We May Not Have a Recession

The media’s view of the economy has turned dark. The Washington Post instructs, “How to Recession-Proof Your Life,” ABC News counsels, “How to Prepare for a Possible Recession,” and Bloomberg says, “U.S. Recession Is Now More Likely Than Not.” These doomsday reports are reliable clickbait, and faltering consumer confidence suggests that many people believe them. Yet they fail to consider what’s happening in business investment, employment, corporate profits, and consumer spending. 

Start with the basics. The economy runs on consumer spending and investment, and what people and businesses earn is a decent indicator of whether they will continue to spend and invest. And from January through April, real personal income and consumer spending held steady. So, while prices rose at an uncomfortable rate, people’s incomes and spending grew at the same clip. 

Business is doing better. The latest data shows that real business investment grew at a 9.2 percent rate in the first quarter of this year (January through March). That’s unsurprising, since the domestic profits of U.S. corporations have soared. Profits in the first quarter (even discounting for inflation) far exceeded those in recent years by more than 14 percent compared to the first quarter of 2021 and by an average of nearly 29 percent compared to the first quarters of 2017 to 2019. 

The job market is booming, too. Employment jumped by more than 1.9 million from January to May, on top of 6.7 million jobs created last year—including employment in manufacturing, which increased by 187,000 through May, again on top of gains of 397,000 in 2021. The only factor holding back job gains is the shrinking pool of people looking for work. In April, U.S. businesses had 11.4 million job openings, including 996,000 in manufacturing, with fewer than 6 million unemployed people looking for work.

Yes, as the doomsayers note, real GDP declined 1.5 percent in the first three months of this year. But it didn’t reflect problems with the fundamentals, because consumer spending grew 3.1 percent alongside the 9.2 percent jump in fixed business investment. 

Instead, GDP was technically pulled down by more peripheral developments. Most notably, the trade deficit jumped 15 percent—which happens when economic demand grows faster here than for our trading partners, and imports rise more than exports. Worried about the Omicron variant, businesses reduced inventories. Federal spending fell back, too, which is good news even as it nudges down the GDP measure. 

Yet, by today’s conventional wisdom, the favorable developments in investment, employment, profits, and consumer spending are sideshows to rising inflation. Inflation can erode people’s spending power. But that isn’t happening: Median weekly earnings of full-time workers kept pace with inflation in the first quarter of this year for the first time since the 2020 lockdowns—and without another tranche of government checks for households and businesses.

Some economists blame today’s inflation on those stimulus payments, especially the last round, which went out in March 2021. That’s a stretch: Inflation began rising in the same month, so given the lag between changes in fiscal policy and price increases, President Joe Biden’s relief program could not have contributed to inflation in 2021. (For an alternative view of inflation’s root causes in broad industry concentration, see Phillip Longman in the new issue of the Washington Monthly.)

Rather, the main culprit is energy prices, primarily set by the world’s most powerful international oligopoly. While consumer prices have jumped nearly 9 percent since March 2021, energy commodities—oil, natural gas, and coal—soared 45 percent, fuel oil prices are up 81 percent, and gasoline prices increased 44 percent. 

Partisan fantasists blame Biden for high energy prices, but the fault lies with OPEC, Vladimir Putin, and U.S. oil refiners. In the first quarter of 2021, oil prices rebounded from their 2020 lows to 2019 levels of about $58 per barrel—and then kept rising to $71 per barrel in the third quarter of 2021 and $92 per barrel by February of this year. That’s when Putin’s war on Ukraine further disrupted energy markets, driving prices to an average of $107 per barrel from March to May.

Another reason fuel oil and gasoline are so expensive is profit seeking by U.S. oil refiners, who have cut back production as the economy expands. American refineries processed an average of more than 17 million barrels per week from 2017 to 2019, compared to 15.6 million barrels weekly in 2021, with GDP growing 5.65 percent, and 16.2 million barrels per week from January to May this year.

The persistence of the energy-driven inflation surprised the Biden administration, as Treasury Secretary Janet Yellen has acknowledged—but not for as long as it appeared. Several months ago, the administration began a covert charm offensive to convince the Saudis to expand global oil supplies, which has already started to produce results. 

More important, rising inflation caught Federal Reserve Chairman Jerome Powell off guard—not the first time that he has mishandled monetary policy. When Powell became Fed chair in 2017, he continued the approach of his predecessor, Yellen, to gradually raise interest rates and phase out quantitative easing. It was a sensible tactic to give the Fed room to deal with the next downturn. But when Donald Trump called for lower rates and attacked Powell, the Fed chair folded and lowered rates repeatedly in 2018 and 2019.

As a result, the Fed had little room to cut interest rates when the pandemic hit. Powell had to flood the system with $3 trillion in quantitative easing. That set us up for inflation driven by supply issues, forcing the Fed to cut demand through large interest rate hikes.Rising interest rates strain the economy but don’t necessarily mean recession. So far, Powell has hiked the federal funds rate from near zero to 1.5 percent, and two more increases of 75 basis points would take the rate to 3 percent. That’s still lower than the average 4.1 percent federal funds rate in 2006, the best year of the George W. Bush expansion, or the average 5.4 percent rate from 1996 to 1998, the height of Bill Clinton’s expansion. So, whatever the media hype and political finger pointing, the economy’s strong fundamentals can keep this expansion going, as long as the Fed proceeds carefully.