Inflation- by NEIL SISKIND

It baffles me to hear economists & the Fed discussing inflation w/o even mentioning an infrastructure plan.

A national infrastructure plan will demand what is, inherently, domestic labor.

This will mean “old school” skills as well as new economy skills.

This will also mean huge demand for metals and energy- where there is domestic production stagnation due to political, legal, & social pressures.

A national infrastructure plan would create a monster employer in the form of the federal govt. & its contractors- & any plan would require the govt. & those contractors to have a certain amount of minority employees.

Less labor slack will lead to higher wages, & higher prices, which can “stick” if people are working.

Then there’s China. As China seeks to re-stimulate & as its plan for a consumption-led economy falters, it will use infrastructure projects to fund growth & that will create great demand for commodities.

While an infrastructure plan will be spread over years, it would create sustainable labor demand & it would create inflation expectations, as contractors & companies ramp-up spending to front-run needs & shortages.

As inflation takes hold, there would be little demand destruction w/ the federal govt. as the main customer & employer.

Do I believe we will have sustainable inflation? No … unless …

Congress passes a national infrastructure plan it seems to want … and then- yes …

But remember- not all inflation is bad inflation … just as long as there is not too much of it.

The Fed’s Conundrum: How to, Nearly Simultaneously, Fight Inflation that is Persistently “Too Low” and Inflation Expectations About to Rapidly Rise

Persistent or “sustainable” inflation can only occur if there is wage inflation (some studies say that wage inflation “follows” price inflation, rather than vice versa. But in this “top line growth” “market share gain” driven economy, where companies seek to keep prices low (or free), wages low, and corner and control markets, I don’t find those studies useful. No one is looking to raise prices, anymore, unless input costs force it).

The combination of: i. Restriction of the U.S. labor supply far below what we experienced in 2019 that leads to wage growth; and ii. energy and commodity demand that outstrips supply (due to OPEC output limits and U.S. fossil fuel related policy, plus pandemic-induced energy production cutbacks), is the only path to structural 2%-plus inflation- and the only path to this outcome is through policy that mandates onshoring, or a de facto onshoring policy- a large national infrastructure plan.

An infrastructure plan will cause an enormous demand for labor, and that labor pool will be inherently domestic labor. Because the labor will be skilled, it will cause wage growth, as corporate America has to compete with the government (it would even create unresolvable shortages in certain skills, including IT skills).

An Executive Order on America’s Supply Chains was signed by Joe Biden on February 24, 2021, directing the investigation and research into supply chains for certain critical products and services (among other things) vital to the protection of our national security, with recommendations to be made to the President related to ensuring security and resiliency of supply chains, including through onshore manufacturing of such critical products.

If we combine either (or both) of the above government-policy causes of a significantly tighter U.S. labor market with fossil fuel production and supply restrictions due to: Federal law, White House policy, the Paris Agreement, and/or energy sector corporate policy (or energy companies’ expectations and self-imposed capex limits on future production due to social and anticipated regulatory challenges and pressures), the principle of demand destruction would not be engaged to keep a lid on consumer prices inflation, as it normally is with retail consumers and private industry, such as airlines, as a larger percentage of oil and gas. And if China joins the infrastructure fray as a way to stimulate its economy to offset weak internal consumption (as well as to offset less exports to the U.S. as the U.S. opens-up and consumers swap their dollars from goods to services), prices in the commodity complex would skyrocket (but China’s need to keep exports flowing to replace shortfalls in domestic demand could have some minor disinflationary impulses for U.S. importers and consumers). Let’s also not forget transportation aspects of a stimulus plan in addition the actual building and development. Ships and planes have to move products, factories have to produce equipment and supplies, and labor has to drive to and from work- Zoom won’t cut it. All of this requires oil and gas. Lots of it.

Rising commodity demand sans demand destruction (which is a more likely outcome where the government is a major consumer) and the U.S. govt. (and its contractors) sucking-up domestic labor- both as the result of a national infrastructure plan- is the only way we’ll get 2%-plus structural inflation (which would be compounded by any onshoring policies); and if we do get such a national plan, the idea of inflation being “merely transient” and due solely to base affects caused by the pandemic and the subsequent (or consequent) monetary and fiscal stimuli and pent-up demand, will be excised from the conversation.

And it appears that alternative energy development (at the expense of fossil fuels) not only as a political and social and environmental policy, but also as a domestic, green-job creator, is at the top of the Biden and Democrat agendas. It has a dual purpose. It also appears that policies to mandate the movement of critical product supply chains onshore is a priority- making domestic labor even more popular.

Far less fossil fuel production, far less labor supply for businesses due to a national infrastructure plan, and far more manufacturing at home … a lethal dose of shortages that could cause a lethal dose of upward price pressures.

Powell is right about the risk of persistently low inflation- but only if, and until, a large portion of an infinite global labor force, the U.S. labor portion, is removed from the equation by the U.S. government for its own infrastructure needs (and that conversation is afoot), and domestic labor suddenly has shortages and, thus, pricing power with employers that have domestic parts to their operations, as well as those that are strictly domestic in nature, such as domestic manufacturers and service providers.

Can an enormous artificial labor stimulant bring the Philips curve back to life when even a 3.5% unemployment rate could not do it in 2019? Yes. Here’s why. That 3.5% rate was sans one titanic employer causing much of it. Add that employer into the mix of things, and private industry has to fight for the few leftovers. Certainly this will be true in certain industries and sectors with respect to certain skills.

And companies will have pass-through pricing power because consumers are working. This is known as a “business cycle” (remember those?) Higher growth causes higher wages. Higher wages cause higher prices which can be managed by consumers because they have higher wages. This leads to higher inflation expectations and higher interest rates. Welcome back to the mid-20th Century.

In other words, this time may be different.

If, and as, a large infrastructure bill and subsequent law becomes increasingly likely, especially as energy production supply is stagnant (for multiple reasons), the Fed should consider what a fiscal impulse of this sort- such as it has been wishing for- would do if any inflation pressures have already begun to build even before such a plan has been adopted and passed. The mere expectation of an infrastructure plan as those conversations commence in Washington, is, itself, inflationary.

Keep in mind, though, this would not be the sort of wage inflation the Fed can control. Raising the target fed fund rate is not going to get the U.S. government to lay-off workers, or slow its infrastructure operations. It’s an inorganic supply constraint- not one based on natural forces of supply and demand. The only answer to the wage or other inflation pressures, in such situation, would be to try to slowdown private domestic industry to prevent an unhealthy inflation build caused by the government- which would not make much sense if private industry is not the source of productivity and source of demand that is the prime source of the wage inflation. So this, in itself, would be a conundrum for the Fed.

Consider this: While the Fed is fighting disinflationary impulses with its average inflation targeting policy that allows inflation to “run hot”, the fiscal side is negotiating, in a very public way, a plan that would, by its nature, require millions of employees and untold amounts of oil, gas, and copper. This is in addition to the stimuli already in the system. This is how “transient” inflation could becomes sustainable and structural. Even without the relief and stimuli to date (and coming shortly), an enormous absorption of the domestic labor pool by a bottomless-pocket employer while energy production has been cut back by the leading producers for economic, legal, and social reasons, all while China competes for commodities, would itself be enough for a concerning inflationary impulse.

Consider this: A national infrastructure plan combined with legal, political, and social disincentives to and restraints on domestic energy production. How would that work for gas prices for your SUV? It would work great … for OPEC. OPEC may have little incentive to open the spigots. It may very well smell blood in the water as U.S. producers show scant intent to expand production to offset price restrained OPEC supply and related price increases. OPEC and Russia may have us just where they want us for the first time in a long time. Why would they forego that margin after 2020’s depressed environment? Would you? I’m surprised that markets found OPEC’s restraint this week surprising. I expected nothing less (or nothing more) from OPEC.

I assume the Fed is considering all of this. With one party controlling Congress and the Executive Branch, the passing of an infrastructure plan that both branches want is an easy assumption to keep on the front burner. Perhaps this is why Chairman Powell is not shaken by the rising 10 yr. yield; the market does a little work for him while he maintains credibility with the stated average inflation targeting policy. Or, Powell may just feel the economy is strong and there’s no reason to add stimulus. It really would not matter if the 10 yr. yield is up because of growth or because of inflation- it’s higher, and that helps restrict too-much growth. If it does not restrict regular, trend growth, everyone wins. If the 10 yr. is rising on growth hopes, there’s no purpose for the Fed to interfere. If it’s on inflation concerns, then he certainly should not interfere by stimulating the economy. If the market is concerned about the Fed being behind the curve on inflation, I don’t see what the Fed should do except raise the target fund rate- not lower the 10 yr. yield. If the Fed has all growth impulses in mind, including fiscal aid and infrastructure, then Powell is perfectly right on the 10 yr., for the time being. But the target funds rate is still very, very low, and that is the main control valve. Wider credit spreads and tighter financial conditions would not even cause labor market concerns if spreads are widening on the heels of growth (and inflation) due to a national infrastructure plan- because government (and government contractor) layoffs would not ensue as a cost control measure.

Monetary and fiscal need to be working together to stop the building of concerning persistent disinflationary pressures …

and then, both must- quickly – pivot, to, together, head-off the building of concerning persistent inflationary pressures. Though, at that point, the Fed will be the only defense, if any.

At this particular moment, it seems that while the Fed is working hard to overcome the low inflation concern and disinflation risk to the economy, the White House is gearing up for an inflationary impulse like no other.