Dear Coffee Readers,
“As is often the case, we are navigating by the stars under cloudy skies.”
Who uttered these words and when?
- Christopher Columbus as he led the scared crews of the Nina, Pinta, and Santa Maria into uncharted waters towards what they thought was the end of the earth in 1492?
- Admiral Lloyd Nelson when his fleet was blown off course by an unexpected storm in his attempt to attack the French and Spanish fleets before his victory days later at Trafalgar?
- Lieutenant Commander George De Long in 1880 when he commanded the USS Jeannette during an intense storm as he tried to be the first to reach the North Pole?
- Fed Chair Jerome Powell on August 25, 2023, explaining why he and his board of governors had no idea where the economy was today and weren’t sure where it was going?
I haven’t taught history in a while. So, it’s time to sit back, enjoy some coffee, and let’s learn some history together, and see what it can teach us about our tomorrow.
Christopher Columbus certainly sailed under cloudy skies. And he did navigate by using the stars as a guide. But those same stars were hidden from his view under cloudy skies. But in 1492, the stars were just about all the technology Columbus had at his disposal.
Admiral Nelson couldn’t read his location using the stars either when a prolonged and unexpected storm arose, which resulted in the scattering of his armada before he could intercept the Spanish and French fleets. But when the weather cleared on October 21, 1805, he was able to navigate his ships using the stars that eluded him for days prior and put his ships in a position to split the enemy fleets before sunrise. Only when dawn broke did French Admiral Villeneuve realize what Nelson was doing. While technology had advanced considerably since Columbus, instruments measuring the stars were the “hot technology” of the time.
Lieutenant Commander George De Long could not see the stars under the thickening clouds of a severe arctic storm in 1880. Seventy-five years after Trafalgar, navigation technology was veritably the same. Without benefit of the stars, De Long was navigating blindly when he ran his ship into ice, where it was crushed, killing DeLong and half his crew.
Hence, none of these historic figures could be the speaker of these soon-to-be parodied words.
The correct answer is Fed Chair Jerome H. Powell in a speech at Jackson Hole in August.
As impossible as this parroted metaphor from Powell’s speech is at face value, it speaks an unnerving truth. The Fed is using old rules, formulas, and data. As a result, it can’t see where it is navigating our economy. Let’s hope it’s not into the ice!
Last November, I heard a Fed governor speak at a breakfast. He said his data supported a Fed Funds rate of 4.75. Now we are at 5.5 percent. He may have been right. I think he probably was. But the Fed has raised rates three times since we hit a 4.75 percent rate. How can anyone plan around the Fed zig-zagging its way through an economic mess of its own making?
I want to expand or underscore some thoughts from my previous blogs. First, let’s discuss housing costs. It represents over 30 percent of the Fed’s CPI index. CPI for shelter is surveyed and ultimately calculated consisting of four parts: owner equivalent rent, rent of primary residence, lodging away from home, and insurance. However, the owner-equivalent rent (what an owned home would rent for) makes up 75% of the calculation. In 1950, before satellites, sophisticated radar, powerful and almost immediate analytic tools, cell phones, and GPS, it made sense to determine housing costs by conducting monthly phone surveys of homeowners.
In 1950, before cell phones, the US population was 150 million and the Fed had 50,000 homeowners called on their home phones. In 1950, if your phone rang at home, there was a stampede amongst the family to answer it. Today, the Fed still calls 50,0000 Americans a month at home (yes on landlines!) to ask the very same questions. But today we have 331 million people. Fifty thousand households being surveyed is far less representative. But unlike 1950, who has a home phone today? And those who do – screen their calls and rarely answer surveys. So just who is the Fed speaking to? Why is the Fed still using the stars to navigate when modern tools are available to provide it with accurate and near-instantaneous data?
Another confusing aspect of Fed-think is its reliance on labor statistics to promote monetary policy. The labor rate is a trailing indicator. Why look ahead using trailing data? Even so, last week the Labor Department reported job growth was the slowest since the beginning of the pandemic. What’s more, the Labor Department reported a reduction in jobs created by 110,000 for the prior two months. Even more compelling, the country lost 670,000 permanent jobs and replaced them with a million part-time positions, which is another sign that labor numbers are sputtering.
Anecdotally, furniture manufacturers in North Carolina are laying off workers, filing bankruptcy, or closing their doors. The reasons are two: sales of capital items above $1,000 are way down (except for cars) and the banks have severely curtailed credit. Last week, retail sales for capital items, including furniture and appliances were down significantly. There is good reason to believe the restrictive credit environment coupled with the specter of slowing sales will punish other industries. More jobs are going to construction projects financed from the infrastructure bill. Without this new source of hiring, job growth would plummet or even go negative.
Meanwhile, student debt, which was under a payment moratorium for three years, will restart requiring debt payments beginning this month. China’s economy is tanking. Can anyone seriously think the second-largest economy in the world in a free fall isn’t going to affect us?
Credit card and consumer debt delinquency is rising. Finally, our investors who run successful businesses report sales are down. However, their cost of goods and transportation costs are declining rapidly. These cost savings have bolstered gross operating margins – for now – but will soon reach the consumer easing what the Fed calls “sticky” remaining inflation. This means lower prices are ahead.
In regards to real estate, the Fed is about to break something. The Atlanta Journal-Constitution in a glaring front page banner headline on September 5th reported “Apartments headed to foreclosure”. Interest rates have crushed many owners. At the same time, rents are coming down, 5.3 percent year over year in Atlanta. We are seeing similar pressures in the four other states we operate in. Yet, in July, the Fed reported over four percent year-over-year inflation. Interestingly, 90 percent of the inflation reported came from housing. Yet, rents are lower. So much for the Fed’s 1950 housing cost survey.
Cloudy skies must be rolling in again!
Real estate as an industry doesn’t exist on an island. Banks and other lenders are seriously exposed to the rise and fall of real estate. If real estate suffers any further – if it breaks – many banks and lenders could be caught up in the carnage. And if the banks start failing again, there will be a cascading effect that makes SVP’s collapse a true canary in the coal mine implosion that follows. Surely, even with cloudy skies obscuring the Fed’s vision of the ancient stars, they should still be able to see the danger ahead and navigate around it.
Our economy has issues. There is a war, a blockade of food from Europe’s breadbasket, a burgeoning and unsustainable US deficit, and OPEC desperately holding onto energy pricing and artificially restricting supply. None of these issues can be resolved by the Fed, though preaching economic sanity to the government wouldn’t hurt.
On the other hand, the Fed’s actions have reaped some benefits in the areas it can control in the fight against inflation. The increase in the labor participation rate and the plummeting costs of raw goods and transportation in July are good signs.
The money supply is coming down. Banks have effectively stopped lending. Even the Fed reported inflation is down by more than two-thirds in less than a year. GDP growth is only modest. Labor rates and labor costs are moderating. The distortions caused by the uneven reopening of the post-COVID economic reopening of the world economy are coming to an end. The Fed is so focused on its 2% target it is ignoring the broader, unprecedented problems in the economy clearly ahead and is looking at lagging indicators and old data to continue fighting a battle it has already won. Now, the risk of over-tightening and sending the economy into a tailspin is a much bigger risk than “sticky” inflation.
Despite all this news, and recalling that labor is a trailing indicator, Cleveland Fed President Loretta Mester gave a speech concluding the job market is still too strong. I guess she is navigating using the stars on a cloudy night! Meanwhile, Fed Governor Christopher Weller sees things differently and calls for the Fed to be patient. Atlanta’s Fed President Raphael Bostic thinks rates will be higher longer. I just hope all these conflicting views from people in such powerful positions aren’t steering our economy using a sextant.
The trailing indicator of labor and the Fed’s reliance on the stars to navigate our economy is about to lead us into a recession if the Fed is not careful. Many industries are showing signs of stress. It is critical to read these signs now to prevent wider damage. The last thing we need is to follow Lieutenant Commander De Long into the ice. Otherwise, our economy could be the thing we crush.
Would we fly on an airline that navigated using the stars on a cloudy day today? Absolutely not! So why navigate the most complex and powerful economy in the world using antiquated methodologies and tools? I see the dense clouds as well, Mr. Powell. But instead of looking behind us, in addition to scanning the horizon for stars you may not be able to see, it is time to use Weather.com and GPS. Then, despite the clouds, you can find the path toward the clearer skies that lie ahead.
Regards,
Norman