We thank Javier Corominas for permission to use an excellent chart from the Global Strategy team at Oxford Economics.
(Oxford Economics [Global Strategy], email to subscribers, “Fixed Income: The Fed pivot will be too little, too late,” Dec., 15, 2022)
In his post-meeting press conference, Fed Chair Jay Powell clearly cited the issues of the impact of rising wages and the dislocation in US labor markets. The chart tells the story perfectly. Note the three causes Powell cited for the shortage in workers. They are Covid-19 deaths, early retirements during Covid, and the lack of sufficient immigration of people who want jobs in America. In my opinion, it may take a very tough period to get these two data series to return to levels which will allow the Fed to stop tightening policy.
The chart above from Oxford Economics shows the trajectory. Perhaps by 2024–2025, a 1.5% GDP growth rate and a 2% inflation rate are possible, as my friend Michael Drury outlined in his McVean Weekly Economic Update for December 16. Today, We can look at the yield curve from 5 to 30 years in the US Treasury market and see that market expectations seem to confirm a forecast of median nominal GDP around 3.5% or so. So, 1.5% growth and 2% inflation seem to be consistent with the present medium-term outlook priced in the markets. It’s getting there that will be painful.
On Saturday, December 17, Torsten Slok, Chief Economist and Partner at Apollo Global Management, observed in an email that 2% target inflation must be taken seriously. He cited a key question and Powell’s answer from the press conference that followed the Fed’s recent decision. (The full transcript of the Powell press conference can be found here: https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20221214.pdf.)
Here’s the question (from p. 20):
GREG ROBB. Thank you, Chairman Powell. Greg Robb from MarketWatch. You spoke a little bit ago. You said that the U.S. looks — it looks like we have a structural labor shortage in the economy. Could you expand on that? Talk a little bit more about that. And, really, are you talking about getting Congress action on increasing, like, legal immigration, things like that? Thank you.
Here's Powell’s answer (from page 21). (The bold font is mine. -David)
CHAIR POWELL. So what I meant by that with structural labor shortage is, if you look at where we are now, as I mentioned there, if you just look at demand for labor, you can look at vacancies plus people who are actually working. And then you can take supply of labor by are you in the labor market? Are you looking for a job or have a job? And you're 4, more than 4 million people short. We don't see — despite very high wages and an incredibly tight labor market, we don't see participation moving up, which is contrary to what we thought. So the upshot of all that is the labor market is actually — it should — it's 3 1/2 million people, at least, smaller than it should have been based on pre-pandemic. Just assume population and reasonable growth and aging of the population; our labor force should be 3 1/2 million more than it is. And that — it can — they're easy, lots of easy ways to get to bigger numbers than that if you go back a few more years. So why is that? Part of it is just accelerated retirements. People dropped out and aren't coming back at a higher rate than expected. Part of it is that we lost a half a million people who would have been work — close to half a million who would have been working died from COVID. And part of it is that migration has been lower. We don't prescribe — you know, it's not our job to prescribe things. But, you know, I think if you ask businesses, you know, pretty much everybody you talk to says there aren't enough people. We need more people. So I tried to identify that in my — in a speech I gave a month ago, but I stopped short of telling Congress what to do because, you know, they gave us a job. And we need to, you know, do that job. Thanks.
Let’s cut to the chase.
1. Neither the Fed nor Congress can do anything about a half a million excess deaths from the labor force cohort age group. That’s right — not all the dead are old people. About 35–40% were working at the time they contracted Covid and died from it. The time to think about that was two years ago. Instead, we got confusing information from some government agencies, and that made pandemic views a political trainwreck. Shame on us for permitting that to happen.
2. Congress could immediately relieve pressure on the labor force by amending a tax law to let older folks who receive Social Security have earnings without an onerous tax penalty. The current Social Security law imposes what amounts to a 50% tax on earned income for Social Security recipients below full retirement age. The tax starts with the first dollar of earnings above $21,240. There‘s a phase-in formula until full retirement age is reached. Above full retirement age, there is no limit. (See “Fact Sheet: 2023 Social Security Changes,” https://www.ssa.gov/news/press/factsheets/colafacts2023.pdf.)
Here’s a test. Ask Social Security recipients you know if they would seek some additional income by working if there were no tax penalty. Ask them if they are okay with a tax law change that would permit Social Security recipients to earn unlimited amounts at any age. And remember that, when they are working, these Social Security recipients still pay full taxes on their earned income just as the rest of us do. So the effective tax rate for working is the 50% plus the new taxes on income earned. Given a labor force shortage, this is about the dumbest policy one could imagine, in my view. Addressing this disincentive for older workers is a no-brainer for Congress. So ask your congressperson why it isn’t in the law and if she/he will work to change it.
3. Powell carefully and gingerly mentioned immigration, a hot-button issue in the firebrand political culture-war arena where politicians scream and threaten and don’t debate or research facts. I admire Powell’s courage to speak as forthrightly as he did. If we let a couple of million labor force-age folks into the United States, this employment gap would close quickly. There are plenty of folks around the world who want to come here to work. Think about that one.
We invite readers to take a deeper dive into the subject. To that end, here’s a short reading list:
· The labor force shortfall driven by curtailed immigration of working-age individuals is captured in the chart below and discussed in this January 2022 article from Econofact: “Labor Shortages and the Immigration Shortfall,” https://econofact.org/labor-shortages-and-the-immigration-shortfall.
· From the Joint Economic Committee, we have a breakdown as to the vital roles that immigrants play in the US economy. Three out of four of them are classified as essential workers. They play vital roles in maintaining the US food supply and in providing health care and elder care. They start 25% of new businesses. See “Immigrants Are Vital to the U.S. Economy,” https://www.jec.senate.gov/public/_cache/files/6750b0f0-c851-4fee-9619-295582fd44e8/immigrants-are-vital-to-the-us-economy-final.pdf.
· A December 15, 2022, article from the Washington Post reports on the problem and the need for legislation to address it. Congress is, of course, mired in budget negotiations and not currently focused on solving the labor force shortfall that is impeding the Fed’s efforts to curb inflation and reach its 2% target. See “Trump, covid slowed down immigration. Now employers can’t find workers,” https://www.washingtonpost.com/business/2022/12/15/immigration-reform-congress-worker-shortage/.
Folks in the US can leave any time they want and go anywhere they want. Some do, but most don’t want to lose the citizenship and opportunity available in the United States. Folks from around the world in the millions want to come here and work and study and flourish and settle if they can. Meanwhile, we are short millions of workers, and we have a declining birth rate and a falling life expectancy. So ask your Congress member about this, too. And think of the question when you next wait in line for some purchase or service or delivery simply because there are not enough workers. Seems like the solution is obvious to me.
The Fed is going to stay the course to get to a 2% inflation target because they have little choice. Congress can immediately help this effort and simultaneously slow the inflation rate by closing the employment gap. Failing to do so prolongs and deepens economic pain for Americans.
Will they act? It’s up to the rest of us to demand that they do.
David R. Kotok
Chairman & Chief Investment Officer
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