Oct. 13, 2022

A Recession Is When Your Neighbor Loses His Job

Equilibrium. You know an economy is slipping perilously close to a recession when market after market begins to blow up. And you can recognize which markets are in trouble by the prices. A market-based economy, like ours, always seeks equilibrium. If not enough of a good or service exists, the price rises. Ideally, more producers or suppliers enter the market, and the price falls.


But for over a year now, we've seen higher and higher prices in our economy. Simply put, the economy is now in disequilibrium. This disequilibrium began late last year in the energy sector. A new on the job, President Biden made it one of his primary objectives to replace existing energy systems. Notice, it doesn't matter to the marketplace what systems Biden chose as a replacement. What matter is that these new systems do not produce as much energy as the old systems.

Yes, Biden was using a Great Transition to move away from fossil fuel-based energy and toward renewable-based. And that may prove to be a noble goal. Biden began by shutting down the legacy sources, closing the Keystone Pipeline, canceling Federal Lands oil and gas leases, and now apparently canceling offshore oil leases.

Look at the President's move to cut off Russian gas supplies. He did all that before we had an adequate replacement. In one abrupt action, he shut off 10% of America's gas. A more prudent move would have been first to replace that supply, perhaps with Saudi Arabia or Venezuelan, moves he has now taken after the fact. Had Biden first substituted Russian supply, we would have been able to tell Russia to "take a hike" without incurring today's horrific inflation.

I hope you see that the President's motivation is irrelevant to the economics. To maintain equilibrium in our economy, we must balance our energy supplies with our energy needs. Biden has not done that. We are recklessly under-supplied currently, and that's the cause of these higher energy prices.

So, energy was the first market where inflation raised its ugly head, and the first market we saw skyrocketing inflation.

Now we see a similar pattern in the food market. Yesterday, food inflation surpassed energy inflation for the first time as the number one factor driving Producer Prices. As we've discussed before, inflation morphs into a contagion. The elevated prices in one sector contribute to the soaring prices in another. And, of course, food and energy are intimately tied together. Farm equipment and machinery till the soil, and trucks and trains transport the foodstuffs. Petroleum is a significant component of the most widely used types of commercial fertilizer.

Compounding the current food inflation are several factors outside the President's or any mortal's control, the weather, natural disaster, drought, and, most curious, those mysterious processing plant fires. Recent hurricane Ian is expected to have a burdensome impact on Florida crops, which are now entering harvest season.

These "act of nature" factors are probably sufficient to cause rising food prices, over and above the cost of fuel. But put together as they now mean that we will surely see one of the steepest food price rises in our nation's history.

And notice, again, this is an issue of supply, not demand. In times of inflation in the past, when we had a rapidly growing population and economy, we faced demand inflation. That is when a growing consumer base was outstripping our producers.

Today's economy exhibits flat growth with a rapidly aging population. Our current troubles come not from demand but insufficient supply. Not enough fuel, not enough food. And as the name says: the Supply Chain. Overseas manufacturers, principally from Asia, especially China, have seen their production decline.

And it is on this thin thread of supply that our economic fate hinges. Fail to solve the supply issue, and we sink deeper and deeper into the commercial pit. Solve those supply issues, the economy heals, and prices return to equilibrium.

Oh, yes, the rest of Ronald Reagan's quote goes like this:

"A recession is when your neighbor loses his job.
Depression is when you lose yours.
And recovery is when Jimmy Carter loses his."


And that's just what happened.

 

 

NOTES:

 

In just a few minutes, we'll get the latest report on the Consumer Price Index, the most closely watched economic report of the month. That's because the Federal Reserve has made taming inflation their number one objective. And the CPI is the most popular of all inflation measures.

 

Today, from my perspective, it's food versus fuel. Lately, we've seen a slight decline in the energy markets, with gasoline significantly declining in the last couple of weeks. However, the price of food is coming on strong. And as we saw yesterday in the Producer Price Index, food inflation, for the first time, surpassed energy as the number one contributor to inflation at the Wholesale Level.

 

Wall Street expects a very slight decline in CPI Inflation this morning but still thinks inflation will remain above 8%, giving the Federal Reserve the green light to raise interest rates when they meet again on November 1st and 2nd.

 

Want to know what a cheap, plentiful energy source makes to your inflation rate? Saudi Arabia just reported that their inflation is running at just 3.1% this year. Or only slightly above the Federal Reserve's target inflation for this country.

 

Interesting, isn't it?