This Economy is Ugly in its Bones – Part 1

By William D. Matthew -, Public Domain,

They say, “Beauty is only skin deep but ugly goes all the way to the bone.” Well, the last part of that certainly sums up this economy. It’s such a malformed monstrosity, you’ll wish it were extinct; and, at the rate this behemoth is now dying, it soon will be. You’ll have to look for it in the fossil record of formerly great economies.

In my last article, I said the recessionary dip we saw for the first quarter is only going to get uglier. I suspected, however, that it would not take long before the Wizards of Wall Street figured out how to minimize the bad news with some spin as they always do, and sure enough, they did. Unable to make this pig look better with lipstick, it still took them less than twenty-four hours before they were calling the -1.43% decline in GDP “noise” to be ignored. Suddenly, that word is the talking point that is popping up all over the web as they devise static of their own to tell you why you can ignore this GDP print in order to cajole you into continuing to buy stocks and bonds. (An example of which I’ll get to in part two of this Patron-Post series.)

That’s why I said before the wizard cabal could even spin it that I’d be laying out for you in my next Patron Post why we are highly likely to see another negative GDP print for this quarter. I knew my recession claim would have to stand up against a lot of rosy-eyed sweet nothings. There are, in fact, so many reasons to lay out for a deepening dive into recession, I have to break the support for my claim down into a couple of posts. Of course, it is only after two consecutive quarters of GDP go negative that the US will be declared officially (and retroactively as always) to be in recession. I just see no reason to wait for the official declaration. It can back me up when it finally gets here sometime in the summer. I like to give advance warning, not just tell you after the fact how we could see it coming or should have or why it did. So here we go….

It took the NASDAQ two years to erode away 80% during the dot-com bust. It was far from a single-quarter crash. So far, the NASDAQ has had a half-year downhill run, and most of its stocks are already deep in bear territory. Still, there are many reasons to believe it has a lot more room to run. The stock market is casting all its hope on the Fed backing away from the inflation fight now that recession is staring them down with a mean and ugly look. I’ll tell you why that isn’t going to happen in the next part, too.

Since GDP is the official measure of production, let me lay out the overarching reasons America is not capable right now of producing more:

  • Sanctions are not going away soon even if Russia unexpectedly and cataclysmically loses the war.
  • If sanctions are not going away soon, then neither are any of the supply-chain problems and transportation problems that have choked the economy for months now.
  • If sanctions are going to choke off imports and disturb supply chains even more, then supply-side inflation is not going to back down before the Fed fully stuffs the economy into recession because it is really recessions (force-Fed) that kill inflation by choking the economy half to death until inflation dies because no one can pay higher prices with lower income and unemployment.
  • Americans don’t want to work anymore.

The economy’s broken bones are bound in supply chains

Supply chains form skeletal structure of our consumer economy. If you cannot supply material because you either cannot produce it or cannot move it when you do produce it, then you cannot sell it and cannot consume it. Everything grinds to a halt. So, those who are trying to say the past quarter’s GDP drop is “just noise” need to explain how we are going to end the supply crisis soon enough in the quarter for that negative move to turn positive fast enough for the quarter to come out with a positive average. We have no solid structure upon which to hang all of that.

Let’s look at the supply-chain crisis to see if it is even remotely reasonable for anyone to believe that problem will reverse by the end of this month so we can have enough positive production growth in the final month of the quarter to arrive at a positive change in GDP.

First, China. While imports add nothing to US production (they are subtracted back out of GDP because we did not produce them) they are also absolutely essential to US production. For example, if we produce iPhones or cars or computers here that are dependent on chips from China, then that production isn’t going to happen without those imports that are part of those products. The imported part gets discounted from GDP, but the overall price of the total computer or phone gets added in. So, it’s a value-added metric, measuring what portion of that computer we produced here.

Now, does the Chinese bottleneck in transportation look like a problem that is going away?

I don’t think so. As the tweet says, this is not something the Fed can solve with monetary policy. This is a problem that is ugly in its bones. Even if China totally reopened for business today — cleared its “zero-Covid” policy off the deck, demanded everyone goes back to work at the Port of Shanghai and other ports, I cannot even begin to imagine how long it will take to clear out the existing traffic jam, and remember the situation isn’t static. More ships keep arriving every day. So, even when they start clearing traffic, they’re adding more almost as fast as they can clear the backlog.

Can you imagine the disarray a bottleneck of that size at the world’s largest port causes for all other ports? Right now it means nothing is moving through that area, which is why a drought for US truckers is being predicted for this summer. However, when the logjam finally breaks in Shanghai and other affected Chinese ports, it means an endless stream of ships to ports around the world, taking them back into the major traffic jams they have already been trying to work through. It is impossible that this massive bottleneck is going to clear up soon, even if Chinese ports open tomorrow.

We’ve gone from ports in the US that were jammed to ports where most traffic is not arriving, and then we’ll go back to ports that are jammed when Beijing is finally back in business. Right now in the US that looks like this:

The problem is that the Covid lockdowns shut things off. Then suddenly they surge back open, so you go from nothing to more than you can process … so inefficiency. It’s stalling and surging and stalling and surging. Right now, it’s stalled. So, how is that going to make for a good quarter if growth now? We may get a mini boom when it finally surges again, like we saw at the end of 2021, but that is not what is on deck for the current quarter and, according to Craig Fuller, founder and CEO of FreightWaves, not what is on deck for summer either.

Not even the experts can guess when that logjam is going to break:

As if that is not bad enough, look at what is happening to cost of moving those goods across land whenever they finally do arrive here, and then tell me there is not more inflation in store as all those parts get moved to factories, put into products and then moved again:

Does anyone seriously think the cost of diesel is going to drop with one of the main sources for diesel being sanctioned out of the market?

Get real!

If it does drop, it will only be because nothing is moving because China is still on lockdown, and that still means recession!

And more inflation just forces the Fed to tighten more in order to look like it is doing something.

What you have there is a big, ugly mess that is far more than skin deep. It’s ocean deep and ocean wide. It so complicated that even those most-in-touch with shipping have no idea how and when it will resolve.

And China is still in lockdown. With the largest port in the world still locked down and some other Chinese ports, too, tell me how the present recessionary numbers fade by the end of this month to give us one month so glorious it will turn the whole quarter’s US production positive. While China may not, by itself, prevent positive growth, it is a heavily weighting factor among several other big factors I’ll lay out.

And Shanghai’s traffic jam isn’t even due to all the disruptions from sanction shutdowns. It is almost entirely due to the lingering affects of the Covidcrisis, thanks to China’s “zero-Covid” policy closing ports. AND Covid is back on the rise again; so, unless Xi decides to lose face on his big-savior-of-China status and say, “Oops, that didn’t help,” this is not getting better this month or this summer and maybe not even this YEAR. And we don’t even know what new waves Covid might have in store for China or for other nations.

This is just the latest wave, but not the last. As it has affected China, it is affecting the whole world. China is now seeing an increase in Covid cases, and New York just upped its Covid-threat status again this week. So, there could be a new wave coming.

That’s one big-picture item — a broken hip in our global skeletal structure that hugely impacts the flow of production within the US economy by limiting imported parts — which, as we witnessed last year, can entirely stop the production of some lines of cars or anything else dependent on those parts and can limit our ability to export, which backs up into production and curbs production.

Americans don’t want to work anymore

Wolf Richter just wrote a piece about another major reason America cannot increase GDP right now. If you cannot get Americans to go back to work, then the only way to increase production (GDP) is by replacing workers or improving their efficiency with automation. While that will be increasingly happening, it certainly isn’t going to happen so quickly that it saves the present quarter from showing a negative move in GDP like the last quarter just did. I haven’t read a lot of evidence of new automated factories or major retooling on the kind of broad level that is going to change the nation’s inability to produce due to lack of workers in a single quarter or that is going to domestic all supply chains by the end of this month. People have to be smoking some wild weed to believe the labor stoppage that is seriously restricting production is going away anytime soon.

You have to wonder if anyone even thinks before they write their glib proclamations that the past quarter was just noise, so ignore it. Or are they outright lying?

Richter just reported,

The number of job openings jumped further into the astronomical zone, to a record 11.55 million (seasonally adjusted) at the end of March, up by 36% from a year ago. Compared to March 2019, job openings spiked by 57%; that’s 4.2 million more job openings in March 2022 than before the pandemic.

Wolf Street

While shiploads of companies would apparently like to produce more, they cannot find the workers to do it. You may recall that some people were speculating the Great Resignation would end when the stimulus checks ran out. I said I didn’t believe that would prove true, and it certainly hasn’t. The stimmies have ended, but the shimmies continue. Here we are far past the point when the main stimulus programs ended, and the labor crisis remains as bad as ever.

People may have learned they can live on less and be happier. They may have built up some savings from the stimulus checks or made bank on Robinhood. If so, their reluctance to go back to work will end when the money runs out; but one would think with 75% of all US stocks deeply in their own bear markets, where even the FAANGs have tanked, the surplus funds would be gone by now.

People may eventually be forced back to work, but think about how that works. It only happens after the nation goes deep enough into recession that people have no choice but to go back to work. America isn’t going back into production until Amercans go back into production; so that means America needs to go deep enough into recession to force them back to work. It’s a catch-22. There is no way at this point of escaping that part of the business cycle.

Richter believes the following cycle explains, at least in part, what is happening in the job market right now:

What this shows is that employers poach workers from other employers because they cannot find enough unemployed people willing to take those jobs, and to poach a worker from another employer, they have to offer better pay, benefits, and working conditions – thereby pushing up the costs of labor across the economy. And by poaching a worker, they create a new job opening at the prior employer, for a lot of churn.

That means the job openings may be phantoms, just created by poaching. In which case, they don’t represent expanded production. Richter’s scenario means inflation is going higher due to rising labor costs, not lower. Inflation eventually means people will be buying less because they can afford less. That means recession. We have trouble, which starts with a “T,” which rhymes with “P,” which stands for “pool,” meaning “labor pool.” We have deep disconnections down in the joints of the labor market. Workers and jobs are not coming together or working smoothly.

Richter presents the following graph of job openings with a certifiably reasonable explicative at the top:

With astronomical job openings, it seems inconceivable that America’s production is not up. However, those are jobs open, not jobs filled. Most are staying open for a very long time. So, atypical to how we usually think of all these job openings, they are not indicative of a rapidly expanding economy, hiring more and more workers as the rosy-eyed optimist might try to spin it, but are indicative of a nation that doesn’t want to go back to work. What we’re seeing is a pile-up of openings that have not been filled, and that means they represent production that is not expanding to meet demand.

With such celestial-level openings floating above us in the rarified atmosphere, there will either have to be a lot more wage hikes to entice people to fill those slots or a lot more austerity (recession) to force people back to work by making them more desperate. The fact is we cannot all be consumers and not be producers, too, because we’ll have nothing to consume if no one is making all the stuff we are demanding. China certainly isn’t making it. Neither are we, judging from those unfilled job positions.

One last observation comes from the February quits rate: after the number of Americans quitting their job hit an all time high 4.510 million in November, it then dropped modestly for a few months in a row, but then reversed sharply higher again in February and March, rising by 284K in the two months and increasing to a record 4.536 million, which confirms that once again, more Americans than ever are willing to take their chances and quit their job in hopes of finding higher pay elsewhere.

Zero Hedge

However, these are not just low-end service jobs. The bulk of the openings are in, first and foremost, the business and professional category, then health care and social assistance; but the number of openings hanging out there in the wind without being filled is sky-high in all categories. So, it would seem, there is a lot of higher-end pay looking for a larger slice of the pie than corporate wants to give. (Because if they do, how will they pay out the lofty executive bonuses and give shareholders all those sizable buybacks that keep driving up share values? So, we may be seeing a battle of greedy and the needy over how the pie gets sliced, and right now labor appears to be holding the knife.)

Of course, Biden would like to fill the labor shortage (as would many Republican business leaders) with cheap labor from outside the country — pie holes who ARE in more desperate circumstances who are more than ready to come here and take those jobs. The jobs, as noted, are largely in skilled positions, so many migrants won’t qualify; and, to the extent the easy migrant worker path is followed by politicians and industry, how does that help the majority of the US population, which has languished for decades with wages that never made any real gains (for the same task at the same level of experience, adjusted for inflation).

Now, an argument can be made that the employment situation is not as short-staffed as all the unfilled jobs make it appear to be because actual hires have risen back to being on track with where they were before the Covidcrisis:

In fact, they appear to be on a higher, steeper trend than they were before the big job bust of the Covidcrash and the immediate rehiring that took place upon reopening our artificially closed economy. However, clearly something is way broken in those job opening numbers that won’t settle down. It may just be that companies want to hire more to meet a lot of excess demand, but they can’t. Even that means prices rise because supply can’t keep up with demand … until demand is crushed by affordability falling.

Richter concludes the fix for resyncing supply and demand (as well as the labor market) is the good old-fashioned hard reset that has always done the job with inescapable pain:

The Fed will tighten monetary policies to reign in out-of-whack demand which will lower inflationary pressures. And given the huge demand and out of control inflation, the Fed will have to tighten by a lot, and this will likely cause a recession – and it should because that’s what this out of whack economy with all its shortages needs in order to allow everyone to catch up.

Wolf Street

We are paying for the pain we avoided

It may be precisely because we have done all we can with financial intervention to avoid recessionary resets, that we now have a much larger reset that will have to happen. We have tried to avoid the normal business cycle, and that has allowed excesses and problems to build up below the surface. And that is partly why our economy is ugly in its bones. It looked pretty to many who only looked superficially, but deep down there was a lot of bone cancer growing.

So long as we don’t go back to massive money printing to keep the demand side fueled, inflation and recession will do the rebalancing act the hard way. Prices will keep rising. People who are not going back to work will start running out of money. As a result, people will buy less, so business owners will produce less because their warehouses back up with inventory; jobs will be terminated, rebalancing the labor equation, and the economy will be deep in recession because of all of that.

If, on the other hand, the Fed DOES go back to money printing with the desperate government pushing it to keep the milling masses happy, then we’ll have something worse. Those with plenty of money will not go back to work. There will remain, therefore, a supply shortage, and so we’ll have hyperinflation wherein there is still nothing to stock the shelves because no one is producing it, but people pay all they can to get what little there is, using that free money. So, all we wind up with is no more stuff to fill our wants but a lot higher prices for what there is.

There is, in other words, no painless fix. The ugliness in the bones of this economy exists because we have been doing nothing but cheap fixes — financial interventions — rather than resetting the broken bones and killing the cancer that weakens them. So, we just have an ugly cancerous mess of bubbly bones breaking up.

Here is what Richter says it will take just to right the imbalance in the labor market, which remember is only one reason we are going deeper into recession:

a big dip in demand that mostly eliminates 5 million job openings and brings the job openings back to normal….

The problem is how do you get a dip in demand without a rise in impoverishment (recession) or a rise in prices (moving, in that case, toward hyperinflation)?

You don’t. People don’t stop wanting, unless for one of those two reasons they cannot afford to want. If you cannot increase supply, then you have to diminish demand as Wolf writes. That means people must have less money to buy with, and that is accomplished via raising interest and shrinking money supply. They don’t want less just because less is available. And that is why the Fed is pressed to start tightening, even though we are already seeing a recessionary move in the economy before they have in any serious way even begun. If the Fed doesn’t do that, then inflation does the job of rectifying the imbalance for them by raising costs until people want less. And that means you live with less anyway.

This is the trap I said the Fed was taking all of us into. When you cannot raise supply, you kill demand by curtailing employment (thus, lowering wages) and the ability of people to pay or by raising prices, which inflation happens on its own until supply and demand match back up.

More in my next post about why supply isn’t going to catch up (GDP grow), so it’s recession or even higher inflation in store for us. The latter forces Fed tightening, which causes the former anyway. The two big supply constraints in this post were Chinese bottlenecks and labor bottlenecks, neither of which have any possibility of resolving soon enough to increase production in what is left of this quarter.

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