There’s a Shortage Of …
Got some bad news. We regret to inform you that we are raising the price of this newsletter, with immediate effect. We tried to keep costs down, but with shortages of paper, toner, and shipping bottlenecks, we will not be making an adequate return on the newsletter. So, we are doubling the price. I know, 100% is a huge increase, but that pales in comparison to other price increases, so consider yourself lucky.
All joking aside (okay, that’s a hollow commitment), it would be very easy to fill up my entire 6 page allotment with anecdotal accounts of inflation and supply shortages given how pervasive they are. It has been utterly fascinating to come into work and see a news story every single day about something new that is in short supply. We’ll go down that road, but then we’ll get to the heart of the inflation matter, what really matters: the labor market.
The subject of inflation is of extreme importance to financial markets, monetary policy, the economy, and pretty much anyone who is in any way attached to any of the above (which is everyone, unless you are 100% off the grid, living off the land, and you don’t own or rent that land). Inflation can be dangerous because it eats away at your long-term purchasing power and debt service inevitably takes over the fiscal budget, requiring higher taxes. Many of us take for granted that we won’t have runaway inflation, simply because we haven’t had it in this country in the last 4 decades. What were the ingredients necessary to produce it in the mid-late 1970s? There is no consensus answer on this question, and that’s why the nascent inflation of 2021 presents a lot of “what if” questions. But there is broad agreement on why inflation has been contained since the 1970s: plentiful growth in the labor market (demographics + immigration) and globalization. All 3 of these forces seem to be going in reverse now.
You don’t need government-produced inflation statistics, or a Fed Chair’s declaration, to know if prices are rising. You know it because you observe it. And while one anecdotal account doesn’t tell a complete story by itself, if you put a lot of pieces together, it starts to look like a completed puzzle. Who is the first to notice that inflation is not 2% anymore? That’s right, the average consumer. Check out the following chart, which is Consumer Sentiment:
Why in the world is consumer sentiment (right axis) suddenly lower than in the depths of the pandemic last spring?? We have a resurgent economy, more jobs open than people know what to do with, and the average consumer still sitting on top of most of their pent-up savings from the travel/entertainment hiatus and fiscal stimuli. And yet consumers are suddenly miserable?? Large drops in consumer sentiment are typically associated with recessions, which are indicated by the blue areas. A couple other non-recessionary drops were in fall 2005 and fall 2011. What do 2005, 2011, and 2021 have in common? Inflation! In 2005, a sudden spike in energy prices courtesy of Hurricane Katrina kicked commodity inflation into high gear for 3 more years, although it didn’t really metastasize into core inflation. 2011’s energy spike was short-lived.
Dig a little deeper into sentiment (and other) surveys and you find that inflation is a very real concern for consumers. They don’t like inflation right now, and they expect inflation of OVER 5% IN 2022 and inflation of 4% over the next 3 years. So much for the Fed’s assurance of a quick return to 2%? Consider that median household savings in the U.S. is roughly $20,000…that’s the total amount in savings, bank accounts, investment accounts, and retirement accounts, for the median American family. Half of American families are below that level. When you start to add thousands to the median American family’s expense line, there isn’t much margin for error. You might also take note of the President’s disapproval rating, now at 51%. While covid’s resurgence and Afghanistan undoubtedly have hurt him, his disapproval rating was 36% in January, when covid was worse. I guess that covid outbreak was on Trump.
Now, don’t accuse the Fed of ignoring common man. Fed Chair Jay Powell is not blind to the price of arugula. He has been very busy trying to get in front of the inflation problem, ever since late last year. His weapon of choice has been to tell us that year-over-year inflation comparisons by spring 2021 would look high, and that’s because prices fell 1.2% in spring 2020 amidst the lockdowns; it’s very unusual for prices to fall at all. Remember when the price of oil fell to negative $37 last April? So, he told us all to look the other way this spring, because it was “transitory,” meaning (if we understand the definition correctly) it would soon end after that. Plus, by then, all those pesky supply-chain bottlenecks would be cleared up.
Powell thought he and his basic math skills were teed up to win the battle, but it’s looking more likely he has lost the war at this point. Real-time inflation became +5-7% every month as spring turned to summer. Powell persistently hauls out the “transitory” moniker, but keeps pushing it off into the future. It reminds us a little of Baghdad Bob, the head of Saddam Hussein’s intelligence department. During 2003, when the U.S. was at war with Iraq, Baghdad Bob was a permanent fixture on TV, denying that Iraqi forces were succumbing to American forces. During some live interviews with Baghdad Bob, buildings behind him were being bombed.
To his credit, Powell is now suggesting that the Fed start “tapering” (reducing) its bond purchases, which it should have done a year ago, but hey, time flies. Raising rates would come sometime after the tapering is complete. Now, let’s remember that Powell faces a lot of political pressure to keep the money printing presses rolling, to keep interest rates low because the U.S. has issued trillions of debt and Congress hopes to borrow trillions more to finance its social spending bill. But still, we would love to know whether he is actually buying what he is selling. We want to believe that Powell is an intelligent man and actually believes inflation has already become more pervasive, but has caved to pressures to keep interest rates low.
To ignore the evidence of inflation in 2021 is to ignore both statistics and anecdotal evidence. Pretty sure even the guy living off the grid in the woods has noticed. In case you’ve not been keeping a list of shortages and sudden price spikes, here’s a starter list:
- New cars, used cars, rental cars (shortage of semiconductors + rental agencies liquidating their fleets in 2020 to raise cash, only to desperately want the cars back in 2021)
- Gaming consoles (Nintendo, Xbox) and PCs (remember when PCs were going to be made obsolete by iPads?)
- Any parts machined by machines that use semiconductors
- New housing (construction materials + labor + gun-shy developers), anything else constructed, furniture, appliances
- Plastics, chemicals, chlorine, foam that goes in furniture cushions (chemical plant shutdowns in Texas during deep freeze in February + plant shutdowns thanks to Ida)
- Natural gas in Europe (not enough supply from Russia or U.S. LNG…liquified natural gas), leading to significantly higher electricity prices, especially in the U.K., also home to gasoline shortages (shortage of tanker truck drivers)
- Fertilizer (Europe fertilizer plant shutdowns because electricity prices rose too much), ammonia (because fertilizer plants shut down), CO2 for medical uses and soft drinks (because ammonia is in short supply)
- Electricity in China (not enough coal)
- Rubber gloves to the restaurant channel (now $90/1000, up from $18)
- Bikes, toys, Nike shoes, tennis balls, golf balls
- Paper, paper cups, paper bags, toilet paper (again!?)
- Chicken breasts, chicken wings, beef, bacon
- Lunchables (this wins the prize for most hilarious of all American shortages; apologies if your life has been malaffected by the Lunchables shortage)
- Alaska salmon and halibut (because the White House won’t let it come through Canada)
- Aluminum and steel for food cans, any food that goes into cans
- Coffee, Chik-fil-A sauces, Taco Bell, school lunches
- Covid rapid tests, blood donations
Frankly, the list should also say “Anything imported,” given the shipping problems at every stage of shipping. Every day in the past few weeks, the number of container ships moored off Long Beach has gotten larger. But before you throw the longshoremen under the bus, ship berths were 60% higher in August than pre-pandemic. Supply simply can’t keep up with demand.
In all fairness, we should show a list of things that are in greater supply than normal:
- Invasive bugs (Armyworms)
Is there any hope that these shortages will abate? The good news is that companies are willing to spend money to expand capacity where the supply-chain bottlenecks reside. For example, transportation equipment orders shot up 5.5% in August from July, now 15% higher than the run-rate at the end of 2020. But labor is also needed to run that equipment. So will there be enough labor?
The Great 2021 Labor Shortage
Most of the goods shortages today can be traced to a shortage of labor to either produce or ship the goods. True, weather has played a role, as well as excess demand, some directly created by the pandemic, some indirectly. It’s also possible that consumers and companies are over-ordering in order to restore depleted inventories, on top of their already higher demand. How on earth did a pandemic and an economic shutdown create excess demand? Because so much of the service sector necessarily needed to shut down (indoor dining, concerts/shows, travel, even gyms and salons), most consumers suddenly weren’t spending nearly as much money as they had been. Then the government sent out stimulus checks…twice. Savings shot up. Finally, a sudden interest in la casa sparked a domestic spending boom—home office, technology, home improvement projects, landscaping and gardening—borne of workers spending more time at home. Voila, a virtuous cycle for goods spending, shown here:
Nonetheless, I think we all have a sneaking suspicion that the American supply chain has proven to be the opposite of resilient. Thanks to just-in-time manufacturing, efficiency at all cost, and globalization, sourcing parts from around the world and assembling them far away, we are slave to factors far out of our hands.
But back in the states, it is becoming patently obvious that we have a labor shortage on our hands. This is not new information to anyone who drives anywhere and sees help wanted signs at basically every business, or knows a business owner who is down many workers. In case anyone dares suggest we are relying too much on anecdotal information with this observation, here is the data on job openings, compiled by the Bureau of Labor Statistics. Note July’s 10.9 million number is 32% higher than pre-pandemic:
This comes at a time when the actual number of people employed is still 5.3 million less than it was in February, 2020, peak employment. Job openings were 7.0 million then. Technically, demand for labor is still short of the 2/20 high by 1.4 million jobs. But supply of labor seems to be off by millions more than that. Why?
This is the point where we could veer into issues that could gratuitously be called “political.” We try to go out of our way in this newsletter to stick to the facts, albeit with a capitalist bent. Admittedly some of our writers do a better job than others (I won’t name names).
The labor market has gone through more upheaval in the past 1 ½ years than it did in the previous 20 years, mirroring the upheaval we have all felt. Covid deaths have totaled 141,000 for ages under 65. Drug overdose fatalities rose 30% in 2020 to 92,183, a record. Combining both, and using the U.S. labor participation rate of 61.7%, we estimate a loss of 100,000 workers. Not an insignificant number, but not the main reason.
The bigger sources can be lumped into a few big categories: second earner parents, scared of covid, couch surfers, and retired. The couch surfing population was supposed to have returned to the work force by Labor Day, when federal extended unemployment benefits expired, leaving the unemployed with only state benefits, which generally translate into an existence of subsistence. But alas, statisticians have not yet seen this cohort return, even as the numbers show millions rolling off the PUA (Pandemic Unemployment Assistance). Some could still be fearful of contracting covid in the workplace. Some have underlying health conditions, and perhaps this prevents them from getting vaccinated (yes, we will touch on vax mandates in a bit).
The remaining two issues are by far more significant, and more concerning. Millions of second earning parents have dropped out of the work force to care for kids at home, especially when school went virtual. We need to acknowledge a similarly large cohort of single parents who dropped out of the work force for the same reason, and have been living off unemployment benefits. To call them couch surfers would be unfair. You might rightly ask whether they “should” join the work force once extended unemployment benefits ended, but this typically necessitates finding child care, whose price has shot up and whose availability has dwindled as many day-care centers have closed. Is it enough that starting wages have shot up to $15/hour for most jobs? Sometimes, but only if child care exists for them.
Now that school is back in session, are those second earners returning to the work force? The numbers don’t tell a compelling story. We believe that many have started side businesses or taken to freelance work. We suspect many returned to the work force and found themselves running around like a chicken with its head cut off, like everyone else at their company, because of how short-staffed the company is, and quit. So, the monthly jobs reports might reflect a sort of sloshing around, with people re-entering and then re-leaving.
The numbers indicate that a very large number of people have retired. According to Pew surveys, 3.2 million Boomers retired in 2020, versus 1.6 million in 2019. Many probably didn’t want to work virtually, perhaps if tech adoption was not among their skill set. Many were downsized and just decided enough was enough. Many lasted through the pandemic but have since decided their 401(k) was big enough to retire. This is called the wealth effect, typically used to justify spending by consumers who feel richer, but also applies to workers who feel rich enough to make it on what they have.
Finally, there is undoubtedly a skill-set mismatch, which is common to any disruption in the labor market, such as recessions. Typically, a lot of jobs are lost in industries that were at the “scene of the accident” and take a long time to come back (i.e. bankers, mortgage bond derivative traders, and construction workers after the housing bust/financial crisis), necessitating that they find a new career. Some are lost to automation and “productivity,” meaning that employees find ways to do more with less when threatened with job loss. This time, job losses have been concentrated in the restaurant/leisure/travel sector, and many of the jobs lost were entry-level. Surely some have become drywallers and welders, but probably not many.
At the end of the day, the simple truth is that we have a supply-demand imbalance in the labor market. If you believe in economics (it is a science, you know), such imbalances can be solved with price. If businesses jack up their wages and signing bonuses high enough (and, ahem, raise pay for their loyal long-time employees), they should be able to bring people out of the woodwork to work. Wages have indeed shot up, but the labor shortage seems to keep getting worse. Even Cookie Cottage closed its doors for a stretch. If people don’t want to work in a place that smells like cookies all day, where will they work?
Wages can keep going higher, if and until a couple things happen. First, if corporate profit margins start to get hurt. This hasn’t happened yet, although snidely you could make a strong case that payrolls have hardly expanded because they haven’t hired more workers. Second, if companies can pass along price increases, they can continue to raise pay. This should resurrect memories of “bad inflation” in the 1970s, when businesses raised prices because they had to pay higher wages, and employees demanded higher wages because prices were rising.
Does it all come back to the consumer’s propensity to spend at ever-higher prices? Great question, and you are correct. So far, the consumer has shown virtually no hesitation to pay up. Consumers understand that products are in short supply and sometimes they are just happy to have them at any price. Most of the time we are not happy ($9.99/lb for round steak?), but when faced with few alternatives, we suck it up rather than go without. This could change if/when supply chain shortages are alleviated. But if the labor market shortage isn’t alleviated, it will create a very interesting setup for 2022 and beyond.
The success of government intervention will also play a role. In the U.K., the government this week addressed the tanker truck driver shortage by deploying the military and its fleet of tanker trucks to refill fueling stations. Brilliant. Perhaps unfair timing, but contrast that to the state of New York’s decision this week to mandate vaccinations for all health care workers in the state. Suddenly 53,000 non-vaccinated workers are out of a job. That’s 53,000 doctors, nurses, and health care aides in assisted living facilities no longer providing New York patients with care. That’s just one industry in one state. What if all companies are compelled to mandate vaccinations?
This is where you probably want us to say we are definitively expecting one outcome or another. If so, you must be new to reading our newsletter. Welcome! We are obviously monitoring developments in the economy to guide some investment decisions at the margins. We are looking closely at all our companies to ascertain how resilient they are in terms of pricing power, labor needs, and supply chain management. If the labor shortage proves to not be “transitory,” businesses will inevitably substitute capital for labor. But when I find myself 16th in line at the self-checkout at Kroger because someone wasn’t available to manage the area, it reminds me even this has limits.
Written by John Meyer