The Capital Letter -- Inflation, Infrastructure, Innovation, China & More


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The Week of August 9, 2021: Inflation, infrastructure, innovation, and more

Regular readers will know that optimism is not one of my defining characteristics, but in a note on Wednesday, I did note that July’s CPI number might offer some grounds for hope, if only for the short term:

There is a limited amount that can be drawn from one month’s numbers, but these latest data provide some grounds for optimism that the pandemic effect on inflation may slowly be passing (for a relatively upbeat view on the prospects, take a look at this analysis by Matthew Klein), but that’s still far from a given.

And then came Thursday and the PPI numbers.

Bloomberg:

Prices paid to U.S. producers rose in July by more than expected, suggesting that higher commodity costs and supply bottlenecks are still adding to inflationary pressures for companies.

The producer price index for final demand increased 1% from the prior month and 7.8% from a year earlier, Labor Department data showed Thursday. Excluding volatile food and energy components, the so-called core PPI also rose 1%, a second-month of record gains.

Compared with July 2020, the core index was up 6.2%. The advances in the overall PPI and core measure from a year ago were the largest in annual data back to 2010.

The median forecasts in a Bloomberg survey of economists called for a 0.6% month-over-month advance in the overall PPI and a 0.5% increase in the core figure. The PPI has exceeded estimates for five months.

Producer prices have been accelerating for much of this year against a backdrop of robust demand, supply chain constraints and shortages of materials. The increases in input costs, combined with recent upward pressure on wages, help explain higher consumer inflation. . . .

Almost three-fourths of the jump in the July PPI reflected a record 1.1% pickup in services. . . . The PPI report showed prices for goods increased 0.6% after a 1.2% advance in the prior month. . . . Prices of energy climbed by the most in four months, while food costs fell for the first time this year.

One extra wrinkle:

Costs are advancing at a robust clip earlier in the production pipeline as well. Processed goods for intermediate demand rose 1.7% in July and were up 22.9% from a year earlier. The annual increase was the largest advance since 1975.

Uh . . .

But:

Nearly one-fifth of the monthly gain was attributed to a surge in prices of cold-rolled steel sheet and strip.

This appears to be a case of lumber 2.0, sort of, and is so best seen as a distortion related to the pandemic, even if there are reasons to think, as the author of a July article in Fortune explained, that steel may have further to run, as the potential sources of demand for it are more broadly based than for lumber.

Meanwhile in other inflation news, there’s this from Bloomberg:

U.S. home prices rose the most on record in the second quarter as buyers battled for a scarcity of listings.

The median price of an existing single-family home jumped 23% from a year earlier to an all-time high of $357,900, the National Association of Realtors said in a report Thursday. About 94% of 183 metropolitan areas measured had double-digit gains, up from 89% in the first quarter.

Much of this is the product of ultra-low interest (and thus mortgage interest) rates, but, as I noted on Wednesday, that’s not the end of the matter. These rates (which, depending on the mortgage terms, may end up leaving homeowners with a liability they cannot cope with if interest rates ever start to spike, a plight, incidentally, that they could end up sharing with the U.S., as it too piles up “cheap” debt) have combined with a structural housing shortage and a dearth of sellers to produce the squeeze that we are seeing now.

What that means is that the greater affordability (however transient) that ought to come with lower interest rates is often being canceled out by increases in the sticker price. Markets are like that.

Bloomberg:

The price increases have hit particularly hard for renters looking to become homeowners. Among first-time buyers, the monthly mortgage payment for a loan with 10% down jumped to 25% of income in the second quarter, up from 21% a year earlier, according to the report.

“Housing affordability for first-time buyers is weakening,” Yun said. “Unfortunately, the benefits of historically low interest rates are overwhelmed by home prices rising too fast.”

Sooner or later, these increased housing prices are going to feed through into the CPI (there’s normally a lag of four or five quarters, because of the way that process works, basically through an increase in imputed rent), which will not, as I have noted before, help the argument that all we are seeing is a “transitory” increase in inflation, even if some balance ought to return to the housing market in due course, albeit, I suspect, at higher levels.

And frustrated first-time homebuyers will not be the only people feeling left behind by inflation. The question of whether wages are keeping up seems to depend on the period being looked at (they lagged in July, but more than kept pace on a three-month basis), and the answer is further muddled by changes in the type of job that is restarting.

Nevertheless, I was struck by this from the Wall Street Journal:

Real (after inflation) average hourly earnings have declined for seven consecutive months (overall 2%) and nine of the past 12 months. . . . Contrast this to the year before the pandemic when wages rose broadly while inflation was in check. Real average hourly earnings increased 1.4% in the 12 months from August 2018 to July 2019 compared to a 1.3% decline over the last year.

Changes in workforce composition in these two years make this comparison imperfect, with lower-wage workers re-entering the workforce this year. But real average hourly earnings even for better-paid production-level workers fell each month from January through June this year and were flat last month.

Now check out these polls.

The New York Post:

The vast majority of Americans say surging grocery and household goods prices are causing them financial hardship and nearly 80 percent blame the Biden administration’s economic policies, a new poll says. . . .

The Hill (July 28):

Nearly 6 in 10 Americans say that the Biden administration’s economic policies are to blame for the 13-year high in inflation, according to a new Morning Consult-Politico poll released Wednesday. . . .

Only two polls, of course, and it is unfair to blame Biden for where inflation currently stands. Nevertheless, if the price of a house is moving out of reach for more and more people and if it is indeed correct that real wages are lagging, and that the voters are settling on someone to blame, there must be some doubt whether the willingness to accept that inflation is transitory will persist for much longer (even if people are googling “inflation” less). That’s worth remembering given the close relationship between inflationary expectations and inflation’s ability to feed upon itself.

As I noted about the CPI numbers, there’s only so much that analysts should take from one month’s data, and that’s as true for the PPI as it was for the CPI. Nevertheless, the Wall Street Journal’s editorial board was not wrong when, after discussing the latter, it commented:

The Council of Economic Advisers and White House budget office also released a report explaining that its “proposed critical investments” expanding the welfare state would address what it calls “long-standing cost pressures.”

So spending more to goose demand amid scarce supply, and borrowing trillions of dollars more to make it harder for the Fed to tighten monetary policy, will subdue inflation. Yikes. Who writes this stuff?

The same administration that believes that the Taliban will care what the “international community” thinks about them, that’s who.

Bloomberg’s Karl Smith, writing before Thursday’s in line weekly jobless claims report:

It’s plausible that the failure of the job market to recover — there are still about 7 million fewer jobs than there were before Covid — isn’t due to a lack of overall spending. It’s due to supply constraints; the spending is leading to higher prices instead of more jobs.

Some of the more extreme constraints will ease on their own, bringing down the overall rate of inflation. But more fundamental constraints seem likely to persist. It’s these constraints that President Joe Biden and Democrats should be worried about as they continue their efforts to add even more spending to the economy.

Meanwhile, note this too from the Wall Street Journal:

Energy prices were relatively stable for the three or so years before the pandemic. But in the past year prices have risen 41.8% for gasoline, 4% for electricity and 19% for piped gas service. The spot price of natural gas is the highest in nearly seven summers, and energy analysts predict that natural gas (and thus electricity) rates will rise more this winter. . . .

The White House knows it has an inflation problem—political and economic—but its attempts to explain it are more amusing than persuasive. On Wednesday there was a plea for OPEC to pump more oil. . . .

That the administration is doing this at the same time as it is attempting to clamp down on domestic energy presumably accounts for the Journal’s doubtless grim amusement. For more on this, please see here.

Sooner or later, incidentally, people are going to start talking about the problem that “greenflation” is going to pose, but that’s a topic for another day.

Good times.

The Capital Record
We released the latest of a series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.

In the 30th episode, David hosted industry legend and economic guru James Grant, longtime publisher of the highly regarded Grant’s Interest Rate Observer, for a lengthy chat about economic history. They go through the highs and lows of the Fed and the growing social discord Grant expects from current monetary policy.

And the Capital Matters week that was . . .

Infrastructure
Kevin Hassett:

In these partisan times, it is easy to wake up in the morning and hate whatever it is your political rivals are doing. They often give you great cause to. But this bipartisan infrastructure bill is, for the most part, likely to be a small net positive for the economy. Our modeling suggested that President Trump’s $1.5 trillion plan would add between 0.1 and 0.2 percent per year to growth over the decade. The $550 billion plan, then, should be expected to have a proportionately smaller effect.

To be sure, there are things in the bill that would never have been part of a purely Republican bill, and rightly so, especially the massive increase in spending for Amtrak. But the bill does allocate $110 billion to roads, $40 billion to bridge repair, $11 billion to improved safety, $65 billion to broadband, $17 billion to ports, and $25 billion to airports. Given the sorry state of each of these, even inefficient projects are likely to pass a reasonable cost-benefit analysis.

The bill will increase the deficit, a problem that is significant and likely to put added stress on the Treasury market (even more so, of course, if it paves the way for a second, much larger bill, as Brian Riedl discussed on Capital Matters here). But the other concern raised by opponents, that the spending will feed inflation, is simply a red herring. While inflation does appear slated to increase substantially, the infrastructure bill will not drive prices up further. . . .

Agustin Forzani:

The general understanding on Capitol Hill is that America requires a massive infrastructure overhaul, as was shown on Tuesday by the approval of the $1 trillion bipartisan proposal in the Senate. Most lawmakers favored increasing public spending on infrastructure. However, neither Democrats nor Republicans seemed to recognize that these types of government plans come with extra costs beyond the proposed expenditure. As Henry Hazlitt would have said, it is not only the “seen” effects of proposals such as these that matter, but their “unseen” direct and indirect effects.

Consider the $110 billion allocated to rebuild roads, highways, and bridges in the bipartisan infrastructure framework. That money could have been spent elsewhere if taxpayers had been allowed to hang onto it. Such a reduction in their consumption, in turn, will entail fewer cars, TVs, computers, clothes, food, and services bought, and thus manufactured or provided. And that, in its turn, will mean less private-sector investment, quite a bit of which would be located in this country.

That’s not to deny there will be indirect benefits from the investment in public-sector infrastructure, but, as a rule, the private sector spends, whether for consumption or investment, more wisely than the state. People will see the bridges, highways, and roads built, but they will not see all the goods and services that will never be produced — a cost that is rarely factored into the calculation of whether that spending was worth it. . . .

China
Joseph Sullivan:

For audiences abroad, however, Chinese officials flip the script. Historically, they have emphasized the refrain, now-familiar among Western audiences, of “reform and opening up.” This is the party line, or at least it was until whenever the party stopped trying to reassure foreign investors that their capital was safe in China. Abroad, talk of socialism and Marxism is verboten. A June 2021 appearance on Chinese television by a card-carrying professor with known ties to the CCP’s international communication apparatus illustrates this duality. He fielded a question from a Chinese college student about “how [to bring] Marxism to other countries in the world, such as . . . the people oppressed by the United States.” His advice? Showcase China, but never speak of socialism or Marxism directly. “We don’t need to talk about politics, just tell the world about our daily lives, like how we can pay by mobile phone and how women can safely walk around at midnight, to show daily lives under socialism with Chinese characteristics that will shock them,” he said. “We don’t talk about spreading Marxism with Chinese characteristics to the United States.”

Steve Hanke:

China has an outsized dominance in what I term the Three Ms: (1) Mining and Mineral Engineering, (2) Metallurgical Engineering, and (3) Materials Science and Engineering. When it comes to rare earths and the Three Ms, China is fully aware of just how strategically important their position is.

When it comes to the world’s top-flight universities, China is nowhere to be found in the top 20. But, when we move into the Three Ms, things change dramatically. China dominates in Mining and Mineral Engineering, with nearly half (45 percent) of the world’s top-20 programs in those fields. When it comes to Metallurgical Engineering, China holds down 45 percent of the top-20 programs in the world. In Materials Science and Engineering, China slips a bit, but still holds down 25 percent of the world’s first-class programs.

As the Global Times, a state-owned Chinese newspaper, put it, rare earths are “an ace in Beijing’s hand,” and this is something that Beijing has understood for a while. As far back as 1992, Deng Xiaoping stressed that “the Middle East has oil; China has rare earths.”

China knows that rare earths can be weaponized. . . .

Economics and Politics
Iain Murray:

If identity issues are now paramount, then economic issues will be far less important going forward, and economic arguments will become less salient. When economics is important, you care about your pocketbook. When identity is important, you care about your voice. This helps to explain the concern over Big Tech, and how many fair-weather defenders of free markets and property rights have turned against them.

Its effect on the left is also important. “White woke” is just as much an identity as race, sexuality, or class. If you’re woke, you feel guilty about white privilege and want your wealth redistributed, which dovetails with socialism. That might explain why young whites are more likely to be socialists than African Americans or Hispanics. LGBT activists want big government, not to give them money but to force compliance with their demands. Environmentalists want the entire economic system rebuilt regardless of cost or impact.

This means that economic conservatives will need to find other ways to make their arguments. . . .

Innovation
Ingrid Chung:

The infrastructure bill recently passed by the Senate contained a provision that would impose on the trading of cryptocurrency the same reporting requirements applied to the transaction of other traditional financial securities, such as stocks. U.S. Securities and Exchange Commission chairman Gary Gensler has also been advocating for more regulations on cryptocurrency trading and soliciting congressional support for his position. This has fueled concern in the financial industry that the growing interest in the cryptocurrency market may be dampened by the anticipated regulations.

This isn’t the only new venture now suddenly threatened by congressional regulation. . . .

Inflation
Andrew Stuttaford:

Strain is right to be concerned that the Fed may be too relaxed about what might lie ahead for inflation. What’s more, given the way that the nation’s debt is ballooning, the central bank enjoys relatively little room for maneuver now —  and will have far less in the years to come. It is not too hard to see how the country could reach a point when a Volcker moment (when Paul Volcker became Fed chairman in August 1979, the Fed Funds rate stood at 10.5 percent or so: It peaked at around 20 percent less than two years later) is essential but impossible. Under the circumstances, the Fed would do well to err on the side of caution. On the brighter side, the sharp spike in Americans googling “inflation” appears to have reversed, so there’s that.

And then there’s the small matter of all that money that’s been created out of thin air. . . .

Energy
Benjamin Zycher:

Incoherence is nothing new in the Beltway, but it’s still quite something to see the Biden administration simultaneously pursue new constraints on U.S. production of fossil fuels as a central component of its “climate” policies, while at the same time attempting to avoid the adverse price effects of that production stance. The administration on August 11 issued a plea for another increase in crude-oil production by OPEC+ (the 13 members of OPEC and ten other major international producers). . . .

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