United States Outlook

U.S. households are sitting on over $4 trillion in checking account balances, almost five times as much as pre-pandemic. Consumer demand will remain strong based on wealth effects alone, which will help carry the economy into 2023.

Although asset prices have fallen from last year’s peaks, maintain perspective: Stock markets are still 15% to 20% above where they were pre-pandemic.

In a clear sign of the nation’s retirement-driven labor shortage, the U.S. job openings rate now sits at 6.3%, well above its pre-pandemic peak of 4.8%.

On the surface, 2022 has not been a good year for the U.S. economy. National GDP has functionally stagnated: it was roughly the same level in the 3rd quarter of this year (the latest data available) as it was in the last quarter of 2021. Along the way the nation has also been experiencing a sharp increase in prices. In response to both underlying inflation and the Federal Reserve’s subsequent rate hikes, interest rates have shot up rapidly, rising from record lows to something more on par with historic averages. While interest rates are not high from any long run perspective, their rapid increase has nevertheless sent asset markets reeling. Financial markets have fallen from peak levels and U.S. real estate markets are turning ice cold. Unsurprisingly, many forecasters (and pundits) have yet again been making the recession call. But before you barter your possessions for bars of gold and extra bullets, it’s worth looking past the standard ‘miserabilist’ screed to figure out what is actually going on. Once you do that, the economy looks much less scary, although the Fed looks even more frightening.

Let’s start by acknowledging the obvious. The U.S. economy is not currently in a recession despite the lack of overall GDP growth. The nation’s economy has added 4 million payroll jobs since the start of this year, the U.S. unemployment rate remains well below 4%, and the job openings rate is at 6.3%, well above the pre-pandemic peak of 4.8%. At the same time, industrial production is at a record high, manufacturing orders are still rising, and overall inventories remain low. The U.S. economy is clearly operating at capacity, the exact opposite of what economists refer to as a ‘recession’— a period of time when an economy, driven by some type of negative shock, produces less than it could. Today’s economy, in contrast, is one running at full speed.

Still, there’s a mystery here—what is behind the decline in labor productivity? Afterall, overall output in the United States has remained the same even as the nation’s economy added 4 million payroll jobs—meaning the increase in jobs was necessarily offset by an equal decline in labor productivity. Part of the reason for the decline is that the economy is turning back towards the production of services, which, by definition, delivers lower output per worker, lowering the overall average. Another reason is due to a standard cyclical effect: During a business cycle, the lowest productivity workers are first to go and last to come back, typically causing productivity to rise at the start of a downturn and decline during the recovery. Another factor is that a good portion of the decline in output is related to real estate construction and other capital-intensive sectors that have highly lagged employment effects. Still another reason can be explained by the auto sector, which has been its productivity hampered by ongoing supply issues (output could be much higher in this sector but for these issues). And a final reason is that the nation probably didn’t really add 4 million jobs in the last year—the household figures show far more modest gains, particularly in the last six months. Both surveys  are subject to large revisions and we may well find the truth to be somewhere in between. 

Regardless of the causes, the United States is clearly struggling—not with a lack of demand, but with meeting that demand. This is a nation still suffering from a shortage of workers, rather than an excess supply of them. Indeed, the Christmas holiday season appears to be off to a good start based on the preliminary readings of the sales numbers coming out of Black Friday. And the Atlanta Fed’s GDPNow indicator suggests growth in the 4th quarter could come in well above current consensus forecast, perhaps even over 4%. It’s likely that the U.S. economy will enter 2023 with some decent momentum, unlike the condition in which it entered 2022.

You may be thinking, well what about the sharp declines in asset prices? And high inflation (which is supposedly crushing consumers)? How about rising interest rates and the turning of the housing market? And what about the enormous hole opening up in the California state budget? Or all the tech industry layoffs? All of these are being cited in shrill predictions projecting imminent economic collapse. Yet, as discussed in Beacon Economics last few outlooks, none of these are drivers of a coming recession, but rather symptoms of the stimulus hangover the nation is currently suffering from. There is no reason to think that this hangover will devolve into a full-blown recession. If left to its own devices the economy would very likely ride out the bumps being caused by inflation and asset price declines and ultimately achieve the proverbial ‘soft landing’, meaning that the post-pandemic expansion would simply continue, albeit slowly given labor supply issues and the standard implications of an inflation cycle. 

In other words, Beacon Economics simply does not see a recession as an assured outcome as many other forecasts have been suggesting. But we certainly acknowledge that bad choices by policymakers in the months ahead could set one off. Today’s economy is indeed fragile and highly susceptible to a truly large negative shock. But that die is not cast yet.

There was never any reasonable justification for the $6.5 trillion in stimulus money that Congress flooded the U.S. economy with during the course of the pandemic. The recession lasted less than one quarter, and the economy was in very good shape prior to the onset of the crisis. We estimate that the closures caused roughly $1 trillion in lost output, so the stimulus replaced each dollar of loss with a whopping $6.5 in free federal money—sounds like a heck of a deal until you understand how they pulled it off. 

Under normal circumstances it would have been almost impossible to fund such an enormous deficit in the debt markets without causing serious changes in the economy (one has to laugh at the idea of a President Trump hawking Federal pandemic bonds the way Roosevelt hawked Federal war bonds). Luckily for the executive and legislative branches of the government, the Federal Reserve was ready and willing to deploy its new weapon—quantitative easing. The purchase of $5 trillion in government debt by the Fed more than offset the need of the massive stimulus. Remember, the United States was already forecast to have a $1 trillion deficit during those years due to then President Trump’s tax cut, so the Fed functionally monetarized the entire stimulus and some of the baseline deficit. In doing so they caused the sharpest short-run increase in money supply ever seen in the era of the modern Federal Reserve Board.

The U.S. economy responded to this massive injection into the money supply exactly as Uncle Milty (Milton Friedman to the uncool) taught us it would: it immediately set off huge increases in asset prices, even as interest rates dropped sharply. This, in turn, set off a massive wave of new consumer and business spending. Unfortunately, and entirely predictably, this quickly devolved into inflation, as all the additional money pushed aggregate demand far beyond the capacity of the economy to actually produce things. Inflation, after all, is the consequence of too much money chasing too few goods. In other words, on average, U.S. consumers and businesses have not been harmed by inflation but have propelled it because today’s price hikes are not being driven by supply problems but by excessive demand. Inflation causes interest rates to shoot up and then asset prices swoon until everything falls back into a new overall, and higher priced, equilibrium.  

The Fed responded to inflation relatively quickly and have been pushing up the Federal Funds rate dramatically—one of the greatest U-turns in policy history. They started with one of the greatest loosening’s of monetary policy and rotated to one of the most rapid tightening’s ever seen. Today, asset prices have started to fall from last year’s peaks and the damage so far is small relative to the gains experienced in the short upswing that occurred from mid-2020 to the end of 2021. Stock markets are still 15% to 20% above where they were pre-pandemic, and corporate profits have been rising recently. If home prices end up falling 20%, they will still be 20% above where they were pre-pandemic. 

Couldn’t these asset price declines lead to massive systemic problems in the lending markets the way they did in 2009? No, not really. The bubble prior to the Great Recession was caused by a huge flow of debt to high-risk borrowers. Hence the decline in asset prices was necessarily accompanied by enormous loan losses. This recent bubble was driven by new cash from the Fed—equity. Prices can fall substantially without systemic problems in the debt markets exacerbating the situation. Similarly, the rest of the U.S. economy simply hasn’t had enough time to become truly warped by the bubble the way it did prior to the Great Recession. For example, currently, overall housing supply remains tight; we do not have the vast swaths of excess supply in the system that we did in 2008. Consumers may have started indulging in too much new debt, but the rapid turn in Fed policy that has caused interest rates to spike will prevent a dangerous build-up. And remember that most consumer debt today is mortgage debt, and most of that is fixed rate. The rise in interest rates will largely slow new borrowing but will not cause existing debt to become excessively expensive.

Nothing here suggests that consumer demand will start weakening, at least from a wealth perspective. U.S. households are sitting on over $4 trillion in checking account balances, almost five times as much as pre-pandemic. Consumer demand will remain strong based on wealth effects alone. But it isn’t just wealth. Add to this the surge in income that is occurring among workers due to the nation’s retirement-driven labor shortage. While pundits are fond of noting that average worker incomes are growing more slowly than the rate of CPI inflation, they are missing the mark on both sides of this calculation. The right inflation rate comes from the Bureau of Economic Analysis in the form of the PCE deflator—which is lower than CPI inflation for technical reasons that are well understood. Moreover, the Bureau of Labor Statistics’ average wage is wrong because it is biased down by high-income workers retiring and new, lower-paid workers entering the labor force. The Atlanta Fed Wage tracker corrects for this and shows that worker earnings are growing faster than inflation. This will continue to bolster consumer spending numbers. And if the consumer is healthy, they can power the economy through all sorts of turbulence.

And there will be some turbulence. Real estate construction will continue to take a beating until investors are able to factor the new higher rates into their models. While the overall consumer economy is healthy, we know that inflation is accompanied by transfers of real wealth—from savers to borrowers, from those on fixed incomes to those on variable ones—and some households will be hurt. The Federal interest burden on existing debt will also start climbing, putting unknown stress on the Federal deficit. But none of this should matter in the short-run, as long as the Federal Reserve doesn’t overdo it. 

Indeed, that is the greatest current risk to the economy. The oddest Fed action over the last three years is that they loosened with quantitative easing but are tightening with the Federal Funds rate. Ultimately, the hike in interest rates will do little to cool demand, and hence do little to cool inflation. While peak inflation is behind us, Beacon Economics expects it to remain far hotter than normal for at least the next two years, perhaps even more. Will the Fed continue to uselessly raise rates until something truly snaps in the lending markets? Possibly. And if they do they will needlessly cause a recession. If, on the other hand, they respond to the current shrieking about a coming recession and start to moderate, then we stand by our call of no recession. 

And therein lies the ultimate irony—it may well be ‘miserabilism’ that prevents a recession.