Econ Weekly (July 26, 2021)

Inside this Issue:

  • More Learnings from Earnings: Higher Costs but Strong Demand
  • Still the Vim without the Stim? Economy Faces New Tests as Measures Wane
  • Just More Drama? Or this Time Trauma? Another Debt Ceiling Debate (Ugh)
  • Money Laundering: Big Demand for Whirlpool Washing Machines
  • Package Power: A New Book About Labor Relations at UPS
  • Dating the Dip: NBER Says 2020 Recession Lasted Two Months
  • Man-Made Brains: The Future of Artificial Intelligence
  • And This Week’s Featured Place: Lexington, Kentucky: Growth Sources Beyond Race Horses

Quote of the Week

“No way did I or anybody else in the last six months realize how difficult it was going to be to try and get people to come to work these days. It is an enormous challenge for us to go out and find people that want to be conductors on the railroad, just like it’s hard to find people that want to be baristas or anything else. It’s very, very difficult. Nor did we anticipate that a lot of the people were going to decide they didn’t want to work anymore. So our attrition was much higher in the first half of the year than what we had expected.”

-CSX Railroad CEO James Foote

Market QuickLook

The Latest

Americans are still buying lots of stuff. That much is clear from the growing list of companies that have now reported their Q2 earnings. More importantly, this strength in demand is—for most companies, anyway—outweighing the negative impact of higher input prices and supply chain headaches. Indeed, Corporate America says profits are strong.

The economy, however, will soon be tested. How well can it stand on its own? For now, there’s no additional fiscal stimulus coming (beyond what hasn’t yet been spent from previous bills). Perhaps as early as this week, when it holds its next policy meeting, the Federal Reserve will outline initial steps toward unwinding the extraordinary stimulus it enacted last spring. If not this week, then maybe at an August event in Wyoming. Separately, a federal moratorium on home evictions expires at the end of this month, perhaps heralding an increase in foreclosures and homelessness. Also expiring at the end of this month: Congressional permission for additional federal borrowing.

Even without any additional borrowing after July, the Treasury will have enough cash to pay its bills for a while. Exactly how long is hard to say. Secretary Yellen notes that in October, the Treasury has a large payment due for a Defense Department-related retirement and health care investment. Of course, the money could run out even earlier. Expectations for now are that Congress will eventually—after some political brinkmanship—increase or suspend the debt limit, removing the frightening prospect of a federal loan default. No American in their right mind would want to see that.

In the meantime, Covid remains a threat as the Delta variant spreads and vaccination refusal persists. Also somewhat unsettling: An increase in Americans applying for unemployment benefits. It’s the labor market, remember, that’s the primary focus of the Federal Reserve right now, never mind high rates of inflation that—were this the pre-Covid era—might have called for immediate and panicked tightening. No need, the Fed still insists. The inflation is just transitory.

The labor market’s big moment will be September, when schools reopen, and unemployment bonus payments expire. Hopefully then, unemployment rates will drop to pre-Covid lows. As a reminder, GDP already has returned to its pre-pandemic level, but the job market has not. Unfortunately, September probably won’t mark an end to supply strains on the economy. Intel, for one, says the shortage of critical semiconductors could last into (gulp) 2023.

In the giant health care sector (now approaching a fifth of total U.S. GDP), HCA reported a “strong rebound” in demand for medical services deferred during the pandemic. During Q2, the hospital chain said, Covid patients accounted for just 3% of admissions, compared to 10% in Q1. Separately, Alcoa said it’s currently the most profitable time ever to be in the aluminum business. American Express sees a surge in credit card spending, especially on travel and entertainment. Netflix, less happily, faces some challenges with subscriber growth but boldly wants to offer video games. AT&T, as it undertakes a change in media strategy, sees positive growth trends in its core cellular and cable businesses.

Amazon founder Jeff Bezos followed Richard Branson high into the sky, kindling prospects of the further commercialization of space. Satellite communications are already a big part of the space economy. Might we one day mine asteroids for raw materials and operate factories in space as a way to cut carbon emissions? Will space tourism become an option for more than just billionaires?

Back on planet earth, the stock market, after swooning early in the week, returned to expansion after strong corporate earnings settled nerves. The market for oil and Treasury debt were mostly unchanged.

This week brings more earnings fun, led by Big Tech. Amazon, Apple, Google, Microsoft, Facebook and Tesla all report. Joining them will be Comcast, Lockheed Martin, GE, UPS, Pfizer, PayPal, McDonalds, Ford, Boeing, Qualcomm, ExxonMobil and so on. And don’t forget: Two separate trillion dollar-plus spending proposals remain alive in Congress. There’s a lot to watch.

Companies

  • Whirlpool: Everybody talks about used cars and gasoline. But don’t neglect washing machines. In the Labor Department’s latest CPI report, prices for laundry equipment show a sharp 3.5% one-month jump (May to June) and a 29% spike from this time last year. Bad news if you’ve got lots of dirty clothes. Good news if your Michigan-based Whirlpool, whose revenues increased by almost a third y/y during the April-to-June quarter. Profits grew too, with operating margin hitting double digits—margins were particularly high in North America. Laundry equipment generates about a third of Whirlpool’s revenues, with another third coming from refrigerators, and most of the remainder from cooking appliances and dishwashers. With people spending so much time in their homes during the pandemic, it’s no wonder why demand for these appliances grew. Less favorably for Whirlpool—and competitors like Samsung, LG, Panasonic, Electrolux and Haier—raw material costs are spiking; management specifically mentioned steel and resin. The semiconductor shortage too, is affecting production. Looking ahead, laundry and kitchen appliances should benefit from the 5G-enabled Internet of Things phenomenon. Whirlpool sees a future in which its appliances are connected to the internet and responsive to voice commands. One example: Washing machines that automatically replenish detergent. Another example: Refrigerators that always know what’s inside, making shopping much easier.

Tweet of the Week

Sectors

  • Health Care: Can technology and new business models fix the broken American health care system? The Wall Street Journal profiles Chicago-based Oak Street Health, a nine-year old company trying to improve the quality and cost efficiency of health care for seniors covered by Medicare. That’s an addressable market of more than 60m people, whose health care costs exceed $800b a year. Oak Tree is taking a unique approach to care, relying not on revenue from fees every time a patient receives a service—many say this model leads to more services performed than necessary. Instead, Oak Tree works for a monthly fee per patient, assuming the full financial risk of caring for the patients. The focus, is says, is on “quality of care over volume of services.” By doing everything it can to keep people healthy, it can earn a margin from the difference between the fees it collects and the longterm cost of care. The Journal article describes some of its practices, including attempts to see patients soon after they’re discharged from the hospital to prevent a repeat visit. There are frequent checkups, preventive screenings, meetings with social workers and so on. What’s perhaps most intriguing about Oak Tree’s model is that others are trying it as well. Other expanding companies with a similar approach include Cano Health and Agilon Health. Big insurers like United and Humana are trying the model as well. And it’s attracting lots of new capital from investors.
  • Health Care: Also appearing in the Wall Street Journal was an opinion piece by former White House economist Casey Mulligan. He defends the system in which a large portion of Americans receives health insurance through their employers. These employers have negotiating clout with health care providers, he argues, which helps control costs. He compares it to Costco reducing prices for its members thanks to its buying power with suppliers, and its ability to shut out suppliers from its network of members if they don’t provide low costs. Mulligan separately thinks health care benefits tied to employment encourages people to work.

Markets

  • The latest unemployment claims data from states (compiled by the Department of Labor) showed a weekly increase. And while one week hardly makes a trend, it’s not a welcome development. The Department’s Bureau of Labor Statistics separately said the percentage of people working from home doubled during the pandemic, to 42%. That figure will decline as people return to offices. But by how much. Some workers are eager to get back. Others found the work-at-home thing quite nice.

The Inflation Debate

  • Conor Sen, a columnist for Bloomberg, makes an important point about high energy prices. They tend not to cause runaway inflation because they ultimately lead to slower economic growth, which weakens pricing power. The same is true of spikes in freight prices or import tariffs.
  • This year, Social Security benefits (and Supplemental Security Income) have increased 1.3% from last year. That’s thanks to a built-in cost-of-living adjustment (COLA), in this case based on the increase in the consumer price index from Q3 2019 to Q3 2020. This affects roughly 70m American seniors. Looking ahead, next year’s social security COLA increase will likely be much larger, based on the last three quarters of CPI inflation rates. It would be a large extra expense for the federal government.

Government

  • Debt: Here’s the latest on the national debt: The Federal government owed $28.5 trillion as of mid-July, with $22.3 trillion of that held by the public. Public debt outstanding does include the $5.1 trillion held by the Federal Reserve. It doesn’t include money the government owes to itself, including Treasuries held by federal trust funds including Social Security. Also note that $1.5 trillion of money that Congress allocated for Covid relief hasn’t yet been spent.

Places

  • Lexington, Kentucky: Louisville is Kentucky’s biggest city. Frankfort is the state’s capital. Covington is home to its busiest passenger airport, which actually serves the Ohioan city of Cincinnati. Louisville’s airport is the busiest in the world for shipping giant UPS (see Looking Back section below). Lexington, however, has a few of its own economic advantages. Most importantly, it’s home to the University of Kentucky, a school with more than 30,000 students and some 17,000 employees. It’s a public university, though the majority of its revenue comes not from state tax dollars or even tuition, but rather from health care services operated by its affiliated hospital. Lexington also has what Greenville-Spartanburg has: A giant foreign auto plant, in its case owned by Japan’s Toyota. The plant, in nearby Georgetown, employs roughly 10,000 people—it’s Toyota’s largest production facility anywhere in the world. But Lexington isn’t best known for its colleges or factories. It’s best known as the horse capital of the world, situated in the state’s Bluegrass region just west of the Appalachian Mountain range. The Kentucky Derby, a famous horse race, is held in Louisville. But Lexington has its own popular racetracks, not to mention large horse auction markets. Bluegrass country is famous for its Bourbon distilleries too, which also attract tourists and retirees. In fact, Lexington’s 9% population growth during the 2010s was almost double that of Louisville’s rate. Amazon is a big employer in the region, as are Conduent (once part of Xerox) and Lexmark (once part of IBM). Lockheed Martin employs more than 1,000 people in the area as well. Put it all together, and it’s a rather well-diversified economy. According to the Department of Housing and Urban Development, government accounts for 20% of all jobs, professional services another 14% and health and education just 13%. Manufacturing (11%), retailing (11%) and leisure and hospitality (10%) are all important but not systemically so. Demographically, Lexington’s metro area has similar percentages of white and black residents as the national average. But its Hispanic and immigrant populations are significantly smaller. Education levels are quite high thanks to the university. Looking more broadly at Kentucky, the state faces economic challenges from its exposure to coal mining and tobacco. On the other hand, it’s well situated for east coast distribution and logistics, which UPS and Amazon have figured out. The spectacular growth in ecommerce, therefore, is a boost for Kentucky. And for Lexington too.
  • Belvedere, Illinois: In the far north of Illinois, just before the Wisconsin border, lies a city called Belvedere. It’s part of the Rockford metro area, which lost about 5% of its entire population during the 2010s. A booming area it is not. Now, another blow: Stellantis, owner of a Chrysler, plans to move production of its Jeep Cherokee from Belvedere to Mexico, AutoForecast Solutions reports. The Illinois facility is currently facing major disruptions due to the semicon shortage. Being close to Chicago and Milwaukee, for sure, has its benefits. UPS and Amazon Prime Air are both very active at Rockford’s airport.
  • Arizona: The website Calculated Risk, citing Arizona Regional Multiple Listing Service (ARMLS) reports, says total home sales in the state rose nearly 2% y/y in June. But the number of homes for sale was down 33%. No wonder why prices are up so much.

Abroad

  • Consider for a moment just how devastating the Covid pandemic has been to humanity. More than 4m people have died from the virus, with that number still growing. Many more have endured intense physical and emotional suffering. The World Bank, meanwhile, estimates that the pandemic caused 97m more people to fall into poverty. The IMF has some statistics of its own about how much money governments spent to support their economies during the pandemic. The total was about $16 trillion, not including the $7.5 trillion expansion of central bank balance sheets. Still, the world lost $22 trillion in output, relative to what the IMF forecasted pre-pandemic.
  • China: Fires in the U.S. west. Floods in Europe. Floods in China. The South China Morning Post calls the calamities a “global climate emergency.” It describes the tragedies unfolding in the city of Zhengzhou, where heavy rains have displaced more than 1m people. The city, though far lesser known internationally than places like Beijing or Shanghai, happens to be important to the world economy. Most significantly for Americans, it’s home to “iPhone City” a giant Foxconn plant that builds products for Apple. The city is also a major center for textile manufacturing, the SCMP explains, owing in part to its strategic location. Beijing lies to the north, Shanghai to the east, Xian to the west and Guangzhou to the south. That makes Zhengzhou a critical railway hub, serving more passengers than any other in China.

Looking back

  • The 2020 Recession: How long did the economy contract last year? The National Bureau of Economic Research, or NBER, is a non-profit research group whose business cycle dating committee tries to pinpoint the start and end of recessions. So when did the 2020 recession start and end? As a reminder, the NBER’s definition of a recession is the period between an economy’s peak economic activity—which in this case was February 2020—and its subsequent low point, which came in April 2020. There it is: The recession lasted just two months. The NBER did say that normally, it wouldn’t classify such a brief period as a recession. But this one was so sharp and steep that the label is apt.
  • The 2020/21 startup boom: NBER’s webpage has a wealth of studies about different economic topics, including one published just this month about how applications for new business startups surged in the second half of 2020 and first half of 2021. Author John C. Haltiwanger notes how this was not the case after the last downturn in 2008-09, when financial conditions were far tighter. The increase has been most dramatic for “non-store retailers” including companies selling goods via online platforms like Amazon. Another big category of startups: Personal services for things like laundry. Lots of people are starting professional and technical service firms too. Restaurants and bars are also on the list. Were Washington’s stimulus programs responsible? Hard to say, because they boosted incomes for potential entrepreneurs but also boosted incumbent businesses through PPP loans. Historically, Haltiwanger says, most new businesses wind up failing. But a few that succeed (think Amazon or Google) wind up growing rapidly, with profound implications for job creation, innovation and productivity growth.
  • UPS: Author Joe Allen joined the New Books Network podcast to discuss, well, his new book. It’s called “Package King: A Rank-and-File History of United Parcel Service.” UPS, as its better known, got started as a bicycle messenger service in Seattle in 1907. Today, based in Atlanta, it’s the largest unionized private-sector employer in the U.S. That’s a distinction that for many years was held by General Motors. The book, to be sure, is highly critical of labor practices at UPS, saying the company “combines modern technology with 19th century working conditions.” (Ouch). One specific area of criticism is the company’s heavy use of part-time workers. Allen also recounts the 16-day UPS strike in 1997, a milestone in modern labor relations. Allen’s provocative condemnations aside, he insightfully notes how the distribution and logistics sector is a focal point for labor relations in the 21st century U.S. economy (much like auto manufacturing, railroads or textile mills were in earlier eras). Amazon, a non-union company facing unionization efforts, happens to be the largest UPS customer, accounting for a full 13% of the latter’s total revenues. UPS itself, in moving “something like 2% of the economy every day,” employs more than half a million people. More than three-quarters (of those based in the U.S.) are represented by unions, including drivers, package handlers and pilots. In addition to delivering packages, UPS helps companies manage their logistics and supply chains. UPS has its largest air cargo hub not in its home city Atlanta but in Louisville, Kentucky. Philadelphia, Dallas, Ontario (near Los Angeles) and Rockford (near Chicago) are important UPS freighter hubs as well.

Looking ahead

  • Artificial Intelligence: Machines are rapidly—more rapidly than many appreciate—gaining the ability to perform more and more human tasks. That’s the opinion of OpenAI CEO Sam Altman, who joined the journalist Ezra Klein on Klein’s New York Times podcast. Starting around the 1970s, he argues, the phenomenon known as Moore’s Law enabled humans to produce computers that kept getting better even as their prices dropped. AI, he believes, is bringing Moore’s Law to a whole host of human activities, often at zero marginal costs beyond the initial computing investment. AI will increasingly replace things humans didn’t want to do or can’t do, from serving as a personal translator or tutor to interpreting medical information. In roughly ten years, Altman sees chatbots becoming sufficiently useful to become personal assistants to people—they’ll book your travel, tutor you in Spanish, etc. Eventually, everyone will have AI systems at their disposal to perform tasks “for almost anything.” Naturally, AI’s emerging power brings uncomfortable questions regarding how it might disrupt the labor market—will AI bots replace humans for many jobs? There are also questions about ethics, algorithmic bias and geopolitics—the world of 2050 could look very different depending on who develops the best AI fastest, the U.S. or China.
  • Cryptoeconomy: When the prices of cryptoassets were shooting to the moon earlier this year, the business world could hardly talk about anything else. The frenzy has since dissipated, but crypto-enthusiasts remain. Raoul Pal is certainly one. He tells “The Defiant” podcast that all his net worth (yes, all of it) is now in crypto, with an outsized allocation to Ethereum. But unlike many blockchain cheerleaders, Pal’s greatest enthusiasm is not for digital money or decentralized finance (Defi). What he’s most excited about are the prospects for social tokens. These are assets that a specific person or community or organization creates, aimed at fans, customers or product users. He gives the example of Disney, which currently has to “rent” many of its customers from advertising platforms like Google and Facebook. Only in its stores, or at its theme parks, does Disney have a direct relationship with its customers. By issuing Disney tokens, however, they’d potentially become the currency for all things in the Disney universe. Token holders might have access to special discounts or the right to see newly released movies before the wider public. In theory, such tokens would grow more valuable as the network of users grew. And fans and customers would now own an asset linked to Disney’s business, kind of like how people own stock in companies today. Of course, it’s not just companies that could issue social tokens, but sports stars, TikTok performers, charities and so on. Does it all sound fanciful? Well, Facebook doesn’t think so. Its Libra initiative, since renamed Diem, envisions a new digital currency which would function like, Pal says, a “token for the Facebook economy” (clarification: digital “currencies” have their own blockchain while digital “tokens” are built on existing chains like Ethereum). As with many crypto projects, however, Facebook has run into pushback by regulators.

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