Economic Take Podcast Transcripts

Welcome! I’m Jim Glassman, Head Economist for JPMorgan Chase Commercial Banking.

Financial markets don’t usually do well with surprises. Folks tend to react first and think later.

And reactions are more extreme when markets are illiquid, like they often are on Black Fridays. But honestly, I thought the market’s reaction to the news that there’s a new COVID-19 variant bubbling up out of southern Africa a little weird.

Haven’t we just been through this before? The summer wave of delta variant cases did slow us down a little bit, but didn’t force us to shut down like we did last year. Over time we have been getting better at managing around these issues. And the pharma companies are telling us that they can tweak existing vaccines and have something up and running within 100 days should the vaccines need upgrading. Remember, it took a year to do that the first time.

But the strangest thing about last week’s market reaction is that you would think observers would see a new headwind as something that would give us a little break from the bottlenecks and inflation pressures we’ve been consumed with all year. Wouldn’t a growth slowdown stretch things out and give businesses time to catch up?

Which gets to the inflation issue. I think most people understand that what we’re dealing with is not your typical inflation dynamic, and that the upheaval from the pandemic, which in time will pass, is the real culprit.

The auto industry, which accounts for more than half of the rise in consumer inflation this year, can tell you all about this. Automakers aren’t struggling to meet off-the-charts demand. It’s just that they can’t get enough microprocessor chips to meet today’s even muted demand.

But here’s the thing: People get superstitious about anything related to inflation. Even though we know what the culprits are, we tend to link inflation headlines with monetary and fiscal policy actions. It’s worth thinking about what folks worry about, because the claim is that the paper trail of money caused by the policy response hasn’t gone away and will haunt us in the future. You hear versions of this all over social media.

So, let’s go through the stories.

First, “The Fed’s asset purchases are like ‘running a printing press.’” Actually, no. That’s a confused story that people think they remember from their money and banking courses ages ago. It was proven to be wrong a decade ago. Here’s why that idea was wrong. Yes, the Fed is printing something, but it’s called reserves. Printing reserves is not the same thing as printing money if no one is borrowing from their banks. That, by the way, is why the boatload of reserves the Fed has created this past year has just piled up as excess reserves. Excess reserves mean that the “money” the Fed is printing is just sitting in quarantine and not working its way into the credit market—and so not morphing into money.

Second, what about the money the government “printed” when it released $7 trillion of funds to help people? I mean the money folks got that they saved temporarily instead of spending went right into their bank. Retail deposits went up, and so did the M2 measure of money that captures that. But fiscal actions don’t create money. They just move chairs around on the deck. Only the Fed can create money. That tells you that the folks who loaned the government money to finance the transfers last year must have made adjustments—sold something to buy the Treasuries—that you don’t see in the M2 measure of money.

Third story—What about demand? Demand has recovered nicely, thanks to the help from government policies. But is demand off the charts? The auto industry would beg to differ. Employment is still way below where it was. And the improvement in labor productivity is implying that we may need still more demand in order to achieve the Fed’s goals. The problem is centered in the delayed wakeup on the supply side.

Here’s another one you hear, and it sounds sensible enough until you connect a few dots. Labor pay is rising rapidly--4% over the last 12 months according to the employment cost index, and that’s up from 2% to 2.5% in earlier years. Isn’t that forcing businesses to boost prices? That may be true for some. But you know this is not the issue more broadly, because in the aggregate, unit labor costs have been falling and profit margins are rising. In other words, improved business productivity is paying for the added rise in business labor compensation.

Here’s another story—reasonable, sort of—goes like this. OK, so maybe today’s bottlenecks are the real culprit, but doesn’t all that money that is showing up in the Fed’s monetary measures like M2 represent chickens that will come home to roost? Not sure why chickens coming home is a bad thing, but it’s an old expression warning about how curses can come back to haunt you. I don’t think this is a big threat. As you may know, M2 surged 25% last year. Over the past year M2 growth has slowed to half that pace and will continue to slow. But that’s a couple trillion dollars of M2 that is out in the system.

The problem is that it’s become very difficult to connect the dots between money measures and the economy in recent decades. That’s because people respond to interest rates when they invest their savings. The velocity of M2 has plunged to the lowest level in memory. That isn’t surprising, because interest rates are back to the lowest they’ve been since the time of the Ancient Greeks. Seriously—pick up the interesting book “A History of Interest Rates” by Sidney Homer and Richard Silla. When rates are low, there isn’t much of a penalty for holding your savings in a bank deposit. At the same time, financial innovation has made it much easier to move savings around from instruments that aren’t classified as money to bank accounts that comprise the money supply.

If this sounds too dismissive, I’m not the Lone Ranger. Consider the forecasts of the staff at the Federal Reserve Board that you could read about in last week’s FOMC minutes. The staff’s views are worth keeping an eye on, because they tend to be more dispassionate than most of us. The staff forecast at the Federal Reserve Board anticipates that the level of real GDP will remain higher that the economy’s potential level.

On demand, this is what they have to say: “In 2022, real GDP growth was expected to remain close to its [5-6%] 2021 pace, supported by the continued reopening of the economy and the resolution of supply constraints in most sectors. With the boost from these factors fading, real GDP growth was projected to step down noticeably in 2023 and to be close to potential output growth in 2023 and 2024. However, the level of real GDP was expected to remain well above potential throughout the projection period, and the unemployment rate was expected to decline to historically low levels.”

Despite all that, on inflation: “PCE price inflation was … expected to step down to 2 percent in 2022 and to 1.9 percent in 2023 before edging back up to 2 percent in 2024”.

Forecasters are looking for another strong jobs report this Friday, with unemployment down. The number of people getting benefits from unemployment insurance programs is back to where it was prior to the pandemic. That points to another big step back to where we were in February 2020. I’m referring to the 3.5% unemployment rate that we saw before the pandemic swept us off our feet.

Take a look at jpmorgan.com/cb for more economic analysis.

Hi there! I’m Jim Glassman, Head Economist for JPMorgan Chase Commercial Banking.

The trends in the air travel industry are quite insightful, because they’re timely. Usually, you know what happened the day before. And because this industry has been in the vortex of all the pandemic upheaval.

Flying was never off-limits when COVID-19 came ashore, unlike what happened to customers of restaurants, pubs or fitness centers, because the airlines have good ventilation systems and because they’ve taken a lot of measures to clean the aircraft and keep people safe on planes. 

And you may have noticed that in contrast to the early days, most of the seats are now filled, including the middle seats. But all the activities that tend to drive travel demand—domestic and international tourism as well as business travel—have been squeezed by the pandemic. And that’s why the air travel system suffered as well. In fact, it turns out that the back and forth of air travelers seems to be very sensitive to the waves of COVID-19 infections.

The air travel industry saw a remarkable recovery earlier this year, with the number of people passing through TSA checkpoints recovering to about 14 million weekly by summer. That was a big improvement over the virtual wipeout in April 2020. And it wasn’t that far below the 16 million people who were flying every week before the pandemic.

The industry hit a bit of an air pocket this fall however, where there was a brief flareup of people sick with COVID-19 late last summer. That seems to be behind us, and air travel is picking up again. Thanksgiving travel is expected to be fairly frenzied.

Looking ahead, air travel is likely to get back to where it was prior to the pandemic fairly shortly. There are a number of reasons to think this may be so.

For one, we’re learning that the COVID-19 vaccines are pretty effective—certainly more effective than the flu vaccines. Boosters will give a little extra insurance. And in a sign that the treatment of the disease is improving, fatalities represent a falling percentage of new cases.

Secondly, we’re beginning to lift some restrictions on international travelers with the appropriate procedures for testing and checking for vaccinations.

Third, business travel really holds the key to the last leg of the recovery of the industry. Business travel is almost certain to return to pre-pandemic levels. Businesses that have to manage overseas operations find that it is virtually impossible to do so virtually. At the same time, although many existing operations can be managed reasonably adequately by virtual communications, it’s impossible to prospect for new business over the internet.

Fourth, the opinions of the business planners who are recalibrating future aircraft needs are useful to monitor. Aircraft manufacturing is recovering steadily. We’re not there yet, but aircraft production has recovered about half of last year’s shrinkage. And aircraft manufacturing now is about 55% of where it was at the peak in late 2018 before Boeing’s troubles.

More telling, orders have picked up even faster than production and now are running higher than the number of new airplanes coming off the assembly line. That means the backlog of orders for non-defense aircraft now is higher than it was in 2018. It’s almost back to the $700 billion peak level reached just before the pandemic. We’ll get another update on this story with this week’s October report on durable goods.

Bottom line: This nightmare is coming to an end for the air travel industry and all those who depend on it. 

Take a look at jpmorgan.com/cb for more economic analysis.

Thanks for tuning in! Jim Glassman here, Head Economist for JPMorgan Chase Commercial Banking.

Last week the Federal Reserve published its quarterly Financial Stability Report. This is a legacy of the last crisis, when financial instabilities caused by housing speculation did so much economic damage. In this report, the Fed monitors the valuation of financial assets, borrowing trends by households and businesses, leverage within the financial system, and funding risks which can cause problems if there is a run on particular institutions or sectors.

Last week’s report noted something that has become a very popular opinion, that “across most asset classes, valuation measures are high relative to historical norms”. This is very interesting because the Fed staff is very thoughtful and balanced in its assessment of economic and market trends. It raises two issues.

Most people wonder, why doesn’t the Federal Reserve target asset prices along with its other congressional mandates of maximum employment and 2% inflation over the longer run? It’s a big issue that has dogged monetary policy experts for ages. I think you’ll find the answer pretty straightforward and obvious.

What level of stock market valuation should the Fed target? There are lots of smart people at the Fed to think about this. But being smart is less important than knowing about the activity of the millions of businesses out there. As capable as the Fed is, it doesn’t come close to the collective knowledge that bubbles up through the ranks of millions of investors who themselves are trying to figure out the appropriate value of companies.

The Fed cares a lot about the stability of the financial system, and the evolution of asset values shapes its views of the outlook because unexpected changes in wealth drive consumer spending and demand. But that’s a far cry from targeting the level of asset prices. The Fed has its hands full just managing the two goals that Congress has given it: maximum employment and 2% inflation over the longer run.

But here’s what intrigues me about the Fed’s assessment of asset valuations, that “valuation measures are high relative to historical norms”. Of course, that’s correct. Most people agree with the Fed there. But I ask myself, why are historical norms relevant?

Take the rate that investors use to discount future earnings—what determines the price-earnings multiples that they use to value a business. Turn the camera over to the macroeconomics debate. It’s well known by now—and has been since the turn of the new millennium—that the natural level of risk-free interest rates has been falling. Guess why? Real GDP grew about 3.5% annually on average in the last century, through the ups and downs of many business cycles. It has slowed to half that pace in the last decade. And the Congressional Budget Office, which has been flagging this economic story in its projections of a growing fiscal imbalance, assumes that this is the way it’ll be for a while.

Japan probably was the first to feel this story. We learn in our economics courses on the theory of longer-run growth that the natural level of real interest rates is highly correlated with, if not equal to, the economy’s growth potential. Research from the Fed has shown that the equilibrium level of the federal funds rate has come down notably. Other factors are at work as well, including a secular decline in what we call the real-term premium—the compensation that investors need to commit funds to long-term projects.

And some time ago, we economists realized that massive international trade imbalances between emerging economies and developed economies was lifting the level of global saving. If you heard that Americans were going to save more, surely you would guess that interest rates in the U.S. would stay low, just to remind us that this global saving issue isn’t really that difficult to grasp.

Why does this all matter? If investors require a lower return when thinking about the net present value of a company’s earnings, the price-earnings multiple that they use to value a company would rise. If discount rates have come down a couple percentage points over the decades, the historically normal 16-times earnings multiple would be more like 25-times earnings today.

Second, business earnings look nothing like historical norms, and haven’t since the late 1990s. Historically, after-tax profits move up and down over the course of a business cycle, but at the end of the day have tended—until this millennium—to revert to roughly 6% of GDP.

But since the late 1990s, after-tax profits have been trending up and have been holding around 10% of GDP despite several very disruptive economic cycles. This is nothing like the historical norm.

Now, assertions that historical norms no longer apply typically are viewed with skepticism—and should be. But most people would not quarrel with the claim that the interest rate environment looks nothing like the past. Most people would not quarrel with the claim that technological innovation is changing the way our economy works and, of course, benefiting the businesses that are spearheading the digital revolution. And most people would not quarrel with the idea that the internet has opened the eyes of the rest of the world to how life could be if they could join the global community and focus on economic development.

If we connect the dots between all of those things and the way we value businesses, it’s not hard to see why historical norms might not be that relevant for the valuation of assets today.

Turning to the topic of the day, inflation, the convulsion of price increases that we’re all focused on have “pandemic” written all over them. We know all about the dislocations in the global supply chain and the gridlock in the transportation system that are the source of the problem.

I think it may be useful to know that the problems are highly concentrated in the commodities arena. In other words, the items that are produced abroad and then shipped here. Inflation in the CPI for commodities has swung from 1.4% annually on average in this millennium, before the pandemic, to 10% over the past year. Inflation in the services components has increased by only about 1 percentage point. Inflation in commodities is much more volatile than services and tends to reverse course abruptly. Part of the reason for this is that it’s a lot easier to expand capacity to satisfy a rise in demand for commodities than it is to find the workers to meet the expanded demand for services. 

The outlook for inflation is uncertain, of course. But I think it’s interesting that there is a huge dichotomy between the conversation of the day that is all about inflation versus the view of the Fed, the professional forecasters, and bond investors, that to a large degree assume that inflation will eventually return in line with the Fed’s longer-run target of 2% inflation.    

Have a good week and stay well.

Take a look at jpmorgan.com/cb for more economic analysis.