Lacy Hunt: The Stability of the US Economy is at Stake
The Fed is at a crucial junction, according to Lacy Hunt. It must contain inflation. If not, the stability of the U.S. economy over the longer term is seriously in doubt.
The economy faces a recession, he said. The issue is whether the Fed perseveres in its battle to tame inflation, or it puts us in a more difficult and treacherous situation for a longer period of time.
Economic stagnation and more inflation will be the consequences if the Fed fails to address inflation.
Hunt is the executive vice president and chief economist of Texas-based Hoisington Investment Management Co., a firm that manages $5.2 billion for pension funds, endowments, insurance companies, and others. He spoke virtually on May 11 at the Strategic Investment Conference, which was hosted by Mauldin Economics.
Hunt began his presentation with a review of the economic metrics that support his recessionary view.
Hunt cited the misery index, which measures the average of the unemployment and inflation rates. But that index doesn’t reflect the mindset of Americans because it is equally weighted. “Inflation hurts much more,” Hunt said.
In the last 12 months, real earnings are down 3%, even though the economy is not in a recession. But that metric is worse than it was prior to every recession since 1980. It has caused 116 working Americans to suffer a permanent loss in their standard of living. Add to that 50 million Americans who are retired and similarly afflicted, and Hunt said that 170 to 180 million Americans have suffered a 3% to 4% permanent loss of living.
As is typical at the outset of a recession, Hunt said that inflation is outpacing wage gains, and consumers are cutting back on spending.
Real disposable personal income is where it was two years ago, Hunt said. The savings rate is down to where it was in 2013, about one-third less than its historical average of 9.2%.
The University of Michigan consumer sentiment index focuses on attitudes related to inflation and its effect on long-term disposable income, and it is below where it was prior to all recessions since 1953.
The dollar is at an extremely high level, which indicates that the U.S. is outperforming Europe, China, and Japan. That signifies, according to Hunt, that our problems are severe but less so than the rest of the world. China’s currency is rising along with the dollar, which he said means it is pricing itself out of competitiveness. China may have to devalue its currency, as it did in the 1970s.
Once the supply chain issues are resolved, though, China’s plight means that there will be a disinflationary impulse that will spread to the rest of the world.
Inventories are building up, Hunt said, and eventually will be a problem. That means we won’t get the growth boost from the inventory surge that we did last year.
Hunt said the economy has been sluggish for three quarters (except for inventory growth). Corporate profits should be deteriorating because output is stagnant and the cost of labor is going up. Productivity has declined sharply, and profits should be reduced. Big corporations get half their earnings overseas, and the strong dollar hurts profits. This, Hunt said, is confirmed by CEO confidence data surveys.
Money supply surged with the onset of the pandemic. This year, growth has slowed to 1.5% annually, which is an extremely low level and the money multiplier has decelerated sharply as consumer demand has weakened. The velocity of money will decline, he said, and will slow the economy.
“The degree of financial risk is greater now than at any time in modern times,” Hunt said. When the Fed and the Treasury combined to increase the Fed’s assets during the pandemic, there was a sharp decline in the velocity of money. That meant, according to Hunt, that “a big chunk of money” was channeled into the financial markets. Now that money supply growth is coming down, he said, Fed tightening is putting pressure on the Fed’s assets.
In two years, 2020 and 2021, we had five years of monetary growth, according to Hunt. To revert that, we need zero growth into 2024.
Demographics are deteriorating, but the U.S. is younger than the rest of the world. Family formation has a big impact on investment, he said, and the lack of it signifies a lack of growth.
The Fed should focus on inflation. But if an excuse comes along, in the way of a financial event, such as what happened to Lehman Brothers, or a weakening economy, it risks getting sidetracked, Hunt said. “The Fed needs to do the right thing for the most people. All the choices are horrendous.”
If the Fed sacrifices containing inflation, it will be a “difficult ride,” Hunt said, similar to the mid-1960s to the 1980s.
We are in a pre-recession, going to a recession. If the Fed acts properly, Hunt said, it will be greeted well by the markets.
“But I am not sure if the Fed has a strategic view of where things are going,” Hunt said.
Robert Huebscher is the founder and CEO of Advisor Perspectives.