A spectacular spectacle in the US

The US government deficit is now close to 20% of the Gross Domestic Product (GDP). You will get spectacular economic growth for that. At least in the short term.

You don't have to be Einstein for it: throw a huge bucket of money into an economy that is already recovering from some kind of meteorite impact and you get a spectacular spectacle. Place of performance is the USA. The various stimulus packages from the previous and the new governments together form the bank with money.

When the crisis broke out last year, policymakers responded with the so-called CARES legislation. The amount of aid granted in this context amounted to more than US$2.000 billion. Another $900 billion package came in December and the new administration pushed another $1.900 billion package through Congress earlier this year. How much that is is shown by the first graph.

The Netherlands makes different choices
In the 12 months to March this year, the federal government posted a budget deficit of more than $4.000 billion, nearly 20% of GDP! Compare that with the Netherlands. In the Central Economic Plan, the CPB estimated the budget deficit of the Dutch government at 4,3% GDP last year and a deficit of 5,9% is estimated for the current year. Clearly different choices are being made here.

Leading economist Larry Summers has been arguing for some time that the size of all those US packages has been "wiped out of the pot" (in my words) and that things will eventually go wrong. For the time being, in any case, it is absolutely clear: if you throw that much money into the economy, you will get a strong rebound in spending and activity.

US consumers already received checks from the government under the CARES Act last year. The December package again included checks for many people at $600 per person. New $1.400 checks for anyone earning no more than $75.000 a year are part of the latest stimulus package. That's a lot of people.

Retail Sales Explosion
I don't know exactly how far the checks are distributed, but they are being issued: retail sales are exploding. In March, it rose 9,8% from February and 27,7% from March 2020. Now the year-on-year comparisons may be less meaningful, as spending took a hit last year.

So there is what is called a 'base effect'. The biggest blow to retail sales came in April last year. If spending in April this year is the same as in March, a year-on-year growth rate of 50% will appear. However, these kinds of comparisons say more about the blow last year than about the recovery now. In the following chart I therefore show the turnover in absolute amounts. Seen in this way, too, the expenditure is impressive.

Labor market and business confidence are improving strongly
The improvement in the labor market, which has stalled somewhat in recent months, now seems to be continuing. The weekly number of new applications for unemployment benefits fell sharply in the week of April 10: 567.000 from 769.000 a week earlier. Easter may have played a part in this. So we'll have to wait and see if the decline continues, but for now it is obviously a very positive development and it fits the picture painted by other indicators.

It is therefore not surprising that the confidence of entrepreneurs is growing. The NFIB index, which measures SME confidence, rose to 98,2 in March, from 95,8 in February. A few regional business confidence indices for April have now also been published.

The Philly Fed index (measures business confidence in the Federal Reserve district of Philadelphia) rose to 50,2 from 44,5 in March. The last time this index rose was in 1973, almost 50 years ago! The Empire State index, a series of the Federal Reserve of New York, rose from 17,4 in March to 26,3 in April.

Consumers and the confidence of entrepreneurs are somewhat ahead of actual production. But it is also starting to come to life. In March, manufacturing production in the US increased by 2,7% compared to February and 3,1% compared to March 2020. The growth in business equipment production in particular is strong at 5,7 % year-over-year, a sign that companies are investing quite a bit.

Nice, but there is also a bulk inflation in the pipeline
This is, of course, all wonderful. But it also raises questions. I leave the question of the sustainability of public finances on hold here. It's not very acute. More urgent is the question of what will happen to inflation in such a strong recovery. The answer to that question is twofold.

Not much is happening at the consumer level for the time being. US inflation did rise somewhat in March, but that is mainly the result of higher energy prices. 'Core inflation', ie the rate of inflation excluding energy and food, is still well below 2%. But maybe that's the calm before the storm. There is a lot of inflation in the pipeline.

This has everything to do with the increased raw material prices, but also with the logistical disruptions in the world that have led to a multiplication of freight rates and limited availability of various materials. The following chart shows the development of US producer prices. To make it a bit exciting, but also to show the most recent development more emphatically, I show here the price development over a period of 3 months and then expressed as an annual growth percentage. So if the pace of the last 3 months continues for a year.

Unfortunately these series don't go back further than 2010 or at least I can't find them any further. However, you also see this image elsewhere in the world. In Germany, for example, wholesale prices are published for which a long historical series is available. Again, I have taken the change over 3 months and converted the growth percentage to an annual basis. The increase in the last 3 months is the highest since the early 70s. 

Keep in mind that the European economy is not growing nearly as strongly as the American one. So this is really about what economists call 'cost push' inflation, as opposed to 'demand pull'. But in the US, that 'demand pull' may also be showing itself, now that the economy is being whipped up with stimulus packages.

The big question now is whether this sharp rise in 'inflation in the pipeline' will continue and how much of it will eventually end up in consumer prices. The relationship between producer prices and consumer prices is not very tight. And since what we observe now is so unusual, any prediction is surrounded by significant uncertainties.

Wages are an important link in the inflation process. Since spending is growing sharply and entrepreneurs are expanding production considerably, new staff must also be recruited. Despite the fact that there are 10 million fewer people in paid employment than before the pandemic, the labor market already seems to be tightening considerably. This affects wage formation.

The last survey of entrepreneurs that the Philadelphia Federal Reserve did and whose confidence indicator I showed above also asked some questions about wage growth. The answers show that the tighter labor market and at least some of the inflation in the pipeline are likely to translate into higher wage and price increases. Nearly 60% of respondents said payroll budgets have increased since the beginning of the year. Nearly 40% thought they should increase wages more than planned and 21% think that wage increases should take effect earlier than planned. With regard to total wage costs, companies expect an average increase of 4 to 5% this year.

I think there's a good chance that US inflation will pick up quite a bit this year. Initially, this is the result of passing on the cost increases that have already occurred. An inflationary process is likely to kick in later in the year and into 2022 based on those projected higher wage increases, coupled with continued rapid growth in spending and output.

According to documents released by the Fed in March at the time of its last meeting of the FOMC (the policy-making committee), none of the 18 members expect a rate hike this year. That could work out well. A first rate hike before the end of 2022 is expected by only 4 out of 18 FOMC members and only 7 out of 18 expect a first rate hike before the end of 2023. So the majority expects the Fed to leave rates unchanged for almost 3 years. I can't imagine that.

China has made up for economic damage from the pandemic
The Chinese economy has already started an impressive recovery in the course of last year. In the first quarter of 2020, the Chinese economy shrank by 9,8% from the previous quarter, but then posted quarterly growth rates of 11,5%, 2,7% and 2,6%, respectively.

This morning (Friday, April 16), Chinese statisticians reported quarterly growth of 0,6% in the first quarter of 2021. Due to the base effect, year-over-year growth came in at 18,3%. That is an impressive figure, but it was a bit disappointing. If you put the last 8 quarters together, you still have 12,2% growth or let's say 6,1% per year. That is very impressive, because it implies that the production loss due to the pandemic has more than been fully compensated. It is therefore no longer possible to see from the total production level that there was a pandemic, it is as if the economy has continued to grow during the pandemic.

In the course of last year it became clear that consumer spending recovered less smoothly than industrial production. The March figures suggest that the picture is changing. Consumer spending is also picking up fast. Retail sales in March were 34,2% higher than a year earlier (from 33,8% in February). Industrial production growth slowed down somewhat: +14,1% in March against +35,1% in February.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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