“Transitory”- the magic word of the moment for the economy. It’s even more magical than the word “inflation” b/c it defines & qualifies the inflation.
The Fed has been preparing us for “transitory” inflation, due to base effects, pent-up demand, & supply chain constraints, for months.
Now that we are beginning to see inflation materialize, some equities investors are worried (and the bond market can’t decide how it feels- or why). No one disputes that demand side policies, like more employee benefits and minimum wages, have no long term benefits to growth; and it can be inflationary if supply is not increased- like the condition today (more on the present wage and price pressures below).
But this inflation we’re seeing could, in fact, be transitory- at least until an infrastructure bill is presented to the House for a vote.
Keep in mind that “transitory” does not only mean that prices will go lower or, even, level off, it also means that even though we have inflation and higher prices in year 2021 (i.e., 2021 prices over 2020), it does not mean inflation will rise more than 2% in 2022 (i.e. 2022 prices over 2021). If prices rise high enough in 2021, as bottlenecks are removed and as normalcy prevails, we could even see disinflation or deflation in 2022 (i.e., lower prices in 2022 vs 2021’s unusual, pandemic-induced environment).
But if during the (alleged) “transitory” period of inflation, a two-trillion dollar (or so) infrastructure law looks more & more likely to be passed in Congress or forced-through in reconciliation, transitory inflation could run, head-on, into different and sustainable impulses, or, at least, the expectations of such. Even the social programs that comprise a large part of the present “infrastructure” plan will mean new buildings and build-outs for new agencies that require metals, lumber, and concrete, communications infrastructure, oil and gas, construction workers, and, of course, full-time employees to administer and oversee the programs; in other words such programs, themselves, will require physical infrastructure in which to operate. Such an infrastructure plan, especially of the kind proposed by The White House is known as “interventionist supply side policy“. It includes government investment in infrastructure, transportation, communication, and health care, attempting to stimulate both aggregate demand and aggregate supply.
It remains to be seen how the unusual circumstance of an artificial demand shock (the pandemic and related lockdowns) that is alleviating, followed-on by an interventionist supply side policy, plays-out. Usually, such a policy follows-on a recession, to stimulate supply that will stimulate demand- not a period of existing high demand from savings, job opportunities, and prior fiscal stimulus. This kind of policy is meant for early cycle- to be a supply side impulse and begin a new business cycle devoid of supply side incentives and, thus, low demand. We already have the demand. We already have the supply of open jobs that cause the demand and we have the supply of companies with money and desire to make capex. A government supply side impulse starting from the higher 2021 price and wage bases could present breathtaking cost increases for businesses and price increases for consumers if existing price and wage pressures are not given time to wane before the fiscal stimulus is promised.
Inflation and the natural inflationary rate of unemployment have been held lower because of offshoring of costs. This dynamic changes when offshoring can’t be an instrument of disinflation, such as when commodities and domestic labor become necessary in amounts, heretofore, unseen. Namely, I am speaking about infrastructure. The input costs of of copper and lumber can’t be offshored. A domestic employee to build a bridge can’t be offshored. As the costs go higher and then prices go higher, wage demands and wages will go higher, especially where government contracts require wages to be higher (and then private industry has to compete). As time passes, bottlenecks from the pandemic should clear- even of labor. But if we have a new impulse towards costs that can not be offshored, that would change the transitory nature of the inflation. If costs are for finite items- like domestic labor, and like commodities that come from the ground, this is more akin to an “old style” business cycle, where the finite nature of supply cause rising costs and inflation spirals. Once you remove the ability (or policy) to “offshore” costs, you change everything.
Some investors and market observers posit that the long-term nature of an infrastructure plan, where the spending would be spread-out over 8 years, would make it less inflationary. It’s hard to know how that 8 year period plays out. I assume that projects will not be funded at a rate of 1/8 of the funds, per year. Once government contracts are won pursuant to RFPs and bids, purchases of materials & staffing initiatives by contractors could ramp-up fast so that resources are in place & costs are minimized (and profits on contracts are maximized). No contractor would wait to obtain necessary copper or labor until just before needed (i.e., inflation expectations would effect behaviors). These needs could be pursued, immediately, either by hiring or taking possession, or by locking-in prices and contracts (in the case of commodities). While contractors likely would not make purchases 4, 5, and 6 years out, it would really depend on the terms of contracts and ramp-up periods for projects. It’s really hard to anticipate how and when contracts would be awarded and work commenced. Keep in mind the multiplier effects this would have on the economy, how public investment spurs private investment, the high minimum wage levels that would be in federal contracts, and the requirements for contractors to buy supplies and services from U.S. companies. Plus, the labor skills needed by the government and its contractors will be the same as those needed by private industry, creating competition. It wouldn’t be only available U-3 and U-6 people that the government would need; it’d be employees from all across the skills spectrum- even those already employed. Finally, when has a government project not had cost overruns and not had projects go on longer than initially planned? The labor and material needs would likely continue for longer than scheduled and cost more money than originally budgeted.
It’s worth noting that there are wage pressures already materializing today, but they are, likely, due to post-pandemic frictions and due to fiscal stimuli creating work disincentives, and will prove to be transitory as labor supply-demand dynamics correct. Though, if these allegedly “transitory” conditions continue for long enough, higher wages can become structural, since once higher wages are paid, it’s difficult, or impossible, to reduce them and an infrastructure law would put more upwards pressure on wages going forward. So, even if the definition of transitory is that 2021 inflation over 2020 will be permanent, but going forward, 2022 over 2021 will be minimal, a vast infrastructure law could mean high 2022 inflation over 2021 because not only would even more copper, lumber, and concrete be needed, but government contracts would have mandated minimum wages for contractors to pay their labor, and the government would be competing with private industry for labor all across the skill and wage scale.
The Fed may be right about the coming inflation being “transitory”- resulting from base effects and supply constraints. But if the period defined as “transitory” runs into a time where an infrastructure law looks likely to be passed, then supply & demand dynamics from base effects and supply constraints that should dissipate, could transition, quickly, from mere post-pandemic impulses to more persistent pressures as demand materializes for commodities & labor from the long-term fiscal impulse, or, at least, from the inflation expectations by government contractors and private industry that develop in anticipation of that impulse. Then there’s other nations, like China and Russia, that see we will need copper and oil, and will, thus hoard supply and raise prices. These pressures would be on top of an already improved economy, more onshoring and onshore manufacturing investments (requiring commodities to build manufacturing facilities, labor to build the facilities, and long-term labor for business operations), expanding capex, and expanding ESG policies and practices. Again, it isn’t only the government’s commodities and supply demands that push costs higher- the continuing needs of private industry would follow-on those government and government contractor purchases to create an upwards input-cost spiral.
The Fed can keep calling the wage and commodity price increases “transitory” until an infrastructure law passes- and then change their minds. Then what? The Fed could be completely correct about the transitory nature of the present situation, only to see inflation become embedded from the inflation expectations created by an infrastructure law. In such case, the Fed could still say it was right about the “present” causes of inflation. Notice- you never hear the Fed talk about the pending infrastructure plan (that is pending, in some form), and, for some odd reason, no one ever asks them about it. Even if they did, Fed Bank Presidents and FMOC members would reply that they don’t comment on fiscal policy. Secretary Yellen has commented that any plan should not be inflationary …. but Ms. Yellen never saw a monetary or fiscal stimulus she didn’t like or couldn’t justify.
There is nothing wrong with supply side stimulus- as long as it comes at the right time, and as long as the Fed doesn’t miss the resulting inflationary impulses. Inflation is not necessarily bad, by any means. A “true” conventional or classical business cycle demands inflation to take hold, sooner or later. It just can’t be too much inflation, or an inflation spiral, or a debt driven inflation, or stagflation. Moreover, the Fed has to be able to maintain mechanisms that control it. If the government is doing significant spending, higher prices won’t lead to demand destruction, and, also, the Fed raising interest rates won’t stop the spending.
What will be a stronger impulse- getting beyond low base year comparisons and opening up of supply chains helping to remove inflation, or more fiscal spending on commodities and labor that raises demand for finite resources (domestic labor and commodities)?
Even if transitory inflation impulses fade, we may never experience any price or wage alleviations or leveling-off of prices if fiscal impulses grab the inflation baton and run with it.
Whether inflation is transitory depends on, among other things, like inflation expectations, the timing of an infrastructure law, the timing of contract awards, and the timing of contractor materials purchases upon winning bids and resulting contract awards. It also depends in the final size of the infrastructure law and how it effects commodity and labor demand. It also matters if the supply side stimulus is effective to achieve organic growth, rather than excessive debt and stagflation, and a weaker dollar.
The timing of the forthcoming infrastructure plan is everything. And size matters.
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About the Writer
Neil Siskind is: President of The Siskind Law Firm, focusing on business transactions, real estate, product investments, trademark licensing, and product distribution; Founder & Chairman of The Fatherhood Assignment™, a think tank and advocate for children with absentee fathers; Founder of the global charity marketing initiative, Caring is Free®; Founder of National Fatherhood Day™; Owner & Conservator of The Neil S. Siskind Nature Preserve, over 9 acres of conserved waterfront land along New York’s majestic Hudson River; and author of The Complete Guide To The Ways To Manufacture & Sell Your Products. On December 11, 2017, in his article The Yield Curve Speaketh: Why Stocks Might Crash in Early 2018, Neil Siskind accurately predicted the February, 2018 stock crash, the largest single-day point drop in the Dow Jones Industrial Average’s history. All the stock indices are down approximately 6% for 2018. In his September 26, 2018 article, Lots of “Bull” In The Bull Market: Let’s Look At What’s “Really” Growing, Neil Siskind explained that, despite Wall Street’s bullishness, the economic data and stock market underpinnings were in decline, and the economy and stocks were at imminent risk. By the closing of markets on October 23, 2018, the S&P 500 had fallen approximately 7%, with October being the S&P’s worst month since August 2015 (and December being the S&P’s worst month ever), the Nasdaq continues to have its worst month since 2016, and is down approximately 8% from article publication, and the DJIA is having its worst monthly performance since 2008. In 2018, Neil Siskind coined the phrase “synchronized global slowth™” (or “synchronous slowth™”) to describe the occurrence or condition of multiple emerging market and developed market economies commencing a downward trajectory of economic and GDP growth, or actually contracting to a point of slow, stagnant, or negative economic and GDP growth, simultaneously. If you are in need of office space in South Florida, contact Neil Siskind about space availability at The Siskind Executive Office Complex in Boca Raton, FL.
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