State Of The Economy: Strong Or Sick?
A Second Look At The Data
My one hard and fast rule when it comes to analyzing events is simply this: always follow the data. Never assume the narrative is correct or complete, but always realize that the facts will always be the facts. When the narrative does not reconcile with the facts, rely on the facts and adjust the narrative accordingly.
Like so many of the world’s “experts” these days, Federal Reserve Chairman Jay Powell does not share a similar respect for the facts, preferring the narrative above all else. How else to explain his dogged insistence that the US economy is strong while simultaneously arguing that the US economy must be fixed as justification for hiking interest rates in an effort to combat inflation?
This paradoxical rationale was present in his Jackson Hole speech last month:
The U.S. economy is clearly slowing from the historically high growth rates of 2021, which reflected the reopening of the economy following the pandemic recession. While the latest economic data have been mixed, in my view our economy continues to show strong underlying momentum. The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers. Inflation is running well above 2 percent, and high inflation has continued to spread through the economy. While the lower inflation readings for July are welcome, a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.
This paradoxical rationale was present in Jay Powell’s interview last week at the Cato Institute:
“We think we can avoid the very high social costs that Paul Volcker and the Fed had to bring into play to get inflation back down,” Powell said in an interview at the Cato Institute, referring to the Fed chair in the early 1980s who sent short-term borrowing rates to roughly 19% to throttle punishingly high inflation.
Against the “economy is strong” narrative, however, stand a few data points in stark contradiction:
“Core” consumer price inflation (CPI inflation less food and energy) rose to 6.3% Year on Year in August.
Labor force participation declined in August before seasonal adjustments showed an increase.
Retailers are experiencing recession-like accumulations of inventory, despite strong nominal sales gains.
At a minimum, the “economy is strong” narrative needs a bit of nuance to explain these divergent data points. At a maximum, the “economy is strong” is simply wrong and needs to be discarded.
Can data tell us which one it is?
Retail Sales Stagnating
One data set that at first glance appears to suggest strength within the US economy is retail sales. Not only are they rising, but they appear to be rising at a faster rate than before the 2020 lockdowns.
However, the retail sales data is gathered in nominal current-dollar terms. Inflation has not been incorporated into the data. When we look at the percentage year-on-year growth in retail sales, and overlay year-on-year inflation percentages, we see a completely different perspective on the data.
Prior to 2020, retail sales largely kept pace with inflation. During the 2020 lockdown-induced recession, retail sales dropped significantly, and during 2021 retail sales grew at a rate greater than that of inflation. However, that growth ended earlier this year, and now retail sales are once again back to just keeping pace with inflation.
This trend is confirmed when we look at the month-on-month percentage change in retail sales, and overlay monthly consumer price inflation numbers.
After an initial post-recession surge, retail sales in the US have largely kept pace with inflation and that’s it.
Keeping pace with inflation is a break-even position. Retail sales has had strong periods since the 2020 lockdowns, but overall the sector has been going sideways in real terms—it is stagnating, not growing.
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