Mohammed El-Erian of PIMCO coined the phrase “new normal” in 2009 to describe what he observed to be a new, slower growth, a paradigm for the U.S. economy.
Now, El-Erian, A. Gary Shilling and others are forecasting an end to the “new normal.” One can presume that means a return of the “old normal,” where the non-inflationary level of unemployment is about 5 percent and potential economic growth is 3.5 to 4 percent.
Return of ‘old normal’
We have experienced the weakest recovery from a recession in the post-World War II era with average growth since mid-2009 of 2.2 percent versus a 4.2 percent average for the previous seven recoveries.
The unemployment rate is 7.7 percent (U.3); if short-term discouraged workers are included, it is 14.3 percent (U.6). During the past five years, the growth rate of the private capital stock has been the slowest of any five-year period for the past six decades.
Thus, it appears easy to infer that there is plenty of slack in the labor markets and that firms do not see any need to expand capacity. So, to return to the “old normal,” all we need is an increase in demand, something the huge federal budget deficits or 0 percent interest rates have failed to produce. But, if demand were to rise, because of excess capacity, we will then have a period of rapid growth with little or no inflation.
What if ‘new normal’ is permanent?
I always thought that “new normal” meant we simply couldn’t rely on pre-great recession historical perspective to tell us where we might be headed.
Can we really expect the unemployment rate to return to 4.5 percent like it was in 2006-07? What if labor shortages and inflationary pressures begin to appear when the unemployment rate is between 7 percent and 7.5 percent? What if the industrial base in the U.S. already is using its most efficient means of production, and rising demand means using older, less efficient productive processes or having to go to more expensive second shifts?
Labor, capital market conditions
The National Federation of Independent Business recently found that from the lows of about 10 percent of survey respondents, the trend of those not able to fill positions has been upward such that today about 20 percent of respondents cannot find qualified applicants.
In the pre-recession period, that number hovered around 25 percent. The Capacity Utilization rate, at 79 percent, is equal to the pre-recession peak. That indicates that any rise in demand will be met with capacity issues.
Potential economic growth
Looking at markets today, even at the so-called anemic post-recession economic growth rates we have experienced, both labor and capacity appear to be constrained.
So, maybe in today’s “normal,” the potential noninflationary growth rate of the economy is closer to 2 percent-2.5 percent.
Last year, the Congressional Budget Office put out a missive estimating that potential GDP growth was 2.9 percent, a number that the markets, the media and most economists simply ignored. If that is correct, then the 2.2 percent average post-recession growth in this recovery is not all that shabby. Released on March 15, the Economic Report of the President also argues that potential GDP today is much lower than what we might otherwise consider “normal.”
Is inflation close?
If the “new normal” conditions of the past four years apply, both labor markets and capacity constraints could mean that we will begin to see inflationary pressures if economic growth approaches even 2.5 percent.
It is likely that labor shortages will first appear (and, remarkably, we already see these in the construction industry) which will rapidly translate into rising wages. On the industrial front, rising wages, the need to employ older capital, second labor shifts, or to hire and train less-than-qualified candidates reduces profit margins and puts upward pressure on prices.
Fed stuck in the ‘old normal’
Will the Fed recognize this and take away the spiked punch bowl?
There is that possibility, i.e., that interest rates will soon begin to rise in anticipation of higher inflation. But the Fed’s own history of mishandling the yield curve says “no.”
Federal Reserve Chairman Ben Bernanke himself missed the recession when the economy was already in it, and, of course, he told us that the “sub-prime” housing issue had been contained. Under “new normal” conditions, the 6.5 percent unemployment rate target that must be met before the punch bowl is removed and the Fed tightens may very well be much lower than the noninflationary unemployment rate.
There is even a movement on the Federal Open Market Committee to lower that unemployment objective to 5.5 percent. In addition, Bernanke’s likely replacement, should he decide to retire in 2014, is Janet Yellen, whose views on money printing might be even more liberal than Bernanke’s.
So, there is clearly no thinking at the Fed that the “new normal” is permanent. Either that or the Fed never embraced the “new normal” and has continued to use “old normal” guidelines to set policy.
It is, therefore, a good bet that if the economic paradigm is still governed by “new normal” guidelines, inflation will be well-entrenched long before the Fed recognizes it.
Let’s hope that El-Erian and Shilling are right and the “old normal” soon returns. But, I would caution: “Hope” is not a good investment strategy.
Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.