Editor’s note: I’ll have an update on what is going on at Informed later in the month. As Evan Greenberg likes to say….stay tuned!
Editors’s note #2: Yes, I know LMND bought MILE last night, but this note was already written. We’ll get to that news some other time. For now, you may want to re-read last week’s piece and decide if it was good foreshadowing or not!
Last week was full of good news suggesting we might be entering a post Covid boom period with the pending arrival of the Pfizer Covid pill and the very strong unemployment report.
Commentators were quick to proclaim optimism that we can have a return to normal combined with a booming economy that would lift all boats and bring happy days to all.
But is it that simple? You probably already guessed what I would say. No, it’s not. Very simply, we are not starting from the distressed levels that typically come after prolonged macro challenges.
Historical Boom Periods
It is true that following periods like wars we tend to get economic booms from the combination of returning assets to more productive uses and the change in the mood of the country to optimism and euphoria where people want to enjoy themselves and thus consume more rather than save.
There have been a number of people who have made the comparison to the Roaring 20s following not just WWI but the Spanish Flu as well. While that’s an easy analogy, unfortunately history tends to rhyme, rather than repeat, so we need to examine what may be different now vs. other post-crisis boom periods.
Lost to all but the most astute historians is that the Roaring 20s didn’t begin at the turn of the decade. There was a mini depression from 1920-21 that followed the flu & war and preceded the boom.
Interestingly, this depression was caused by deflation due to troops returning to the work force and the Fed raising rates. There are certainly some similar dynamics today with a shrinking labor force and a Fed thinking about raising rates to keep in mind, even if we are presently more worried about inflation.
Something similar happened after WWII as well. The unemployment rate went up due to returning troops and there was a recession in 1945-46 as the giant government spending was withdrawn from the economy. There was another recession in 1949. The real boom didn’t begin until the 50s.
Pent Up Demand
One of the main arguments the optimists make is the huge pent up demand that will be released as life returns to normal. And this is true, to a point. If you are focused on airlines, hotels, or commercial real estate, sure, there will be a boom period.
However, people haven’t eliminated economic activity. Rather, they have repositioned it. So rather than spend on vacations, they spend on furniture. Instead of going to a restaurant, they buy a new oven. As opposed to going to the office or the gym, they remodel their home to add extra space to work or workout.
Sure, there was some net decline in economic activity but, due to all the government and monetary stimulus, it is pretty minimal in aggregate. So while there will be some pent up demand for certain activities, it will be offset by decline in others such as Peloton or Zoom.
Furthermore, a traditional source of pent up demand is the unemployed getting new jobs and spending more. Unemployment is below 5% now. There isn’t some giant group of people on the sidelines waiting to gain spending power. Sure, workforce participation is lower and that could unwind, but there is good reason to think that won’t happen very quickly.
Also consider, for those who adjusted well to working at home, their expenses are often lower and, to the extent they can continue to work remotely, that won’t change just because Covid ends so there are some permanent downshifts in demand.
The Withdrawal of Stimulus
As mentioned, part of what has kept the economy growing close to trend is the unprecedented monetary and fiscal stimulus. As that is taken away, it causes obvious pressure on the economy. Those post war contractions mentioned earlier were partially due to withdrawal of stimulus.
While the current concerns are more related to inflationary pressures from the reluctance to withdraw economic support, it is certainly possible things go the other way. I guess the question to ask is whether it is more likely policymakers will get the balance just right or that they will tilt too far towards one of the extremes?
One other reason to believe that the risk is towards rapid contraction is what is going on with supply chain efficiency. If the natural response to uncertainty is to hold more inventory and extend delivery times, those are both decisions that lower productivity. Lower productivity is clearly bad for economic growth.
Worse, it also tends to pressure prices, so you get a stagflationary pressure that is the worst of all possible outcomes. A permanent decline in the supply of labor due to change in attitudes toward work is also stagflationary.
If the Fed responds mainly to the inflation and raises rates, this might stem the inflation but will worsen the pressure on GDP. If they keep rates neutral, they may be able to stop the pressure on GDP but they will let inflation continue to fester.
There isn’t really a great alternative. The Fed’s muscle memory is geared towards a world where it has been hard to create inflation so there will likely be a slowness in recognizing that circumstances have changed which will cause policy errors.
There is also a lot of overcapacity that needs to be worked off to reflect new habits, such as in office space, public transportation systems, airline networks, etc. that could cause result in a bad debt cycle.
Reasons For Optimism
Now, just because things can go poorly, doesn’t mean all is gloom and doom. There are reasons to think we could have a strong economy over the next few years, whether we have a speed bump first or not.
Technology can obviously bring productivity changes that can offset some of the challenges and arguably worker productivity has been optimized to some extent with remote work a viable option. Worker shortages can be addressed with automation or a more effective immigration policy. There likely will be some animal spirits that will drive people to be more adventurous and spend more.
However, there are challenges and the unbridled optimism that the post Covid outlook is rosy is probably too enthusiastic and needs to be reassessed. We probably won’t get there in a straight line.