If you are a long-term Fed watcher, as I am (for the past 25 years), you cannot help but to notice the word “transitory” appearing in Fed statements. Dictionary.com defines “transitory” as; “lasting only a short time; brief; short-lived; temporary.”
The question I must ask is: How long must conditions persist before they are no longer considered transitory?
The Fed, as well as many financial industry economists and market strategists, believe that soft inflation pressures, low-2.00% growth and low-to-mid 2.00% wage growth are “transitory. However, these conditions have been steadfast, dating back to before the financial crisis.
Core PCE since 1990 (Source: Bloomberg):
The Fact is that, except during the Housing Bubble, Annual Core PCE (the Fed’s favored measure of inflation pressures), did not run at or above the Fed’s preferred level of 2.0% for 20 years. So tell me, which is transitory, sub-2.0% inflation or 2.0% inflation? If I were to run a longer-term chart, it would support the idea of 2.0%-plus inflation. However, 20-years is a heck of a long transitory period. Transformational might be a better word to describe the 20 year trend of lower inflation.
During the past few years, voices from around the financial industry have suggested that an era of lower inflation might be longer lasting. This has drawn the ire of economic academics, who often describe such notions as amateurish and ill-conceived. Why do these learned men and women dismiss and disparage new ideas? I believe it is because they feel as though their life’s work is being attacked.
The first defense of the establishment is to illegitimatize new ideas. For people who have built their entire careers on the understanding or even creating models, the idea that the construct of the U.S. or global economy has changed sufficiently to call their models into question must be frightening. History if full of learned individuals who refused to acknowledge change. Battlefield generals during the Civil War used tactics of the Napoleonic era, with horrific results. In the early stages of the First World War, Allied commanders order charges across open ground which were cut down by German machine gun fire. In World War II, the French believed there were safe behind the Maginot Line, never grasping changed brought about by fast armored vehicles and airborne troops. Of course, sometimes old school thinking, such as during Vietnam when U.S. military planners foolishly decided to build the frontline U.S. fighter, the F4 Phantom II, without a gun, proves correct.
My point is; relying on models and theories when reality says otherwise is foolish and can even be dangerous.
For nearly 20 years, the data has been saying (very loudly), that the inflation and growth story has changed and changes are structural in nature. Aging demographics, technology and globalization are all disinflationary. To think that the U.S. economy is just going to return to old conditions “just because that is the way it is,” isn’t amateurish, it is unrealistic (harsher words come to mind).
As an economy changes (and it has changed during the past 20 years), the monetary and fiscals policies needed to keep it running at peak levels must change. The maximum speed of growth the U.S. economy can reach may have changed as well. Because the changes have occurred over 20 years, many participants in the economy may not realize just how much the economy has changed. During the past 20 years we have seen the internet bring great efficiencies to businesses and consumers.
These efficiencies have reduced or eliminated the need for many local shops, bank branches and mid-level white collar cubicle jobs. Want to publish a book? Do so online. No publishing company or bookbinder is necessary. Want to start a consulting business, newsletter, etc.? Do it online.
What about demographics? The first baby boomers entered their 50s in 1996. That was about the same time the internet began to emerge and cell phones became an affordable means of communication for the masses. It is also about the time that inflation began to trend at much lower levels. Since then, these disinflationary influences have become a more dominant within the economy. These fundamental changes within the U.S. economy probably require different policy responses. Still, growth and inflation might not return to prior conditions.
Why should conditions return to “normal?” Technological advancements have brought goods, services, education and healthcare within the reaches of the masses. Prior to Henry Ford’s moving assembly line, the automobile as a plaything of the wealthy. Even a modest car was out of reach for most U.S. households. Following the introduction of the Model T, automobile prices declined for a decade, in nominal as well as in real terms. Long distance travel was once an expensive proposition. In the mid-19th Century, most people lived their lives without ever venturing a few miles from home. Safe and more efficient trains and ships changed this. Practical automobiles and airplanes lowered the cost of travel further and/or made it more efficient.
This was not without disruption. Few people travel on ships, except for pleasure cruises. Passenger rail in the U.S. is mainly of the commuter variety. Many investors holding railroad stocks and bonds ended up disappointed when the “old normal” did not return. An aging demographic tends to result in less discretionary spending and more spending on necessities, such as medicine and healthcare. Thus, the U.S. consumer is unlikely to drive growth what in the same way he/she did during the past 40 or so years.
The truth is; economic “normal” is constantly changing and evolving. A demographic shift toward a younger population could push conditions toward the “old normal.” A plateauing of technological advancements could reverse recent trends, but none of this seems very likely in the foreseeable future.
Instead of calling current conditions “transitory.” Why not call them what they really are, economic reality. Current conditions will persist until technology, demographics and consumer tastes/values change. It will probably take different policies than in the past, just to keep inflation above 1.5% and GDP growth above 2.0%. Thus, conditions are probably not transitory after all.
Respectfully,
Thomas Byrne
Director of Fixed Income
Wealth Strategies & Management LLC
570-424-1555 Office
570-234-6350 Cell
Twitter: @Bond_Squad
E-mail: thomas.byrne@wsandm.com
