rapidly reversed. Oil was suddenly expensive. Japanese automakers enticed Americans with fuel-efficient cars. Suburban flight accelerated. More factories moved out of Detroit, if not to the suburbs, then to the South, or overseas. The Motor City was still the country’s fifth-largest city as late as 1980. By then, however, the U.S. economy was already reorienting away from manufacturing, in favor of service sectors like finance, health care, education, government and tourism. When the economy boomed in the 1990s, it was partly thanks to another era of ultra-cheap oil. Detroit’s carmakers responded with popular trucks and SUVs, boosting their financial standing. But the real action was in places like Silicon Valley with its information technology, New York City with its finance and tourism, and the Sun Belt with its housing boom and population growth. Chicago too, Detroit’s midwestern neighbor, would offset its manufacturing woes by becoming a hub for knowledge-intensive jobs and a magnet for tourists worldwide. By this time, it wasn’t just Detroit’s white population fleeing the city, but its middle-class black population as well, many even moving back to southern cities their parents and grandparents fled. They helped, for example, turn Atlanta into a quintessential 1990s boom city, on display during the 1996 Olympics. Whatever modest momentum Detroit did regain in the 1990s, it was anyhow lost in the dismal 2000s. High oil prices, ongoing competition from Japan and Germany, growing concerns about climate change, skyrocketing pension and health care obligations, a giant financial crisis in 2008… all conspired to drive GM and Chrysler into bankruptcy, kept alive only with a federal bailout. At its peak in 1950, 75% of people living in the Detroit metro area were living in the city itself. By 2010, one year after the GM and Chrysler bankruptcy filings, the percentage was just 39%. The nation’s fourth most populous city had become its twenty-fourth. Parts of its surrounding suburbs, to be clear, remained extremely affluent, growing with knowledge-intensive professional jobs—doctors, lawyers, auto executives, teachers, accountants, engineers, software developers, hospital administrators, etc. Today, health care and education employ more people in metro Detroit than auto manufacturing. That said, Ford, GM and Chrysler (known today as Stellantis) are still the area’s top three private employers, in that order. The city itself though, with fewer and fewer people, had little choice but to itself file for bankruptcy in 2013. A third of its residents (roughly three quarters of them African American) lived below the poverty line. The city’s debt was about $18b. Abandoned houses. Broken traffic lights. Rampant crime. Failing schools. You get the picture. Fortunately, the story starts to get better from here. The bankruptcy proceeding helped put the city of Detroit in a more fiscally sustainable position, to the point where it was even able to borrow in the bond market—without any state government guarantees—in 2018. For the first time in decades, a sizeable number of people began moving back to the city. Leading the charge was Dan Gilbert, arguably Detroit’s leading business figure today. He’s got nothing to do with the auto industry, but rather the housing industry—he’s the founder of Rocket, America’s largest mortgage lender. Gilbert’s companies currently employ about 20,000 people downtown. Other important employers include Wayne State University and the College for Creative Studies, a top design school. Detroit’s baseball, football, hockey and basketball teams all play downtown. Detroit will get a new bridge to neighboring Canada in 2024, to relieve traffic across the busy Ambassador bridge (which handled more than $300m worth of cross-border trade every day). The entire metro area, meanwhile, which lost 3% of its people in the 2000s, at least grew by 1% in the 2010s. The University of Michigan in nearby Ann Arbor is a critical economic institution. So is Detroit’s airport, a major Delta hub with nonstop flights to Europe and Asia. The federal government, including the Post Office, employs about 30,000 people in metro Detroit. And the automakers are reinvesting again, with GM for one refashioning its Detroit assembly plant as the launchpad for its electric vehicle strategy. Chrysler currently employs nearly 5,000 workers at its Detroit factory. In 2019, it announced a $1.6b investment in the facility, which is located within the city. Manufacturing still represents about 13% of all employment in the wider metro, down from 16% in 2000. The unemployment rate is down to 5.5%, and much lower in the suburbs—metro unemployment was 17% in 2009. The city itself remains troubled, with the lion’s share of new investment concentrated in relatively small areas of downtown, itself challenged by the work-from-home phenomenon. The pandemic of course didn’t make things any easier. The semicon shortage is making life tough for automakers. But the Big Three are nevertheless financially healthy and hiring, allocating at least some of their giant EV investment spending to their home city. It’s not 1963 anymore. But nor is it 2013. Perhaps in another 50 years, Detroit will again be an economic superstar. (Sources: Michigan League for Public Policy, NBC News, Census, Brookings Institution, Detroit Economic Growth Corporation, chart below sourced from the Dept. of Housing and Urban Development).

Looking Back

·   Tesla: “Business Wars,” a podcast series, looked back at the rise of Tesla and its quest to upend the Detroit-centered auto industry. The narrative opens with Elon Musk on the verge of financial disaster at the time of the 2008 economic crisis. His companies Tesla, Solar City and SpaceX were all running out of money, kept alive only with Musk’s personal fortune earned from his PayPal days. At one point, Tesla had about three weeks left of cash. The company, to be clear, wasn’t Musk’s creation. It was founded in 2003 by entrepreneurs Martin Eberhard and Marc Tarpenning. They convinced the temperamental Musk to invest and before long, Musk himself was running the show, forcing the founders out. Tesla in the meantime achieved important technological breakthroughs in its effort to address major challenges like how to prevent battery fires. Detroit, looking on with disdain, called Musk a “loud-mouth huckster,” to quote one GM executive. The Detroit Big Three weren’t exactly operating from a position of strength, however, losing billions and watching enviously as Toyota scored big with its hybrid Prius. Tesla was winning high-profile customers for its new Roadster, including California’s governor Arnold Schwarzenegger. But it was one-thing to build a $100,000-plus high-performance luxury sports car. Building an affordable EV luxury sedan, let alone a mass-produced mainstream vehicle, would be orders of magnitude tougher. Still, with the Roadster getting great reviews, Goldman Sachs agreed to provide funding. So did Germany’s Daimler. So did the U.S. government, hoping to spark investment in EVs. And so did Toyota, part of a deal to sell Tesla its idled $1b Fremont, California, factory for a bargain $42m—Toyota would get stock in Tesla upon the latter’s initial public share offering in 2010 (it sold the shares in 2017). Still Tesla faced many challenges, from navigating production complexities to dealing with battery fires to dealer resistance to its practice of selling cars directly to consumers. Cash would again dip to dangerously low levels in the early 2010s, as it tried to produce its Model S. But sales of the Model S were strong. Tesla would proceed to build its own giant battery “Giga-factory” in Nevada, in partnership with Japan’s Panasonic. The company expanded in China, today the world’s largest market for autos. It led the way on advancements in autonomous driving, pledging to populate the world’s streets with a fleet of Tesla robo-taxis. In 2017, Tesla debuted the Model 3, priced for the mass market. It too proved extremely popular, so much so that Tesla became the world’s most valuable car company, making Elon Musk the richest person in the world. But not without controversy. Impulsive Tweeting, legal troubles, smoking weed on the Joe Rogan podcast, expressing political opinions… all have made Elon Musk a love-him or hate-him figure. Detroit, meanwhile, has followed in Elon’s footsteps, investing billions in phasing out gas-powered vehicles in favor of EVs. One person, discussing lengthy waits to get his Tesla repaired, said he felt like a Cubs fan: extremely loyal but extremely frustrated.  

·   Regarding Tesla, the latest edition of The Economist features an article entitled “The great Teslafication: How supply-chain turmoil is remaking the car industry.” It describes how even Detroit’s Big Three are now emulating much of Tesla’s strategies, including more vertical integration (doing everything under one roof) and turning cars into computers on wheels (relying as much on processing power as horsepower). Tesla has in fact suffered less from the semiconductor shortage because it designs its own chips and works closely with the firms that manufacturer them.

Looking Ahead

·   The Future of Social Security: C-Span’s Washington Journal aired a talk on the future of Social Security, featuring Max Richtman of the National Committee to Preserve Social Security and Medicare (he’s a big defender of the programs), and Joseph Antos of the American Enterprise Institute (he’s warning about their fiscal sustainability). The discussion centered on a recent report concluding that by around 2035, the program will only have funds to pay about 75% of promised benefits. But the dates could change based on payroll tax collection, inflation, GDP growth and other factors. The Social Security Administration, by the way, estimates that Social Security benefits will provide on average about 40% of what a person earned on average through their career. That’s clearly not enough to maintain one’s standard of living in retirement, meaning personal savings and private pension investments are also important. So how to fix the future funding problem? How, in other words, to ensure that the Social Security trust fund can continue to pay full benefits? One option is to reduce some benefits—raising the retirement age or lowering annual cost of living adjustments, for example, or reducing payouts to high-income earners. An alternative is to boost the fund’s revenues through Congressional appropriation, something Richtman advocates. Raising the payroll tax from the current 12.4% to 15.6%, meanwhile, would eliminate any longterm funding shortfalls, according to official estimates. Applying the tax to income over $147,000 per year (the current cap) would help too. Some prefer a wealth tax, or a tax on health insurance plans offered by companies. Some would rather raise revenues (or at least attempt to do so) by investing funds in assets riskier than Treasury debt, like stocks or corporate bonds. A final note: The Social Security trust fund gets about 93% of its revenue from taxes (mostly payroll taxes paid by covered workers and their employers). The other 7% is mostly from interest earned on investing funds in U.S. Treasury bonds.

Inside this Issue:

• Inflation Getting Worse: Fading are Hopes that Trends Would Reverse

• Oil Hits $121: If This Keeps Going, the Economy’s Done  

• Private High: The Craving for Private (i.e., Alternative) Assets   

• Steel of Fortune: Cleveland Cliffs and the Modern U.S. Steel Sector

• Commiewood: How Beijing Shapes What Hollywood Makes 

• When the U.S. Forbade Trade: A Look Back at President Jefferson’s Embargo 

• And This Week’s Featured City: Pueblo, Colorado, Don’t Stop the Steel  

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Quote of the Week

“We haven't seen any slowdown in terms of the willingness to buy security. It continues to be the number one risk factor for any board of directors.”

-  George Kurtz, CEO of cybersecurity firm Crowdstrike  

Market QuickLook

The Latest

Not so fast. Yes, supply chain pressures are easing a bit. Yes, the labor market shows early hints of loosening. Yes, the strong dollar is pushing down import prices. And yes, these deflationary forces influenced the Commerce Department’s April price index (the PCE), which showed annual inflation ex food and energy dropping below 5%. But Mr. Powell, put down the champagne.

The latest Labor Department inflation reading—the consumer price index for May—was an unmitigated refutation of any progress the PCE report might have suggested. Prices, the CPI showed, jumped a full percentage point just from April to May, after rising only 0.3% from March to April. Annual CPI inflation now stands at 8.6%, up from the 8.3% annual reading in April. U.S. prices are now rising at their fastest clip since 1981.

Markets reacted with alarm. Stock prices, already battered this year, dropped again—the S&P 500 index is now 8% below its level this time last year. Yields on 10-year Treasury bonds, which in theory should rise when investors worry about future inflation, did exactly that last week, soaring once again beyond the 3% mark. The cost of a 30-year mortgage, accordingly, jumped as well. The mood wasn’t brightened any by oil, whose price reached $121 per barrel. That’s starting to feel more and more like an altitude where the economy starts to have trouble breathing.   

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Inside this Issue:

• Brake It, Don’t Break It: Fed Keen to Slow the Economy but Still Grow the Economy

• Sob Story? Not the Job Story: Another Strong Month for the Labor Market  

• Hurricane Warning: Wall Street Titan Feeling Frightened

• Ford’s Lord: Auto Chief Jim Farley Gives Sweeping View of the World to Come

• Greenback Whack: How a Strong Dollar Could Tank the World Economy

• Attack on Jack: A Rethink of Jack Welch’s GE Legacy

• Ad Queen Leaves the Scene: Silicon Valley Titan Departs 

• Synthetic Biology: Potential to Help, Potential to Harm

• And This Week’s Featured Place: Mercer County, New Jersey, Utopia and Dystopia

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Quote of the Week

“We’re carefully watching the economic data. I know all of you are doing that as well. And so far, we’re just not seeing any material impact from the broader economic world that all of you are in. Our demand environment is very strong.”

-Salesforce CEO Marc Benioff   

Market QuickLook

The Latest

Slow it down—just enough to kill inflation. But not too much—don’t make the medicine worse than the disease.

That, in a nutshell, is what the Federal Reserve wants for the U.S. economy. And so far, more or less, so good. The latest jobs report for May was unambiguously positive: 390,000 new jobs created. But not too positive: April job creation was 436,000. Clearly, some degree of softening is underway. Goods retailers are struggling to react as spending shifts to services. Housing sales are way down. That’s cooled pricing for key commodities like lumber. The container port of Los Angeles, America’s busiest by far, says supply chain pressures are easing. Auto sales are weak. Stock prices are down. And the narrative from corporate America is changing a bit, sounding more concerned. On Wall Street, JPMorgan Chase speaks of hurricanes on the horizon. In Silicon Valley, Microsoft is lowering its financial guidance, and Amazon admits to overexpanding. Netflix will cut jobs, joining other pandemic-era darlings like PayPal and Carvana. As the San Francisco Fed noted in the latest Beige Book report, “recent hiring freezes at a few large tech firms combined with the tightening financial conditions have led a few employers to expect the labor market to cool down in the near future.”

Cooling, of course, could quickly morph into something more sinister. Even as labor markets loosen a bit, and as supply chains get a bit more fluid, a dangerous energy shock persists. Oil prices rose again last week, with fears they might go even higher as demand from China revives post-Covid lockdowns. The Russia-Ukraine war, meanwhile, drags on. America’s large energy sector, to be sure, is benefitting handsomely—just look at how well economies are performing along the Texas and Louisiana Gulf coasts (cargo tonnage at the busy port of Corpus Christi is up by double digits this year, with exports of liquified natural gas up more than 50%!). For the overall U.S. economy, though, $119 oil is a cancer, personified by the embattled American driver. Pricey oil is lifting food prices too, complicating the Fed’s war on inflation.

Frustratingly, oil substitution effects are stunted. Many want to switch to electric vehicles, but there just aren’t enough batteries and other inputs to meet this demand. The chip shortage, moreover, has led some manufacturers to basically stop producing small, fuel-efficient cars—of the 154,000 vehicles that Ford has sold this year, 96% were either SUVs or trucks. The American economy, alas, is still very much dependent on the internal combustion engine, to speak nothing of the fertilizers, chemicals plastics and other vital products—even food—derived from hydrocarbons. As Vaclav Smil writes in his latest book “How the World Really Works: “For now and for the foreseeable future, we cannot feed the world without relying on fossil fuels.” Modern civilization, he adds, depends on them.

Oil’s nefarious assault on the U.S. economy doesn’t mean a guaranteed recession, however. Not with the job market still so healthy. Not with consumers still spending. And not with household bank balances and borrowing capacity still elevated thanks to fiscal stimulus efforts during the pandemic. Bank of America chief Brian Moynihan, speaking at a Bernstein Research event last week, gave these as reasons for his optimism, adding that spending on BOA credit and debit cards hit a record for the Memorial Day holiday. Even Jamie Dimon at JPMorgan, hurricane comments notwithstanding, sounds similarly optimistic about the American consumer—at least right now. He surely does worry about oil though, as he does the Fed’s quantitative tightening program. That began last week, adding uncertainty and potential instability to the world’s most important financial market, i.e., U.S. Treasuries. Dimon also advises against complacency about the Ukraine War, recalling how wars have a way of producing unpredictable outcomes (remember how well the 2003 U.S. invasion of Iraq initially went?).

Dimon went on to caution about credit troubles in unexpected places—in housing during the late-2000s, in telecoms and utilities in the early 2000s, etc. Perhaps it will come this time from the buildup in private credit, he suggested. But his larger point: We just don’t know.

Nor do we know how much of the latest worries—those Big Box retailer woes, for one—are merely the result of consumers shifting their preference from goods to services. Or to use Target’s representative example: from TVs to luggage. Restaurants and bars added 46,000 new jobs last month. Hotels added another 21,000. The monstrous education and health care sectors added 74,000, led by teacher hiring by state and local governments. As the former chief of Goldman Sachs tweeted: “Dial back a bit the negativity on the economic outlook.  If I’m managing a big company of course I’m prepping for the worst. But the economy is starting from a strong place, with more jobs than takers, and is adjusting to higher rates. Riskier times, but may yet land softly.”

Are you similarly optimistic? Or do you side with the pessimists? Ultimately, it’s the Fed’s assessment that counts. When the FOMC meets next week, expect another half-point rate hike. No big uncertainty about that. But will it give any hints about its intentions for the following meeting in late July, or the meeting thereafter in late September? Also in late July, by the way, we’ll get the first BEA estimate on second quarter GDP, following last quarter’s negative showing. The Economist this week, by the way, has an interesting look at the role business inventories might be playing in the stability of GDP readings. In any case, there’d be something odd going on if Q2 shows another negative GDP number—two in a row is the traditional definition of a recession—even while the job market is so strong. Corporate America’s earnings, too, remain pretty strong.   

Back to oil, the OPEC cartel said it would increase output, naturally concerned that high oil prices will break the world economy and lead to crashing prices (as happened in 2008). Back in Silicon Valley, Sheryl Sandberg announced her departure from Meta, having built not just Facebook into an advertising behemoth, but Google before that. Her business legacy is thus unquestioned, yet she also exits a controversial figure, linked with the many alleged ills of social media. Listen to critics like Jonathan Haidt or Shoshana Zuboff to understand the gravity of these allegations.  

Nothing defies gravity quite like Elon Musk’s business endeavors, led by Tesla’s remarkable rise and the revolutionary rockets developed by SpaceX. Like Sandberg though, Musk is a controversial figure, increasingly so as he looks to buy Twitter and steps into the thorny swamps of political debate. The technology he’s introduced is beyond question. The uncertain financial resiliency of his companies, however, combined with legal troubles, could change his reputation quickly (see the Jack Welch item below).

Here's someone hoping to make Musk a bust: Ford’s CEO Jim Farley, who mentioned Tesla 15 times in a discussion at the Bernstein event last week. He acknowledged its path-breaking advances, not just in technology but in areas like marketing (no advertising), distribution (no dealership network) and talent recruitment (a willingness to spend heavily for top engineers). Ford itself is leaning in these directions, dispending with expensive ads and rethinking if not eliminating its relationship with dealers. The current generation of Ford’s electric vehicles, he said, don’t make money. But a second generation—about four years away—will have more efficient batteries, less-labor intensive production and better software that commands more revenue. Software, Farley said, is what matters most now, not motors and gearboxes. Ford, he asserts is “about to change the ride, just like Apple and all the smartphone companies changed the call.”

Ford, incidentally, said last week it will hire another 6,200 unionized workers in Michigan, Ohio and Missouri, while also converting another 3,000 temp workers to permanent full-time status—that means health care benefits. Also last week, in an interesting twist, NBC Universal announced a new film and TV production campus in Atlanta, on property that once featured a General Motors assembly plant.

Featured this week: Updated data on inflation, specifically the May figure for CPI (the consumer price index). The y/y increase for April, remember, was an uncomfortably high 8.3%. Will the May number show some easing?

Companies

·   General Electric: For a long swath of the 20th century, General Electric was among America’s most admired companies. Its founding dates to Thomas Edison and the invention of the light bulb in the 1870s. During the 1940s, GE’s output, including jet aircraft engines, helped win the Second World War. It remained a key player not just

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Inside this Issue:

• Starting to Ease or Just a Tease? Signs Emerging of Inflation Stabilization 

• Plummet from the Summit: Housing Sales Plunge; Mortgage Rates Falling Too

• Retail Sales Tales: There’s Still a Spending Boom, But It May Be Ending Soon

• Dimon Says: Economy Still Strong, Says JPMChief. But Storm Clouds Brewing  

• Jump at the Pump: U.S. Gasoline Prices Hit Memorial Day Record

• That ‘70s Show? Maybe No. Today’s Inflation Looks More Like the Late 1940s

• Grain Street, USA: The Role of Wheat in American History

• And This Week’s Featured Place: Chattanooga, Tennessee, Appalachian Revitalization   

Quote of the Week

“Inflation that is high but falling is much less frightening to the market than inflation that’s high but rising. This should help reduce the market’s fear about a more extreme 1970s’s style scenario.”

-Morgan Stanley strategist Andrew Sheets

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Market QuickLook

The Latest

Maybe Mr. Powell was right all along. Maybe the inflation scourge really is transitory.

The latest data suggests this might be so. According to the PCE price index for April (published by the Bureau of Economic Analysis last week), annual inflation dropped to 6.3%, from 6.6% in March. Exclude the volatile categories of food and energy, and the figure is now below 5%. Goods inflation, more specifically, stands at 9.5%, while services inflation (services are a larger part of the economy) stands at 4.6%. The Fed, keep in mind, puts more faith in these PCE numbers than it does the Labor Department’s CPI figures—those showed inflation at 8.3% for April.

Let’s be perfectly clear: Inflationary forces are still on the loose. Americans are still spending a lot. Supply chains remain clogged. And shortages persist—shortages for workers, houses, cars, minerals, semiconductors, etc. High oil prices alone are infecting the rest of the economy with inflation, swelling the cost of moving goods and producing everything from chemicals to plastics. Longer-term price pressures loom as well—the cost of transitioning to greener energy, a potential economic divorce with China, the loss of Russian natural resources, de-globalization more generally, the impact of climate change on agriculture, the shrinking U.S. workforce, dwindling competition from consolidation and never forget the chronic market failures in housing, health care and higher education (the notorious “Three H’s”).  

Then why are prices showing some hints of easing? Remember when Walmart and Amazon said they’re suddenly overstaffed, suggesting some degree of loosening in labor markets? Several tech companies have even announced layoffs or at least a hiring freeze. The latest S&P update from purchasing managers notes that “[supply] bottlenecks showed further encouraging signs of easing.” Here’s a quote from Morgan Stanley last week: “We’re also seeing encouraging signs that some of the worst disruption to supply chains are easing. Fewer ships are sitting off U.S. ports unloaded. The cost of freight is declining. Many retailers are now reporting plenty of inventory… [and] market-based estimates of future inflation have been declining in both the U.S. and Europe.”

The nation’s four largest freight railroads, meanwhile, currently have more than 2,500 front-line employees in training, heralding further supply chain relief as they graduate later this year. Auto production, though still constrained, is steadily picking up as access to semicons improves. The strong dollar is driving down import prices, with talk now about lowering import tariffs. There’s also talk of retirees coming back to the workforce. And don’t look now but mortgage rates are starting to decline again—the 30-year fixed dropped to 5.1% last week, according to Freddie Mac, from 5.3% two weeks earlier.

Speaking of the housing market, it’s now screeching to a halt. New data from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development show sales of new single‐family houses in April plummeted 17% from just the month prior, and a jaw-dropping 27% from the year prior. Redfin, the online real estate broker, had this to say: “The sudden surge in mortgage rates has reduced homebuyers’ budgets in many markets, forcing sellers to reset their price expectations. Price drops are becoming increasingly common.”

The Fed’s tightening thus seems to be working, slowing a key engine of the economy. Its higher rates have deflated financial assets as well, most importantly stocks. Last week though, stocks finally lurched upward, perhaps an indication that investors, too, see the inflation scourge easing. Sure enough, long-term Treasury yields are also starting to drop again, another possible sign of the Fed achieving its objective. Raphael Bostic, the Atlanta Fed president, began a speech last week by stating unambiguously that inflation is too high and could get even worse—the full inflationary impact of the Ukraine war, he warned, hasn’t yet been fully felt. Bostic told reporters after the speech, however, that the Fed might be ready to pause its rate hiking in September. This is what it sounds like… when the doves fly.

But what about demand? There’s little question that it remains strong. Banks say it. Government reports show it. Another round of retailer earnings calls last week make it clear. But how long will the robust spending last? Last week’s report on personal

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source: Visit North Platte

Inside this Issue:

• Don’t Start Singing that Recession Song: Retail Sales Still Humming Along

• Recession Fears Nevertheless Grow: Stock Market Slaughter Adds to the Woe

• Housing Backbone Somewhat Stiffer: But a Few Gloomy Voices Beg to Differ

• 1970s-style Grief? It’s Not that Bad, Says an Old Fed Chief

• Freight Rail Profits Soar: But Railroad Customers Sore

• Lake News: Major Western Water Supply Threatened by Drought

• Factory Fumes to Hospital Rooms: From Industrial Economy to Care Economy

• Car Hopping: The Quest to Develop Flying Cars

• And This Week’s Featured Place: North Platte, Nebraska, Trains on the Plains  

Quote of the Week

“We can tell you what we saw during the quarter and the start of May, where we just continue to see a resilient consumer. Our traffic numbers are up to start the second quarter.”

-Target CEO Brian Cornell

Market QuickLook

The Latest

Uh oh. Walmart and Target, two behemoth retailers, both posted disappointing financial results for the first quarter, hinting that maybe—just maybe—American consumers are tightening their belts. Falling real incomes. A fast-falling stock market. Higher and higher prices for everything. Maybe the spending is ending. Maybe a recession is coming.

Hang on. Headwinds are blowing, for sure. But the first-quarter disorder at Walmart and Target had nothing to do with slumping demand. On the contrary, both said demand was—and continues to be—exceedingly strong. Walmart’s U.S. sales increased 4% y/y. Ditto for Target. Their problems were instead tied to higher costs, notably for labor, fuel and transport. They also bungled their staffing and inventory management, with Walmart over-hiring during the Omicron wave, and both retailers failing to anticipate abruptly changing patterns of consumption. Households allocated more of their money to necessities like food, for example, and more of their money to services like travel. As Target explained, it sold fewer televisions than it expected, but a lot more luggage.

The larger point is that spending in the aggregate continues to hum. Other retailers reporting last week made that abundantly clear. According to Home Depot and Lowe’s, Americans are still spending a lot of money on home improvement. TJX—owner of T.J. Maxx, Marshalls and Home Goods—sounded no less bullish, in its case benefitting as inflation drives consumers to “trade down” to discounted items, and to “trade over” from buying online to buying in-store. The trade down trend, unsurprisingly, seems to be more pronounced among lower income Americans. TJX markets to a broad range of income demographics but said higher-income stores were preforming better, suggesting perhaps some spending weakness at the lower end. The trucking and logistics giant J.B. Hunt, anecdotally, spoke of slowing demand to ship lower-end furniture. 

But again, the overall sentiment is upbeat, not least from the sneaker retailer Foot

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Inside this Issue:

• Share Bears Everywhere: Another Bleak Week for Stocks

• The Prices Crisis: Inflation Somewhat Abates, but Hardly Enough to Stop Raising Rates

• Travails from the Crypt: Blockchain Pain in Crypto-Land

• Sore Arms: Weapons Makers Not Immune to Supply Chain Pain  

• Fannie Are You O.K.? The Latest from a Mortgage Market Goliath 

• Past Words: An Effort to Make Passwords Extinct

• Vertical Disintegration: A Unique Theory on Why Productivity’s Been Dreary

• And This Week’s Featured Place: Washington, DC, Capital Chill

Quote of the Week

“Every part of our business has been impacted by inflation. We experienced higher costs across our supply chain for all inputs from feed ingredients, live animals and other raw materials to cooking oils and basic supplies. We're also managing higher cost of labor and transportation due to robust demand, higher fuel costs and limited availability. 

-  Tyson Foods CEO Donnie King

Market QuickLook

The Latest

Yesterday, all their troubles seemed so far away. Now, investors are caught in a storm.

O

nce again, stock prices dropped last week, dragging the S&P 500 index down 13% from where it was in late March, and 4% below where it was this time last year. The tech-heavy Nasdaq Composite index is down nearly 30% from its highs last fall. The bloodbath is gorier still for pandemic darlings like Netflix, PayPal and even Moderna. What was hot in 2021 is cold in 2022. The party, alas, is over. A bubble now popped. Investors now nursing their wounds.

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courtesy: Cameron LNG

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I hope you enjoy reading Econ Weekly as much as we enjoy producing it. I want to let you know that next week, we’ll begin charging our regular membership rate. I look…

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Inside This Issue:

• GDP Surprise: Oh My, a Shrinking Pie

• The Latest on Prices: Inflation Loses Heat as Fed Prepares to Meet

• Big Tech Big Five: Supremely Profitable but Not Invincible  

• The Great Reversal: In a Shift, Asset Prices Falling, Consumer Prices Gaining

• Lith Making: Tesla and Other EV Makers Need More Lithium     

• Bear Market: A Look Back at the Fall of Wall Street Titan Bear Stearns

• Biotech in Boston: Kendall Square, a Life Science Lair   

• What If There’s Another Crisis? What Happens Then? Could the Fed Stim Again?

• And This Week’s Featured Place: Susanville, CA, Prisoner’s Dilemma

Reminder: The Econ Weekly podcast is now available on iTunes, Stitcher, Google Podcasts and Spotify. Just search for Econ Weekly and please leave a review to help spread the word. 

Quote of the Week

“We have to watch that balance between the strength of the consumer, as well as what we see in the input costs, etc.… But right now, we see nothing but strength in the consumer and the demand for GM products.”

-General Motors CFO Paul Jacobson

Market QuickLook

The Latest

Did the U.S. economy really shrink in the first quarter of 2022? That’s what the Commerce Department’s latest GDP figures say. From January to March, domestic production, adjusted for inflation, declined 0.4% from the previous quarter, or 1.4% when multiplied by four (to get the annualized figure). It’s a far cry from the vigorous 6.9% y/y growth recorded just one quarter earlier. Is a recession already underway?  

Take a deep breath. The ugly Q1 figure, just like the flattering Q4 figure, was heavily influenced by the rate of change in inventories held by businesses, which the Bureau of Economic Analysis (the folks who do the calculations) calls “one of the most volatile components of GDP.” What’s more, recent inventory swings have a lot to do with what’s happening in the semicon-deprived auto sector—it’s a big sector for sure, but not especially representative. Separately, the Q1 GDP drop was also tied to a drop in government spending, notably defense spending which is poised to soon grow again.

More importantly and relevantly for the economy, the Q1 GDP figures showed that businesses are still investing. And most importantly and most relevantly, households are still spending. Spending in fact grew nearly 3% y/y, despite the omicron setback early in the quarter. Some of that spending, to be sure, was on services and especially goods produced outside of the U.S., which later gets removed from the GDP calculation when subtracting net exports. But this doesn’t negate the point: Americans—thanks largely to a bustling job market and savings amassed during the pandemic—are still spending. Companies, one after the other, are indeed making that crystal clear in their Q1 earnings calls (see the GM quote above). Companies are still earning robust profits as well, which pours more cold water on the thesis that the U.S. economy is already in recession. It’s surely not.

Reassuring news for the Fed, no, as it prepares for its big meeting this week? At the same time, there’s more evidence that prices are cooling off a bit. According to the PCE price index for March, inflation was up 6.6%, or just 5.2% excluding food and energy (which are notoriously volatile). The month-to-month rate ex food and energy was just 0.3%.

Wow, nothing but positive news. Um, maybe not. Yes, it’s true, the American consumer is strong. Corporate America is strong. And inflation is showing a few signs of moderating. That’s quite a fortress. But against this fortress, gale-force winds are blowing.

Inflation, of course, is one of those headwinds. It remains a major headache for households and businesses. Same for supply chain disruptions, which are driving much of the inflation. In some respects, supply-side pressures are easing, with GM and Ford for example both seeing somewhat better availability of semiconductors. On the other hand, supply-side problems could get worse, not better, because of factory and port closures in China (Ford, for one, has 50 major suppliers in the Shanghai-area alone). The Ukraine war presents additional risks. And back home, labor supply remains extremely tight.

That said, American workers are earning less after adjusting for inflation. Real wages during Q1 fell nearly 4% y/y, with government workers seeing an even bigger dip. Workers are getting raises, yes. But these are not keeping up with price inflation. Looking at disposable income (which includes other income besides wages), the declines are even sharper. Americans, alas, are supporting their robust spending by dipping into their savings (which make no mistake, grew a lot thanks to aggressive fiscal stimulus measures during the pandemic).

Oil prices topping $100 a barrel is a further drag, making it pricier to move goods and gas-up the family car. A weakening global economy doesn’t help. The critical housing market is unambiguously cooling, with home sales declining 9% from February to March, and 13% from last March. It’s no bubble, to be clear. And for that matter, even the last bubble wasn’t really a bubble— average home prices are now 69% above their 2007 peak. Still, the slowdown is palpable.

Some spot a trucking slowdown too, though that’s subject to debate. The stock market is unmistakably retreating—the tech-heavy Nasdaq is down by more than a fifth since the start of this year. The bond market certainly isn’t thriving, with rising interest rates hitting hard. A strong dollar puts pressure on U.S. exporters. Like homebuyers, companies (especially those with weaker credits) face more expensive financing. Fading fast now are the carnival market memories of 2021: meme stocks, SPACs, crypto-coins, your grandma’s new tech startup… everything was coming up roses. A young electric vehicle maker like Rivian? Buy, buy, buy!

It’s now bye, bye, bye to those days. In Rivian’s case, a freefalling stock wiped red ink all over the income statements of two of its prominent shareholders, namely Amazon and Ford. Even more symbolic of the pandemic-era hype? The online trading platform Robinhood, which saw Q1 revenues tumble 43% y/y. It also lost nearly $400m and will shrink its workforce by almost a tenth.

It’s almost as if the world of the past 40 years is reversing: instead of asset prices perpetually gaining and consumer prices perpetually stable, it’s been the other way around in 2022. We’ll see if there’s any resiliency to this new trend, which there might be if housing prices begin showing declines. In the meantime, other shorter-term trends tied to the pandemic are clearly reversing: Americans are now spending more on services rather than goods, for example, and spending more at physical stores rather than online.

The latter switch puts some pressure on Big Tech’s Big Five, notably Amazon, Alphabet and Facebook (see the Companies section below). Everyone, of course, would rather talk about Elon Musk and his Twitter escapades. But in Detroit, Ford and GM were focused on their electric vehicle ambitions, and beyond that their vision for autonomous vehicles. Ford last week debuted its newest F-150 pickup, an electric version of America’s best-selling vehicle. The new Lightning F-150 is in high demand but supplies are limited (a metaphor for the economy, no?). As Autoline Daily pointed out, it uses about 1,700 microchips, compared to more like 200 for the ICE version.

ICE vehicles, make no mistake, aren’t disappearing anytime soon, which is good news for oil companies, this year’s best stock market performers. Berkshire Hathaway, which held its always lively annual meeting on Saturday, knows that well from its holding of Occidental Petroleum. Chevron, in its Q1 earnings call, says oil prices could see further upward pressure because international air travel hasn’t yet recovered, China is still in lockdown, independent shale producers are prioritizing cash returns to shareholders (over drilling) and global energy giants are shifting investments to green energy. “Recent events remind us,” Chevron said, “of the importance of energy.”

No reminders needed of this week’s big event. Get ready. The Fed will make is big interest rate announcement on Wednesday. 

Companies

·   Apple, Amazon, Microsoft, Alphabet and Meta: As usual, the “Big Tech Big Five” reported astoundingly enormous revenues, collectively reaching $359b for just the three months that ended in March. That’s roughly 90 days of revenue equivalent to the entire GDP of Egypt. Their collective Q1 operating profits, meanwhile, reached $83b, further underscoring the importance of Silicon Valley and Silicon Seattle to the modern American economy. The Big Five overlap and compete in some critical markets—Meta vs. Alphabet in online ads, for example, or Amazon vs. Microsoft vs. Google in the Cloud. But they each have distinct business models. All are both revered and often controversial. All are among the country’s largest spenders on research and development. All are at the cutting edge of information technology, including machine learning. Their financial muscle and political clout, meanwhile, approximates that which railroads, Wall Steet and oil companies wielded in decades past. At the same time, the Big Five face some important vulnerabilities, some of which are highlighted in the chart below.

·   One specific vulnerability is the subject of Tim Hwang’s book “Subprime Attention Crisis: Advertising and the Time Bomb at the Heart of the Internet.” Online advertising, he writes, generates 90% of Meta’s revenue and 80% of Alphabet’s revenue. They earn it by connecting advertisers with targeted customers, which they can do effectively because of everything they know about all the billions of people that use their services (i.e., search for info on Google.com or post photos on the Instagram app). It’s a form of advertising, the companies boast, that’s more measurable and trackable than say, T.V. or radio advertising. Hwang, though, questions its effectiveness. He points to Google’s own research that suggested that half of online ads are never even seen. There’s the threat of ad blocking software. Recommendation algorithms, furthermore, are often not very good—he cites the case of someone that ordered metal address numbers for his mailbox on Amazon, which prompted the latter’s algorithms to start suggesting other numbers he might like. Hwang said Procter & Gamble, one of the world’s largest advertisers, recently cut $200m from its online ad budget without much effect. A business—data-driven, micro-targeted ads—that “might be based on nothing?” An unconventional view for sure, but an interesting one. In a related point, The Economist notes that online ad spending is heavily concentrated among a few big spenders, typically retailers, financial services firms and travel companies (think Home Depot, Geico and Expedia).  

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Sectors

·   Private Prisons: In 2014, The Atlantic magazine ran a story about rural America’s “prison industrial complex.” Panicked amid disappearing coal mines, shuttered factories and other severe setbacks, many small towns began building prisons as an economic development tool. The prison population, after all, was growing sharply due to tougher sentencing laws. Prisoners themselves, besides, are a source of low-wage labor. But more important, as the article describes, is the “industry that springs up around the prison system.” It continues: “First, someone will be contracted to build the prison. Then you’ll need a staff for maintenance. Next comes the restaurants and hotels in the nearby town that feed and house relatives coming to visit the incarcerated in these far-off places. When you’re finished, you have an entire local economy dependent on the existence of a prison.” Susanville, California (see below), is one such rural area. Franklin Township in far upstate New York (profiled in the Oct. 9th issue of Econ Weekly) is another. Alabama, a mostly rural state, is now using federal stimulus funds to build two new prisons. In Florida, the state legislature is considering construction of two new 4,500-bed correctional facilities as part of its modernization program. In 2020, according to the U.S. Justice Department, 1.4m Americans were held in federal and state prisons (this doesn’t include another 750,000 or so in local jails). But this 1.4m was down by a quarter from 2010. Simply put, Americans aren’t locking up as many people anymore, following a dramatic increase in the 1980s and 1990s. Indeed, in 2020, the imprisonment rate was 459 per 100,000 American adults, the lowest since 1992. Most of America’s prisons are government-run operations. But some are outsourced to private-sector companies, including GEO Group and Core Civic, both publicly traded. In their latest earnings calls, they discussed how they’re dealing with declining inmate populations—in GEO’s case, seven of its Justice Department contracts were not renewed last year. These firms also have contracts with the Department of Homeland Security’s U.S. Immigration and Customs Enforcement (ICE), which should see a surge in demand for detention capacity once Title 42 is rescinded (that’s a Covid-era authority that allows immigration officials to expel illegal border crossers without access to asylum hearings). Private prison firms also provide services like electronic monitoring of non-incarcerated offenders—in 2020, roughly 4m Americans were not behind bars but still under the supervision of adult correctional systems. During the Covid crisis, many prisoners were given furloughs, home confinement or early releases to enable more social distancing within facilities. Do these companies make money? In 2021, Core Civic reported a $127m net profit adjusted for special items on $1.9b in revenue. Geo Group, which by the way runs America’s largest private prison in Baldwin, Michigan, earned a $159m adjusted net profit last year, on $2.3b in revenue. A few final points about the U.S. federal and state prison population: Nearly half of all inmates are serving sentences for drug offenses. Just 8% are in for violent crime. Most of the rest are guilty of what’s called “public order” offenses, ranging from illegal weapons possession to tax violation. For the most dangerous and notorious inmates, like the drug lord El Chapo and the Boston Marathon Bomber, the U.S. has what’s called a “Super Max” prison in rural Colorado. The military runs detention facilities as well, most famously in Guantanamo, Cuba.

Markets  

·   Lithium: During Tesla’s Q1 earnings call, Elon Musk mentioned lithium as one of the “limiting factors for accelerating the advent of a sustainable energy future.” In fact, the word lithium was mentioned 26 times during the call, underscoring its importance to electric vehicle batteries. Musk emphasized that there’s absolutely no shortage of lithium on earth. But it needs to be extracted and refined, a process requiring lots of industrial equipment. And there’s simply not enough of this happening, despite soaring prices that you’d think would make it an attractive investment. Indeed, lithium happens to be the single biggest cost growth item for Tesla in percentage terms.   

·   Savings: Synchrony Financial, a Connecticut company once part of GE, said one-third of U.S. consumers have depleted the entirety of the cash stimulus the received from Uncle Sam during the past two years. But the other two-thirds still have either all or part of it still saved.

Government

·   Monetary Policy: Economists celebrate former Fed chief Paul Volcker as the person who slayed the inflation dragon of the 1970s by sharply raising interest rates. Eric Leeper, though, adds the point that fiscal policy also played a role. Leeper, a University of Virginia professor and former Fed economist, explained on the Macro Musings podcast that Congress—after a big tax cut in 1981—raised taxes four times during the 1980s. For inflation fighting to work, he concludes, “tight monetary policy has to be followed by tight fiscal policy.” This raises the question: How about now? Will Congress raise taxes to complement the Fed’s rates hikes? If the FOMC winds up moving overnight interest rates to 5%, as economist Larry Summers for one has suggested, this would balloon the Federal debt by $1 trillion. That’s a lot more money, i.e., Treasury securities, that the Fed would need to “print.” Higher taxes might be the only way to offset the inflationary effects of that.

·   A quick reminder on specifically how the Fed alters overnight interest rates, and how its method changed during the 2008-09 financial crisis. Pre-crisis, the Fed could move overnight rates where it wanted by adjusting the amount of bank reserves in its system (banks hold reserves with the Fed to satisfy regulatory requirements and ensure they have enough liquidity to meet day-to-day needs like ensuring uninterrupted flows of interbank payments). That was then. During the 08-09 crisis, the Fed created so many new reserves that the old way of doing things no longer worked. So the Fed has since manipulated rates by paying banks a chosen interest rate on those reserves, and by offering nonbanks (that don’t have accounts with the Fed) an alternative way of earning a small return in the overnight “repo” market. The two rates together provide a ceiling and a floor for overnight rates, or what the Fed calls its target range. The current floor is 0.25%. The current ceiling is 0.50%. But expect that range to increase by at least a quarter point at this week’s big meeting.

Places:

·   Susanville, California: The history will sound familiar. Like so many towns in the American West, people originally came for the mining, the farming and the logging. Today, however, the people of Susanville, a town in remote northeastern California, depend for their livelihoods on something altogether different, a local industry, in fact, facing a major crisis. This is not the California you see on T.V. No Hollywood movie stars. No billion-dollar tech startups. No cutting-edge aerospace companies, tourist-filled beaches or world-class farmland. The economy in Susanville revolves around just one thing: Prisons. Three of them in fact, two run by the state of California and one by the Federal government. One of the state facilities, however—the California Correctional Center (CCC)—is slated for closure in June. It’s part of the state’s plan to cut $172m from its $14b prison budget. And it reflects a national trend to reverse a decades-long surge in the number of incarcerated Americans. Susanville’s economy, as a result, faces ruin. The three prisons provide roughly half of the town’s employment. And much of the other half—local government, retail, health care, etc.—depends on the incomes of prison workers. Even the local community college gets by with significant enrollment from Susanville’s prisoners. A documentary about the town produced by No Way Back profiled a small business owner with a contract to provide milk and other dairy products to the prisons. With all of this now threatened by the CCC closure, Susanville’s real estate values are plummeting. Residents with the means are leaving, accelerating a long-run population drop reflective of declines throughout rural America—Susanville saw its non-prisoner population shrink 14% in the 2010s. The prison population, meanwhile, is about 6,000. There’s a small Indian Reservation in the middle of town, where the tribal government runs a modest casino and hotel. There’s a Walmart in town too. But the best-paid jobs are those in the prisons, specifically prison guards represented by one of California’s most powerful unions, the California Correctional Peace Officers Association. With two large prisons remaining after CCC’s closure, Susanville will still have plenty of state and federal money flowing in. But it seems inevitable that the economy will shrink sharply from its current level. A once-vibrant sawmill industry is long gone, with the last mill closing in 2004. The town’s efforts to reinvent itself are challenged by the area’s remoteness, and the fact that just 6% of residents over 25 have college degrees. Reno, a booming economy across the border in Nevada, is 1.5 hours away by car, making it a difficult daily commute. Sacramento, California’s capital, is 3.5 hours away. Still another threat to Susanville: Destructive fires and droughts. As for basic local services like police and fire protection, the town has some breathing room thanks to the American Rescue Plan Act that Congress passed last year. ARPA, officials say, “provides the city with some time to research revenue increasing or cost saving items that may preserve the city’s ability to provide the vital services at the level our citizens are accustomed.” But it adds “the City’s General Fund financial situation is serious, and the city cannot continue to operate at its current service levels unless revenues increase.” (Sources: U.S. Census, San Francisco Chronicle, Los Angeles Times, U.S. Bureau of Prisons, Congressional Research Service).   

·   Boston: Kendall Square isn’t nearly as well-known as Silicon Valley. Come to think of it, it might not even have the same level of recognition as Route 128, the Boston area’s Silicon Valley-like tech corridor. Kendall Square though, in the Cambridge neighborhood in the heart of Boston, has become what Robert Buderi calls the “biotech capital of the world.” Buderi’s new book is called “Where Futures Converge: Kendall Square and the Making of a Global Innovation Hub.” It’s a history of the area, which lies within walking distance of both Harvard and MIT Universities, two of the world’s most prestigious. Today, the neighborhood’s most famous company is Moderna, whose mRNA helped greatly in the struggle against Covid-19. The square is also home to Biogen, the area’s first major biotech firm. Another big player is Genzyme. According to the Boston Herald, there are more than a hundred biotech firms in just one square mile. “Kendall Square is simply the densest collection of life scientists in the known universe,” said Eric Lander, director of the Broad Institute of MIT and Harvard, speaking with the Herald in 2020. Research labs are everywhere, as are the many professionals catering to these scientists—real estate agents, lawyers, doctors, etc. But Kendall Square wasn’t always about biotech. Long ago, it was a center for developing rubber products and railroad cars. It was home to the camera company Polaroid and Lotus123, which made spreadsheet software before the days of Microsoft Excel. Today, Big Tech firms like Amazon and Google have a large footprint in Kendall Square as well.

Looking Back

·   Bear Stearns: Jeff Snider, whose Eurodollar commentary has become somewhat of an internet sensation among financial wonks, gave a good synopsis of what happened to the investment bank Bear Stearns in the run-up to the 2008 financial meltdown. During the early 2000s, he said, financial markets depended on the practice of taking illiquid loans like subprime mortgages and turning them into “safe” assets through various fancy forms of securitization. One purpose was to use these assets as collateral to borrow, often in the overnight money market. That’s how firms like Bear Stearns operated—they ensured they had enough cash on hand each day through overnight borrowing, in those days from other banks like JPMorgan. When it became clear that these assets weren’t so safe, however, JPMorgan told Bear Stearns it would need a lot more collateral if it wanted to keep borrowing. Increasingly, overnight lending counterparties stopped accepting junk mortgage securities as collateral, demanding super-safe Treasuries instead. Bear Stearns eventually lost access to the overnight lending market and collapsed, ultimately swallowed by JPMorgan itself. One final point to remember: Bear Stearns was an investment bank, not a commercial bank that funds itself with deposits (i.e., checking accounts held by individuals and companies).   Instead, it funded itself in the market for overnight loans. This worked perfectly fine for decades, until, as William Cohan wrote in House of Cards, “the funding evaporated like rain in the Sahara.” Much of Wall Street, in other words, was always just 24 hours away from a funding crisis.”

Looking Ahead

·   Public Debt: Berkeley’s Barry Eichengreen joined the New Books Network podcast to discuss his work “In Defense of Public Debt.” He recounted how the U.S., France and Britain all brought down their government debts in the decades after major wars—the Civil War in the U.S., for example, and the Napoleonic Wars for Britain. The latter in fact mostly ran primary budget surpluses for almost a century leading up to World War I (the term primary surplus excludes debt payments). Eichengreen warns that this sort of budget discipline is much less likely in today’s world. For one, 19th century voters were typically wealthier, white males that owned bonds—in other words, they were creditors with a financial interest in avoiding inflation. Today’s democracies are much more inclusive. After World War II, meanwhile, governments shrank their debts thanks to rapidly growing economies and populations—the third quarter of the 20th century, Eichengreen said, was “the period of fastest economic growth in the history of the world.” While it’s possible some new and revolutionary, productivity-lifting technologies save the day, demography in most parts of the world foretell a future of slower growth. The professor concludes: “Public debt is a powerful and valuable instrument to deploy in emergencies, be those wars, pandemics, financial crises or whatever. We have just passed through a period marked by successive crises, so we’ve utilized that weapon and kind of depleted our reserves… So I do think it’s imperative now for governments to restore strength in their capacity to borrow, especially given that that capacity will be strained going forward by those higher interest rates. The ways that governments restored that capacity in the past are not going to be available to the same extent today because growth rates are going to be slower than in the mid-20th century [and] budgets surpluses are going to be harder to sustain than in the mid-19th century.” He does end with a bit of hopefulness, suggesting perhaps the green energy and digital revolutions could help boost economic growth. Pure luck is a factor too, as Britain enjoyed during a century of relatively few major military conflicts leading up to World War I.   

·   The Next Crisis: When the mortgage market triggered a financial collapse in 2008, the Federal Reserve stepped in with various measures of support, including a reduction of overnight interest rates to zero and heavy bond-buying to boost financial sector liquidity. When the Covid epidemic caused another market crisis in early 2020, the Fed again responded by lowering rates to zero and buying bonds. Congress, in both cases, added fiscal support to the Fed’s monetary actions. Alright, so what happens if tomorrow, there’s another major crisis? Would the Fed and Congress respond in a similar fashion? Doing so would be riskier, with federal debt having already grown so much, and with inflation now a significant concern. A crisis would by itself perhaps solve the inflation problem by depressing demand. But the point is, with each successive crisis, the monetary and fiscal stakes get higher. Also keep in mind the links between monetary and fiscal policies—as the Fed raises rates, it becomes more expensive for Congress to borrow, and vice versa.

Issue 65: April 25, 2022

Inside this Issue:

• Top Dollar: U.S. Currency Showing its Appreciation

• Nuclear Bonds: A Bloody Outcome for Fixed Income

• For Doves, Powell Disappoints: Says Fed Might Hike by 50 Points

• Streaming of Better Days: Netflix Bears Tank its Shares

• Uncommon Comment: Health Insurer Anthem Downplays Inflation

• Bubble Trouble? Four Reasons Why for Housing, it’s Not 2008

• Gas Extinction: America’s Gas Stations Face Existential Threat

• The Re-Shoring Conundrum: Firms Bring Jobs Back but Labor They Lack

• And This Week’s Featured Place: Kansas City, Missouri, Yesteryear’s Vegas of the Plains

Reminder: The Econ Weekly podcast is now available on iTunes, Stitcher, Google Podcasts and Spotify. Just search for Econ Weekly and please leave a review to help spread the word. 

Quote of the Week

“The bond market, the banking system, the financial system is not really designed to have the entire bond market lose 10% of its value in four months. Every other time we’ve seen this we’ve always run into problems.”

-  Jim Bianco of Bianco Research, speaking on Bloomberg Surveillance

Market QuickLook

The Latest

Inflation running wild. An $860b trade deficit. More than $28 trillion in federal debt. An uncertain U.S. growth outlook. Heightened interest among governments to transact in other currencies. Doesn’t sound like the backdrop for a strong U.S. dollar. Yet the dollar has indeed been super-strong lately, lifted by the Fed’s increasingly forceful pledge to gun down rising prices with rising interest rates.

Rising U.S. interest rates, to be sure, make U.S. dollars more valuable—you can earn more by lending them out, even if just to Uncle Sam in exchange for a Treasury bond. As the Wall Street Journal’s Joseph C. Sternberg wrote last week: “Investors are flooding into the greenback because the Federal Reserve seems to be tightening more aggressively than any of its major peers.”

So, is this a good thing or a bad thing? Bad, if you’re an American selling stuff to foreigners. But good if you’re an American buying stuff from foreigners, meaning the strong dollar should help a bit with inflation. In February alone, Americans bought $318b worth of goods and services from foreigners, including $73b of consumer goods, $29b of automobiles (including parts), $16b of crude oil and $6b of semiconductors. Again, that’s just during the month of February.

Unfortunately, the dollar’s helpful impact on inflation is more than offset by countervailing forces, most importantly supply-side disruptions that just won’t go away. In fact, they could get worse with Covid lockdowns affecting Chinese ports and factories—and with commodity markets upended by the war in Ukraine. Demand, meanwhile, continues to hold more or less firm, as the latest corporate earnings reports seem to indicate. A newly-published S&P Global survey of purchase managers likewise suggests ongoing economic strength, albeit with some hints of pessimism—there’s understandably some concern among companies that repeated price hikes (to offset rising costs for labor and materials) will eventually dent consumer spending.

That’s the situation as the Fed inches closer to its greatly anticipated meeting next week (May 3-4). At an IMF event last week, Fed chief Jay Powell affirmed that a half-point rate hike was “on the table,” and that policymakers will no longer stand by and wait for supply chain relief for inflation relief—that’s out of the Fed’s control. Powell made clear it’s “appropriate in my view to be moving a little more quickly,” sending yet another signal of the Fed’s hawkish intent. Treasury yields rose again in response, further battering the values of existing Treasuries issued with lower rates. Corporate bond values were naturally affected as well. An important point about the Treasury market though: Their declines last week were again more pronounced at the midpoint of the time curve (the two-year rose the most). The gains were more muted for longer duration borrowing like the 10-year and 20-year. That’s a likely sign of investor bearishness about longer-term GDP trends. An anticipation, perhaps, that the Fed will at some point have to reverse course and start lowering rates again, maybe in response to another demand shock. Others see longer-term rates depressed due to simple demographics, with America’s shrinking labor force destined to constrain future GDP growth (as it’s arguably doing already).

Powell, at the IMF event, did make sure to say that the U.S. economy looked strong, with “a lot to like” about the labor market. He also suggested though, that the world economy could be entering a more fragmented state, threatening the efficiency—though also avoiding the risks—of hyper-efficient global supply chains. The IMF incidentally lowered its forecast for global GDP growth this year, to 3.6%. Russia’s sanction-battered economy is one reason. The worsening food and energy crisis affecting developing nations is another. Still another is the pressure exerted by the strong dollar. Consider Japan, which usually likes a strong dollar because it sells so many cars and whatnot to Americans. But it also needs to pay for its imported oil and other commodities in dollars, one of which now exchanges for about 128 yen. At the start of 2021, it only took 104 yen to buy a dollar.

Back and home, there’s no longer any doubt that the housing market is slowing, cooled by sharply rising mortgage rates—the U.S. Treasury might not be seeing a sharp rise in 30-year borrowing costs, but homebuyers sure are (their average rate’s now 5.11%, according to Freddie Mac). From February to March, home sales under contract fell 4%, said the National Association of Realtors. Existing home sales fell 3%.

The Fed’s latest Beige Book came out last week, as always providing insightful anecdotes about economic conditions across the country. All throughout are tales of frustration about supply chains and labor shortages but also encouraging descriptions of demand. The New York Fed, for one, described businesses with “severe shortages of truck drivers, construction workers, IT staff and human resource professionals.” Some, it added, “have grown less picky about required qualifications for open jobs and have become more flexible about remote work arrangements.” On a brighter note, New York City is seeing a rebound in its critical tourism sector, with domestic visits now back to within about 90% of normal levels, and visits from abroad about 65% back to normal. The New York Fed, incidentally, also said “residential rents across the district have trended up briskly.”

Also in the Beige Book, The St. Louis Fed said one of its contacts in trailer manufacturing believed they “could double their sales if they had the workers.” Hospitals, meanwhile, “continue to face shortages of nurses and lab supplies.” Makes you wonder if it’s time to reverse recent moves to decrease immigration and increase tariffs.

Everyone’s still wondering if Elon Musk will wind up controlling Twitter. Blackstone, the asset manager specializing in private equity, took a bet on student housing. Student loans, meanwhile, remain a topic of debate in Washington—should the government cancel the debt? According to the Education Data Initiative, 43m Americans owe $1.6 trillion to the Department of Education. The issue is further complicated by concerns about racial equality, with Black students most likely to finance their college studies with federal loans.

It's now the thick of Q1 earnings season, with last week featuring its share of good performances and bad. Mr. Musk dazzled investors with excellent results for Tesla. Bank of America sounded bullish on the U.S. economy and the U.S. consumer, pointing to household deposits and cash levels that remain $3 trillion higher than they were before Covid. CEO Brian Moynihan asked: “Could a slowdown in the economy happen? Perhaps. But… consumer spending remains strong, unemployment is low and wages are rising. Company earnings are also generally strong. Credit is widely available. And our customers’ usage of their lines of credit is still low, i.e., they have capacity to borrow more.” Sounds bullish, no?

More bearishly, Netflix saw its stock price take an epic tumble, unnerving investors with post-pandemic subscription declines. CNN’s new subscription offering, meanwhile, lasted less time than it takes Anderson Cooper to utter the words “BREAKING NEWS!” (i.e., a celebrity’s cat got caught in a tree). Signs of a popping bubble in streaming media? In the transportation world, airlines are flying high thanks to insatiable leisure demand, but freight railroads—though extraordinarily profitable—have shippers up in arms over unreliable service. Truckers, for their part, downplayed talk of a looming freight recession. As the trucking firm Knight-Swift told investors: “Reports of the death of the freight market… have been greatly exaggerated.”

This week, the earnings spotlight turns to Silicon Valley and Silicon Seattle, with Amazon, Apple, Microsoft, Meta and Alphabet all reporting. ExxonMobil and Chevron go as well, offering new insights on the turbulent oil market. Oil prices, by the way, dropped a bit last week, but not enough to save the stock market from another decline. With the bond market in meltdown as well, investors have their hands full.

Companies

• Netflix was a poster child for pandemic-era prosperity. People confined to their homes were subscribing to its streaming video service in droves. The company’s stock price went higher and higher, at one point topping $700 a share (it was $329 at the start of 2020). Then came last autumn, when investors began losing their appetite. It was partly a lost appetite for all high-flying IT growth stocks, which looked less appealing in the face of rising interest rates (see item below). It was more than just getting caught up in the moment, however. Netflix roused specific concerns, one being the surge in competition—Disney, AT&T, Paramount, Apple, Amazon, Comcast, Hulu, Discovery, YouTube… the better question might be who isn’t offering a streaming video service these days? Amid this worry came last week’s Q1 earnings report, which downright alarmed Netflix investors. Shares plummeted 35%, ending the week at $ To be clear, the company reported solid profits. And it’s still the leader by far in number of paid subscribers—220m at the end of Q1. But for the first time in a decade, the company is losing subscribers, including a sizeable number in Russia. People around the world, it seems, are predictably spending less time watching television now that Covid fears have eased in most places. Inflation doesn’t help, with Americans pressed by higher gas prices, for example, perhaps less willing to subscribe (Netflix itself raised prices earlier this year). To help win back investor good graces, management is tackling a long-vexing problem, namely the huge number of customers that share their passwords with friends and family. It estimates that 100m households watch Netflix using another household’s account. The company is also considering a cheaper service that includes advertising, something co-founder and CEO Reed Hastings has long resisted. Streaming video games are another area of potential revenue growth—it’s a huge market but likewise highly competitive. It’s now been nearly 20 years since Netflix, born in Silicon Valley, burst on the scene and drove video rental stores like Blockbuster to the dustbin of history. In the early days, it was DVDs with licensed shows and movies, sent to people’s homes via the mail. Now it’s internet-delivered, on-demand television, filled with original programming produced (at heavy cost) in-house. From House of Cards to Squid Games, Netflix has become a global cultural phenomenon. But has its business model reached a peak?

• A quick word on why investors lose their appetite for growth stocks when interest rates rise. It’s because of the financial world’s most important concept: The time value of money. Growth implies dollars earned in the future. But the higher interest rates go, the more valuable it is to hold dollars in the present. It’s less appealing, in other words, to wait for your money, i.e., to buy growth stocks. Inflation, of course, also erodes the value of future money. Consider someone who manages a retirement fund. The goal is to grow a pool of money over a long period. If interest rates are low, it’s harder to grow that pool, so you might be inclined to buy riskier assets like tech stocks. As interest rates move higher, safer bonds tend to look more attractive, especially if held to maturity. O.K. wait a minute, then why are bond prices tanking? Because for those who trade bonds before they mature, rising rates are a curse (remember, there’s a “primary” or new bond market and a “secondary” or pre-owned bond market, to use a car analogy). That bond you bought yesterday at 2%? It’s now worth much less in the secondary market with rates having moved to 3%. And so another cardinal rule from the world of finance: When rates rise, bond prices in the secondary market drop (and vice versa).

• Omnicom is a global marketing agency based in New York City, not to be confused with the Covid variant Omicron. The company, reporting earnings last week, naturally welcomed the possibility that Netflix might start running ads. Said CEO John Wren: “In the environment where the consumer has to be a little bit more cautious of the amount of money they spend to get what they want, I think you’re going to see more and more advertising in some of these services.”

• Anthem: During the decades-long stretch of low inflation in the U.S. economy, the one major exception was health care. Now that inflation is raging, ironically, health care is the one area where costs have remained relatively restrained. In the March consumer price index, medical care showed just a 2.9% y/y increase. Anthem, the country’s second largest health insurer after UnitedHealth, said in its Q1 earnings call that it’s no doubt seeing cost pressure from a tight labor market. Many of the care providers it works with (i.e., doctors and nurses) face higher costs of supplies and other essentials. But for insurers, the number one cost item is what hospitals are charging for services. Anthem typically negotiates contracts with hospitals that last for three years, so prices don’t move around all that much. There has been some upward movement, it said, “but at this point, we’re not seeing incremental rate pressure.” Like other insurers, Anthem is trying to move to a system where it pays hospitals and doctors based on health outcomes (“value-based care”) rather than just the quantity of tests and services they do (the “fee-for-service model”). How its efforts unfold are of great significance to the entire U.S. economy, a fifth of which involves health care.

Tweet of the Week

Sectors

• Gas Stations: Recode’s Rebecca Heilweil writes about the likely demise of gas stations as electric cars and trucks proliferate. Some stations are installing chargers themselves to serve this new market, but many electric vehicle drivers do their charging at home or at charging stations in shopping center parking lots. In California, Tesla opened a charging hub for its vehicles that incorporates a lounge, an espresso bar and free Wi-Fi. In Norway, where 90% of new cars sold are EVs, gas station visits are way down. Back in the U.S., a big push is underway, backed by federal money, to install charging stations across the nation’s road network. Heilweil describes gas stations as the “middlemen between the fossil fuel industry and drivers.” She writes: “Oil companies need a place where they can easily distribute their product to customers, and drivers need a convenient, reliable spot to fill their gas tanks.” Gas stations, of course, don’t just sell gas. Econ Weekly’s issue from Oct. 11, 2021, looked at their underlying business model, referencing a profile by journalist Zachary Crockett. Most stations don’t earn much profit (if any) selling gas itself. Instead, they earn generally high profit margins from the convenience stores they operate, selling everything from snacks to energy drinks to alcohol to cigarettes to lottery tickets. To lure customers in, offering restrooms is key. And perhaps gas stations will remain the most convenient place to stop for a restroom break. Or maybe not. In Heilweil’s words, “the phasing out of travel by horse also meant the demise of the horse-drawn carriage industry and the repurposing of stables. Now, after a century spent building complex infrastructure around gas-powered vehicles, another transition seems inevitable.”

Markets

• Housing: Ben Carlson, co-host of the “Animal Spirits” podcast and author of a blog called “A Wealth of Common Sense”, gave four reasons why a slowing housing market doesn’t mean a repeat of the 2008 housing collapse. 1) The large millennial demographic is now reaching prime home buying age, which supports demand. 2) Housing supply nationwide is extremely tight after years of underbuilding. 3) There’s hardly any rush for existing homeowners to sell because many are luckily locked into low mortgage rates. And 4) Household balance sheets are strong, meaning there’s still plenty of spending power to buy new homes even if mortgage rates have moved higher. On the other hand, it’s a terrible time to be a first-time homebuyer.

• Gas: Bank of America said that while fuel costs are up 40%-plus from last year, fuel today represents only about 6% of overall debit and credit card spending among U.S. households. It probably helps that more people are working from home rather than driving to an office.

Labor

• The U.S. lost a lot of manufacturing jobs in the past half-century-plus. Can it win some back? Yes, it seems, as companies reorder their priorities in the wake of the supply chain crisis. Build more at home, the theory goes, because it’s less risky even if more expensive. Chris Kuehl of Armada Corporate Intelligence, however, raises an important point. Speaking at a Kansas City Chamber event in December, he highlights the extremely tight U.S. labor market as an impediment to reshoring. The simple demographic reality is that every month, 10,000 Baby Boomers are reaching retirement age, he said. And after years of low birth rates and the recent decline in immigration, staffing existing manufacturing jobs is difficult, let alone new ones. He separately mentioned another overlooked challenge: That many communities don’t want manufacturing jobs, fearing more traffic, noise, pollution, loss of open land, unsightly buildings, etc. Which U.S. states, by the way, are leading the nation in manufacturing job growth? Kuehl names Texas, Oklahoma and Arizona.

• The Economist ran a piece about India’s leading IT services firms, namely Tata Consulting (TCS), Infosys and Wipro. Their armies of low-cost coders first assumed a meaningful role in the U.S. economy during the Y2K scare leading up to 2000, helping U.S. companies ensure their software wouldn’t crash at the turn of the millennium. More recently, they proved useful in helping companies transition to remote working during the pandemic. They’re now involved with important transitions like the shift to electric vehicles and the transfer of data and computing to the cloud. The Indian firms are busy writing code for cybersecurity software as well. U.S. firms themselves are hiring people in India. IBM for one has opened a cybersecurity office there, catering to its Asian clients. JPMorgan Chase, The Economist adds, plans to add 6,000 people to its Indian workforce, developing artificial intelligence software among other things. The article notes: “Wages for new hires in India can be as little as $5,000 annually, less than a tenth of the going rate in rich countries. Even factoring in other costs, Indian projects are at least 20% cheaper than the same endeavors in the West, estimates Peter Bendor-Samuel, boss of the Everest Group, a consultancy.” Indian wages are rising, however—McKinsey estimates that compensation costs have risen by 20%-to-30% over the past year. To be clear, India’s big IT firms don’t just do work in India. Infosys alone has more than 30 outposts across the U.S. and is building a new $245m campus in Indianapolis. It plans to add 10,000 American workers in the next few years, bringing the total to 35,000. That said, most of the value U.S. companies derive is from offshore outsourcing the IT work, which is politically controversial—the U.S. doesn’t want to lose white-collar jobs to offshoring like it lost so many blue-collar jobs. It’s also becoming harder to secure visas for Indian software engineers to work in the U.S., another common practice. Take a PATH train from New Jersey to Wall Street on any given weekday, and you’ll see it filled with Indian software engineers employed on temporary visas.

Government

• North Carolina State Treasurer Dale Folwell, speaking several weeks ago on the Bond Buyer podcast, had not-so-nice things to say about the health care industry. He called it a cartel, controlled in large part by Wall Street, alongside “multibillion dollar corporations that disguise themselves as non-profits to avoid taxation. North Carolina’s government has nearly 750,000 employees on the state’s health insurance plan, which of course gets more costly as health care costs rise. Folwell, by the way, also chairs North Carolina’s Local Government Commission, or LGC, which decides which entities can borrow money using tax-free bonds. Typical candidates include water and sewer districts, along with universities and hospitals.

Places

• Kansas City, Missouri: A sleepy midwestern town? That might be its reputation today, fairly or unfairly. But that was certainly not the case a century ago. During the prohibition-era of the 1920s, and even into the Depression years of the 1930s, Kansas City was more associated with adjectives like sinful, sketchy, edgy and perhaps what we’d today call Las Vegas-like. There’s a reason why Wilbert Harrison went there to chase women and wine, as “Kanas City,” his number one hit song from 1959 recounts. America’s most geographically central metro started out like many cities on the western lands once owned by France—as a place to trade furs. It is, after all, located where the Missouri and Kansas Rivers meet, quite conveniently for river commerce. When the railroads came and expanded after the Civil War, Kansas City boomed, becoming a mini-Chicago of sorts. It was number two behind Chicago in meatpacking, for example, and likewise served as a commercial hub for surrounding farm products—a place to buy and sell grains and seeds and animals, etc. It also, less welcomingly, mimicked some of Chicago less-flattering characteristics, including government corruption and organized crime. Amid a wave of impoverished European immigrants, one family’s arrival from Ireland would shape the city for decades. The Pendergasts, led by brothers Jim and later Tom, built one of America’s most powerful urban political machines, on par with the Dailey machine in Chicago or Tammany Hall in New York City. In the meantime, by the early 1900s, Black Americans eager to escape the South rode the rails and busses northward in search of better lives. Amid these migrants were many musicians from New Orleans, destined to turn Kansas City into one of the great Jazz capitals of America. The Pendergast machine, working closely with organized criminal syndicates, made sure the nightclubs and gambling dens were open, and that the alcohol freely flowed, even during the Prohibition years. Gambling. Seedy nightclubs. You get the picture. It’s much different to be sure, than today’s image of Kansas City. Post-World War II suburbanization changed the city’s downtown character, robbing it of its vibrancy until some measures of revival more recently. It’s never experienced an urban renaissance like Chicago though, in part because it simply doesn’t have the scale to be a global commercial and tourist hub. What it does have is a fairly diverse economy with an above-average workforce of professionals. It’s still a leading transportation hub, with more rail traffic than anywhere but Chicago. That’s unsurprising given its geographic centrality, which makes it a major trucking hub as well. It punches below its weight in air traffic, however, owing to its limited tourism and modest size (it’s the country’s 35th largest metro by population). But its aviation heft should improve with the modernization of its airport now underway. That alone is a project providing lots of construction jobs. Kansas City is attracting more than its fair share of new facilities characteristic of the 21st century economy, including call centers, health facilities and especially warehouses. Meta, owner of Facebook, is building an $800m data center. Kansas City, which straddles the states of Missouri and Kansas, has plenty of prosperous suburbs, major league baseball and football franchises and decent population growth (7% during the 2010s). Though neither state capital nor home to a large university, the area has one of the largest federal government workforces (non-military) outside of Washington. The IRS alone has nearly 5,000 workers in Kansas City. After Uncle Sam, the largest metro area employer is a hospital, followed by Cerner, a health care technology firm with nearly $6b in revenue last year. Hallmark, H&R Block and the investment firm American Century are other familiar corporate names with Kansas City headquarters. Thanks in part to its distributional and logistic advantages, the area is home to major GM and Ford auto plants. The Ford plant is in fact one of the country’s largest, building the company’s most popular product, the F-150 pickup. Honeywell, an aerospace giant, is helping to modernize the country’s nuclear weapons at its Kansas City facilities. Grain and livestock processing, an old staple from the city’s past, remains important today (the local baseball team got its name from an annual livestock show called the American Royal). The city likewise remains home to one of 12 Federal Reserve banks across the country (oddly enough, St. Louis, Missouri, has one too). Kansas City officials do express some concern about mergers that have swallowed some prominent corporate citizens, including Sprint (purchased by T-Mobile) and DST Systems (purchased by SS&C). A Canadian railroad is now buying Kanas City Southern, though their combined network (assuming the merger is approved) could boost the city’s stature as a gateway for traffic moving between Mexico and Canada. There have been some high-profile factory closures in recent years, including those by Harley Davidson and Procter and Gamble. In sum, Kansas City has a solid economy with solid population growth, outperforming other midwestern cities that peaked in national prominence during the first half of the 20th But nor is it a growth superstar in the vein of say, Austin, Nashville, Charlotte or Denver. The nickname “Paris of the Plains” sounds a bit hyperbolic. But better that, surely, than being the subject of songs about sin. (Sources: HUD, Census, Mid-America Regional Council, Economic Development Corporation of Kansas City, KC Chamber).

• Kansas City: If you’ve ever read David McCullough’s classic biography about Harry Truman, you might recall a chapter about the President’s experience as a men’s clothing store owner, and later a civil servant, in Kansas City during the 1920s. It portrays the city under the control of the exceedingly corrupt Pendergast political machine, which doled out everything from construction contracts to liquor licenses—to supporters, of course. It’s a good look at how political machines develop and operate, in this case with the elder Pendergast arriving from Ireland in the 1870s, at first working in a slaughterhouse and later an iron foundry. After winning money by gambling, he purchased a hotel and saloon where other people could come to gamble. Later came wholesale liquor distribution. Then election to local office. Then using public money to build loyalty among Irish immigrants and other poor and needy citizens of Kansas City. McCullough writes that he reached out to the city’s Polish, Slavic and Italian communities, and even its African Americans. Kansas City, by the way, continued to experience a construction boom beyond the roaring 1920s and well into the Great Depression. You might even call it the Austin of that era.

• Wichita, Kansas, is a major hub for aircraft manufacturing, thanks to companies like Boeing supplier Spirit AeroSystems. No surprise then, that the Canadian planemaker Bombardier just announced Wichita as its new U.S. headquarters. (See Econ Weekly’s issue from May 24th, 2021).

Looking Back

• General Motors: Alfred P. Sloan, Jr., the greatest business leader in American history? The American Business History Center makes the case as it profiles his career. Sloan ran General Motors from 1923 to 1956, quite a feat of managerial longevity. Before his arrival, GM was earning much lower profits than its rival Ford, whose founder Henry Ford pioneered the use of assembly lines and other revolutionary production methods. By the time Sloan retired, GM had become America’s largest company, with profits significantly higher than those of not just Ford but also the next two largest U.S. companies: Standard Oil of New Jersey (now ExxonMobil) and AT&T. Along the way, Sloan introduced management practices that were arguably as groundbreaking as the assembly line. He centralized and modernized many core functions, including financial controls, product design, research and development, marketing, legal matters, purchasing, real estate and factory design. Yet GM also stressed decentralization, with operating division managers given full autonomy over their “profit center.” Earlier, under former CEO Billy Durant, headquarters had little idea of how each division operated and whether it was truly profitable or not, often leading to costly overproduction. Sloan’s system also separated corporate strategic decisions (i.e., where to invest) from operating decisions (executing and implementing). The former were largely made by committees rather than individuals. This produced the multi-brand portfolio that GM still sports today, marketing different products to people with different income levels—“Chevrolet making starter cars, Pontiac offering a step up, Oldsmobile and Buick even higher, and Cadillac at the top, with slightly overlapping pricing.” Remarkably, GM under Sloan didn’t even lose money during the Great Depression of the 1930s. During World War II, it was the single largest supplier to the U.S. military. By mid-century, GM was at the center of the U.S. economy, employing some 600,000 American workers. The American Business History Center’s Gary Hoover, who authored the profile, further details Sloan’s legacy, including his relationship with dealers and unions. Today, thanks to philanthropy, his name graces MIT’s Sloan management school, as well as the Sloan-Kettering Cancer Center.

Looking Ahead

• Climate Change: To understand how the economy reacts to a warming planet, watch the insurance industry. That’s one takeaway from Eugene Linden, author of the new book “Fire and Flood: A People’s History of Climate Change, from 1979 to the Present.” Appearing on the Bloomberg BusinessWeek podcast Linden says insurance firms are often underpricing climate risk, partly because they can offload some of that risk to reinsurers (not unlike mortgage underwriters offloaded risk during the ill-fated 2000s housing boom). On the other hand, property insurance companies have been leaving the Florida market for years, forcing the state government (in 2002) to form its own non-profit insurer. The state is experiencing somewhat of an insurance crisis in 2022, with more firms pulling out. The insurer AIG, Linden notes, left the California market where wildfires are costly to cover. Unhelpfully, many of the country’s hottest housing markets during the pandemic were in the most climate-vulnerable places—think coastal cities like Miami. At some point, Linden thinks, it will become simply too expensive to insure property in such places. Without insurance, banks won’t provide mortgage loans. And that, Linden says, could trigger a 2008-like mortgage crisis.

• Climate Change: Along those same lines regarding risks to property, Jenny Schuetz fears the current U.S. housing stock simply isn’t adequate to meet the challenge. Speaking on the New Bazaar podcast, she gives the example of basement apartments in New York that flooded during a recent hurricane, and homes in the Pacific Northwest that weren’t built with air conditioners to handle the coming extreme heat. Schuetz is the author of the new book: “Fixer-Upper: How to Repair America's Broken Housing System.”

Issue 64: April 18, 2022

Inside this Issue:

• Uneasy Prosperity: Gloom in the Time of Boom

• Q1 Earnings Season Underway: What do Companies Have to Say?

• The Shopping’s Not Stopping: But Americans Paying More for Less

• Inflation Starting to Cool? Some Positive Signs ex Food and Fuel

• Morgan’s Menaces: Largest U.S. Bank Sees Strength but Volatility

• Higher Fare? We Don’t Care: Delta Seeing Record Sales

• Alarm on the Farm: Ag Sector Thriving but Ag Counties Dying

• Andrew Jackson’s Thriller: An Epic 19th Century Bank Battle

• And This Week’s Featured Place: Navajo Nation, Where are the Walmarts?    

Quick Note: The Econ Weekly podcast is now available on iTunes, Stitcher and Spotify. Just search for Econ Weekly and please leave a review to help spread the word. 

Quote of the Week

“I cannot foresee any scenario at all where you’re not going to have a lot of volatility in markets going forward [but]… I can't forecast the future any more than anyone else. And, you know, the Fed forecasted and everyone forecasted, and everyone’s wrong all the time.”

-JPMorgan Chase CEO Jamie Dimon

Market QuickLook

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Consumers are still spending. Banks are still lending. Corporate profits are unbending. Job growth seems never-ending. In many ways, 2022 feels like a time of great prosperity for the U.S. economy. Yet it’s a highly uneasy prosperity. Globalization, it seems, may be ending. Supply chains, it seems, aren’t much mending. Risks from all directions—from the Federal Reserve to the battlefields of Ukraine—are unmistakably ascending. Is a recession impending?

Consider the mixed signals from America’s consumers. Resting on a concrete foundation of strong employment, elevated savings and a lengthy run of soaring real estate and equity markets, households are sure enough keeping their wallets open. Americans spent nearly $666b on retail goods and food services last month, up a half-point from February, and up more than a full point if you ignore vehicles, where people surely would be spending more if the semicon shortage hadn’t decimated inventories. That said, much of this spending growth stems from a 9% increase in outlays at gas stations—put another way, people are spending more because gasoline has become so much more expensive. That’s true for most other things too—Americans continue to spend but are getting less for their money.

The March report on retail and foodservice spending, to be clear, ignores the larger bucket of spending on services—on health care, for example, or housing, utilities, education and travel. There’s in fact mounting evidence of a post-pandemic shift from goods spending to service spending, reversing an earlier trend. It’s something several banks said they’ve seen in their credit card business. Delta, for one, made it perfectly clear that Americans are eagerly buying airline tickets.

That’s true despite surveys showing dismal levels of consumer confidence. It’s true despite wage gains not keeping up with price gains. It’s true despite what’s now a slumping stock market. It’s true despite a clearly slowing housing market, chilled by a sharp and sudden spike in mortgage rates. Rates are up, of course, because the Federal Reserve wants it that way. The Fed wants it that way, of course, to wrest control of inflation.

Inflation now stands at a still-alarming 8.5%, according to the annual change in the March consumer price index (CPI), published by the Bureau of Labor Statistics last week. In just the one month from February to March, the index jumped by 1.2%. Much of that jump, to be clear, reflected the shock to food and energy markets triggered by the Ukraine conflict. Remove food and energy, and consumer inflation rose just 0.3% from February to March, and just 6.5% y/y. Used car prices, though still up 35% from last spring, dropped nearly 4% last month. Perhaps a sign that inflation ex commodities has peaked.

First quarter earnings season, now underway, will offer more clues on whether inflation and other headwinds herald a drop in consumer spending. There’s little evidence of pessimism so far. Albertsons, the grocery chain, said simply: “We are not seeing a change in behavior… We are still seeing the consumers very strong.” CEO Vivek Sankaran said not even high gas prices are causing any “material change.” Nor, he added, are consumers trading down to cheaper items—purchases of pricier organic foods are actually up.

So why is there so much talk of a looming recession, or even a repeat of 1970s-style stagflation? Again, as reporting banks explained last week, conditions remain strong right now but many headwinds swirl. The economy’s firm foundation, you might say, is increasingly tested by an infestation of termites—the inflation pest, spiking interest rates, cooling asset markets, wildly volatile food and energy markets, and so on. Keep an eye on China as well, where key U.S. suppliers face more Covid-disruptions. Shanghai is in the headlines, but also affected are cities like Zhengzhou, where many iPhones are produced.

Back onshore, a separate risk concerns the “plumbing” of the financial system, and how it will react as Fed policy radically shifts from quantitative easing (buying bonds) to quantitative tightening (reducing bond holdings). This plumbing involves the mechanics of how money moves through the economy, ensuring that payments can be made, and that companies and governments can access the daily cash they need to operate. Boring but essential stuff. Why the worry? Because America’s financial plumbing has systemic vulnerabilities made clear during multiple periods of distress since breaking down catastrophically in 2008. A meltdown in March 2020, for example, was narrowly averted only with massive Fed intervention.

Oil prices, by the way, raced back above the $100-mark last week. Bond yields spiked again, making investors think twice about lending money (why lend today when you can lend at higher interest rates tomorrow?). Stock prices fell again. There’s growing talk of a trucking slowdown. Don’t forget too that springtime spending is momentarily getting a boost from large tax refunds this year—the IRS has issued $240b worth as of April 1, according to Jonathan Smoke of Cox Automotive, appearing on the Moody’s Inside Economics podcast. SNAP payments, better known as food stamps for lower-income Americans, are decreasing as well, with Covid-era fiscal relief now winding down. Same for emergency farm subsidies and other aid.

Did we get this far without mentioning Elon Musk? America’s most iconic business figure since Steve Jobs wants to buy Twitter, the social media firm. Twitter, in turn, is resisting. Elsewhere in tech-land, Amazon’s new CEO Andy Jassy penned a Jeff Bezos-like letter to shareholders, highlighting some remarkable facts. The company, for one, hired 300,000 people last year. And it made $100b in capital investments during the last 15 years. Amazon is indeed bringing jobs and investment to communities big and small across America, on a scale arguably unmatched by any other company. But not without controversy, specifically over how it competes, how much tax it pays and how it treats employees. Musk, incidentally, will report Tesla’s Q1 results this week. Amazon and its Big Tech peers will go next week.

A few other notes from last week’s earnings presentations: Citigroup’s Jane Fraser said she’s “positive around the U.S. economy and the U.S. consumer,” supported by “momentum in the labor market.” Fastenal, which literally sells nuts and bolts (and lots of other industrial and construction supplies), sees U.S. companies still facing supply and cost pressures, but are increasingly learning to deal with them. Goldman Sachs and Blackrock both appear convinced that the era of globalized commerce is reversing. Blackrock also noted a growing investor appetite to protect against inflation with real assets like infrastructure, commodities and real estate. PNC, a large Pittsburgh-based bank, expects 3.7% U.S. GDP growth this year, and a Fed Funds rate of around 2% to 2.25%. Like everything else about the economy right now though, forecasts are all over the map.

Companies

• JPMorgan Chase: Bankers used to bank. Now the big ones do that and much more. JPMorgan Chase, the biggest U.S. bank, certainly does a lot of traditional banking, as in lending money to households and companies. Last year in fact, it provided $1.3 trillion in loans to corporations, $331b to consumers (including mortgages and credit cards) and $22b to small businesses. But it’s also a big investment bank that helps firms raise money, arrange mergers and formulate strategy. It’s an asset manager, helping people protect their wealth and invest for retirement. It’s involved in payments, risk management, market-making and many other financial services as well. Even when in lending, much of JPMorgan’s profit these days takes comes from fees rather than charging interest. Altogether, this collection of activities produced $31b in revenue last quarter, more than $8b of which was profit. In some respects, business has slowed from last year’s extraordinary strength. A corporate frenzy to raise new funds—via issuance of stocks and bonds—has quieted, meaning lower fee income. Home loan origination is down as interest rates rise. The company suffered substantial losses, furthermore, linked to turbulence in commodity markets (nickel most notably) and exposure to derivative counterparties associated with Russia. None of this, however, dilutes JPMorgan’s near-term optimism. Demand for commercial loans is growing and households continue to spend. “The consumer has money… they’re spending their money,” said CEO Jamie Dimon. Other aspects of the economy likewise indicate strength, including housing prices which remain high, and the $2 trillion Americans have in their savings and checking accounts. That said, Dimon sees “significant geopolitical and economic challenges ahead due to high inflation, supply chain issues and the war in Ukraine.” The oil market is another “cloud on the horizon,” albeit one that’s highly unpredictable. The Fed’s fight against inflation too, will have hard-to-predict consequences. JPMorgan sees its job as not trying to guess what’s going to happen, but to prepare for anything that could happen, helping clients manage the associated risks. Today’s JPMorgan, by the way, was born from Chase Manhattan’s 2000 takeover of the old JPMorgan, followed four years later by the takeover of Chicago’s Bank One, which Dimon ran at the time. (For a more detailed history, see the Nov. 15th, 2021, issue of Econ Weekly).

• Delta Air Lines: The January-to-March quarter was another bloody one for U.S. airlines, with even Delta—a profit leader pre-Covid—spilling nearly $1b in red ink. Keep in mind, however, that January and February are slow months for air travel even in good times. It’s the spring and summer when airlines typically earn an outsized portion of their profits, and demand this spring and summer (based on bookings) looks exceedingly strong. Delta in fact earned a solid profit during just the month of March, which happens to coincide with Florida’s peak season. Indeed, it’s pretty hard to find an American who isn’t flying to Florida or Arizona or the Caribbean or somewhere warm and relaxing this spring. The raging pent-up demand shows few signs of cooling, even in the face of rising ticket prices as airlines respond to rising fuel prices. Overseas travel too is picking up as most countries relax entry restrictions (China and Japan are notable exceptions). Delta expects a 12% to 14% operating margin for the current April-to-June quarter. And yes, that’s really good in the dismal airline business (for the record, Delta’s operating margin in the same quarter of 2019 was 17%, but with fuel just $2.08 per gallon; the forecast for this year’s Q2 is $3.30). A few facts about Delta: Its largest market by far is its hometown Atlanta, the busiest airport in the world. Its workforce is much less unionized than those of its rivals. It has important alliances with overseas airlines like Air France/KLM, Virgin Atlantic and Korean Air. And it’s been among the more conservative airlines with respect to capacity restoration from pre-Covid levels.

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Sectors

• Agriculture: There’s an odd paradox present in American agriculture. On the one hand, farmers are prospering, thanks to high crop prices and a large increase in already generous federal support during the pandemic. On the other hand, as The Economist describes, “rural America is in deep decline.” Farmers, it writes, saw their incomes rise 25% last year, to their highest level since 2013. And soaring commodity prices should make 2022 almost as good as 2021, despite the expiration of some Covid relief programs. Farming real estate, meanwhile, is selling for record prices. Yet parts of the country where farming is prevalent—rural America—saw population decline during the 2010s. It was the first decade ever to see a decline. School enrollment throughout rural America is shrinking. Churches and other community institutions are closing. Young people often leave to find jobs. Some two-thirds of rural counties lost people last decade, and those that didn’t were mostly “pretty places where people go to retire, near mountains or the ocean, or those with lots of oil.” If farming is such a good business, why isn’t rural America thriving and growing? In some ways, rural America is a victim of farming’s success, specifically, it’s remarkable ability to produce more output with fewer people. Farms, simply put, don’t need much labor these days thanks to extremely advanced machinery. This is especially true for the crops that Washington heavily subsidizes like corn, wheat and soybeans (growing fruit and vegetables is more labor intensive but mostly unsubsidized). And so, The Economist concludes: “Even if farmers are getting wealthier, the communities they live in are not.”

• Agriculture: Keep in mind that when the United States was first founded in the late 1700s, a large majority of its residents were farmers. Today, the figure is just 1.4%, according to UDSA. Yet agriculture remains economically important, especially in states like Iowa. Montana and the Dakotas—in these states, according to USAFacts, more like a tenth of all workers are farmers. Agriculture also of course supports the broader food industry, including food processing, food retail and away-from-home dining. All of that accounts for about 10% of the U.S. labor market.

Markets

• Debt: Bill Gross has been getting lots of attention recently. He’s the subject of a new biography by journalist Mary Childs called “The Bond King,” a reference to his influence as founder of Pimco, a leading bond investment firm. Gross almost single-handedly “turned the sleepy bond market into a destabilized game of high risk, high reward.” Before Pimco’s founding in 1971, trading was indeed a mostly sleepy affair—investors would lend money to governments or companies and hold the bond until maturity, earning interest along the way. Gross helped create an active secondary market for trading bonds before they matured, just as people trade stocks after they’ve been initially offered. The bond market today, in fact, is much larger than the stock market. Gross himself, a mercurial figure eventually fired from Pimco, recently appeared on Bloomberg’s “Masters in Business” podcast to share his side of the story. He attributed part of Pimco’s success to timing—its launch in the early 1970s coincided with the U.S. abandoning the gold standard for international transactions, meaning credit could more freely be created (no need for every new dollar created to be backed by gold reserves). This opened the door to a lot of new borrowing by governments and corporations, sometimes via traditional bank loans but increasingly by issuing bonds. In 1971, Gross said, America’s total credit—including government borrowing, mortgages, credit card debt and everything else—amounted to about $1 trillion. “Today that number is $87 trillion.” Gross firmed his trading reputation by anticipating the housing crisis of the late 2000s but then incorrectly bet that Treasury bond prices would drop after the final crisis. They in fact rose… and continued rising, in tandem with ever-declining interest rates. Finally, in 2022, interest rates are rising again, sending bond prices down and triggering a debate about whether the decline is a new longterm trend—or just a momentary aberration.

Labor

• Health Care Workers: Here’s more data highlighting the immensity of America’s health care sector. It currently employs nearly 9m Americans, according to the Bureau of Labor Statistics. That’s about 6% of all jobs in America. This 6%, of course, pales in comparison to the roughly 20% of U.S. spending allocated to health (or put another way, the sector accounts for 20% of GDP). Unfortunately, the economics of health care are tough to get right, and—as every American has surely experienced—the U.S. system is riddled with bureaucracy, complexity, non-transparency and epic cost inefficiency… to a degree that threatens U.S. fiscal health. It does provide many good jobs though, with the mean wage across all healthcare practitioners reaching $91,100 in May 2021. The mean for all U.S. workers? Just $58,260. In many communities across America, health care along with education and government form the backbone of the labor market, accounting for an outsized percentage of all jobs. Health care jobs, of course, can range from highly-paid surgeons to minimum wage hospital clerks and custodial staff.

Government

• Financial Market Reform: In the old days, a financial crisis usually meant a “run” on banks: everyone withdrawing their deposits at once. Federal insurance of bank deposits, implemented during the 1930s Great Depression, largely ended that. More recent financial calamities have instead involved runs on non-bank institutions and markets, sometimes called the shadow financial system. These days, with banks largely paying zero interest on checking and savings accounts, many households and companies park a portion of their cash in money market funds, or MMFs. These are designed to be just as safe and readily retrievable as bank deposits, aside from the fact they’re not federally insured like bank deposits. Fidelity, JPMorgan, Vanguard and Blackrock are among the largest providers of such funds. To stay safe, they typically invest in ultra-safe securities like short-term U.S. Treasuries, municipal bonds or short-term bonds issued by blue-chip companies (sometimes called commercial paper). In that sense, MMFs are not just useful for households and companies looking for a safe place for their cash. They’re also useful for governments and companies that need to raise cash. MMFs, in other words, are an important source of short-term financing for governments and companies, including financial companies like banks. The more money people put in, the more money that’s available to borrow. But what happens when everyone panics—like they did in 2008 and 2020—and withdraws funds at the same time? That’s the modern equivalent of a bank run (which incidentally is a risk for blockchain-based stablecoins as well, serving as they do as places to park and easily withdraw cash). With all of this in mind, the Securities and Exchange Commission (SEC) recently proposed reforms to protect against an MMF run. Many are rather technical but seek to ensure, for example, that a certain percentage of an MMF’s assets be highly liquid, as in accessible within one day or one week. The SEC wants to increase data reporting requirements as well, and limit the ability of funds to block withdrawals in times of distress (the fact that they can do can scare investors, encouraging them to withdraw when times get tough).

Places:

• Navajo Nation: America’s largest Indian reservation is larger in fact than ten states—16m acres. But it doesn’t have a single Walmart. Not one. And the reason goes a long way toward explaining why the economies of Native American lands are so difficult to develop. Navajo Nation, whose reservation lies in the “Four Corners” region of the U.S. west, overlaps with four states: Arizona, Utah, New Mexico and Colorado. But not all Navajos (sometimes called Diné) live on the reservation. In fact, fewer than half do, owing to limited economic opportunities. The number is about 174,000, according to the Census. That’s roughly the size of Abilene, TX, or Bloomington, IL. Like many of America’s 300-plus Indian reservations, the one governed by Navajo Nation suffers from extreme poverty and underdevelopment. According to the Nation’s President, Jonathan Nez, writing in the Washington Post last year, 40% of the reservation’s residents lack running water while 27% of homes lack electricity, let alone broadband. Some 80% of the area’s roads are unpaved. Fewer than a tenth of residents have a college degree. The unemployment rate between 2013 and 2017 averaged close to 20%. Rates of alcoholism, suicide and domestic violence are high. Covid hit hard. Unlike the Cheyenne River Reservation, however (see the Econ Weekly issue from April 19th, 2021), Navajo Nation possesses valuable natural resources including oil, gas and coal. Revenues from these resources, combined with federal aid, help fund a tribal government that operates various business enterprises, including a power company, an energy exploration and production company, a network of gas stations, a casino operator, a power utility, and so on. Public employment, including jobs with the Federal Bureau of Indian Affairs (BIA) and the Indian Health Service, dominates the reservation’s labor market. Some residents earn a living as artisans or service workers. Local flea markets are popular places to buy and sell items. The reservation attracts some tourists, often driving through on road trips. There’s enough of an economy, no doubt, to support a Walmart. Sure enough, Navajo residents routinely shop at Walmart and other familiar retail establishments… but not in reservation towns—not even in the Navajo capital of Window Rock. Instead, they cross the border to shop, in towns like Gallup, NM, and Flagstaff, AZ. Albuquerque is a roughly three-hour drive from Window Rock. Phoenix is about seven hours. Walmart and other businesses, simply put, are averse to managing the legal complexities and liabilities associated with tribal law, which coexists with U.S. law. This in turn deprives the Navajo Nation of valuable tax income. Real estate law is one area of complexity that often proves a barrier to development. President Nez, for his part, lays some of the blame on Washington, specifically the (BIA), which is charged with delivering government funding and services to tribal areas. He said the BIA “strangles us in red tape anytime we attempt to improve conditions on our lands.” An example is the multiple layers of approval required for development projects and having to deal, more generally, with multiple overlapping government bodies. As Nez said in a recent address: “We are, by far, the most over-regulated population in this country.” Banks are certainly deterred, often unwilling to do home loans or construction loans because tribal land is held in trust by Washington and can’t be used as collateral. Most Navajo residents live on rented land or in government housing. Small businesses and Navajo entrepreneurs are further challenged by underdeveloped transportation, utility and communication infrastructure. With education achievement low, employers have to hire many non-Navajo workers for higher-skilled jobs. The Navajo tribal government itself, the reservation’s largest employer, says 70% of its contracted work goes to non-Navajo businesses, with much of the compensation spent off the reservation. In 2019, tribal revenues dropped sharply following the closure of a coal-fired power plant long operated by Peabody, the country’s largest coal company. A nearby mine was closed as well, reducing Navajo Nation’s revenues by an estimated $30m to $50m a year, according to President Nez. The Covid crisis naturally hurt casino and tourism revenue. On the other hand, Covid-related stimulus payments, as well as money from Washington’s infrastructure bill, offer a fiscal windfall. Nevertheless, Navajo Nation still depends greatly on taxes and royalties from natural resource development, prompting a push to diversify. Working with Four Corners Economic Development, it’s contemplating a freight railway that would connect the reservation to BNSF’s main east-west line running through the U.S. Southwest. Last year, the medical glove manufacturer Rhino Health expanded its production capacity in Navajo Nation. Interestingly, the tribal government came close to buying the bankrupt gun manufacturer Remington in 2020. It’s now investing in clean energy projects including solar and wind. Helium extraction is likewise viewed as an opportunity. Some think legalizing cannabis sales would provide a meaningful boost. As for the economy today, Derrick Watchman, formerly CEO of Navajo Nation Gaming Enterprise and currently president of the tribal advisory firm Sagebrush Hill, estimates the reservation’s total GDP to be something around $8b to $10b. Enough to support a Walmart? Absolutely. (Sources: Navajo Nation, Change Labs, Derrick Watchman, Four Corners Economic Development).

• New York City’s economic might since the 1980s makes it easy to forget how troubled the city was in the 1960s and 1970s. It’s a story Thomas Dyja tells in his book “New York, New York, New York: Four Decades of Success, Excess, and Transformation.” When mayor Ed Koch took office in 1978, the city’s finances were largely under the control of a commission appointed by New York State—this was a condition the State imposed in exchange for a 1975 bailout (President Ford famously told New York City to ‘drop dead,’ or so read a famous newspaper headline from the time). According to Dyja, Koch had to cut taxes, cut debt and cut social spending, and also cut 20,000 additional government jobs to secure a Congressional loan. Since 1969, poverty in the city had increased more than 40%, while median family incomes had dropped 18%. Manufacturing jobs had left the city in droves. Mob families, Dyja writes, took control of key service sectors like waste haulage, which drove up costs. It didn’t help that longtime city planner Robert Moses (immortalized in Robert Caro’s famous biography) failed to invest in railways, favoring highways instead. The “gut punch” in Dyja’s assessment, was the death of New York City’s port, long the largest employer of its unskilled labor. With the advent of container shipping, port activity moved to New Jersey (you can read about that in Marc Levinson’s book “The Box.”).

• New York City would have another extremely rough period between 1989 and 1992, when it lost 14% of its jobs and the unemployment rate was twice the national average. Median home prices in Manhattan, according to New York magazine, dropped by a quarter and overall construction dropped by a third. The pain was caused by overinvestment in commercial real estate, a crime wave that depressed tourism, the 1987 stock market crash and a national recession characterized by more lost manufacturing jobs and more clerical and back-office jobs being replaced by personal computers.

Looking Back

• Andrew Jackson’s Bank War In 1816, the U.S. revived the idea of a national bank. Not extending the charter of its first national bank—Alexander Hamilton’s Bank of the United States—proved problematic when the country needed to finance the War of 1812 against Britain. Proponents also argued that a national bank was good for economic stability and investment. “What makes the economy go is access to credit,” said historian Paul Kahan on the “Age of Jackson” podcast. So the Second Bank of the United States was born, again functioning not quite like a modern central bank but with some central bank-like functions—it held the federal government’s money for example, and collected its taxes. It also issued its own currency, though other banks could do that as well. It was really a commercial bank, making money by making loans (typically to farmers buying land and slaves). It was, at the time, the country’s only bank operating across state lines, with branches in multiple cities. In fact, it was then the country’s only company with a nationwide footprint. The bank, indeed, was a private business—the federal government only owned 20% of its shares. So naturally, it was controversial, having many government-like privileges but earning money for private investors. Local banks hated the competition. Many farmers resented the bank for tightening credit standards and repossessing land after the Panic of 1819.

• Enter Andrew Jackson of Tennessee. In 1829, he became the first U.S. president not from either Virginia or Massachusetts, states whose political influence was waning. The economy was changing rapidly as well during the 1820s, from one dominated by farmers importing a lot to one in which industry and small manufacturing had a greater role, often exporting what they made. The new economy required a lot more capital and by extension more banking. Paul Kahan writes in his book “The Bank War” that by the time Jackson came to power, the Second Bank of the U.S. “exercised an incredible amount of influence over the economy.” It originated a fifth of all U.S. loans, issued a fifth of its currency and held one-third of its gold and silver reserves. Early on in his presidency, Jackson’s disdain for the national bank was mostly rhetorical; he showed little indication of wanting to destroy it. Close advisors though, including Vice President Martin Van Buren, was unambiguously hostile—Van Buren knew banks in his home state of New York would benefit if the Philadelphia-based Bank of the U.S. was shut down. Bank president Nicolas Biddle, working behind the scenes with Jackson’s rival Henry Clay, angered the President by asking Congress to renew the bank’s charter early, which it did. But Jackson vetoed it. He then won reelection in 1832 and removed federal funds from the bank, reallocating them to “pet” banks across the country. The Second Bank of the U.S. went out of business in 1841, surviving for a while as a state-chartered bank. But not before the pet banks embarked on a lending boom that inflated cotton prices (cotton was like the oil of its time, underpinning the textile industry). This contributed to the Panic of 1837, one of the worst in U.S. history. In the wake of the Bank’s demise, financial power would shift from Philadelphia to New York City. The economy, meanwhile, would spend most of the next three-quarters of a century without a national or central bank. Only in 1913, responding to the Panic of 1907, did Congress create the Federal Reserve.

Looking Ahead

• Health Care: Deloitte, a consultancy, published a report on “the future of health,” predicting the industry is poised for large-scale disruption. It highlights major changes in six key areas: data sharing, interoperability, equitable access, empowered consumers, behavior change, and scientific breakthrough. Deloitte says all six have the power to transform U.S. health care from being “treatment-based reactionary care to prevention and well-being.” There’s certainly lots of money directed toward health innovation, with venture funding for health tech reaching a record $14b in 2020. Some of that money is searching for new breakthroughs in treatment, but also prevalent are efforts to improve affordability and access. Deloitte is optimistic that coming changes will help reduce costs as well.

Issue 63: April 11, 2022

Inside this Issue:

• The Fed Makes It Clear: Won’t be Cavalier in Busting Inflation’s Rear

• Markets Get the Message: Will Spiking Rates Cause Housing Wreckage?

• Bye Bye Benjamins: A Disturbance in Global Dollar Dominance?

• Dimon Charge: A Literary Fling from Wall Street’s King

• Lack of Immigration Causing Inflation? The Labor Market’s Missing Millions

• Passing It On: Conagra’s Costs Soar but the Slim Jim Costs More

• Reaching for the Stars: Amazon Sends Satellites to Space

• And This Week’s Featured Place: Minneapolis-St. Paul, Minnesota, Minnesota Miracle

A Quick Note: The Econ Weekly podcast is now available in iTunes, Stitcher and Spotify. Just search for Econ Weekly and please leave a review to help spread the word. In this week's episode, we talk about Fed policy, inflation, airline consolidation, the Twin Cities and lots more... 

Quote of the Week

“The whole world that we have is built on structurally low interest rates. Higher interest rates, higher inflation… It blows everything apart.”

-Joseph Wang, former Fed trader and author of the Fed Guy blog, speaking on the program “Forward Guidance”

Market QuickLook

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We’re not kidding around. No, really, we’re not kidding around.

That was the message Lael Brainard delivered last week. She’s the number two person on the Federal Reserve’s Board of Governors (or will be pending Senate confirmation), and she’s making it perfectly clear that defeating inflation is now job number one. No more talk about patience. No more invocations of the word transitory. The cannons are out, and the Fed is ready to fire them.

Its chief weapon is raising overnight interest rates, which it started doing at its last meeting in March—and which it will all but certainly do again at its next two-day meeting that begins on May 3rd. Not stopping there, the Fed intends to rapidly shrink the $9 trillion pile of Treasury and mortgage bonds it amassed to encourage lending during the pandemic. This should begin sometime this summer, putting further upward pressure on borrowing costs. Brainard’s message, importantly, was reinforced by what Fed policymakers said amongst themselves during their March meeting—the transcript of this meeting was published last week. One revelation: Many were ready to hike by a half-point, electing for just a quarter-point only after the Ukraine conflict introduced new uncertainty.

The idea, to be clear, is to slow demand by making borrowing more expensive—but not so much as to cause a recession. Financial markets are clearly getting the message, with longterm borrowing rates—30-year home mortgage rates most importantly—up by roughly a full percentage point in just the past few weeks. According to Freddie Mac, the average 30-year mortgage rate now stands at 4.72%, up from 3.76% at the beginning of March and around 2.8% last summer. The last time mortgages were this expensive? Late 2018.

This naturally has implications for the systemically vital housing market, which sure enough seems to be cooling. That’s probably a good thing following the massive runup in prices during the past year and a half. But it could affect consumer spending. So might the impact of higher borrowing costs for credit card loans. The auto market too, is sensitive to interest rates, though the most pressing problem there continues to be the semicon shortage that’s crippling output. Student debt, amounting to a higher figure than even credit card and auto debt, will be less of a short-term risk to household spending, because most student debt is owed to the federal government, which is again extending a freeze on repayments (until September). Washington’s own borrowing costs, meanwhile, are unambiguously increasing, with 10-year Treasury yields ending the week at 2.72%. They started the year, remember, at just 1.63%. Historically, borrowing costs below 3% are still extremely low. But sharp increases can be worrisome, especially for a government with $30 trillion in debt. Reminder: The value of everything the U.S. produces (GDP) is only $24 trillion.

Oil prices mercifully stayed below the $100 mark, helping the Fed’s cause (though $98 is no bargain). Encouragingly, used vehicle prices dropped 3% from February to March, according to Manheim Consulting. They’re still up 25% from a year ago, however. Stock prices dropped last week, but here too a y/y comparison is helpful—the S&P 500 is still 9% higher than it was last April. The Nasdaq Composite index is down y/y, however, reflecting recent investor distaste for tech stocks like Meta, Netflix, PayPal, Zoom and the electric carmaker Lucid.

Amazon’s stock is down 9% y/y, in part because of worries about labor costs as unionization efforts advance. Workers at an Amazon warehouse on New York City’s Staten Island voted last week to become the company’s first U.S.-based union. Amazon’s rival Walmart, meanwhile, clearly has labor issues of its own, specifically finding enough truck drivers. This might do the trick though: A new plan to pay first-year drivers $110,000 a year.

The driver shortage could ultimately disappear if autonomous trucking becomes the norm. The concept is inching forward as Pittsburgh’s Aurora plans trial journeys between Dallas and El Paso for the trucking firm Werner. Warren Buffett’s Berkshire Hathaway, the country’s fourth-largest firm by revenues (after Walmart, Amazon and Apple), became the largest shareholder in HP, best known for its personal computers and printers. Berkshire, remember, is also one of the largest shareholders in Apple, not to mention other familiar names like Bank of America, American Express and Coca-Cola. That’s in addition to full control of companies like Union Pacific and Geico (yeah, the one with the lizard).

Still, Warren Buffett no longer ranks as America’s richest person. Forbes currently has him at number four, behind Bill Gates (no. 3), Jeff Bezos (no. 2) and the richest of them all Elon Musk. Mr. Musk was again making headlines last week, buying a major stake in Twitter and opening a new Tesla factory in Austin. In Washington, Treasury chief Janet Yellen gave a speech about digital currencies, downplaying the likelihood of the U.S. government issuing one anytime soon, notwithstanding China’s advancements in this area. “Issuing a CBDC [central bank digital currency] would likely present a major design and engineering challenge that would require years of development, not months.” Some of the issues aren’t economic, like protecting people’s privacy.

Back to the Lael Brainard speech last week, one sub-theme of her inflation discussion was inequality, and how rising prices disproportionately affect lower-income Americans. Lower-income households, she said, spend 77% of their income on necessities, more than double the 31% spent by higher-income households. The difference in housing expenditure is stark as well: 45% vs. 18%. The Labor Department’s consumer price index (CPI) she notes, doesn’t show this, including for example, caviar and canned tuna in the same index category.

An exceptionally interesting read was Jamie Dimon’s take on the American economy and its financial sector. Dimon is often called the King of Wall Street, running the country’s most powerful bank, JPMorgan. In a letter to shareholders, he flagged a few critical trends, one being the rise of non-banks when it comes to lending. Banks like JPMorgan today account for just 32% of mortgage originations, he said, compared to 91% before the financial crisis a decade ago. They’ve also seen their role as market makers in money markets diminish, referring to the important overnight lending markets that the economy depends on to ensure adequate day-to-day funding for companies, along with smooth operation of payments moving throughout the economy. (This has forced the Fed to step in as a money broker of last resort on several recent occasions). Dimon, separately, expects more bank mergers as competition from non-banks including fintech startups and retailers like Walmart intensify. (For more on Dimon’s letter see the Companies section below).

Dimon will take center stage again this week as JPMorgan kicks off Q1, 2022 earnings season. Joining it will be other banks like Wells Fargo, Citi and Goldman Sachs, along with UnitedHealth, Delta Air Lines and the world’s largest money manager Blackrock. Also keep an eye on Fastenal, a large Minnesota-based distributor at the heart of America’s strained industrial supply chain. Oh yeah, and Tuesday will bring the latest CPI inflation data, for March. Later in the week: New data on retail sales.

Companies

• Conagra: Minneapolis-St. Paul, with companies like Cargill, is known for its food processing (see the Places section below). But Chicago punches above its weight in foods as well, with companies like Conagra. The latter reported earnings last week, which were strong (double-digit margins) despite the twin scourges of inflation and supply chain headaches. If that sounds familiar, it was perhaps the single top theme of calendar Q4 earnings season, or in Conagra’s case, the theme of its earnings that covered December, January and February (its unusual fiscal third quarter). American shoppers know Conagra through its popular brands, like Duncan Hines, Birds Eye, Orville Redenbacher and Slim Jim. They’ll also surely notice that prices are up, as the company responds to what can only be described as extreme cost inflation. “At the time of our Q2 call, we expected Q4 gross inflation of about 11%. Today, we expect Q4 gross inflation of approximately 16%... On a two-year basis, Q4 gross inflation is expected to be an unprecedented 26%.” OMG! That’s for sure putting pressure on margins, even if still healthy. But management expects recent pricing actions to effectively neutralize the cost spike, which by the way is most acute for Conagra in commodities and transportation. Though it sells to restaurants and cafeterias, etc., it benefits most when people do more of their eating at home, which is what happened during the pandemic—and what it says is happening right now as households react to inflation by cutting their restaurant visits.

• JPMorgan: More on America’s largest bank this week. But last week, CEO Jamie Dimon penned a letter to shareholders that (as mentioned above) highlighted important trends challenging large U.S. banks. He separately noted that the number of publicly-traded companies in the U.S. stands at just 4,800 today, down from its peak of 7,300 in 1996. Over the same time, the number of privately-held companies—which are less regulated and less transparent—went from 1,600 to 10,100. “Is this in the country’s long-term interest?” Dimon asks. Regarding labor markets, he cited the pandemic-era phenomenon in which 2m people retired early, the supply of immigrant workers dropped by 1m, available jobs soared to 11m, the number of job seekers dropped to 5m and wages spiked, especially for lower-income workers. Closely watched for sure is Dimon’s take on the Fed, which “needs to deal with things it has never dealt with before (and are impossible to model), including supply chain issues, sanctions, war and a reversal of QE [quantitative easing] in the face of unparalleled inflation.” Rates, he asserts, “will need to go up substantially.” And with respect to JPMorgan’s ability to cope: “Our bank is prepared for drastically higher rates and more volatile markets.”

• JPMorgan: A separate section of Dimon’s lengthy letter dissects the world economy as it unfolded after the great financial crisis of 2008-09. From 2008 to 2014, he writes, the global financial sector sharply cut lending which slowed economic growth and by extension, reduced the incentive among businesses to invest. Onerous bank regulations further reduced lending and money supply. The Fed’s bond purchases (quantitative easing) merely added to a global savings glut, meaning the supply of capital far exceeded demand. All of this contributed to the slow U.S. GDP growth of the early 2010s, which some economists like Larry Summers called “secular stagnation.” Dimon himself used the term in his letter. And today? He’s hopeful business investment will increase, with GDP now growing faster and with lots of capital required (an estimated $4 trillion annually) to address climate change. Lending, meanwhile, the main driver of new money creation, will likely increase to fund business investment, and also to fund ever-greater spending among governments. Central banks and private banks, meanwhile, won’t need to buy as many unproductive safe assets as they did after the 2008-09 crisis.

Tweet of the Week

Sectors

• Airlines: Not so fast, Frontier. JetBlue, America’s sixth-largest airline by revenues (after Delta, American, United, Southwest and Alaska), made a surprise counter-bid for Spirit Airlines. On Feb 7th, Frontier agreed to pay $26 a share for Spirit, which likewise sports a business model featuring dense seating configurations and heavy dependence on non-ticket revenues (i.e., charging for bags and other services). JetBlue, with a more upscale business model, said it would pay $33 per share. The day before the offer, Spirit’s stock was trading at $22. It reached as high as $39 in early 2021, while trading in the $50 range before the pandemic. JetBlue could have an antitrust problem, however. It also needs consent from competition regulators for an alliance with American that it hopes to develop. JetBlue and Spirit also fly a lot of overlapping routes along the U.S. east coast. Given the context of rising inflation and the Biden Administration’s pro-competition sympathies, getting waivers for both the Sprit and American plans could be a tall order for JetBlue. In any case, at stake is a battle for Florida, a giant tourist market where JetBlue, Spirit and Frontier all deploy substantial amounts of their capacity. It’s a market where demand held relatively strong during the pandemic, and where demand is currently red hot. But that’s naturally attracted a lot of new supply, pressuring ticket prices. One interesting fact here: Former Spirit CEO Ben Baldanza is currently a JetBlue board member. JetBlue, by the way, is based in New York City. Frontier is based in Denver and Spirit’s in Fort Lauderdale.

Markets

• Labor: America’s aging population is surely the biggest reason why labor force participation has steadily declined in the past several decades. There’s simply a much larger percentage of Americans who are retired now. More recently, immigration—or lack thereof—has exerted additional pressure on labor supply. On the “Macro Musings” podcast, the Cato Institute’s Alex Nowrasteh calls immigration crucial to the longterm economic health of the U.S. given declining native birth rates. The 7% U.S. population growth during the 2010s, he said, was the lowest ever in the country’s history, with the number of 18-year-olds actually shrinking. As mentioned in last week’s issue of Econ Weekly, Nowrasteh estimates that the U.S. would have between 2.5m and 5m more immigrants today had arrival trends from 2015 persisted. More stringent visa policies enacted during the Trump Administration, followed by the pandemic, are the chief reasons for the slower pace of legal immigration. More recently, with the U.S. economy recovering, and with so many jobs unfilled, illegal immigration has increased. But it’s still well below its 2007 peak of about 12.2m, according to Pew Research. Illegal immigration was down to more like 10m in 2019. Taking a longer look back, Nowrasteh claims: “If we had no immigration since 1800 there’d be about 95m to 100m people living here [rather than today’s actual U.S. population of 330m].” If the U.S. needs labor so badly, why not welcome more immigrants? It’s a controversial topic, with some arguing that newcomers are a net cost to taxpayers. More important is the political reality that immigration has important sociological and cultural effects as well, some unwelcome by large numbers of people. In the “Macro Musings” discussion, the speakers described a “brains vs. stomachs” division between those that view immigrants as brains that produce new wealth, and those who view immigrants as extra stomachs to feed.

• Labor: What’s indisputable is the timeless role of cheap immigrant labor in the development of the American economy, to speak nothing of the free labor on which the pre-Civil War South depended (or the native-born female laborers used by early New England textile mills). Irish workers helped build the Erie Canal. Chinese workers helped build the transcontinental railroad. Eastern European workers staffed the country’s steel and auto factories. The examples are many. More recently, arrivals from Asia and Latin America have proved critical to sustaining the U.S. service economy (think nurses from the Philippines or hospitality workers from Mexico). It’s really not unique. Every successful economy depends on a pool of cheap labor: Turks in Germany, North Africans in France, Eastern Europeans in Britain, rural Chinese in urban China, Indians in the Gulf kingdoms, Filipinos in Hong Kong… one could go on. Japan is often cited as an exception, though it relies heavily on offshore low-cost labor, producing autos in Thailand and China, for example. The U.S., importantly, has looked offshore for cheap labor as well, becoming heavily dependent on cheap Chinese factory labor to build the iPhones, toys, furniture and so on that fill the homes of Americans. One influential argument is that such outsourcing (especially since China joined the World Trade Organization in 2001) has decimated U.S. factories and the American manufacturing workforce, hurting American males in particular. Some cite this narrative in explaining everything from the sharp drop in male labor force participation to the opioid epidemic to the political rise of Donald Trump.

• Labor: One final thing to say about labor in America, in this case regarding not cheap low-skilled labor but expensive ultra-high-skill labor. This has also been a key ingredient in American economic growth since the country’s founding. As Derek Thompson, host of the Plain English podcast points out, immigrants account for more than half of all U.S. Unicorns—that is, startups with a value of at least $1b. Google was in fact co-founded by a Russian immigrant. Amazon’s founder was raised by a Cuban immigrant. Microsoft’s CEO is an Indian immigrant. Apple’s founder was the son of a Syrian immigrant. Tesla’s CEO is a South African immigrant. You get the point.

Debate

• The End of Dollar Dominance? The U.S. dollar is America’s currency. That’s obvious. But the dollar is also—in a sense—the world’s currency. Put another way, it’s the currency used for most international transactions. International trade is largely invoiced in dollars. Lots of international borrowing and lending involve dollars, even when the U.S. is not involved. Central Banks around the world hold dollars as reserves (to ensure they have ample supply to obtain the international goods and services their economies need). It’s an offshore dollar-based monetary standard—often called the “Eurodollar” system—that first developed in the 1950s. The system started with U.S. banks (and later non-U.S. banks) lending dollars outside of the U.S. to avoid U.S. interest rate regulations. And remember, lending dollars means creating new dollars, meaning growing the money supply. The system was reinforced by dollars becoming the exclusive currency with which to buy oil—you’ll sometimes hear the term “petrodollar.” In the early 1970s, the U.S. decided to end its policy of backing the dollar by gold, meaning holders of dollars could no longer automatically swap them for gold on demand. Still, the dollar retained its dominance in international commerce. U.S. price stability from the 1990s to the 2020s helped solidify global confidence in the dollar. Foreign companies increasingly issued bonds in U.S. dollars (one of the largest dollar borrowers pre-pandemic was China’s Evergrande). Today, estimates Boston University’s Robert McCauley, roughly $13 trillion worth of dollars is owned by non-banks outside the U.S. Is this dollar dominance, however, destined to erode? Is it already eroding? This is currently one of the most talked-about topics in macroeconomics. Will the dollar remain dominant?

  • No, the dollar’s influence will fade: On March 22, the IMF published a working paper by Serkan Arslanalp, Barry Eichengreen and Chima Simpson-Bell. Its title: “The Stealth Erosion of Dollar Dominance.” It notes how central banks have steadily reduced their use of the dollar as a reserve currency; it accounted for 79% of all reserves in 1999 but just 59% in 2021. About a quarter of the lost share, the authors note, has shifted to the Chinese yuan, reflecting China’s growing importance in world trade. It’s almost as if finance is becoming like technology, with different currency platforms emerging just like Apple iOS coexists and competes with Google’s Android, Eichengreen has said. The yuan, incidentally, is now starting to circulate in digital form, another reason why it’s poised to eventually replace the dollar—hedge fund magnate Ray Dalio is a leading proponent of this theory. Credit Suisse analyst Zoltan Polszar, a closely followed commentator on the global financial system, believes the commodity shock caused by Russia’s attack on Ukraine will lead to more international transactions invoiced in non-dollar currencies. Russia in fact, now wants Europe to pay for its oil and gas in rubles. Saudi Arabia, meanwhile, has agreed to accept yuan for some oil. When the U.S. and its allies seized Russian dollars held abroad, Polszar and others argue, it sent a strong message to China and others that relying on a dollar-based international economy carries major geopolitical risks. Geopolitical incentives to diversify currency usage have thus increased with Russia’s war. High rates of U.S. inflation now add to the dollar’s unattractiveness. What besides the yuan might eventually replace the dollar as an international currency for trade, finance and reserves? How about a digital currency like Bitcoin? Gold again? The euro? A unit of account tied to multiple currencies? If Blackrock’s Larry Fink is right, and international commerce is becoming less globalized, then perhaps a fragmented international monetary system featuring multiple currencies will indeed emerge.

  • Yes, it will remain dominant; there are no viable alternatives to the dollar: Barry Eichengreen, one of the co-authors of the IMF paper mentioned above, is also a longtime defender of the idea that reserve currencies have always come from countries with predictable legal systems and full convertibility rights. This is where the yuan falls short. Holders of Chinese currency can’t just convert it anytime to dollars or euros or gold. Beijing has capital controls. That diminishes the yuan’s usefulness as a store of value. Only the dollar, Eichengreen has argued, has the liquidity, flexibility and reliability that’s required of a reserve currency. True, more central banks are holding yuan and other currencies as reserves these days. But for international transactions, universal use of the dollar lowers transaction costs and works well as a medium of exchange. The dollar’s value is also anchored by the U.S. economy’s enormous size and resources, buttressed by extremely liquid capital markets. David Beckworth, a George Mason professor and host of the Macro Musings podcast, argues that the dollar is deeply embedded in the world economy, comparing the relationship between foreigners and the dollar like a long-lasting romantic relationship. “Breaking up takes time, there is no one else as special and the relationship is an eternal flame. There is no other currency system that comes close to providing so many safe and liquid assets to the world… If investors wanted to break up with the global dollar system, there would be nowhere else to go to meet all their relationship needs.” This is reinforced, Beckworth adds, through network effects. “As investors turn to dollar investments because they are in ample supply, the network of dollar users expands and, in turn, makes dollar assets more liquid. As a result, this enhanced liquidity increases the demand for dollar assets and reinforces the dollar’s dominance.” If anything, some economists assert, dollar dominance has only grown since the 2008-09 global financial crisis and the 2020-21 pandemic. During both events, the Federal Reserve acted as a dollar provider of last resort to the entire world, not just the U.S. banking system. It did so through temporary dollar swap lines and collateral repurchase agreements accessible to foreign central banks. This essentially ensured that foreigners didn’t run out of dollars, which could have destabilized the entire world economy, America’s included. One effect: To further entrench the dollar’s dominance. As for digital currencies like Bitcoin one day replacing the dollar? For one, governments would fight hard against it. And in Bitcoin’s case specifically, the computer program that underpins it includes a hard cap on the total number that can ever be issued. A central lesson from financial shocks, however, is that currencies need to be elastic, expanding with economic activity and contracting with recessions. Otherwise, you get damaging deflation (like all too often under the gold standard) or inflation.

• Does U.S. dollar dominance even benefit the U.S.? That’s another debate. The predominant view is that a strong dollar is an “exorbitant privilege,” giving the U.S. lower borrowing costs, a liquid market for its government debt and no worries about an international payment crisis, not when all the goods you need from abroad are purchased in your own currency. There’s the benefit of seigniorage too, the simple fact of creating an asset with value (the dollar) out of thin air. It also entails geopolitical might, as the ability to punish countries like Russia and Iran by restricting their dollar usage shows. Michael Pettis of Peking University, however, prefers the term “exorbitant burden” when describing the impact of dollar dominance on the U.S. economy. He and others like Luke Gromen argue that global demand for dollars makes them more expensive, which makes exporting from the U.S. uncompetitive. The inevitable result is huge chronic trade and current account deficits with the rest of the world, along with strong economic incentives to import goods and services from low-wage countries with cheap currencies, most importantly China. This has contributed to America’s de-industrialization, the decline of America’s middle class and perhaps even the opioid epidemic and the rise of political populism. Economist Lyn Alden writes: “Folks who are often on the higher end of the income spectrum who worked in finance, government, healthcare, or technology benefitted from this system, since they obtained many of the benefits of globalization and none of the drawbacks. Folks who are often on the lower end of the income spectrum, specifically those that make physical things, are the ones that benefitted least and gave the most up, since their jobs were outsourced and automated at a faster rate than other developed countries.” The Eurodollar system of global dollar usage certainly benefitted German and Japanese automakers, Taiwanese and Korean semiconductor fabs, and Chinese manufacturers of consumer goods working for U.S. firms like Apple. For Pettis, he views America’s geopolitical might anchored not with dollar dominance but with “the creativity of Hollywood and New York in entertainment and fashion, with technological innovation in San Francisco, Boston, New York, Austin, and elsewhere, with its composers and artists in New York, San Francisco, and elsewhere, with its overwhelming military superiority, with its universally-valued ideal of ethnic inclusiveness and individualism, with its Ivy League and elite universities, with its think tanks, with its astonishing scientists, and with a host of other factors more important than the currency denomination of central bank reserves.”

Places:

• Minneapolis, Minnesota: “The Silicon Valley of Food.” That’s one way someone once described Minnesota’s Twin Cities, whose economic rise depended less on traditional manufacturing than many of its Midwestern peers. While Detroit was busy building cars, Pittsburgh busy building steel and Chicago busy building, well, pretty much everything, mills in Minneapolis and St. Paul were busy turning wheat from America’s Great Plains into flour used for bread. From those humble roots emerged a 21st-century food processing powerhouse of global significance, not to mention an economy that in many ways looks more Sun Belt than Rust Belt. The Minneapolis metro area, which includes the adjacent city of St. Paul, is home to Cargill, an agricultural goliath with $134b in annual revenue. That makes it similar in size to Ford and General Motors, and larger than even JPMorgan Chase or Johnson & Johnson. Cargill, with 155,000 workers, is America’s largest private company (in other words, the largest without publicly traded stock; it raises money by other means). Cargill, furthermore, is one of the four “ABCD” firms that dominate global agricultural commodity trading, the others being Archer Daniels Midland, Bunge and Dreyfuss. You might recognize other corporate manifestations of the Minneapolis industrial food complex, like General Mills (maker of Cheerios and Wheaties), Hormel (headquartered south of the city) and Land O’Lakes. There’s the Minneapolis Grain Exchange. And there’s CHS, an agribusiness giant indirectly owned by some 500,000 farmers and ranchers. The Twin Cities are also leaders in biotech innovation, which naturally has implications for food manufacturing (more commonly referred to as food processing). Food, however, is far from the only reason this economy gained weight. The Minneapolis economy is by any measure a successful economy, extremely well-diversified and unusually well-defended against recessions. These days, it’s perhaps more renowned for health care than food, which served it well during the 2008-09 recession, which barely affected the health care sector. The pandemic of course was a crisis centered on health care, but one in which many health care companies nevertheless thrived. One was Minneapolis-based UnitedHealth, the country’s largest health insurer and sixth largest U.S. company overall, behind only Walmart, Amazon, Apple, Berkshire Hathaway and CVS (based on annual revenues). Not too far from the metro area is Rochester, Minnesota, home of the famed Mayo Clinic. The largest employer in the Twin Cities is the Allina Health system, with a staff of nearly 30,000. Health Partners and Fairview Health are almost as large. According to the Minnesota Department of Employment and Economic Development, the area is home to more than 40 medical device manufacturers with at least 100 employees each. During the pandemic, local companies 3M and Medtronic were key suppliers of personal protective equipment and ventilators, respectively. The story doesn’t end with food and health care. The state-run University of Minnesota is located downtown along the Mississippi River. St. Paul is home to Minnesota’s state government. The largest employer outside of health care, education and government is a familiar name to all Americans: Target. Wells Fargo, though larger in San Francisco and Charlotte, has a giant presence in Minneapolis as well. US Bank, the nation’s fifth-largest bank, is headquartered in the Twin Cities. So is the retailer Best Buy and so is the trucking giant C.H. Robinson. Fastenal, mentioned in the Companies section above, is based about two hours south in a town called Winona. In fact, the Twin Cities are home to 16 Fortune 500 companies, putting it in the same league as Atlanta and Washington, DC. It even attracts a decent amount of tourism, thanks to major sporting venues and the Mall of America, which pre-Covid attracted 40m visitors a year (the mall also employs more than 10,000 people). But what about information technology, a key engine of 21st-century economic growth? Yes, here too, Minneapolis is strong, benefitting like Silicon Valley, Boston and Los Angeles—if on a much smaller scale—from Cold War-era defense contracts for various military supplies, computer products and scientific instruments. The area has an abundance of finance jobs too, some of which—like some IT jobs—cater to the health sector. No wonder why the Minneapolis metro today has the 28th highest per capita income in the country, out of the nearly 400 ranked by the Commerce Department. Though it ranked as high as the ninth-largest metro in America by population a century ago, it ranks a still-impressive 16 today, holding its place thanks to robust 9% population growth during the 2010s. That’s high for a place not in the Sun Belt or Far West. It was certainly high compared to other cold-weather places like New York, Chicago, Philadelphia and Detroit. Minneapolis is a major international airline hub thanks to Delta. Unemployment was 3.1% before Covid and just 2.4% currently. The area’s labor force participation rate is 72%, compared to 63% nationally. It did lose manufacturing jobs during the 2000s like the rest of the country, but even during the 2008-09 recession, it added nearly 8,000 new health care and education jobs annually, similar to the gains before the recession. This gave rise to the term “Minneapolis Miracle,” still relevant given conditions in 2021. So is there anything negative to say about the Minneapolis economy? Well, labor shortages are pretty severe, holding back further expansion. The region’s extremely cold winters don’t help when attracting newcomers, and many people given the choice to work from home would rather do so in places without the need to shovel snow. Sure enough, the population shrank slightly in the 12 months to July 2021. Perhaps most worrying are the challenges the Twins Cities have faced in fostering economic opportunities for historically disadvantaged groups. It’s of course a challenge not unique to Minneapolis, but one that burst into national attention there with George Floyd’s fatal encounter with Minneapolis police officers. Also key to the future health of the economy is the area’s immigrant population, which accounted for 16% of the Minneapolis-St. Paul labor force in 2019, according to the New American Economy. Large immigrant groups include Somalis, Ethiopians. Mexicans and the Hmong community from southeast Asia. To be clear, Minneapolis never gained the immense economic scale of Chicago or even Detroit. But nor did it experience as difficult a transition from the industrial economy to the knowledge economy. Likewise, Minneapolis never became quite a global superstar city like Chicago in the 2020s, owing to the domestic orientation of its top industries like food and health care, along with its relatively sleepy downtown. Nothing wrong with that though, as the Minneapolis Miracle makes clear. (Sources: PNC Bank, Minneapolis Fed, Census, HUD, Minnwest Bank, New American Economy, Minnesota Department of Employment and Economic Development, MPLS Regional Chamber).

Abroad

• Here’s a quick one: What was the fastest-growing economy in the world last year? Guyana, according to The Economist. Why? The South American nation recently discovered oil.

Looking Back

• The First Bank of the United States: Thanks to the efforts of Alexander Hamilton, the U.S. was early to adopt a central bank—sort of. A better term would be national bank, with the right to operate branches across state lines, and the responsibility of managing the Federal government’s tax collection (much of it from import tariffs) and debt payments. The First Bank of the U.S., based in Philadelphia, was controlled by private investors, even though the Federal government was the single largest shareholder with a 20% stake. The bank didn’t conduct monetary policy. It wasn’t a lender of last resort. It didn’t regulate other banks. It didn’t have a monopoly on issuing currency (though its notes were the only currency accepted for paying federal taxes and backed entirely by gold reserves). It wasn’t allowed to lend to Washington by buying Treasury bonds (though it could loan money to the U.S. government via direct bank loans). So no, it wasn’t quite a modern central bank but a private bank influential enough to “alter the supply of money and credit in the economy and hence the level of interest rates charged to borrowers.” That last description is from the Federal Reserve History website managed by the St. Louis Fed. Congress ultimately voted against renewing the bank’s charter in 1811. Not having a national bank, however, proved problematic when trying to raise money to fund the War of 1812. So Congress chartered a new similarly-structured bank that would open—again in Philadelphia—five years later. The Second Bank of the U.S., alas, would also fade into oblivion, a victim of President Andrew Jackson’s anti-bank fervor. More on that in next week’s issue.

Looking Ahead

• The Space Economy: In a challenge to SpaceX, Amazon says it’s launching 83 missions to deploy a constellation of more than 3,000 satellites designed to offer high-speed broadband internet for people anywhere on earth. One of the companies providing the rocket lift is Blue Origin, owned by Amazon founder and recently-retired chief Jeff Bezos. Also involved are France’s Arianespace and United Launch Alliance (a joint venture between Boeing and Lockheed Martin). Project Kuiper, as Amazon calls its satellite business, promises to deliver “affordable” broadband, targeting individual households as well as schools, hospitals, businesses, government agencies, disaster relief operations, mobile operators, and other organizations working in places without reliable internet connectivity. The satellite launches will take place over the coming five years. Amazon, by the way, has more than 1,000 employees working on Project Kuiper.

• Delivery Drones: Wing, a subsidiary of Google’s parent Alphabet, began delivering Walgreens packages to homes in the Dallas-Worth worth area—by drone. It’s the first-ever commercial drone delivery service in a major U.S. metro, Wing says. It’s starting out on a small scale in just two neighborhoods but hopes to expand before long. Another partner besides Walgreens is Blue Bell Creameries, which will use Wing to deliver ice cream—the drones can sure enough keep items cold. Texas Health, meanwhile, plans to use Wing to deliver first aid kits. Many safety and logistical hurdles remain before drone delivery becomes widespread. But it has the potential to radically alter the logistics industry, perhaps no less so than autonomous trucking.

Issue 62: April 4, 2022

Inside this Issue:

• Jobs: Another Month of Gains, but Too Few Bodies and Brains

• Oil Off its Recent Highs: As U.S. Taps Reserve Supplies

• Race to the Top: Wages Still Rising but Cost of Living Rising More

• Who’s the Champ for GDP? Last Year’s Winner was Tennessee

• Corpulent Profits for Corporate America: A Big Home Run in 2021

• Put that in Your Pipe: Pipeline Firm Says Hydrocarbon Economy Alive & Well

• Bay Area Gray Area: How Exactly, Did Silicon Valley Achieve IT Preeminence?

• Does Not Commute: For Public Transit, a Massive Dip in Ridership

• Great Offense, Shaky Defense: The Parlous State of U.S. Cybersecurity

• And This Week’s Featured Place: Harpers Ferry, West Virginia, From John Brown to Tourist Town

Quote of the Week

“Our business will be relevant and healthy for a very long time.”

-  Magellan Mainstream Partners, an oil pipeline company anticipating “a slower energy transition pace than many are expecting.”

Market QuickLook

The Latest

Lots of new data and developments to digest. So here we go:

First, the latest jobs report. In March, the economy created 431,000 new jobs, another solid gain after adding 750,000 in February and 504,000 in January. There’s no ambiguity here: The U.S. job market is red hot. Companies are fervently hiring. Demand for workers has rarely been greater. The supply of workers, however? That’s still a problem, if easing a bit. The percentage of American adults working or looking for work (the participation rate) is still a full point lower than it was just before the pandemic. It means 1% fewer people are working now versus then, which means 1.6m fewer people. Yet employers have 4.4m more job openings (11.3m currently versus 6.9m in Feb. 2020).

The fact is, there simply aren’t enough people who want to be—or are qualified to be—truck drivers, nurses, childcare workers, construction workers, cybersecurity specialists, airline pilots, fruit pickers, hamburger flippers... you get the point. The Covid plague made things worse, but much of the problem stems from mere demographics. On Bloomberg’s Surveillance program last week, JPMorgan’s Jim Glassman said the number of 20-year-olds in America was growing by 50,000 per month a decade ago—it’s now declining by 50,000 a month. Alex Nowrasteh of the Cato Institute, speaking on the Macro Musings podcast, estimates that sharp immigration curbs since 2015 left the U.S. with between 2.5m and 5m fewer immigrants than had earlier trends continued. The 2010s, in fact, saw the slowest overall population growth in U.S. history—it grew just 7%. More worryingly still, the number of Americans under 18 declined. The retiree population, by contrast, expanded and continues to expand rapidly. The U.S. last week did say it will make more seasonal H-2B worker visas available this summer. These are commonly used for work like landscaping, forestry, food processing, hotel service, amusement park staffing, etc. (Recall the Sitka, Alaska item in last week’s issue about Silver Bay Seafood, a large user of H-2B visas).

Of the 11.3m current job openings by the way, 2.2m are in education and health, with another 2.1m in professional and business services. In terms of total employment, some sectors are still smaller than they were pre-pandemic, none more so than leisure and hospitality, notwithstanding tourism’s strong comeback this year. Manufacturing and health care employment has fallen as well. Employment has grown substantially, by contrast, for professional and business services, along with transportation and warehousing.

Last week’s jobs report separately showed a 4.6% y/y gain in weekly earnings for American workers, or 5.8% excluding supervisory workers. That’s not keeping up with the 7.9% rise in inflation, as measured by the consumer price index (CPI). Nor is that keeping up with another major inflation gauge published last week, namely the Personal Consumption Expenditure (PCE) index. Its y/y increase was 6.4%, or 0.6% just from February to March. Of course, with so many new jobs created, there’s additional spending power in the economy, even if real wages are falling. Total consumer spending in fact rose 0.2% from February to March, though people are getting less for their money with prices up.

Along with its latest PCE report, the Bureau of Economic Analysis gave detailed figures on GDP growth in the final quarter of 2021. Adjusted for inflation, Q4 production rose at a rapid annual rate of 6.9%, following 2.3% expansion in Q3. America’s economy is now worth $24 trillion, with Texas leading the way with 10% GDP growth in Q4. The state is benefitting from both a resurgent energy sector and a red-hot tech sector. For all of 2021, the growth champion was Tennessee, which expanded by nearly 9%. Nashville, like Austin, is emerging as one of the superstar economies of the 2020s. Next on the list of best performers last year were New Hampshire (people migrating from Boston), California (with its thriving tech firms) and Nevada (tourism is coming back). The worst economic performers in 2021? Energy states like Alaska, Wyoming and North Dakota. But don’t be too concerned about them. With energy prices now soaring, 2022 is shaping up to be a blockbuster year for energy economies. Texas, by the way, was also weighed down in the first half of 2021 by low energy prices. It thus ranked just number 19 in GDP growth for the full year despite its Q4 trophy.

Big news in the oil market last week: President Biden announced a large release from the country’s emergency reserves—the largest release ever in fact. The OPEC-plus-Russia alliance, for its part, refrained from any major moves on supply. But the U.S. supply action, along with similar moves by allies, plus growing concerns about demand in China, helped sink WTI below the $100 mark, ending the week at $99 a barrel.

Last week also marked the end of 2022’s first quarter, a turbulent one for markets and geopolitics alike. Following three straight years of extraordinary stock returns, the S&P 500 index fell 5% between January and March. The decline would have been worse if not for gains late in the quarter, including another increase last week thanks to the strong jobs report and the decent consumer spending figures. More specifically regarding stocks, technology companies were hit hardest in Q1, reversing a euphoric run throughout the pandemic (the tech-heavy Nasdaq fell 9% in the quarter). Inflation was of course another defining trend in the quarter, along with spiking commodity prices and rising bond yields (bond prices, conversely, fell 6%, using the iShares Core U.S. Aggregate Bond ETF as a proxy). Progress on supply chain relief was frustratingly minimal during the quarter. All the while, the Fed has turned demonstrably more hawkish.

But Corporate America, by all indications, continues to thrive. We’ll know a lot more when companies start reporting Q1 financial results starting next week (JPMorgan, Wells Fargo, Delta Air Lines and Blackrock get things started on April 13th). Keep in mind that 2021, according to Bloomberg News, was the most profitable year for American corporations since 1950, with aggregate profit margins above 13% during all four quarters of the year. Only once in the previous 70 years, Bloomberg states, had Corporate America earned above 13% for a single quarter.

That sure doesn’t sound like a recession is lurking. But it’s still a concern, especially with lowish long-term Treasury yields suggesting weaker output ahead. Economists are now debating the implications of current inversions along the yield curve—the U.S., for example, is now paying more to borrow for three years (2.58%) than for ten years (just 2.38%). Is the three-year, ten-year comparison even the most relevant one? Do yield curve inversions even merit any attention? Can they really predict recessions?

The yield curve is certainly a hot topic on Wall Street. So is the future of global dollar dominance (more on that in next week’s issue) and the future of globalization. On the latter point, diplomat Richard Haas for one, sees “globalization as a reality, not a choice.” But Adam Tooze of Colombia University points to Brexit, the election of Trump, the collapse of the transpacific trade pact and rising tensions between China and the US as evidence of waning globalization, which could make consumer goods more expensive. US foreign direct investment in China, he notes, peaked in 2008 at $21b, falling to just $9b in 2020.

Back at home, UnitedHealth, America’s sixth largest company by revenues, will buy the at-home care specialist LHC. It’s hardly a trivial purchase—LHC has 30,000 employees. Then again, United has 350,000. The scale of America’s health care sector, including its role in the labor market, never ceases to amaze.

The amazing Fred Smith, founder of FedEx, will retire on June 1 after a half-century at the helm. Giant tech platforms like Google and Amazon face growing momentum to outlaw such firms from unfairly favoring their own products. The Dallas Fed rattled some nerves with talk of a “brewing U.S. housing bubble.” FreightWaves, a publication covering supply chain developments, sees emerging softness in trucking demand. The U.S. agricultural sector is delighted by high crop prices but greatly challenged by high fertilizer prices. President Biden proposed a unique new tax on unrealized gains for ultra-wealthy Americans. Walgreens, with 9,100 stores across the U.S., reported a $1.2b operating profit in its latest quarter. Sales data from automakers highlighted the ongoing impact on sales from the semicon shortage. Columbia University’s Center on Poverty and Social Policy distressingly said the U.S. poverty rate reached 14.4% in February, up from 12.5% in December, the last month in which child tax credits were distributed. Child poverty, it added, jumped from 12.1% to 16.7%.

We’ll get a transcript from March’s Fed meeting this week, perhaps shedding more light on its intentions. Things get more interesting next week, though, as Q1 earnings season gets underway.

Companies

• Magellan Midstream Partners, based in Tulsa, held an analyst day event in Houston last week. Its company slogan pretty much sums up what it does: “Moving What Moves America.” More specifically, Magellan transports, stores and distributes petroleum products, owning what it claims is the longest pipeline for refined petroleum products nationwide. If you see a pipeline running from a U.S. refinery—to gas stations, airports, railroad depots, truck stops, etc.—there’s a good chance it’s owned by Magellan. Pipelines tend to be the lowest cost method of transporting fuel, though it moves by trucks, railroads and barges as well. At its event, executives spoke at length about the energy transition, referring of course to the shift from hydrocarbons to cleaner and greener forms of energy. They highlighted areas of progress, including battery and battery storage technology, renewable fuels and technologies that capture and store carbon. But it also cited obstacles still in the way: the lack of cost competitiveness of alternatives, questions about power grid readiness, the intermittency of renewable power supply, reliance on subsidies, logistical challenges and uncertainty about feedstocks (the materials used to produce the clean energy). Citing one example, the executives said renewable fuels (including biofuels) are simply not yet profitable without subsidies. Magellan also warned about the potential for “external factors to hasten or slow the pace of the transition.” Geopolitics is one such factor. Government policy could be another.

• Walgreens Boots Alliance, better known to Americans as simply Walgreens, reported results for its unusual December-to-February quarter. The company, with annual revenues similar to those of Ford or Verizon, generated $34b worth for the reporting period. Its operating margin adjusted for special items was 4%. In management’s earnings call, CEO Rosalind Brewer said Walgreens was developing its model of providing technology-driven health solutions, including new automated fulfillment centers to handle drug prescription orders. Today, most orders are handled by pharmacists within retail stores. As for retail sales, they rose by double-digits y/y, boosted by purchases of at-home Covid tests. Some profits were sacrificed, however, in the name of investing in local primary health care services. To that end, it purchased a major stake in VillageMD, which is building clinics attached to Walgreens stores. The company also bought a majority stake in CareCentrix, which specializes in home-based health care. Walgreens separately said it’s administered 62m Covid vaccines to date. It’s also seeing an increase in digital sales and in loyalty plan members. Interestingly, it sees digital advertising as a major opportunity. Think about it: with 100m loyalty plan members and 9,100 stores, it can offer potential advertisers a lot of valuable data on consumers.

• Astec is a Chattanooga-based firm—with about 4,000 employees—that designs, manufactures and markets equipment used primarily for road building. That requires expertise in asphalt, the pavement material for 90% of all surfaced roads in the U.S. (a small portion of the interstate highway system is paved with concrete). Astec produces equipment for other customers too, including miners, construction firms, demolition experts, power stations and operators of ports and railroad yards. Many of the projects it works on, especially roads, are financed with government money. So naturally, it was pleased to see Congress pass a large infrastructure bill last year. The legislation allocates a massive $548b in government spending to new infrastructure over the five-year period concluding in 2026, some of that specifically apportioned to fund highway and bridge projects. The demand picture for Astec thus looks bright. But as with most companies these days, Astec faces supply chain delays, staffing challenges and input cost inflation. It’s specifically exposed to prices for liquid asphalt, oil, natural gas and steel.

Tweet of the Week

(WFH = Working from Home)

Sectors

• Apparel: According to a Bloomberg report, the modern textile industry is surprisingly one of the largest users of petrochemicals, making them important contributors to global carbon dioxide output. Its output is greater, says the U.N., than international flights and shipping combined. Polyester, a form of plastic derived from crude oil, has “overtaken cotton as the backbone of textile production.” In addition, garments made from polyester and other synthetic fibers are a prime source of microplastic pollution, which is harmful to marine life. Estimates from the consulting firm McKinsey and the World Economic Forum, the Bloomberg report notes, suggest the number of garments produced each year has at least doubled since 2000. Of all the products made from petrochemical plastics, textiles rank number two in volume behind only packaging. And one more stat from the Bloomberg piece: “The U.S. throws away up to 11.3m tons of textile waste each year—around 2,150 pieces of clothing each second.” The textile industry, by the way, was the very first major industry, ushering in the industrial revolution that transformed the global economy. But not always for good. Demand for textiles created demand for cotton, much of it grown by enslaved Americans. A lot of that cotton went to British mills but certainly U.S. mills as well, first in New England before migrating south after the Civil War and later overseas.

Markets

• Bitcoin: Charles Schwab’s Randy Frederick, speaking on a company podcast, estimates that 85% of all Bitcoin—that’s the first and still most widely-owned cryptocurrency—is held by just 2,000 accounts worldwide. Bitcoin’s creator Satoshi Nakamoto, whoever that may be, alone holds 5% of all outstanding Bitcoin, which is currently worth close to $50b. An NBER paper by Igor Makarov and Antoinette Schoar last fall similarly found a large concentration of Bitcoin ownership among a small group of holders.

• Labor: Workforce participation rates have been declining for decades. But nationwide rates vary greatly by state. Annual Labor Department data for 2021 show Nebraska with the highest employment-to-population ratio, at 67.7%. South Dakota was next at 66.4%. On the other end of the pole: West Virginia, with just 51.9%, followed by Mississippi at 52.0%.

Government

• Childcare: The Cato Institute, a libertarian think tank, warns about the risks of a federal program aimed at providing universal preschool. Researcher Colleen Hroncich is the author of a new paper entitled “Universal Preschool: Lawmakers Should Approach with Caution.” It argues that a Biden administration proposal includes mandates on teacher pay and levels of qualification—a prerequisite for states to receive federal funds—that would hurt the viability of many existing preschools. In Hroncich’s words: “Unfortunately, the mandates and regulations that would accompany a federal universal program would likely put many providers out of business.” That’s especially true, she says, of smaller providers, often associated with religious institutions. A few states including Florida already have a program for universal pre-kindergarten for four-year-olds. But funding levels and quality of care and instruction vary a lot. Since 1965, the Federal government has offered a program called Head Start for low-income children. It provides funding to about 1,500 different public, private and non-profit providers across the country, so long as they comply with certain performance standards. There’s also an Early Head Start (EHS) program for children younger than three, started in 1995. Hroncich cites a Department of Health and Human Services study that found the Head Start program had little or no effect on student outcomes that persisted through third grade, despite costing more than $7b per year at the time, or $7,900 per child. “The program now costs more than $10 billion, or more than $10,000 per child.” Other studies though, including some cited by Laura Bauer of the Brookings Institution, show positive effects.

• Public Transit: In 2020, America’s public transportation providers (mostly government-run) recorded just 4.7b trips, down dramatically from 10b in 2019. The main reason, of course, was the pandemic and the sudden surge in working from home. According to the Congressional Research Service, about 48% of pre-Covid public transportation trips were made by bus, 38% by heavy rail, 5% by commuter rail, 5% by light rail and 1% by ferry. Most ridership occurs in large metro areas like New York, Chicago, Los Angeles, Washington, Philadelphia, San Francisco, Boston and Seattle. The New York City subway is the largest public transit system in the U.S.

• Defense: There are seven different regional command centers of the U.S. military. Where are they based? Central Command, in charge of the Middle East, is headquartered in Tampa, Fl. Southern Command, responsible for the Caribbean and Latin America, is in Miami, FL. European Command is based in Germany, as is Africa Command. Northern Command is in Colorado Springs. Indo-Pacific Command is in Honolulu. Finally, there’s the newly-created Space Command, slated to move from its temporary home in Colorado Springs to Huntsville, Al—assuming strenuous efforts by Colorado’s Congressional delegation to stop the move don’t succeed. The U.S. military also operates four “functional” command centers: for strategy (in Omaha, NE), special operations (Tampa), transportation (St. Louis) and cyberspace (Fort Meade south of Baltimore).

Places:

• Harpers Ferry, West Virginia: There are no coal mines in this part of West Virginia. Instead, Harpers Ferry, located in the state’s northeastern panhandle, is best known for an 1859 revolt against slavery. Today, much of the town’s economy depends on visits from history-minded tourists, eager to see the site of John Brown’s rebellion. Though quickly suppressed by the U.S. Army, the action triggered abolitionist sentiment and Southern unease, contributing to the outbreak of Civil War in 1861. Harpers Ferry happens to be a picturesque little town in the Shenandoah Valley, all the more reason to visit. It overlooks the meeting of two prominent rivers—the Shenandoah and the Potomac—bordering both Virginia and Maryland. No, this is not Las Vegas- or Orlando-volume tourism here; just 300,000 or so arrivals in a good year, most from surrounding areas. The pandemic counterintuitively boosted tourism, at least in 2021, when 310,000 people visited Harpers Ferry National Historic Park (which includes a large swathe of land surrounding the town). That was up 3% from 2019 as Americans, during the Covid outbreak, favored car trips to nearby places rather than more distant trips by plane. Only a few hundred people actually live in Harpers Ferry proper. Those employed in the tourist sector typically commute from nearby towns, including those elsewhere in Jefferson County, population 58,000. In 2020, the county had a per capita income of $55,000, high by West Virginia standards but a bit below the U.S. national average of $60,000. Average housing prices are lower, however. The current unemployment rate is just 2%, partly reflecting the health of local tourism. Nearly a third of Jefferson County’s residents have at least a bachelor’s degree, compared to just 23% for all of West Virginia. Other major employers include Shepherd University with roughly 3,000 students, a local casino, multiple wineries and distilleries, and of course schools and health care facilities. Europe’s TeMa, which builds products for the construction sector, has a factory in the county. Giants Procter & Gamble and Clorox are in a neighboring county. Agriculture (wheat, soybeans, corn, etc.), warehousing and manufacturing complement the tourist sector. Federal agencies including the Departments of Homeland Security and Agriculture, as well as the Coast Guard, have facilities in the county too. Importantly, Harpers Ferry is less than 90 minutes by car from Washington, DC, making it a prime location for “super commuting,” in other words combining remote work with occasional office visits. More convenient are commutes to the Virginia suburbs around Dulles airport, an area booming with defense contractors and IT firms. Dennis Jarvis of the Jefferson County Development Authority notes how 1.8m people live within a one-hour drive of the area, with commuters flowing both in and out. Amtrak and Maryland’s MARC rail, as it happens, run daily trains from the center of town to Washington’s Union station. This also makes it easy for Washington residents to come enjoy a day or two hiking around Harpers Ferry or learning about its intriguing history. That history, in fact, runs deeper than just Civil War-era events. Harpers Ferry first gained attention when President George Washington selected it as one of two sites for a federal armory (the other was in Springfield, Mass.). For a time, it was an ideal place to build guns and many other industrial products thanks to the cheap hydropower provided by the town’s two rivers. A canal, and later a railroad, facilitated movement of raw materials in and finished products out. Cheap labor came from Ireland and Germany. Harpers Ferry was thus one of America’s earliest industrial hubs, featuring not just arms manufacturers but iron foundries, machine shops, sawmills, cotton mills, flour mills, tanneries, blacksmiths, woodworkers and wagon makers. That was before the 1860s. The Civil War would destroy much of the town’s infrastructure. And efforts at post-war revival failed amid recurrent floods and droughts. The second half of the 19th century instead became an age of coal, steel, oil and large factory towns with armies of low-wage workers toiling for giant corporations. During a later war—World War II—the U.S. established Harpers Ferry National Monument, later adding Storer College, a school built after the Civil War for newly freed slaves. Fast forward to 2022, and the eastern panhandle of West Virginia is the fastest-growing area in a state that overall saw population shrink during the 2010s. Jefferson County by contrast grew 7%, and neighboring Berkeley County double that. The contracting coal mine economy? Not in this part of West Virginia. (Sources: U.S. Census, Jefferson County Development Authority, BEA, National Park Service).

• Kansas City, Missouri, scored a high-profile business win by securing a new “hyperscale” data center built by Meta, the company formerly known as Facebook. It’s an $800m investment, creating as many as 100 new jobs. It will be, according to the city and the company, “one of the most sustainable data centers in the world,” powered by 100% renewable energy. Touting its strengths to prospective tech companies, Kansas City cites its geographically central location (for improved network connectivity between coastal data centers), its relatively low exposure to natural disasters (i.e., no earthquake or hurricane worries though tornados are a thing), competitive energy prices, renewable power options, an airport upgrade finishing next year and a growing pool of tech talent. Kansas City’s largest private employer, by the way, is Cerner, a health tech company. Other big ones are Ford, Honeywell, Hallmark, Kansas City Southern Railroad, H&R Block and Sprint, now part of T-Mobile.

Looking Back

• Economic Development: Sebastian Mallaby, in his new book about venture capital, recounted the tech-sector history of California’s Silicon Valley and Boston’s Route 128 corridor—these were America’s two leading tech hubs in the 1980s. Both benefitted from heavy defense spending, in Boston’s case thanks to giant contractors like Raytheon and Wang. Both cities remain tech powerhouses today, but Silicon Valley ultimately became the premier global hub, for reasons often discussed and debated. Mallaby, speaking on the “Masters of Business” podcast, cites an explanation by the Berkeley sociologist AnnaLee Saxenian. She says Boston’s IT companies tended to have hierarchical and secretive cultures. In Silicon Valley, by contrast, ideas tended to spread more widely. Mallaby compares the entrepreneurs of the area to bees flying around, pollinating flowers. No need to shed any tears for Boston though. It’s become what’s arguably the world’s top center for biotech, supported by world-class universities.

Looking Ahead

• Cybersecurity: “What kind of attacks do you think we should be most concerned about right now?” This was a question posed to Chris Painter, appearing on the “Hidden Forces” podcast. Painter, who once served as the senior White House director for cybersecurity, said ransomware attacks are surely a concern. These are conducted mostly by criminal groups, targeting hospitals, municipal governments and other institutions, locking their computers until the victims pay a ransom, usually in Bitcoin. Nation-state attacks are another worry. Russia, China, North Korea and Iran are the “Big Four” in this realm, often engaging in theft of intellectual property (a top target for China), intelligence or in some cases just money (North Korea). Nation-states have the capability to damage physical infrastructure too, though Painter downplays the risk of a longterm, wide-scale shutdown of the energy grid or something similarly catastrophic—that would just be incredibly hard to pull off. He was quick to note also that America’s nuclear command and control is not connected to the internet so can’t be hacked (though early warning systems could potentially be faked or jammed). The larger point, he concludes forebodingly, is that “there’s almost nothing that’s connected to the internet that is not vulnerable to a dedicated nation-state attacker.” One of Painter’s biggest concerns is the growing risk of so-called “integrity attacks.” These might involve a hacker breaking into a person’s hospital records and changing their blood type. It could involve messing with a person’s financial transactions. And so on.

• Cybersecurity: If you’re still not frightened, go read Nicole Perlroth’s 2021 book “This Is How They Tell Me the World Ends: The Cyberweapons Arms Race.” Perlroth covers cybersecurity for the New York Times, and her book explains the rise of merchants, hackers and governments exploiting bugs in software code. It tells the story of cyber-attacks on everything from hospitals to local governments to pipelines to Hollywood studios to centrifuges in Iran. Russia’s exploits are well covered, including its high-profile sabotage of Ukraine’s economy a few years before invading, and its efforts to influence the 2016 U.S. presidential election. Things got really worrying for the U.S. when its own best cyberweapons were stolen. America’s annual losses from cybercrime, Perlroth writes, now eclipse losses from even terrorism. Some speak of a coming “cyber-Pearl Harbor.” The Fed’s Jay Powell has said a cyberattack is something that keeps him up at night.” One person in the book described the current state of cyber-affairs as a soccer game with a really high score, in other words, one in which everyone (including the U.S.) is great at offense but bad at defense. Perlroth writes that it’s “now arguably easier for a rogue actor or nation-state to sabotage the software embedded on a 737-MAX than it is for terrorists to hijack planes and send them careening into budlings.” Yikes.

• Cybersecurity: So not to end on such a dark note, let’s remember what Painter (see above) said about a catastrophic attack being extremely difficult to pull off. In the meantime, computer scientists are hard at work designing a new generation of semiconductors with “contamination chambers” designed to wall off any malware, preventing its spread. There are likewise efforts underway to do away with passwords, using biometric or other means of authentication. The end of passwords, in fact, is on MIT Technology Review’s latest list of top ten breakthrough technologies.

• So you must be wondering: What are the other nine breakthroughs? Here they are: Covid variant tracking, long-lasting grid batteries, artificial intelligence for protein folding (for devising new medicines), a malaria vaccine, proof of stake (an energy-efficient means of verifying blockchain transactions), a pill for Covid, practical nuclear fusion reactors, synthetic data for artificial intelligence (to avoid privacy and bias concerns) and carbon removal factories.

Issue 61: March 28, 2022

Inside this Issue:

• “Nothing” Burger: Powell Tough Talk Batters Bonds

• Observe the Curve: Does Inversion Mean Recession?

• Globalization Cessation? What does Fink Think?

• Mobility Debility: Why Americans Don’t Move as Much Anymore

• Flows or Pros? What Really Moves Stock Prices?

• Ethereum Delirium: One Crypto Captain Says ETH has No Teeth

• The Contractor Factor: Booz Allen and America’s Defense Spending

• Greenback Attack: How the U.S. Financed the Civil War

• And This Week’s Featured Place: Sitka, Alaska, Russian Roots

Quote of the Week

“Retail sales of new vehicles this month are expected to reach 1,044,500 units, a 27.8% decrease compared with March 2021 when adjusted for selling days… In April, with inventory and production levels still projected to be at historical lows compounded by global events, the overall industry sales pace will continue to be supply constrained.”

- from the latest J.D. Power, LMC U.S. Automotive Forecast

Market QuickLook

The Latest

Sometimes, just a single word can move markets. Even a simple word like “nothing.”

“Nothing,” said Fed chair Jay Powell, responding to the question: “What would prevent you from doing a 50-basis point move in May?” His cavalier dismissal of any restraints, sure enough, signaled a willingness—an eagerness, even—to do whatever it takes to slay the inflation dragon.

“Inflation is much too high,” Powell flatly stated, at a conference hosted by the National Association of Business Economics (NABE). While emphasizing that he and his FOMC colleagues haven’t made any decisions yet in advance of their next meeting in early May, he left no doubt about the ““obvious need to move expeditiously.” He’s talking of course about moving interest rates higher, following a modest quarter-point lift earlier this month.

The hawkish tone sent bond prices tumbling, as theory would predict when investors anticipate rates to rise. Some parts of the Treasury yield curve, to be sure, are rising faster than others. More specifically, shorter-duration debt is rising faster than that with longer maturities. Uncle Sam is now paying more to borrow for three years than he is to borrow for ten-years, an inversion that historically has presaged recessions. Powell dismissed this concern however, stressing the greater relevance of spreads among shorter-duration debt, which for now are still properly slowing upward (he specifically mentioned the first 18 months of the curve, rather than the often citied 2-year/10-year comparison).

Powell again made clear that he thinks the economy is in good shape (stocks reacted well to that). There are still fewer Americans working than before the pandemic. But add the number of workers plus the number of job openings, and this figure greatly exceeds pre-pandemic levels. The Fed’s best estimate is that roughly half of the decline in labor force participation comes from early retirements. In any case, Powell’s larger point is that the labor market, while booming, can’t boom for long unless price stability is re-established.

Other speakers and panels at the NABE event gave a clear window on what America’s economists are thinking about these days—Fed policy, of course, along with inflation, geopolitical unrest, labor participation, supply chain bottlenecks, oil prices and the energy transition, promoting inclusive growth, the health of the housing market, the pros and cons of a central bank digital currency, and so on. Atlanta Fed president Raphael Bostic stressed the growing trend among companies to prioritize resiliency over cost minimization, especially with respect to their international supply chains.

Regarding international business, one prominent corporate titan just declared the death of globalization. Larry Fink, head of Blackrock, wrote in a letter to shareholders: “The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.” What’s more, “the large-scale reorientation of supply chains will inherently be inflationary.” Fink separately addressed the challenge of securing sufficient retirement income for all Americans—Blackrock is after all, the world’s largest money manager, championing exchange traded funds. “As people live longer and healthier lives, their risk of outliving their savings is accelerating the ‘silent crisis’ of financial insecurity in retirement.” He cited the example of a 25-year-old in 1982, who saved $10,000 in bank deposits. That would be worth approximately $50,000 today. If he or she invested in a broad-equity index such as the S&P 500, by contrast, it would be worth more than $800,000.

Retirees lucky enough to own homes, of course, are sitting pretty following an extraordinary pandemic-era spike in home values. The party is definitely slowing though, as the Fed’s pivot to hiking interest rates has its intended effect on mortgage costs. According to Freddie Mac, the average 30-year fixed-rate mortgage hit 4.42% last week. It ended 2021 at 3.11%. At one point last summer it was 2.77%. That translates to significantly higher monthly payments for borrowers, deterring demand as the latest trends suggest: The National Association of Realtors for example said existing home sales dropped 7% from January to February. Homes sales under contract but not yet finalized fell 4%.

Higher rates will impact the auto market as well. Here, the supply shortage is even more acute than in housing, owing to all those missing semiconductors. LMC Automotive and JD Power, in their latest monthly report, said U.S. retail sales of new vehicles fell a thunderous 28% y/y in March. The drop for all of Q1 should be about 15%. Americans will still spend an astonishing $125b on new vehicles this quarter, as higher prices offset the impact of fewer transactions. Automakers are earning strong profits. So are auto dealers. And here’s one more interesting piece of data from the report: Trucks and SUVs are on pace to account for a record 80.5% of new-vehicle retail sales in March. Will this change now that oil prices are spiking?

Tesla, of course, hopes more people will go electric. The company has hyper-ambitious growth plans, underscored by last week’s opening of a new plant in Germany. Germany’s Volkswagen, meanwhile, is the latest automaker to announce a multi-billion investment in North American production. In Nebraska, Warren Buffett’s Berkshire Hathaway announced a $12b acquisition—the target is an insurance company called Allegheny. The food giant General Mills expects pricing to keep pace with inflation. Uber is making peace with New York City’s taxis. Amazon faces another unionization drive.

New Census data show which cities attracted the greatest population growth in the year to July 2021. St. George (Utah), Coeur D’Alene (Idaho), Myrtle Beach (South Carolina), Punta Gorda (Florida) and The Villages (Florida) top the list. No place, on the other hand, shrank more than Lake Charles (Louisiana) and Odessa (Texas), two fossil fuel centers hit hard by last year’s oil collapse but surely thriving again in 2022 as oil prices come roaring back. The next biggest population decliners were the giant cities of San Francisco, New York City and Los Angeles, with Silicon Valley (the San Jose metro) included as well. This reflects an exodus from big cities during the pandemic, along with the rise of remote work and the economic impact of absent international visitors.

Looking just at domestic migration, some surprising places saw an influx of people. Fort Myers was number one but no surprise there. Also among the leaders, however, were prominent victims of de-industrialization like Hartford, Detroit, Albany and Cleveland. All were places that were losing people before the pandemic. A renaissance in the making? Or just a momentary aberration?

With Q4, 2021 earnings season all but over, Q1 festivities are now just a few weeks away. JPMorgan Chase, whose reporting usually marks the symbolic start of a new earnings season, is scheduled to go on April 14th. But no need to wait until then for excitement. This week is a big one for government data. The Bureau of Labor Statistics will publish its jobs report for March. The Bureau of Economic Analysis, meanwhile, will publish its latest inflation index based on personal consumption expenditure (PCE). Also on this week’s agenda: an OPEC meeting that could impact the direction of oil prices. Last week, incidentally, oil prices spiked again.

Companies

• Booz Allen Hamilton: Think defense contractors and which companies come to mind? As the chart below from Defense News shows, Lockheed Martin is the largest in the U.S., followed by Raytheon, Boeing, Northrup Grumman and General Dynamics. But not all defense contractors build weapons. Number 26 on this year’s Defense News list is Booz Allen Hamilton, based unsurprisingly in the Washington, D.C. suburbs near the Pentagon. It started as a general management consulting firm more than a century ago. But a contract for the Navy during World War II led to its current government focus. As CFO Lloyd Howell disclosed at an investor event earlier this month, 47% of the company’s current annual revenues come from defense consulting. Another 30% comes from civilian federal agencies, with most of the remainder from intelligence agencies. Just 2% to 3% of sales are from what the firm calls its global commercial business, often work related to cybersecurity. Booz employs about 30,000 people, many of them software engineers and data scientists. Some 70% of its workforce has a federal security clearance. An important point about the U.S. economy is that private sector contractors—including Booz Allen Hamilton—receive a large portion of the federal government’s roughly $5 trillion in annual spending. In that way, the public and private sectors are closely intertwined, especially in the defense sector but also very importantly in health care. Washington separately provides funding and credit directly to the household sector, indirectly benefitting private companies in sectors like health care, education and housing.

Tweet of the Week

Sectors

• Wheat is the topic of a new “Odd Lots” podcast, featuring University of Illinois ag economist Scott Irwin. He details the current crisis now unfolding, with major supplies from Ukraine potentially unavailable. Let’s be clear about what wheat is. It’s a type of grain (other grains include corn, soy and rice) used to make food products like bread, pasta and crackers. It’s an important source of food for not just humans but animals that are raised for other food products like beef and pork. And it just so happens that both Russia and Ukraine are huge global wheat suppliers. The Russian crop will likely grow without interruption but whether it gets to global markets amid sanctions is uncertain. Spring wheat, meanwhile, needs to be planted in April or early May, which might not happen in Ukraine this year due to the war. Winter wheat, to be clear, which is planted in the northern hemisphere’s autumn, is produced in much larger volumes than the spring crop. But the world market could be extremely short this summer, to a catastrophic degree in import-dependent countries like Egypt. Irwin stresses the inter-connectedness of commodities—pigs eat wheat products, for example, so higher wheat prices will mean higher pork prices. There’s also the issue of fertilizer, whose supplies from Russia and Belarus are threatened, leading to a big price spike for farmers. In any case, commodity traders will play a key role in getting sufficient supplies of food to where they’re needed. The four big ones are the so-called ABCDs: Archer-Daniels-Midland, Bunge, Cargill and Dreyfuss (with Glencore’s Viterra unit trying to play in the space as well). Separately, Javier Blas, who co-authored a book about the ABCDs (see Econ Weekly from March 8, 2021), wrote last week about one grain product that’s thankfully not in short supply right now: Rice, a critical food staple for much of Asia.

• Housing: Americans are moving less. During the 1980s, according to the Census, nearly a fifth of all Americans in any given year were moving to a new home, either within the same state or in a different state—the figures include people moving to the U.S. from abroad as well. That’s consistent with the narrative of America being a very mobile society since its origins—people constantly moving within and foreigners constantly arriving. Mobility, however, has been steadily declining since the 1980s, with just 10% of people moving in 2019. Rates have dropped even more during the pandemic. Why? The culprit seems to be a lack of affordable housing in places with lots of open jobs. In the 19th century, Americans moved ever farther west seeking employment. Throughout the industrial era, Americans—including African Americans from the South—moved into northern factory cities like Detroit. De-industrialization led people away from the north and into rising Sun Belt cities like Las Vegas and Atlanta. The Sun Belt lurch continues, albeit more slowly as the mobility data show. The jobs are there but the housing isn’t. That’s actually more true of superstar cities (see the Places section below) like San Francisco and New York, where it’s challenging to live without a household income that’s way above the national average. That eliminates most civil servants like teachers and firefighters, or workers in retail, hospitality and transportation/logistics. It’s a reminder that America (and many other developed economies for that matter) have a housing shortage problem, one that’s great for incumbent homeowners enjoying rising prices but bad for mobility—and by extension the economy.

Markets

• Stocks: Tracy Alloway of Bloomberg’s aforementioned “Odd Lots” podcast likes to call it “flows before pros.” It’s the idea that stock prices are determined more by the flows of money into and out of the market, rather than fundamental valuations as calculated by professional traders. Hari Krishnan and Ash Bennington, in fact, wrote a book about the idea, called “Market Tremors: Quantifying Structural Risks in Modern Financial Markets.” According to classical valuations of stocks, they explained on the “Hidden Forces” podcast, prices should adjust to exogenous factors like an earnings release, new financial guidance or geopolitical events. In other words: “Everything is priced fairly until news comes in, and prices adjust.” In reality, they argue, price movements are greatly influenced by the flow of dollars—who has them to sell, who has them to buy, how many of them is the Fed creating, and so on. Also influential is the derivative market, where lots of money flows into and out of stocks according to the behavior of risk managers and speculators. This was clearly the case when options trading caused meme stocks like GameStop and AMC to skyrocket in early 2021. Krishnan and Bennington talk about other forces shaping modern financial markets, including the rise of passive ETF investing, bank regulations and the practice of investors crowding into specific asset classes or strategies.

Abroad:

• Toronto: It’s not quite Silicon Valley, or even New York City. But Toronto, according to a New York Times profile, is now the third largest tech hub in North America. The real estate firm CBRE, in fact, ranks it much larger by number of tech workers than up-and-coming U.S. technology hubs like Austin and Miami. Two big reasons are the University of Toronto and the nearby University of Waterloo, serving a similar incubator role as Stamford University in Silicon Valley. Also critical: Canada’s relaxed immigration policies, luring global talent no longer welcome south of the border—U.S. immigration rules have tightened significantly in recent years. Toronto’s average tech worker salaries, meanwhile, are lower than they are in Silicon Valley. Toronto happens to be the fourth largest city in North America by population (nearly half of its residents are foreign born); only Mexico City, New York City and Los Angeles are larger. Shopify, an e-commerce platform challenging Amazon, is a home-grown corporate resident. But U.S. superstar firms like Google and Facebook have large Toronto offices as well. The University of Toronto is currently building a complex to house artificial intelligence and biotech companies. The government of Ontario, furthermore, recently outlawed enforcement of noncompete contract clauses, which can be an impediment to would-be entrepreneurs. Keep in mind though: “Investment in new Toronto companies is still tiny compared with Silicon Valley,” the Times writes. “In 2021 and 2022, investors pumped $132b into Silicon Valley tech start-ups, according to the research firm Tracxn. In Toronto, that figure was $5.4b.”

Government

• State and Local Government (SLG): The National Association of Homebuilders, in its “Eye on Housing” blog, gives a breakdown of where the SLG sector generates its tax revenue. Nationwide, 36% comes from property taxes (mostly on residential or commercial land and buildings, and mostly levied by counties, cities, municipalities, school districts, water authorities, etc.). Another 31% is from income taxes on individuals. Sales taxes are responsible for 27%. Much of the remaining 6% is from income taxes on corporations. These figures, of course, vary by state and locality, with some depending more on this or that tax. According to the Urban Institute, New Hampshire and New Jersey are most dependent on property taxes. Alabama, Arkansas and Delaware are at the other end of the scale. Nevada and Washington are most dependent on sales taxes, while five states don’t even have a sales tax (Alaska, Delaware, Montana, New Hampshire and Oregon). Alaska, thanks to its oil wealth, doesn’t levy income taxes either. Same for Florida, Nevada, South Dakota, Tennessee, Texas, New Hampshire, Washington and Wyoming. Are taxes the only source of revenue for the SLG sector? No, it also receives direct transfers from the federal government—Montana depends most on federal transfers, Hawaii the least. States also charge fees for various services, including tuition for public colleges, payments at public hospitals and roadway tolls. South Carolina depends most on these fees, Connecticut the least.

Places:

• Sitka, Alaska: Long before tensions over Ukraine, long before the Cold War and long before even their alliance in World War II, the United States and Russia made a deal. It was 1867, a few years after the American Civil War, and a year after Russia’s defeat in the Crimea War. The Russian Czar had war debts to pay. So he gladly accepted $7m in gold from the Americans, in exchange for the barren lands of Alaska, where Russians had established small settlements and fur-trading businesses. A grand “folly,” some in the U.S. Congress said at the time. Even so, the deal was approved, and the transaction sealed on October 18, 1867. A ceremony was held in Russia’s Alaskan capital: Sitka. Today, a Russian Orthodox church still stands in Sitka’s city center, a rebuilt version of one originally constructed in the days of Russian rule. It’s one of many reasons why 200,000 tourists were expected to visit in the summer of 2020—that is, before Covid mothballed the cruise industry. Most come for the stunning natural beauty and exotic wildlife. And come they will: Officials expect a record-breaking tourist season this summer. A year ago, Econ Weekly profiled the economy of nearby Juneau, also located amid the archipelago of islands stretching down the coast of southeastern Alaska. A key theme was seafood, likewise a staple of the Sitka economy. The city is home to three large processing plants including Silver Bay Seafoods, the largest. It’s also the base of hundreds of commercial vessels, most operated by self-employed commercial fishermen. The economics of the seafood industry aren’t easy, not with competition from lower-wage countries like China, and Russia too before recent events. Labor at home is hard to come by, so the processing plants have long recruited from as far away as Asia, Latin America and Eastern Europe. They’re in fact among the most prolific issuers of foreign H2-B visas authorized for temporary non-agricultural jobs. In 2019, non-Alaska residents (including seasonal workers from Seattle and elsewhere on the U.S. mainland) accounted for 34% of Sitka’s workforce. According to the Sitka Economic Development Association, the city ranks as the 15th busiest seafood port in the U.S. based on value (major products include salmon, halibut and black cod). Sitka’s single largest employer is the local hospital. Though the state capital moved to Juneau a few decades after the Russians left, government work is still a major component of Sitka’s labor market. The U.S. Coast Guard and the U.S. Forest Service have sizeable footprints. Another notable employer is the Sitka Tribe of Alaska (STA), a federally recognized government entity representing Native peoples including the Tlingit tribe. The Tlingit have inhabited the area for thousands of years, at one point engaging in military conflict with Russia. The Census counts about 12% of Sitka’s population as Native American. Roughly 8% are Asian and 7% Hispanic. Overall, the population of about 8,5000 is shrinking and aging, a big reason for the seafood sector’s labor shortage. One thing that’s definitely not in short supply though, is fresh water and cheap hydropower. Is Sitka wealthy? It does have a rather high median household income of $82,000, compared to $78k for all of Alaska and $65k nationwide. Alaskan residents should get a big check next year thanks to high oil prices—the state redistributes much of its oil wealth to Alaskans through an annual dividend payment. Imagine, by the way, if Russia had kept Alaska. It would be an even larger oil power today, never mind all the gold that was discovered a few years after the sale. Understatement of the century: That $7m sale turned out to be a pretty good deal for America. (Source: Sitka Economic Development Association, Sitka Salmon Shares, U.S. Census, Southwest Alaska Municipal Conference, Northern Southeast Regional Aquaculture Association).

• Sitka: One more thing about Sitka’s history when it was still part of Russia. This is from the Sitka Economic Development Association: “During the mid-1800s, Sitka, known as the ‘Paris of the Pacific,’ was the largest, most industrious city on the Pacific Rim, with Canton, China and San Francisco, California following behind. Ships from many nations visited the port. Furs, salmon, lumber and ice were exported to Hawaii, Mexico and California. There was an active shipyard and foundry.”

• Atlanta, Dallas, Denver, San Diego, Salt Lake City, Orlando, Kansas City, St. Louis: These are some of what the Brookings Institution calls “rising star” cities—places attracting lots of new people, capital, companies and workers. They’re benefiting from the boom in remote working, a pandemic-era phenomenon that’s simultaneously erasing jobs from superstar metros like Boston, the San Francisco Bay Area, New York and Los Angeles. Between 2010 and 2019, Brookings notes, the U.S. tech sector grew by 47% and added more than 1.2m jobs, nearly triple the growth of the economy as a whole. But a lot of this growth was concentrated in the superstar coastal cities—just eight of them (San Francisco, San Jose, Austin, Boston, Seattle, Los Angeles, New York and Washington, DC) accounted for nearly half of all tech job creation in the latter half of the decade. More recently, however, Silicon Valley companies like Palantir, Hewlett Packard Enterprise, Oracle and Tesla have moved inland to places like Colorado and Texas. Intel announced a giant new investment near Columbus. And so on, hinting at a possible decentralization of the nation’s tech sector. Tech growth in superstar cities is now slowing, while taking off in not just the rising cities listed above but also northern business centers (Philadelphia, Minneapolis, Cincinnati); warm-weather cities (Charlotte, San Antonio, Nashville, Birmingham, New Orleans, Greensboro, Jackson, Stockton); university towns (Chapel Hill, Madison, Boulder, Lincoln, Tallahassee, Charlottesville, Ithaca); and Sun Belt vacation and retiree spots (Virginia Beach, Ogden, Albuquerque, Tucson, El Paso, Santa Barbara, Barnstable, Gulfport-Biloxi, Pensacola, Salisbury). The Brookings report emphasized that “the tech industry still remains more a “winner-take-most” affair,” with most jobs still concentrated in those superstar cities. But “intriguing signals point to possible decentralization.”

Looking Back

• The Civil War: The government had no authority to raise taxes, no national bank, no national currency. This was the situation on the eve of the Civil War, as Roger Lowenstein describes in his new book “Ways and Means: Lincoln and His Cabinet and the Financing of the Civil War.” In fact, the federal government at the time was really just the Post Office and a modest-sized army, funded mostly by tariffs on imports and taxes on products like whiskey. So how was Washington supposed to pay for the conflict? The job went to Lincoln’s Secretary of the Treasury Salmon Chase who was able to borrow some money from banks but not nearly enough. With the support of Congress, which at the time held more economic power than the presidency, Chase managed to implement the nation’s first progressive income tax. He also created a national fiat currency (not backed by gold or silver) dubbed the “Greenback”—until then individual banks across the country issued their own currencies. Printing the new greenbacks led to inflation as high as 80% over the course of the war. But that was nothing compared to the 9,000% inflation experienced within the Confederacy. The South, for political and philosophical reasons, couldn’t tax incomes. And almost all the region’s wealth was tied up in slaves and land, producing cotton that couldn’t get to Britain’s textile mills because of the Union blockade.

• The Civil War: Lowenstein makes the broader point about the Civil War being revolutionary for federal government expansion (as wars and national emergencies often are). In addition to the new income tax and national currency, Congress in the early 1860s created the Homestead Act granting western land to settlers, established land grant colleges and created the Department of Agriculture, supporting what was then the country’s largest industry. After the Civil War, the income tax disappeared, returning in modest form in 1913, and then with large revenue-raising power a few years later to finance World War I. The U.S. kept its greenbacks after the Civil War but anchored their value to gold prices. Things stayed that way even after the Federal Reserve opened in 1913. Not until the Great Depression in 1933 did Washington end the gold standard domestically. The dollar remained convertible to gold for international transactions however, until that is, President Nixon ended all gold convertibility in 1971.

Looking Ahead

• Crypto Economy: Sam Bankman-Fried is the billionaire founder of FTX, one of several crypto exchanges that advertised in this year’s Super Bowl. Naturally, he’s bullish on the emerging crypto economy, a virtual world where information and data can be verified without verifiers (a decentralized network of computer “miners” takes care of that). Bankman-Fried, however, in an interview with George Mason’s Tyler Cowen, expressed bearishness about Ethereum, the world’s second most owned crypto-asset after Bitcoin. Ethereum is designed to be a platform for automated “smart” contracts between two parties. But its ability to process transactions is far too slow to gain traction—just 10-to-15 per second, compared to the millions that payment platforms like Visa and MasterCard can perform. Bankman-Fried thinks the Ethereum blockchain might be able to reach a few thousand per second but that still won’t be nearly enough to handle demand. A technique called sharding will help—that’s when multiple blockchains run in parallel and then synch up with each other. But he says blockchains don’t talk to each other easily, and in any case, this would complicate transactions.

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photo courtesy of Visit Cheyenne

Issue 60: March 21, 2022

Inside this Issue:

• Rate Adventure: The Tightening Era Begins

• Quarter Point Order: But More Hikes Ahead, the Fed Said

• Reaction to Powell’s Action: Stocks Jumped, Bonds Dumped

• Oil Gains Blunted: But Still Over a Hundred

• Signs of Softness: Retail Sales Show Hints of Slowing

• Cyber Optic: Consulting Firm Gartner Sees Scary Things Ahead

• A Dance with France: Remembering the Franco-American Alliance

• And This Week’s Featured Place: Cheyenne, Wyoming, Missile Muscle

Quote of the Week

“Now, we always also said that once that gas price reaches over $4 a gallon, which it has now, that we normally see the consumers stay closer to home.”

-Dollar General CEO Todd Vasos

Market QuickLook

The Latest

And there you have it. The Federal Reserve’s policymakers, at their much-anticipated meeting last week, raised interest rates for the first time since 2018. The increase was just a quarter of a point, from levels near zero. But it marks the first step toward reversing heavy monetary support for the economy—an economy that suffered a near-meltdown when the Covid crisis first struck in March 2020. Since then, the U.S. economy has come roaring back, with nearly 6% GDP growth last year, plus a job market that’s hotter than hot. Maybe too hot, in fact, leading to levels of inflation not seen since the late Carter/early Reagan years. Consumer prices are 8% higher than they were a year ago. Producer prices are 10% higher. No wonder why the Fed feels it’s time to cool things off a bit by making loans more expensive.

But just a quarter point? Some economists say it’s not enough. Some, instead, say anything more hawkish would be dangerous in the face of growing headwinds, notably rising crude and food prices. Higher interest rates themselves can prove toxic to an economy, and in this case—the doves argue—won’t do much anyhow to quell the kind of inflation now raging; in other words, inflation stemming not from too much money or too much demand but constrained supply (not enough workers, not enough semicons, not enough port capacity, etc.).

In fact, the Fed itself seems to agree with the hawks. Yes, it hiked by just a quarter point. But members of the policy committee now project the federal funds rate (more on this in a second) to reach 2.8% next year. That implies a lot more hiking in the months ahead. Chair Jay Powell amplified the hawkishness by announcing a readiness to commence “quantitative tightening” as early as their next meeting in early May. This means shrinking the giant pile of government and agency bonds it amassed while conducting “quantitative easing” throughout the pandemic.

Powell characterized the economy as “very strong,” with extremely tight labor markets and inflation running well above the Fed’s long run goal of 2%. GDP, he said, should increase 2.8% this year, still rather bullish if not quite as sizzling as last year’s 5.5% growth. The health of household and business balance sheets—along with the red-hot job market—form the bedrock of the current economic strength. But high levels of uncertainty remain, he admits, amid geopolitical tensions, “subdued” labor supply, high energy prices and bottlenecked supply chains made worse in recent weeks by Covid outbreaks abroad, particularly in China (ask Apple about that). Powell’s bottom line: The probability of a recession is low, but the risk of inflation causing unhealthy outcomes is growing. Hence the readiness to tighten rather aggressively in the months ahead.

To clarify, when the Fed “raises rates,” what it’s specifically doing is setting a target for what financial institutions charge each other for overnight loans—that’s the Federal Funds rate, hovering below 0.10% throughout the pandemic but reaching 0.33% as of Thursday (the day after Powell’s press conference). The rate was 1.10% just before the crisis. How exactly does the Fed influence the overnight rate? If you really want to know, here’s a good explanation: https://www.stlouisfed.org/open-vault/2020/august/how-does-fed-influence-interest-rates-using-new-tools#:~:text=The%20Fed%20uses%20its%20monetary,reserves%20in%20the%20banking%20system.

The idea, anyway, is that if rates for overnight lending go up, then rates for longer-term lending will go up as well. That’s been happening, but with an important caveat: Shorter-term rates—what the U.S. government is paying to borrow for two or three years, for example—have risen much more sharply than longer-term rates. In fact, it currently costs more for Uncle Sam to borrow for three years than it does for ten, a counterintuitive inversion that’s historically foreshowed recessions. One interpretation is that large portions of the market prefer to buy safe longterm Treasury bonds right now, rather than lend for more productive, GDP-enhancing purposes. Others disagree, saying longterm rates are suppressed not because of anemic animal spirits but rather large bond buying by the Fed and fellow central banks, along with other actors merely stuffing themselves with safe assets to comply with regulations. Still others attribute low longterm rates to demographic factors, growing wealth inequality or low productivity in sectors like housing, health care and higher education (the infamous Three H’s).

One critical category of longterm interest rates now rising: Home mortgage rates, typically for 30-year loans, which now top 4% on average, according to Freddie Mac. This upward drift contributed to a 7% decline in existing home sales from January to February, says the National Association of Realtors. Demand, you can see, is clearly softening. But to be clear, most housing economists see home prices continuing to rise this year given extremely tight supply. The homebuilder Lennar, for its part, said last week that the housing market remains “very strong in all of our major markets (see the Sectors section below),” never mind a “supply chain that is all but broken,” plus “a workforce that is short in supply, and the intense competition for scarce and titled land assets.” Sadly under these supply-constrained conditions, 87.5m households are currently unable to afford a median priced new home, says the National Association of Homebuilders.

Turning to commodity markets, extreme volatility continued, with oil prices dropping sharply though still ending the week north of $100 per barrel. Stocks reacted well to the Fed’s bullish pronouncements. Treasury yields rose. One reason for oil’s decline, by the way, is mounting distress in the Chinese economy, now facing higher energy costs, a deflating real estate bubble, sluggish household demand, a worrisome reliance on exports (especially to the U.S.) and Covid lockdowns in key production centers. Don’t forget: the U.S. imported $506b worth of goods and services from China last year. $506b!

That makes China, for one, keen on updates about the American consumer? So how’s she doing? The Census published data on U.S. retail sales for February, which rose slightly from January, after much bigger gains a month earlier (they actually declined in February if you exclude spending at gas stations). The retail sales figures are not adjusted for inflation, meaning rising sales partly reflects people paying more for the same stuff, rather than buying more stuff. View the chart below for more detail. But the key takeaway is that consumer spending shows some signs of cooling off.

Some updates from Corporate America: Elon Musk says Tesla and Space X both face disruptive inflation. Costco, Kroger, BJ’s and Walmart’s Sam’s Club, the Wall Street Journal reports, each get about 10% of their revenue from gasoline sales. Dollar General says Americans stay closer to home when gas prices exceed $4 a gallon. It also says the economic health of its mostly low-income customers depends most importantly on the job market, i.e., “whether they’re gainfully employed or not.” Dollar General believes, incidentally, that inflation helps its business by encouraging people to “trade down” from higher-priced stores. Walmart, perhaps in a similar position, plans to hire more than 50,000 additional workers, including tech professionals at newly established offices in Atlanta and Toronto. HCA, the giant hospital chain, says it’s beyond the Omicron surge. The Atlanta-based railroad Norfolk Southern, meanwhile, sees the auto crunch easing as semicon availability improves. “We’re seeing less and less [disruption] every week.”

And this week: Jay Powell will be heard from again, heading a high-powered list of speakers scheduled to address an annual economic policy conference (hosted by the National Association for Business Economics, or NABE). Other speakers include Atlanta Fed president Raphael Bostic, the head of President Biden’s Council of Economic Advisers Cecilia Rouse and Nobel Laureate Paul Krugman. The ghost of Paul Volcker will be at the conference as well.

Companies

• Vail Resorts: For most companies dependent on tourism, including many airlines and hotels, summertime is peak season. Not for Vali Resorts. All but a few of its 37 mountain resorts—six of them in Colorado—peak during the winter months. They’re chief activity, after all, is skiing. The firm does own a few resorts in Australia, where ski season coincides with America’s summer. But still, Vail Resorts is a winter-centric company, generating a large majority of its revenues between mid-November and mid-April. Unfortunately, this past ski season was marred by severe staffing shortages, especially during Covid’s Omicron wave in December and January. Labor availability has since improved, accompanied by better snowfall. But the 2021/22 ski season will soon end. The company has a big presence in Breckenridge, Colorado, the most visited mountain resort in the U.S. Naturally, its namesake city Vail is another one of its big markets. It owns resorts in the eastern U.S. too, earning money from entry passes, lift tickets, dining, retail, ski instruction, lodging, etc. During summers, its resorts offer activities like mountain biking and hiking, but these draw far fewer visitors than the winter sports. Let’s end with some fun facts: Europe is the largest ski market in the world, triple the size of North America’s in terms of visitations. And in terms of U.S. states, California gets the largest number of tourist arrivals, followed by Florida, Nevada, Texas and New York.

Tweet of the Week

Sectors

• Housing: The homebuilder Lennar, in its earnings call last week, gave an assessment of housing markets by geography. Florida, it said, is benefitting from local demand as well as in-migration from the northeast, midwest and west coast. Texas is the country’s strongest housing market for Lennar, and Austin its strongest market within Texas—people are moving to the Lone Star State from both east and west. The Carolinas are hot. Same for Atlanta and Huntsville. Colorado is attracting buyers from other states thanks to strong job growth. Phoenix and Las Vegas continue to be “two of the hottest markets in the country,” benefiting from “business-friendly environments, real job growth and immigration from California.” California itself remains “very strong” as the state’s severe housing shortage means more demand than supply even with heavy out-migration. Specific California areas of strength include the Inland Empire, Sacramento and East Bay of San Francisco. The Pacific Northwest, which includes the roaring economies of Seattle and Portland, continues to be a strong market, “as significant land use and development restrictions limit production to meet growing demand.”

• Energy: EPC Power, a San Diego-based manufacturer of energy storage systems—and producer of a podcast called the “Energy Gang”—presented its top five energy developments of 2021. Topping the list was the Texas “freeze wave” that disrupted power and proved a wake-up call to Americans about the questionable resiliency of their energy systems. Another big event was the activist shareholder victory at ExxonMobil, long reluctant to accept the realities of climate change. “Green stimulus” also made an important impact last year, specifically all the new government money allocated to address climate change. EPC cited the large number of company, industry and government commitments to net zero carbon emissions—even Saudi Arabia was among them. And finally, the top five list included major advancements in battery storage, with costs falling and supply increasing.

• Airlines: At a JP Morgan investor event last week, the country's largest airlines sounded exceptionally bullish. Delta, for its part, said it's never "seen demand turn on so quickly as it has after Omicron.” Demand is so strong, in fact, that most airlines feel confident about passing along the recent rise in fuel prices. Delta again: "We are very, very confident of our ability to recapture over 100% of the fuel price run-up in the second quarter." Transatlantic bookings have softened since the Ukraine invasion, however. On the other hand, American Airlines said domestic leisure demand has been higher than it's ever been, adding that "we don't have as many airplanes as we want." But business demand is bouncing back "very quickly" too, says United. Note that U.S. airlines also collect large sums of revenue by selling frequent flier program points to banks, which use them to entice new credit card customers. And sure enough, credit card revenues are strengthening for airlines, in Southwest's case coming in "stronger than anticipated."

• Digital Advertising: Alphabet and Meta, better known as Google and Facebook, are the kings of online ads. But don’t forget about Amazon, with $30b in ad revenues, and Apple, with perhaps $5b, according to analyst estimates. Even Walmart, with its growing online presence, generated more than $2b in advertising revenues last year. Still, these figures pale compared to Google’s roughly $250b in annual ad revenues, and Facebook’s $110b. For Google, these revenues mostly come from online searches, which is “the best and most profitable form of advertising,” according to Stratechery, a newsletter by Ben Thompson. He writes: “Google doesn’t have to figure out what you are interested in because you do the company the favor of telling it by searching for it. The odds that you want a hotel in San Francisco are rather high if you search for ‘San Francisco hotels’; it’s the same thing with life insurance or car mechanics or e-commerce.” Meta/Facebook’s ad model is different, based not on search but on assigning a unique identifier to each of its users gleaned the mobile device they’re using. When a user clicks on an ad and ultimately buys something, that’s information useful to advertisers. Or as Thompson writes: “Advertisers take out new ads on Facebook asking the company to find users who are similar to users who have purchased from them before.” More recently though, Apple’s new privacy rules make it difficult for Meta to collect information on users that download the Facebook or Instagram apps from the Apple App Store.

Markets

• Short-Term Credit: The Economist featured a story about the resiliency of credit markets in the U.S. and other developed markets, giving praise to financial reforms enacted after the 2008-09 crisis. “Credit is the financial system’s oxygen supply,” it writes. When suddenly unavailable during the crisis of 2008 (banks stopped lending to each other), Lehman Brothers collapsed, “and a subprime mortgage crunch turned into a global financial crisis.” Once again in 2022, with Russia’s war on Ukraine causing unease, financial actors are curtailing riskier lending, preferring safe assets instead. That usually means, most importantly, scrambling to own U.S. dollars and U.S. Treasury bonds. “A rush into American government debt—the safest asset of all—has pushed Treasury yields down even as inflation expectations have risen.” Lenders, the Economist adds, are “prizing security over returns.” What’s wrong with that? For countries outside the U.S., borrowing in dollars has suddenly become more expensive. For U.S, companies that earn a lot of their revenue abroad (think IBM or GE), depreciating foreign currency means lower income. But more importantly, a rush to safe assets presents risks to short-term money markets, in other words, markets to borrow and lend money for just a day or two, or just a month or two. It’s a giant but often overlooked part of the financial system (sometimes called its plumbing), on which banks, companies and other economic actors depend to ensure they have enough cash to operate each day. Overnight borrowing and lending also ensure the smooth functioning of payments moving between different parties, including banks settling who owes what to each other at the end of every day. Unfortunately, things might not go smoothly when everyone is demanding safe assets like Treasuries at the same time (or put another way, when everyone wants to lend to Uncle Sam at the same time). That’s what happened in 2008 when banks stopped trusting each other, and thus stopped lending to each other, preferring to make short-term loans to the Treasury instead. Things nearly got worse in March 2020 when people didn’t even think Treasuries were safe enough—the Fed quickly stepped in with a firehose of liquidity. Is there another jolt to short-term money markets now underway? No, The Economist reports, thanks to past central bank actions. The Federal Reserve, for one, introduced huge amounts of reserves, which are a form of money available to Fed member banks. It’s also introduced programs to ensure access to dollars for institutions that are not. banks belonging to the Federal Reserve system. Money market funds, for example, can now borrow directly from the Fed as well. Foreign central banks, furthermore, now have access to dollar swap lines, protecting against a destabilizing dollar shortage abroad (most of the international economy operates on dollars). The Fed has also provided guarantees to the repo market, where trillions of dollars are borrowed and lent overnight (using Treasuries as collateral). Thanks to this large repo market, The Economist explains, banks and other financial institutions no longer need to rely so much on direct lending to each other. The repo loans are collateralized, which is safer, but it means heavy demand for collateral, contributing to a shortage.

• Long-Term Credit: What about the current health of longer-term lending? The Economist article had something to say about that as well. “Longer-term credit conditions are also weathering the storm remarkably well,” it writes. Even very risky companies, whose bonds are often called “junk,” are still trading at yields that aren’t much above safe asset yields. One reason, according to Lotfi Karoui of Goldman Sachs, is that “a fifth of the $1.6 trillion American high-yield bond market is issued by oil, metals and mining firms that are benefiting from—not hurt by—ballooning commodity prices.

Places:

• Cheyenne, Wyoming: Sixty years ago, as the Cuban Missile Crisis threatened humanity’s existence, President John F. Kennedy thankfully decided not to fire. But if he did, a group of highly-trained U.S. Air Force personnel in Wyoming was ready. In 2022, the U.S. and Russia are again adversaries, and once again, there’s unnerving talk about usage of nuclear weapons. Also once again, the folks in Wyoming are ready. Just in case. Cheyenne, Wyoming, specifically, is home to the F.E. Warren Air Force Base, a critical node in America’s nuclear defense. It’s one of three bases—the others are in North Dakota and Montana—equipped with underground silos capable of firing nuclear-armed Minutemen III ICBMs (intercontinental ballistic missiles). The base also happens to be central to Cheyenne’s economy, alongside state government. Wyoming, as it happens, is a relatively young state, and today the least populous of any state. Like many cities of the Great Plains and Rocky Mountains, it owes its existence to the first transcontinental railroad, completed in 1869. Two years earlier, the Union Pacific railroad chose present-day Cheyenne as a base of operations, roughly 1,000 miles west of Chicago and 1,000 miles east of San Francisco. A U.S. army base—on the site of what’s today the Air Force base—was established there as well. When Wyoming became a state, Cheyenne became its capital. The “Cowboy and Indian” culture of American lore soon developed, tied to the cattle trade. Cheyenne was briefly a major airline hub in the early days of aviation. Today, Wyoming is the country’s largest coal producer thanks to reserves in the Powder River Basin. Alongside agriculture and energy is tourism, the third leg of the state’s economy today. Wyoming is, after all, home to Yellowstone National Park, not to mention Jackson Hole, an affluent resort that hosts an important Federal Reserve event each summer. Grand Teton National Park is in Wyoming as well. But these sites are in the mountainous northwest corner of the state. Cheyenne, in the southeast corner, is in flat country, lacking any natural wonders to attract tourists. Instead, it lures them with its cowboy and Native American culture, celebrated each year at Frontier Days, a ten-day event that attracted 550,000 people last summer—the event was canceled the year before due to Covid. The University of Wyoming, in nearby Laramie, also has a major impact on the Cheyenne economy. Health care facilities, public schools and retailers like Walmart are major employers. So still, incidentally, is Union Pacific. Hardly just focused on its railroading past, however, Wyoming, including Cheyenne, is now trying to become a hub for the crypto-economy. Favorable laws and regulations are attracting crypto organizations like Kraken (an exchange), Cardano (a smart contract platform) and Ripple Labs (payment solutions). That’s controversial in some circles, but not as controversial as the state’s financial secrecy laws, allegedly making it a haven for tax avoidance. This came to light with the Pandora Papers, a collection of leaked documents that prompted the Washington Post to write an article entitled: “The ‘Cowboy Cocktail’: How Wyoming Became One of the World’s Top Tax Havens.” (For more on tax havens see Econ Weekly: May 3, 2021). For all its financial ambitions, military might and clout in state politics, Cheyenne remains a small city with just 100,000 people in the metro area—roughly 15,000 are associated with the Air Force base, including military retirees and their families. That 100,000 figure makes it about the same size as Grand Forks, North Dakota, or Hot Springs, Arkansas. Its population did grow a healthy 8% during the 2010s, boosted by the residual impact of Denver’s mega-boom just an hour-and-a-half to the south. Between Denver and Cheyenne is Fort Collins, Colorado, where population rose a scorching 19% last decade. Will the growth continue to bleed north and ultimately turn Cheyenne into a boom town? Not having an attractive mountain landscape like Denver or Jackson Hole hurts. Housing prices have nevertheless been rising sharply, though that’s been true almost everywhere during the pandemic. The current jump in energy and ag prices certainly helps Wyoming. The state is one of nine without an income tax, which can be both a magnet for new residents but an obstacle to development projects, including plans to revitalize downtowns, improve broadband access or attract new air service. Of course, Wyoming’s distaste for government taxing and spending belies Cheyenne’s economic dependence on federal military dollars and state government. As for Warren Air Force base, the military originally armed it with ICBMs in the 1950s because of its location in the center of the country yet far enough north to strike the Soviet Union over the North Pole. The Soviet Union is gone, but the missiles remain, ready again to defend the U.S... just in case. (Sources: U.S. Census, US HUD, Roger Coupal of the University of Wyoming, Wyoming Economic Development Association, Cheyenne Leads and Wyoming PBS, which produced this interesting profile:

• The Nuclear Triad: Warren Air Force base in Cheyenne is one of three places where the U.S. military stations its Minuteman III ICBMs (397 in total). The two other sites are Malmstrom Air Force Base in Montana and Minot Air Force Base in North Dakota. But keep in mind, America has a three-pronged nuclear force, called the Triad. Nuclear weapons are launched not just from underground missile silos but also from Trident submarines (14 of them) and aerial bombers (76 B-52s and 20 B-2s). The subs are based in Bangor near Seattle and Kings Bay north of Jacksonville, FL. The B-52s are based at Barksdale near Shreveport, LA, and Minot in ND. The B-2s are at Whiteman base in central Missouri.

• Northern Cheyenne Indian Reservation: Don’t confuse Cheyenne, Wyoming’s capital, with the Northern Cheyenne Indian Reservation, which is located within Montana. It’s home to about 5,000 people, with an economy that depends mostly on federal and tribal government, along with public services like schools and utilities. Farming, ranching, textiles and construction are present as well. But according to the Minneapolis Fed, only 14% of residents (and just 8% of male residents) have a college degree. Less than half of households have broadband access. The unemployment rate is 27%. As on many Indian reservations, alcohol and drug abuse are all too common. So are suicides. The reservation does, however, sit on one of the richest coal deposits in the country, as described in a 2017 story on National Public Radio. But as the piece described: “Despite high unemployment and systemic poverty, the Northern Cheyenne Tribe has never touched the coal.” It’s a controversial topic, with some eager to tap the economic benefits and others seeking to protect the land and environment.

Looking Back

• The Franco-American Alliance of 1778: Would the United States exist today were it not for France’s help against Britain in the Revolutionary War? Surely not. A program on Britain’s BBC, “In Our Time with Melvyn Bragg,” gathered a group of U.K.-based historians to discuss the origins of the early relationship between the Americans and French. Frank Cogliano (University of Edinburgh), Kathleen Burk (University College London) and Michael Rapport (University of Glasgow) begin their discussion with the Seven Years’ War (1756 to 1763), also called the French and Indian War. Britain (supported by its American colonists) defeated France (supported by various American Indian tribes). There was no longer any question now about which country was the world’s most powerful: It was Britain, not France. The victory was costly, however, and so was maintaining a North American troop presence to defend all that newly-won territory. London wanted the American colonists to help pay for it. No thank you, said the Americans, separately upset at the British for blocking them from settling in Indian Territory (in what’s today the midwest and Appalachia). No taxation, the colonists insisted, without representation in Britain’s parliament. Britain insisted: A Stamp tax in 1765. That same year: a demand that colonists house and feed its soldiers. More taxes in 1767. Colonists reacted with boycotts of British imports. Tensions came to a boil, leading to episodes of history known to every American schoolchild: The Boston Massacre (1770), the Boston Tea Party (1773) and a Declaration of Independence (1776). By then, war was already raging, but France wasn’t yet ready to intervene. The British, after all, were heavily favored—until that is, the American victory in the Battle of Saratoga (1777). Now the French were ready to help. Revenge, however, wasn’t their only motivation. Economics played a part too. As the panel of historians explains, the Seven Years’ War left France with heavy debts. And one way to generate more income to repay those debts was supplanting Britain as the main trading partner with the Americas. Thus was born the Franco-American alliance in 1778, negotiated by Benjamin Franklin in Paris. It provided the Americans with both economic and military aid that would prove decisive. Suddenly, the British Navy and Army had to defend their far-flung overseas possessions from French attack. These included India. They also included the Caribbean, at the time an extremely lucrative source of trading revenue for Europe (think slave-based sugar plantations). Sure enough, London redeployed ships and soldiers away from the American theatre, ultimately leading to defeat at Yorktown and recognition of American independence (1783). As for France, things didn’t quite unfold as planned. The American struggle wound up encouraging a revolution at home, one that would eventually lead to the rise of Napoleon. It was Napoleon, in fact, who sold the Louisiana Territory to Thomas Jefferson in 1803. The early 1800s would also see the young United States divided between sympathies for Britain and France, at times leading to heightened tensions between America and its former ally.

Looking Ahead

• Cybersecurity: Sorry to be so morose, but cybersecurity risks are getting scarier and scarier. They might even become lethal. Gartner, which provides information and consulting services, estimates that by 2025, attackers will have weaponized a critical infrastructure system that can harm or kill humans. Yikes. In fact, the risk is already a reality. In 2020, a woman in Germany died while her ambulance was forced to take her to a more distant hospital because the closer one was hit by a major ransomware attack and unable to take new patients. It’s not just hospitals that have to worry. As Gartner points out, critical infrastructure also includes energy production and transmission, water and wastewater treatment, and food and agriculture.