Chicago - Sep. 19, 2020
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Trump's Banana Split Economy

Prior to the outbreak of the novel coronavirus, the main commentary I heard about the economy was that the USA was rosy, would stay so in the future, and would help re-elect President Trump. The 10-year GDP expansion was the highest ever recorded and would continue with no end in sight. The standard unemployment rate, at 3.6%, was the lowest in 50 years.

Like a giant banana split, the economy looked full of sweetness, with whipped cream and cherries on the top. Eating it would give you a sugar rush and you would be grateful to the person who gave it to you.

But I couldn't help but think of a childhood friend who tried to down a 50-scoop "I Bet You Can't Sundae" at a local snack shop in Detroit, and ended up with a frozen tongue.

The extension of the Obama expansion from the 2008 recession into the Trump years has been partly caused by sound, appropriately expansionary macroeconomic policy by Janet Yellen at the Federal Reserve Bank (monetary policy) and Larry Summers at the Treasury Department (fiscal policy). Despite expansionary policy in the Obama years, the economy was held back by a Republican Congress pushing for fiscal austerity brought on by fear of inflation, rising deficits and national debt (the accumulation of previous deficits). That austerity kept GDP growth lower than it could have been.

As I see it, the big push in keeping the expansion going under Trump was old-fashioned Keynesian deficit financing of the federal budget, and an accommodating monetary policy keeping interest rates low and money expansion high. This would be appropriate if done at a period of high unemployment. But it was done at a period of what many thought was close to full employment.

Sure, there are some benefits to this Trump expansion. But, as in eating a banana split, we are now experiencing after-consumption indigestion, and soon this indigestion will turn into regurgitation which will manifest as stagflation.

Stagflation is a period of macroeconomic instability with simultaneous low growth or even decreases in real GDP and increases in average price levels (inflation). This regurgitation phase will be exacerbated by the spread of the new coronavirus, making the upcoming stagflation even worse, as the two seem to be mutually reinforcing.

In this Trump expansionary economy, we did not get more of both guns and butter, but through tax cuts going disproportionately to the wealthy, along with a military expansion, we got more yachts and missiles. (The U.S. recreational boating industry has been in an eight-year expansion; total annual military spending had been declining from 2010 to 2016, and since then, it is has been increasing in total and as a percent of the total federal budget expenditures.)

An early part of having indigestion in this particular deficit-induced expansionary economy is higher inflation that is subtle and not counted in the various price indices. Price indices, using a basket of goods and services, tend to focus on goods more than services, and on trying to correct for quality increases more than quality decreases. Of course we notice higher prices of goods like milk, restaurant meals, and housing, but what we don't connect to in an over-stimulated macroeconomy is the lower quality of many goods and services - especially services.

It has been noted, as an anomaly, that inflation is unusually low in this period of near-full employment. Usually, when an economy is near full employment, bottlenecks develop that result from constricted sectors trying to bid away resources to relieve the supply gridlock. If widespread, this induces inflation. But in this time, I assert that inflation shows up more in quality decreases than price increases. Price increases are happening but they are generally below (now 1.75%) what the Federal Reserve considers as its target inflation mandate of 2%.

The unmeasured lower quality of goods and services understates the rise in consumers' true cost of living because it does not take into account how the decreased quality of existing services and goods reduces it. To stay competitive and maximize profits, many companies cut corners, reducing the quality of goods and services they sell. They introduce the quality cuts before the consumer has a chance to figure it out. Cutting prices is very noticeable. So, instead of cutting prices, many businesses cut quality because it is harder to detect. When regulation of organizations have decreased, or disappeared, firms are incentivized to continue along the route towards becoming a Sinclairian Jungle.

Two Big Recent Examples

The most noticeable example of quality-cutting is Boeing's Max 737 aircraft, which still sits idled and makes for less reliable air travel as airlines have to scramble and pay a premium to find substitute aircraft.

It is much harder to realize the quality decline in sophisticated goods. It took two fatal air crashes before the flaws were uncovered. On average, industries have become more concentrated through mergers, acquisitions, and expanding the lines of services they provide. They spread themselves too thin, which is sometimes called diseconomies of scale, but rather than let average costs go up, they reduce quality, particularly when a release time target is involved. Republicans often associate this condition with government services, but I think it now occurs just as much or more in for-profit companies and even in non-profit organizations.

Another recent example is the 2020 Iowa Democratic Caucus app, developed by a for-profit company that is owned by a non-profit organization, which caused not only a huge delay in giving out results but also put into question the accuracy of the results. The causes of the slowdown in producing results vary from coding error, log-in problems, difficulty in installing the app on one's smartphone, overloading of phone lines, lack of training for precinct chairs, not testing at the statewide scale, and excessive secrecy prior to launch.

Though under a deadline, I suspect many of the errors of the app could have been eliminated if the company that produced it had more staff to check for errors and do beta testing. I assert that this lack was due to an attempt to hold down costs and the difficulty of finding skilled technical workers in a tight labor market.

10 Personal Examples

Service quality decreases are hard to document, but I personally have gotten more bad service in the recent past, leading me to spend extra money and time to correct mistakes by large organizations. Here are a few firsthand examples:

1. My retirement investment management company is the fourth-largest manager of 401(k)-type plan assets in the United States. Yet it has consistently made mistakes in calculating my required minimum distributions to the Internal Revenue Service. I had to hire a private accountant, at my own expense, to straighten things out.

2. I regularly see doctors at the largest and richest hospital in Chicago. At my last visit, my doctor came into my room and tried to see the results of my recent lab work to explain them to me, but he could not get the computer to work in that room.

3. At that same hospital, when going to the emergency room, I am seen by several doctors who walk in and out of my room. Few identify themselves and none will write their name on a board or give me their card. Personnel changes at shifts. If I want to tell a new doctor what a previous doctor told me, I may not remember; instead, I could give the new doctor the name of the previous doctor, but I do not know that doctor's name.

4. I bought a new wireless printer from a major big box electronic retailer and purchased technical assistance services. I paid double the price for technical set-up assistance because I wanted to make sure the technical person who came to my house stayed for a decent amount of time to get the job right. Not only did he leave early, but he provided me no report of what he did. I asked the store to send someone else to finish the job and was told it will be a long wait because they have only one specialist (in the City of Chicago) for setting up printers. When I asked if the person coming to my house to set up the printer knew how the printer I purchased worked, the technology manager said, "Technology is changing so fast, no one can know everything."

5. I was once able to eat tasty affordable home-cooked type meals in my walkable neighborhood, but rents and property taxes have become so high that I have to travel far outside my neighborhood to get a good affordable restaurant meal. Restaurants in my neighborhood close down because they can't afford the rents or taxes or the owners of buildings prefer to sell to a residential developer or rent to an upscale chain store. In general, immigrants know and appreciate good food better than upscale yuppies. Because there are fewer immigrants in this now-more upscale neighborhood, restaurants can serve lower quality food, charge high prices, and get away with it.

6. I have lived, and continue to live, in an old house that requires a lot of repairs. In the past, I could find affordable handymen. Now, it is nearly impossible to do so. My neighbor is a real estate developer and I asked him for a referral. He told me that with immigration down, particularly from Poland and Mexico, even he is having difficulty finding workers. If I find someone affordable, either they don't have the skills or the tools or they don't want to commit to work for more than few days, or worse, they commit to work for a few days and then don't show up. On the labor supply side, it is great for skilled trades workers to be more choosy about jobs, but from the consumer demand side, it makes house repair services less reliable and more expensive.

7. My local bank merged with a large national financial corporation. It is one of the largest banks in the United States; the company was ranked 366th in the Fortune 500 in 2018. Yet, when we were forced to move our accounts over to this larger bank - but in the exact same building space - they made several mistakes in moving our money over and I had questions no one could answer. The bank did not plan for a smooth transition for its customers and did not spend enough on training its workers.

8. I go to a supermarket which is part of a large chain in Chicago. To try to stimulate me to shop there, they set up incentives for me to get a discount on gasoline, which is activated by the checkout clerk entering my phone number in their checkout system. But the last two times I shopped there, the clerk did not ask for my number and I was going to miss out on getting the discount. I had to take time to wait to see a manager at the front desk so the manager could enter my shopping total into their gasoline discount program app. The value of my time was worth more than the discount I got. It was not really the clerk's fault. She was new and they did not put the resources into training her.

9. I have several computers at my home and my university office. At home, my main computer, where I store all my data, uses Windows 7 as its operating system. It works stably and has old software that I know how to use. But now Microsoft says it no longer supports the Windows 7 operating system updates for ordinary users. To switch to Windows 10 will require having to learn to use new software, some of which cannot even be bought any more and some which is only available in new versions to rent. That substantially increases the cost of computing for my household.

10. I bought hearing aids from a large big box retailer, which is purported to have the best value in hearing aids. Promises were made to me but not kept. The hearing aid specialist salesperson did not follow through on demonstrating a range of hearing aids, nor did she know how to program my smartphone to adjust the hearing aids. It is hard to keep up with technology, but companies which sell technical products are supposed to hire people who know their intricacies.

These reductions in quality of service make life more difficult for everyone, but especially for low- and middle-income people who have to struggle, increasing expenditures and using up time, to find easement from the harm done to them by these mistakes in service provision. Higher income people have accountants, lawyers, administrative assistants and consultants who can adjust for these to make the flow of life go smoothly. But low-income people do not have these luxuries available. This exacerbates the inequality of income by making it harder for low-income people to keep up with utilizing the common necessities of living, and continues to widen the digital divide.

Austerity Starving Of The Beast Comes After The Dessert

Republicans portray The Beast as government expenditures for safety net programs that target low-income people. Yet, Congress and the president have been willing to incur large deficits, largely through tax cuts and increases in military spending. This is a set-up.

Republicans, who hate what government does in the realm of safety nets for the poor, now have a rationale to cut back on these programs because of the so-called dangers of high deficits. Those fiscal dangers were not raised when the deficit-generating policies were passed into law. Nonetheless, they are used to beat back the size of the welfare state and thus focus less of the economic gains of growth on the poor.

Since Trump took office, real GDP has grown between 1% and 3%, hitting a rate of 2.1% in the fourth quarter of 2019. The labor share of GDP has been growing slightly since 2010 but it is still much lower than its two recent peaks of 64% in 2001 and 60% in 2008. Since 2016, the annual percentage change in median usual weekly real earnings of full-time wage and salary workers (16 years and over) has fluctuated from negative 1% to positive 3%. Labor productivity, as measured by annual percent change in Nonfarm Business Real Output Per Hour of All Persons, has been more stable in the Trump years compared to the Obama years, but is still weak. It ended at 1.4% annual change for fourth quarter 2019.

While wage increases are modest, they may be enough to start a cost push inflation when coupled with low productivity growth. More fully recognized, contractionary macroeconomic policy normally follows, and that is when unemployment increases, along with higher inflation, put into momentum by previous Trump economic policy. This regurgitation of the banana split is called stagflation - simultaneous increases in unemployment along with increases in average price levels.

This expectation is reinforced by the economic impact of the coronavirus pandemic. Already we have seen a big drop in the value of the stock market, a leading indicator of macroeconomic activity. As the virus spreads, there will be supply shocks as more domestic and foreign workers are quarantined, reducing output of goods and services as well as causing shortages which leads to price increases. Firms will look for new supply chains and they will find them, but at added cost.

The demand side is shocked by workers' falling income when a company closes, as well as quarantined consumers having less ability to buy goods and services. Admittedly, this puts downward pressure on prices, and for firms there will be both losers (airlines and hotels) and winners (makers of face masks and virus test kits), but I think the supply shocks will be bigger than the demand shocks. Overall, we will see simultaneous stagnation (falling or slow growing real GDP) and inflation (rising average prices).

This will be worse than previous periods of macroeconomic instability because of Republican-caused decreases in the power of automatic macroeconomic stabilizers such as food stamps (SNAP), Medicaid, rental assistance for low-income people, and Social Security disability benefits.

Stock And Housing Bubbles

In addition to the risk of price inflation in goods and services is the risk of asset pricing instability in the stock market and housing. I wrote a draft of this paper before I knew about the coronavirus. In that draft, informed by others (particularly the writings of Yale professor Robert Shiller), I expected bursting bubbles in stocks and housing. The price of stocks have now substantially declined and housing will follow. Recession will follow that, but this time along with inflation.

Managing The Peril

Economic journalist Wolf Richter looked at delinquency rates for people holding credit cards at smaller banks, a proxy for lower income people. He finds this credit card delinquency rate at 7.05% in the fourth quarter of 2019, higher than this rate was between 2008 and 2009 during the peak of the great recession and higher since 1980.

A decline in economic activity is likely to occur from a decline in domestic macro fundamentals, high economic inequality in both income and assets, weakening in the global economy, executive government branch instability, and the interruptions and closures brought on by the coronavirus. With interest rates already low, the power of the Federal Reserve is limited.

With federal deficits topping one trillion dollars, expansionary fiscal policy is also limited. Democratic economists and policy-makers pay better attention to economic facts on the ground and they have a history of intelligently using Keynesian intervention. They also can combat decreases in hidden quality declines of goods and services by increasing the amount of regulation in those sectors where they occur.

Democrats in charge of steering the economy will give the country a much better chance of weathering these upcoming storms than Trump Republicans, who blindly brought us to this peril.

I want to thank Ugur Aker, Joe Persky, Natalie Davila, Peter Per and Barbara Balkin for giving me comments and ideas. Any inaccuracies or mistakes are solely mine.

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Previously by (or including) Steve Balkin:
* The Maxwell Street Muddle.

* Maxwell Street Malfeasance.

* City Needs New Policy For The Maxwell Street Market: An Open Letter To Mayor-Elect Emanuel.

* The Maxwell Street Market Vendors Association Wants You To Like Them.

* The Olympic Bid That Could Have Been.

* Lil Scotty: 'Give Him His Flowers While He Lives.'

* Remembering Lil Scotty: Bluesman, Buttonman.

* Remembering Lacy Gibson, Master Bluesman.

* Here's To Bobby Too Tuff.

* Continuing The Political Revolution.

* Reducing Chicago's Violence: A 10-Point Plan.

* New WPA Stamps Are a Good Reminder To Bring Emergency Public Employment Infrastructure Programs To Violent Neighborhoods.

* Item: Chicago Efforts To Stop Genocide Of Rohingya People In Myanmar.

* Saving The Rohingya: Stopping Genocide And Volunteering In Chicago.

* Blues Jam Memorial For Chicago Great Arthur "Sambo" Irby.

* An Assault Weapon Proposal.

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Steve Balkin is a professor emeritus of economics at Roosevelt University. He welcomes your comments.



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