2022 Economic Outlook
Inflation as Malinvestment
I thought it would be fun to make some predictions and see how wrong or right I am next year. I consider it an exercise in public humility, so here goes:
The defining economic challenge of the next few years will be the return of high inflation. After decades of printing money with little consequence, politicians of both parties became convinced last year that massively expanding direct payments to the population while hobbling the production of consumer goods could be accomplished in response to the pandemic without producing inflation. At the same time, many industries face labor shortages. The two are related.
Unlike previous stimulus attempts, this time money was given directly to consumers. Unemployment benefits swelled to over $50,000 a year, higher than the starting salaries of most college graduates. Since most Americans have extremely high time preferences, this resulted in people spending more money while simultaneously leaving steady employment. More money in their pocket but fewer of their fellow Americans producing desired goods led predictably to shortages of supply and inflation of the goods that remained. Wages had to rise to compete with government checks. Inflation, then, will tend to solve this problem. It will deplete the ephemeral savings of the voluntarily unemployed and bring them back to work sooner. FedEx recently reported record applicants for their open positions as wages rise and people’s pandemic-check savings run out.
Labor shortages were further exacerbated by the wealth effect of stock market gains, and possibly fear of infection, which convinced many Baby Boomers to take early retirement. This labor is unlikely to come back, absent a stock market crash that should be inevitable at current valuation levels but has been postponed, at this point, way beyond the expectations of anyone expecting a return to historical price-to-earnings norms. If this does happen, most will be unable to find employment at their former wage levels after several years out of the workforce, and after having left jobs where they were likely overpaid relative to younger workers.
Because the net-taxpaying, productive portion of the Baby Boomers failed to have sufficient children to replace themselves in the economy, it was always inevitable that society would face a labor shortage upon their retirement, which was delayed longer than previous generations’ by the Boomers enjoying numerous medical advances and partial fountains of youth like PDE5 inhibitors and widespread hormone replacement therapy. Since retirees by definition spend money to consume without producing in the marketplace, this adds yet more inflation pressure for vital goods and services. If inflation is severe enough, this could initiate a stock market or housing crash, as Boomers are forced to liquidate investments to pay for retirement consumption. Before retirement, it’s easy enough to live on wages and let investments compound, but nearly everyone who retires must be a net seller of assets.
I am hopeful we will see workers’ standard of living rise for the first time since the 1970s, when median wages, adjusted for inflation, stopped increasing. Our elites successfully utilized political solutions to avoid further wage gains even as employee productivity rose, through outsourcing to developing countries with lax labor and environmental laws and increasing labor supply through historically unprecedented levels of immigration. With rising wages globally, has their luck finally run out? Unfortunately, the evidence so far for this is scant because inflation is rising faster than wages.
My instinct is that decades of money printing have resulted in decades of malinvestment. Think of the many brilliant computer programmers employed in the last 20 years building money-bleeding apps and software. These same individuals could have been incentivized to produce basic useful goods and innovations in other fields of engineering that improve baseline quality of life, but easy money took their talents to software Ponzis. As Peter Thiel put it, we were promised flying cars, but we got 140 characters.
So while I think real wages will rise for workers, when that happens depends on how quickly the basic production needs for our society can be rebuilt. Interest rates need to rise to their natural levels so investors can rationally evaluate opportunities and prudent young people with cash savings can afford housing again, as low interest rates raise property values mostly to the benefit of sellers and spendthrifts. Government liabilities tied to inflation, like Social Security and Medicare, must somehow be tamed so money isn’t printed to tax the productive beyond their ability to support those in retirement. The foolish “lean” and “just in time” manufacturing craze to strip-mine industries of their buffer inventory and spare capacity to goose the short-term earnings and stock options of Boomer executives must be reversed. Basic improvements to infrastructure must be made, relieving the wasting of many lifetimes in delays on decrepit roads and airports relative to the rest of the developed world. We must stop enticing and enslaving young people with student loan debt, conferring useless degrees for office drone work when most would be more productive, wealthier, and happier with a trade or useful skill much more needed by society.
That’s my economic sermon, who knows whether it will ever happen. In the short term, the shortages in basic materials and productive capacity reveal the extent of malinvestment in the economy. Just a few months of the pandemic shutdown was enough to crash the global lean manufacturing system. Those who produce these basic materials, at whatever point in the value chain they are bottlenecked, will reap record profits which will incentivize additional investment. Anyone behind the bottleneck will see their margins squeezed. A great example of this is lumber. Timber, the raw material, still has plenty of supply. The bottleneck is in the plants producing lumber, which means timber has remained flat and homebuilders will see their margins squeezed. Lumber is among the easiest basic materials to scale up and down, so supply issues can be addressed in weeks or months. Other more advanced materials could take years.
As consumers pay more for the things they absolutely need, like housing, gasoline, transportation, and food, they will have less overall to spend on higher-margin discretionary items. The further a business is from these basic needs, the less pricing power it will have for dwindling consumer dollars, and the more it will have to absorb increases in raw materials and wages. Businesses who downsized or outsourced key parts of their value chain for short-term cash flow in the past may be squeezed from both ends, as independent suppliers raise costs and customers cannot afford to pay more. They will pay dearly for forgetting Marx’ dictum that the whole point of capitalism is to own the means of production. Corporate profit margins are at record highs and have a lot of room to fall.
Prices and wages tend to be “sticky.” Businesses are paranoid, rightfully so, of losing customers by raising prices, so they hold off as long as possible. Workers are fearful of changing jobs, so they will stick around at lower pay for a time. But once the process gets going, and especially once a psychological change takes place, inflation can surprise all at once to the upside. Shrinking margins and retired Boomer asset selling could lead to an economic contraction and the return of 1970s-style stagflation. These corrections are necessary from time to time to remove economic deadwood, bankrupt the foolish, and reward the prudent. Whether the Federal Reserve can allow even a mild correction remains to be seen.
My specific economic predictions for 2022 are:
Shrinking corporate profit margins, especially for non-essential goods. This is currently not happening, so we would need to see a change in this trend.
Wage growth continues to lag inflation substantially, especially in the white-collar portion of the economy. This is already happening, so I predict this trend to continue.
Huge profit growth for basic industries, especially the most irrationally disfavored and essential one, fossil fuels. I’m super excited about some of my own investments given the 20% cash flow yields of some oil producers while oil consumption is nearly recovered to pre-pandemic levels. This is particularly true if Omicron turns out to be nature’s vaccine.
I hope this finds you well beginning a prosperous 2022. I find writing is the best way for me to systematically organize my thinking, and an audience makes that much easier, so thank you for subscribing.