As the US government reports this week that inflation has hit a four-decade high and the Fed ramps up its efforts to cut prices, President Joe Biden’s economy faces a dizzying array of risks. Growth was already expected to slow this year after surging 5.7 percent expansion in 2021 as both Congress and the central bank withdraw support for the economy. But the hits keep coming – higher energy prices, a slowdown in China and the possibility of a Fed-induced recession.
Here are the major challenges ahead.
The Fed as a “bobsledder”
The biggest threat to the economy is the central bank’s campaign to raise interest rates in a bid to cut spending and curb inflation. But what that really means is that the Fed will slow growth, and that will have consequences for American workers.
The labor market is booming, adding an average of 600,000 jobs per month over the past six months, and as wages have risen, more people have returned to the labor market. This, coupled with the fact that there are more vacancies than workers, has raised hopes that the Fed can reduce demand for labor without causing unemployment to rise. But the harder the Fed slams on the brakes to stop inflation, the greater the collateral damage. And the central bank has often caused recessions in past episodes of anti-inflation.
“The only thing a bobsledder can do is brake,” said William Spriggs, a Howard University professor and the AFL-CIO’s chief economist. “If for some reason you steer the bob incorrectly, that’s all. You’re just stuck on the ice.”
The Fed is aiming for a so-called soft landing, meaning it would slow the economy while avoiding a recession. And economic forecasters from some of the world’s biggest banks — Deutsche Bank, UBS and Bank of America — have said March’s 8.5 percent surge in inflation could be the worst price hike, in part because the central bank will step in.
But success is far from assured. Killing inflation while maintaining job growth is “not an impossible combination, but it takes skill and also a lot of luck,” Yellen, herself a former Fed chair, said during a speech to the Atlantic Council.
Companies also have a lot of debt, and when the Fed raises interest rates, that debt gets more expensive, which could be really painful for some companies. Those fears have played out in the stock market, where investors have tried to gauge which companies to bet on for the long term.
“There’s a lot more influence on companies now,” said Megan Greene, senior fellow at Harvard Kennedy School and chief global economist at the Kroll Institute. “That’s fine as long as interest rates are low and profits are high, and to be fair, companies have built up their cash positions.”
“But if the Fed hikes to 3 percent by the end of the year,” as some are predicting, “it’s going to cause some defaults and some pain in the economy,” she added.
The supply chain problems Powell can’t fix
The inflation the US is experiencing, the highest since the Reagan White House began, was fueled by global manufacturing and shipping delays as the pandemic shut down factories and created labor shortages. But it’s not clear when that will improve, meaning inflation could remain stubbornly high for some time.
This, in turn, will put pressure on the Fed to do more to control inflation, even if its tools can’t solve the supply side problems, only the demand side. Fed Chair Jerome Powell said in a speech last month that he was optimistic these tightenings would gradually ease this year, which would help the central bank to offset the mismatch between demand for goods and supply, but he admitted that he couldn’t rely on it.
“It remains likely that the hoped-for supply-side healing will materialize over time as the world eventually settles into a new normal, but the timing and magnitude of that relief remains highly uncertain,” Powell said.
War Effects: “Like a Big Tax Increase”
Energy prices have soared following the Russian invasion, a phenomenon reverberating throughout the global economy. If oil prices rise, transport costs also rise. Higher oil and gas prices could increase the cost of energy-intensive components like steel, cement and plastics that are used across industries.
“It’s like a big tax hike,” says Joseph Gagnon, a macroeconomist at the Peterson Institute for International Economics. “People need to heat their homes, factories need energy to run. That means you have less money to spend on non-energy things, which means some people are out of work.”
Gagnon said the US is in a better position than Europe because it is actually an oil exporter, meaning the US economy will see some offsetting benefit from higher oil prices. But “those who lose will cut their other expenses faster than those who earn will spend them.”
The conflict in Ukraine is complicating supply chains, just as manufacturing has improved somewhat on the labor side as many people re-enter the workforce.
Russia’s invasion “is likely to be a blow to global growth, and for all those countries that are already food insecure, that’s just a huge concern,” Yellen said.
The China Factor
European Central Bank President Christine Lagarde has also warned that the war in Ukraine poses significant threats to Europe’s growth – dampening sentiment and fueling inflation, which has also been unusually high on the continent. Meanwhile, China’s economy has slowed, a momentum that will only intensify amid renewed lockdowns brought on by the latest strain of coronavirus.
For the US, this means less interest abroad in its exports. That alone probably won’t cause a recession, but it’s another reason why growth will slow, making the economy much more vulnerable to outside influences.
“When the EU goes into recession or flattening out, demand drags with it,” Greene said. “In general, external demand is not looking good for the US. You have to ask yourself what will be the engine of growth.”
Lurking financial risks
Then there is always the danger that something unexpected will break. US corporate debt rose to $18.5 trillion by the end of last year, up more than $2 trillion from late 2019, when corporate borrowing was already at an all-time high. according to the Fed. As interest rates rise, this debt becomes more expensive and could result in defaults running through the financial system. Meanwhile, risky investments – from cryptocurrencies to shell companies known as SPACs – have proliferated during the pandemic. If some of the bubbles burst, even if it doesn’t lead to an economic downturn, it could cause pain.
Jamie Dimon, CEO of JPMorgan Chase, said on Wednesday he was still bullish on the economy in the near-term but warned of “significant geopolitical and economic challenges.”
“I’m not predicting a recession,” Dimon, who runs the largest US bank, told reporters. “But is that possible? Absolutely.”
With Biden’s booming economy, what could go wrong? Here are the big risks.
Source link With Biden’s booming economy, what could go wrong? Here are the big risks.