By Tom J. Velk
In the US, there have been two quarters of negative growth. For everyone but those who refuse to accept the evidence before their own eyes (or at least refuse to accept the calculations of their own staff, who I am sure delivered that second-quarter number only after having checked it “a million times,” all the while shaking in their boots for fear of losing their jobs in the stormy wrath of their political bosses).
For China, the World Bank China Economic Update – June 2022 GDP forecast for the entire year is plus-4.3%. The actual data that came in early on caused the Bank to include some words of caution: That 4.3% number is “0.8 percentage point lower than projected in the December China Economic Update.”
“This downward revision largely reflects the economic damage caused by Omicron outbreaks and the prolonged lockdowns in parts of China from March to May. Growth momentum is expected to rebound in the second half of 2022, helped by aggressive policy stimulus [such as] large public spending, tax rebates, policy-rate cuts, and a more dovish stance on the property sector.…
“[However,] China remains tied to the old playbook of boosting growth through debt-financed infrastructure and real-estate investment. Such a growth model is ultimately unsustainable. [It would be better if] policymakers could shift more of the stimulus on to the balance sheet of the central government and direct public investment towards the greening of public infrastructure.
“Fiscal support could also target measures to encourage consumption directly, [so as to] rekindle innovation and productivity growth [and therefore] help achieve a more balanced, inclusive, and sustainable growth trajectory for China.”
I don’t agree with the Bank on the “greening” point, but I go along with the implied suggestion that standard Keynesian spending programs are inappropriate in the current inflationary context.
But now the really politically tough and technically difficult question before the world is: How bad will the combination of recession and inflation get to be, which I have called “recflation” (pronounced as in car wreck)?
There are quite a few canaries fluttering about in the coal mine whose continuing existence will help answer the question.
The two GDP growth numbers so far on the register, minus-1.6% and minus-0.9%, show that although the US is in recession, the bad is getting less bad, and maybe that’s good. However, the most recent number of minus-0.9% was produced by staff under the most severe political pressure to get out a good number.
That staff might make a political judgment that, if the facts warrant it, and my guess is the facts do so warrant, the revised number for the second quarter, due out at the end of August, will be worse than negative-0.9%.
The cause will be, among other things, the politically correct but economically unwise continuing Covid semi-shutdown (perhaps even including widespread uncertainty and distrust of government policy in general, induced by the unprecedented raid on Donald. Trump’s Florida home).
Such uncertainties and political tensions will move the GDP meter needle further downward, although it is almost impossible to think revised numbers for the second-quarter GDP growth rate will exceed the critical value of negative-1.6%, but it is quite possible to think the revised number will be worse than negative-0.9%.
Keep in mind that there will be a third revision of the second-quarter figure one more month off, at the end of September. There is lots of time for the number gnomes to come clean, assuming they have been playing at least some small game of politics, which in my opinion they most certainly must have been, if for no other reason than that “bad numbers” induce a well-founded fear of losing their jobs at worst, or their prospects for promotion almost certainly.
The next critical US “canary in the coal mine” is the inflation rate. It now teeters on the brink of two digits, coming in at 9.1% in June and 8.5% for July. My guesstimate is that the future re-estimates for July have a reasonable chance of being higher than 8.5%.
When and if the inflation rate moves solidly into the two-digit range, a fire bell will ring in the night, and the associated recession is sure to get worse before it gets better.
The recently passed US legislation (with unintentional irony) called an “inflation control” act will add more than a half-trillion “logs” to the heap of paper money whose flames are keeping the pot of output we call gross domestic product on high boil.
Whatever good that legislation may do, helping seniors pay for drugs for example, has no power to offset the inevitable result of more money added to a world of shrinking goods-pile: higher prices.
Other elements in that new law, for example the increase in tax payments for many small family-operated incorporated business, will cut output, setting the stage for a bigger third-quarter GDP-shrinkage number.
What’s happening in China
Let us cock our ears so as to hear the last chirps of the Asia-sensitive canaries that we find in the world economic coal mine.
For China, a critical number is the cost of production of its exported goods. As the non-wage goods that go into the production of exports rise, three bad things happen.
There is downward pressure on wages paid to domestic Chinese workers, and there is a reduction in the profits anticipated by Chinese entrepreneurs who own or nominally control firms in the export trade.
Also, the tax revenues gathered in by the Chinese government will fall, partly because taxed profits are less and partly because the government will be forced to cut tax rates (as noted by the World Bank) on what few profits remain, so as to protect jobs and keep businesses healthy enough to “fight another day.”
The Producer Price Index for the US was up 11.3% in June 2022 over June 2021. The rate facing China has been hovering around 9%, but the latest indications are that the most current number, like its US counterpart, remains troubling.
For China, Investing.com reports a June 2021 (6.1% actual) and June 2022 (6.0% predicted) Manufacturers Price Index number (corrections may yet come in). But note this is an index measuring the price increases the Chinese manufacturers have managed to impose on their customers, many of them being, quickly or eventually, consumers. It is a precursor of inflation. And not a happy one.
Looking deeper into the input costs that burden the Chinese and Western manufacturing entities, we see that the international price indices for a wide range of raw-material-type goods used in the manufacturing process (not just by Chinese entities) are scary: It seems inevitable that such numbers will be passed on to final buyers, that is, on to the backs of consumers and middlemen.
It is also reasonable to believe that these higher costs of production will break up some companies that cannot easily pass them on, worsening the recession considerably.
Between December 2020 and June 2022, the world export price for iron and steel products rose by 59%, according to the Federal Reserve Bank of St Louis. It is hard to imagine that the makers of hard goods, like autos and appliances, East and West, will fail to pass along these costs.
The price index for aluminum has reversed a long decline, and it has risen 7.8% between July 22 and August 10, 2022. China is the world leader in aluminum production, turning out 13.3 times as much of it than does the US: It is a way to transform coal-produced electricity into a metal that makes money as well as stuff.
But it is unwise or at least uneconomic to ignore the chance to make profit by selling into a rising international market and instead deliver the metal domestically at a subsidized price.
Between September 2021 and August 2022 the index for lithium (an essential input for battery-making) rose 350%. Moore’s law (the number of transistors in a dense integrated circuit doubles about every two years) and the cost savings that it implies have been an anti-inflation factor in the prices of nearly everything for well over 30 years, but most recently that law has failed to operate.
It is not so much because the law is wrong about technology, but because general inflationary pressures are so great that the price of semiconductors haa been going up.
According to the Federal Reserve Economic Data (FRED) source at the St Louis Federal Reserve Bank, semiconductor prices fell almost without interruption from April 1994 to April 2021, but since that low point, semiconductor prices began to go up, so that by August 2022 they have risen more than 5%.
Between April 2020 and May of 2022, the cost of the various sources of energy used in every form of production is up by six times, according to FRED, the St Louis Fed’s data source.
As I mentioned above, the first response for manufacturers to these higher costs of production will be to cut wages, but government policy, public outrage, union pressure and even a sense of how “unfair” or at least how easy it will be for political radicals everywhere to throw blame on the business class for the resulting recessionary atmosphere will mean a general feeling of “we don’t know what to do!”
That generalized sense of being rudderless in a stormy sea is a sure sign of a bad recession, one that is tough to beat, East or West. It is the state of affairs that could be just over the horizon.
Tom Velk is a libertarian-leaning American economist who writes and lives in Montreal, Canada. He has served as visiting professor at the Board of Governors of the US Federal Reserve system, at the US Congress and as the chairman of the North American Studies program at McGill University and a professor in that university’s Economics Department.