Nobody Thinks It Would Happen Again

Doug Nolan

WSJ: "Ten Years After the Bear Stearns Bailout, Nobody Thinks It Would Happen Again."
Myriad changes to the financial structure have seemingly safeguarded the financial system from another 2008-style crisis. The big Wall Street financial institutions are these days better capitalized than a decade ago. There are "living wills," along with various regulatory constraints that have limited the most egregious lending and leveraging mistakes that brought down Bear Stearns, Lehman and others. There are central bank swap lines and such, the type of financial structures that breed optimism.

March 17, 2008 - Financial Times (Gillian Tett): "In recent years, bankers have succumbed to the idea that the credit world was all about numbers and complex computer models. These days, however, this assumption looks ever more of a falsehood. For as anyone with a classical education knows, credit takes its root from the Latin word credere ("to trust") And as the current credit turmoil now mutates into ever-more virulent forms, it is faith - or, rather, the lack of it - that has turned a subprime squall into a what is arguably the worst financial ­crisis in seven decades. Make no mistake: what we are witnessing right now is not just a collapse of faith in one single institution (namely Bear Stearns) or even an asset class (those dodgy subprime mortgage bonds). Instead, it stems from a loss of trust in the whole style of modern finance, with all its complex slicing and dicing of risk into ever-more opaque forms. And this trend is not just damaging the credibility of banks, but the aura of omnipotence that has enveloped institutions such as the US Federal Reserve in recent years."

Gillian Tett was the preeminent journalist during the waning mortgage finance Bubble period. She was seemingly alone in illuminating the degree of excess in subprime Credit default swaps and structured finance more generally. By March 2008, she already recognized "the worst financial crisis in seven decades," while Wall Street was trapped in denial. Ms. Tett also appreciated the damage being done to Federal Reserve credibility. Yet no one could have anticipated the evolution of policy measures adopted by the Fed and global central bankers over the following decade. Credibility's New Lease on Life.

What I remember most vividly from the Bear Stearns episode was how well the markets took the spectacular collapse of a $400 billion Wall Street institution. After beginning 2008 at 1,468, the S&P500 closed at 1,277 on Monday, March 17. The index then rallied double-digits to 1,440 by May 19th. I recall about that time being informed that I needed to "get on with my life." Bear Stearns had been resolved. The Fed had it all under control. The crisis was over - before it even got started.

It was not over. I was convinced the overriding issue was Trillions of mispriced securities and derivatives throughout the markets - the enormous gap between perceptions and reality. Both the financial system and economy had grown dependent on rapid Credit growth. Moreover, mortgage lending had come to dominate overall system Credit, while debt growth was highly vulnerable to risk intermediation fragilities. Speculative leverage, also closely interlinked with risk intermediation, had evolved into a major source of marketplace liquidity.

Risk aversion had begun to significantly restrict access to Credit for the weakest borrowers, and home price declines had commenced in many locations. The financial system was highly levered in risky Credit, while the real economy was severely maladjusted from previous distortions in the flow of spending and investment. At the time, the Fed-orchestrated Bear Stearns bailout only reinforced the misperception that Washington could forestall financial dislocation. This ensured that the inevitable crisis of confidence would prove catastrophic.

I have long argued that a Bubble in junk bonds would not be perilous from a systemic standpoint. Only so many obviously risky bonds can be issued before the marketplace declares, "No more!" Functioning market mechanisms regulate the scope and duration of such booms, thereby limiting structural financial and economic maladjustment.

A boom funded by "money" is inherently problematic - and potentially disastrous. The insatiable demand for perceived safe and liquid stores of value creates the scope for prolonged systemic booms. So long as confidence is sustained in the underlying money-like financial instruments, ongoing monetary expansion (inflation) can continue to inflate securities and asset prices, spending, investment and economic output.

All the sophisticated mortgage finance Bubble-era Credit structures and risk intermediation distorted risk perceptions, spurring inordinate demand for Credit (and finance more generally). Underpinning all the lending, leveraging and speculation was the belief that Washington wouldn't tolerate a crisis in either mortgage finance or housing. Both the Fed and Wall Street had faith that monetary stimulus could resolve any hangover from a period of excess. This confidence was badly shaken by the crisis.

Importantly, however, 10-years of previously unimaginable stimulus measures - culminating in "whatever it takes" Trillions of (non-crisis) QE, negative rates and market manipulation - ensured that faith in central bank power reemerged stronger than ever. There is a critical lesson that went unlearned from the previous crisis episode: government and central bank-related risk distortions are fundamental to self-reinforcing Bubble inflation and resulting deep structural maladjustment.

One can age the mortgage finance Bubble period at about six years, commencing around governor Bernanke's 2002 "helicopter money" speeches and the Fed's focus on mortgage Credit as the expedient for (post-"tech" Bubble) systemic reflation. It would not, however, be unreasonable to date the Bubble genesis back to 1994/95, with the rapid expansion of GSE and Wall Street Credit.

We'll soon be approaching 10 years of what I back in 2009 labeled the "global government finance Bubble." Importantly, this Bubble originated at the heart of "money" and Credit only to metastasized into the risk markets. The abuse and impairment has been unprecedented. 
 
Government debt and central bank Credit were expanded with reckless abandon. Insatiable demand for "money" granted governments at home and abroad blank checkbooks. Central banks have monetized about $15 TN of government debt, flooding speculative global securities markets with excess liquidity. Securities values have inflated to unprecedented levels. The more Credit supplied the greater its price - and the price of virtually all assets.

Stocks rallied back (post-Bear Stearns bailout) in the spring of 2007, with players confident the Fed would backstop market liquidity. Despite widening cracks and mounting signs of looming crisis, markets were emboldened. I have argued that the collapse of two Bear Stearns structured Credit funds in the summer of 2007 was a key Bubble inflection point. I would argue further that market complacency surrounding the Bear Stearns corporate collapse ensured a catastrophic crisis of confidence. Faith in liquidity backstops and bailouts blinds the markets to risk and impedes the ability to self-adjust and correct.

"I would buy king Dollar and I would sell gold." Larry Kudlow, March 14, 2018

March 14 - Bloomberg (Jeanna Smialek and Alister Bull): "The Federal Reserve's independence and monetary-policy approach had a White House ally in Gary Cohn. His successor Larry Kudlow may be a different story. 'Just let it rip, for heaven's sake,' Kudlow said of economic growth in the U.S., during a more than hour-long interview Wednesday on CNBC. 'The market's going to take care of itself. The whole story's going to take care of itself. The Fed's going to do what it has to do, but I hope they don't overdo it.'"
The current backdrop beckons for humility. It has now been almost a decade of experimental massive expansions in both government debt and central bank Credit. The economy is strong, and the financial system appears robust. Through the prism of the 2008 crisis, the big financial institutions today have less risk and more capital. But that's not the appropriate prism. Government debt and central bank Credit have been this cycle's prevailing source of Bubble fuel. Securities market inflation has been a primary inflationary manifestation. For the most part, private-sector lending is not today's pressing issue.

I understand why Mr. Kudlow would say "buy king dollar" and "sell gold." Washington is on a trajectory of dollar devaluation, with massive twin deficits stoking the risk of a crisis of confidence in the dollar. A loss of faith in the U.S. currency would spur selling in U.S. financial assets, certainly including Treasuries and corporate Credit. Interest rates would spike higher, revealing the scope of speculative leverage that has accumulated over the past decade. And a crisis of confidence in financial assets would surely create a boon for gold and precious metals. Washington, of course, wants none of that. Inflate Credit while saluting king dollar.

Kudlow is seasoned, articulate and media savvy. He knows Washington, Wall Street and propaganda. "Just let it rip, for heaven's sake." Over the years I've felt Kudlow would say just about anything. At times I respect his analysis; too often over the years I've grouped him with the other charlatans.

He's an ideologue with an enticing message: "Just cut taxes." Kudlow is considered a "supply-side" free market proponent, but I've always viewed him more as an inflationist. A conservative that seemingly has absolutely no issue with loose "money;" never a Bubble he doesn't adore. And to say he was detached from reality during the critical late-stage of the mortgage finance Bubble is an understatement. He was blinded by his deep ideological biases. 
 
His sight remains distorted.

Wall Street takes comfort from the notion that Kudlow might be able to pull the President back somewhat from major tariffs and trade confrontations. He is certainly a master of touting the stock market. He, as well, seems the obvious perfect spokesman for "Phase 2" of the Trump tax cuts. Why not slash capital gains rates and make individual tax cuts permanent? Deficits don't matter. Lower taxes will spur growth and pay for themselves - with plenty to spare for infrastructure and a military buildup. There is no doubt about this; no open discussion or dialogue necessary.

We're now well into the high-risk phase of the boom cycle. The February blow-up of the "short vol" funds marked an inflection point, one I have compared to the collapse of Bear Stearns structured Credit funds in the summer of 2007. Ten-year Treasury yields have jumped 44 bps so far this year, and the dollar has been under pressure. The VIX, Treasury market and greenback have calmed down of late, which has supported an equity market recovery. Corporate Credit, however, has been notably less resilient.

March 15 - Bloomberg (Molly Smith, Brian Smith and Austin Weinstein): "For years, investors have gorged on corporate debt. Now they're showing signs of being full. Fewer orders are coming in for new bonds, relative to what's for sale. Companies that sell notes are paying more interest compared with their other debt, according to data compiled by Bloomberg, and once the securities start trading, prices by one measure have been falling about half the time. It's the latest signal that the investment-grade debt market is losing steam after years of torrid gains, as rising rates and talk of tariffs weigh on the outlook for corporate profit. 'Investors are starting to be a little more disciplined,' said Bob Summers, a portfolio manager at Neuberger Berman… 'They aren't just waving in every deal now." Money managers' restraint amounts to more pain for companies. The average yield on corporate bonds is around its highest levels since January 2012…"
March 15 - Reuters (Richard Leong): "A gauge of stress in the U.S. money markets grew to its highest level in more than six years on Thursday, bolstering the risk of further increase in the costs for banks and other companies to borrow dollars. The spread between the three-month dollar London interbank offered rate and three-month overnight indexed swap rate widened to 50.65 bps, a level not seen since January 2012. At the end of 2017, it was 27.83 bps."

And a Friday headline from Bloomberg: "Libor-OIS Spread Expands to Widest Level Since May 2009." LIBOR - a benchmark short-term interbank lending rate - is increasing (27 straight sessions) and rising more rapidly than the overnight indexed swap (OIS) rate (indicative of a risk-free borrowing rate). Essentially, short-term borrowing rates are rising while Credit risk premiums are increasing. Liquidity is becoming less abundant, and there are numerous explanations posited: The Fed is raising rates and reducing its balance sheet, massive T-bill issuance, tax cuts have incentivized U.S. multinational repatriation of funds (selling short-term instruments in the process) and less QE from the ECB.

I suspect this rate and spread development is not unrelated to the rising costs of hedging currency exposures. When markets are placid and leverage is expanding, liquidity remains abundant and cheap market hedges/protection readily available. But when markets turn more volatile and less predictable, sellers of risk protection turn more cautious. Hedging costs rise, a dynamic that reduces the attractiveness of underlying securities and derivative holdings, especially those held on leverage. In particular, the rising cost to hedge dollar exposures reduces the attractiveness of U.S. fixed income investment by foreign investors/speculators. Less demand for T-bills, overseas inter-bank dollar balances and dollar LIBOR contracts manifests into rising short-term rates and expanding spreads. As we've seen, bank funding costs begin to rise. On the margin, there is less impetus to embrace risk and leverage.

The big unknown is the scope of financial leverage and embedded leverage in derivatives markets that have accumulated over this long boom cycle. The dynamics of this Bubble contrast meaningfully from than the last. The big financial institutions are not sitting on huge holdings of potentially toxic securities and mortgage-related derivatives. Myriad risks these days are more complex and concealed - and, importantly, even more esoteric.

I would argue that the Bubble in government finance has distorted pricing and liquidity throughout the securities and derivatives markets. Securities markets have succumbed to systemic mispricing, a circumstance fostered by liquidity misperceptions and readily available market risk "insurance." The previous cycle's "Moneyness of Credit" evolved into central bank-induced "Moneyness of Risk Assets." And while virtually everyone takes comfort from the apparent soundness of financial institutions, crisis lurks in the tangled world of securities and derivatives markets liquidity.

About a decade ago, runs on Bear Stearns and then Lehman fomented the '08 market crisis. I suspect the next U.S. crisis will unfold with "runs" on stocks and corporate Credit. We've already witnessed how quickly the VIX and equities derivatives markets can dislocate. I'm curious to see how interest-rate and Credit derivatives perform in a backdrop of faltering equities, illiquidity and derivatives market stress. And considering the direction of policymaking in Washington, don't be all too surprised by an unexpected bout of market tumult for Treasuries and the dollar.

Larry Kudlow's "king dollar" and "let it rip" might play well domestically, surely in the oval office. But I suspect it's not confidence inspiring to our lowly foreign creditors. We're at the stage of the cycle that would seem to beckon for caution, contemplation and prudence. How much trouble could Team Trump and Kudlow provoke? There's ample arrogance and ideology to risk plenty.


The threat to world trade

The rules-based system is in grave danger

Donald Trump’s tariffs on steel and aluminium would be just the start



DONALD TRUMP is hardly the first American president to slap unilateral tariffs on imports.

Every inhabitant of the Oval Office since Jimmy Carter has imposed some kind of protectionist curbs on trade, often on steel. Nor will Mr Trump’s vow to put 25% tariffs on steel and 10% on aluminium by themselves wreck the economy: they account for 2% of last year’s $2.4trn of goods imports, or 0.2% of GDP. If this were the extent of Mr Trump’s protectionism, it would simply be an act of senseless self-harm. In fact, it is a potential disaster—both for America and for the world economy.

As yet it is unclear exactly what Mr Trump will do. But the omens are bad. Unlike his predecessors, Mr Trump is a long-standing sceptic of free trade. He has sneered at the multilateral trading system, which he sees as a bad deal for America. His administration is chaotic, and Gary Cohn’s ominous decision on March 6th to resign as the president’s chief economic adviser deprives the White House of a rare free-trader, signalling that it has fallen into protectionist hands. Not since its inception at the end of the second world war has the global trading system faced such danger.

Rough trade

This danger has several dimensions. One is the risk of tit-for-tat escalation. After the EU said it would retaliate with sanctions on American goods, including bourbon and Harley-Davidson motorbikes, Mr Trump threatened exports of European cars.

The second danger springs from Mr Trump’s rationale. The tariffs are based on a little-used law that lets a president protect industry on grounds of national security. That excuse is self-evidently spurious. Most of America’s imports of steel come from Canada, the European Union, Mexico and South Korea, America’s allies. Canada and Mexico look set to be temporarily excluded—but only because Mr Trump wants leverage in his renegotiation of the North American Free-Trade Agreement, which has nothing to do with national security. Mr Trump is setting a precedent that other countries are sure to exploit to protect their own producers, just as spuriously.

It is not clear whether other countries can respond legally when national security is invoked in this way. This puts the World Trade Organisation (WTO) into a rat trap. Either Mr Trump will provoke a free-for-all of recrimination and retaliation that the WTO’s courts cannot adjudicate, or the courts will second-guess America’s national-security needs, in which case Mr Trump may storm out of the organisation altogether.

The WTO is already under strain. The collapse of the Doha round of trade talks in 2015, after 14 fruitless years, put needed reforms on hold indefinitely. Disputes that might have been swept into a new trade round have fallen to the WTO’s dispute-resolution machinery, which is too slow and too frail to carry the burden. The WTO has not kept pace with economic change.

Investment is increasingly tied up in intangibles, such as patents and copyright, rather than physical assets, such as steel mills. Rules drafted for rich, market-led economies cannot always police state capitalism. The implicit subsidies China gives its producers were a cause of global gluts in industrial metals. No wonder that the world’s second-biggest economy has been the focus of so much anger.

Whatever the WTO’s problems, it would be a tragedy to undermine it. If America pursues a mercantilist trade policy in defiance of the global trading system, other countries are bound to follow. That might not lead to an immediate collapse of the WTO, but it would gradually erode one of the foundations of the globalised economy.

Everyone would suffer. Mr Trump seems to think trade is a zero-sum affair, in which a deficit is a sign of a bad deal. But the vast improvement in living standards after the second world war went hand in hand with a rapid expansion in world trade over eight trade rounds, each of which lowered barriers. Imports are in fact welcome, because they benefit consumers and spur producers to specialise in what they do best.

Without the WTO, cross-border trade would continue—it is unstoppable—but the lack of norms and procedures would leave disputes to escalate. The fewer the rules, the more scope for mercantilist mischief and backsliding. Trade policy could be captured by special interests.

Military power would hold greater sway in trade disputes than economic fair play.

Transnational investment could drain away. As a vast continental economy, America would lose less from this than other countries. It would nonetheless lose a lot, including a pillar of the system that has underpinned its post-war political influence.

How should the world get out of this bind? Even as Mr Trump behaves with astonishing irresponsibility, others must keep their heads. Some may impose limited retaliation—that, after all, is how to treat bullies, and the threat to local manufactures will strengthen the hand of Republicans pressing Mr Trump to relent. But such action must be proportionate and limited.

A tit-for-tat war with America would be disastrous.

Back to basics

The more important task is to shore up support for trade. It would be comforting to think there is global backing to fix the WTO. But just now, there is not. The only new trade deals on offer are regional, such as the Trans-Pacific Partnership (TPP), an 11-country pact signed this week that sets out to be a blueprint for trade modernisation. Although Mr Trump abandoned it, he has hinted he may reconsider, which would be a start.

The best way to help the WTO would be for its other members to co-ordinate any action, including bringing in a WTO complaint about Mr Trump’s tariffs. Even though that may burden the WTO’s court, it would be a vote of confidence in the idea that the global economy should be governed by rules.

The world is a long way from the 1930s, thank goodness. Yet ignorance and complacency have put the trading system in grave danger. Free-traders need to recognise that the WTO can help keep markets open in the face of protectionist lobbying, at home and abroad. It is vital they make the intellectual case for rules-based trade. That will not be easy. For the first time in decades, their biggest foe is the man in the Oval Office.


The Great Labor Crunch

By Avi Salzman

     Illustration: Ryan Garcia for Barron’s 



It took mere months for the Great Recession to claim millions of American jobs. Now, as employers scramble to rebuild the workforce, they’re facing a dilemma: The labor pool is shrinking, and it could be decades before it comes back.

Across the nation, in industries as varied as trucking, construction, retailing, fast food, oil drilling, technology, and manufacturing, it’s becoming increasingly difficult to find good help.

And with the economy in its ninth year of growth and another baby boomer retiring every nine seconds, the labor crunch is about to get much worse.

In the near term, this shortage is undoubtedly good news for workers. Unemployment, at 4.1%, is at a 17-year-low, and wages are rising in a more robust pattern, despite Friday’s employment report showing a deceleration in wage growth in February. More Americans say jobs are plentiful than at any time since 2001. This, of course, is how a labor market works: Production rises, workers get scarce, and employers raise wages to attract employees.

It won’t be so simple this time. A long-awaited demographic shift, and a protracted slowdown in productivity improvement, has stiffened the economy’s joints. Business growth should be sprinting, but it’s stuck at a trot, and most economists don’t see it speeding up over the longer term, even with the recent tax cuts.

Census Bureau projections show the overall U.S. population, a rough proxy for the country’s demand for goods and services, growing faster than the workforce— which supplies those goods and services— through 2030 and probably beyond. From 2017 to 2027, the nation faces a shortage of 8.2 million workers, according to Thomas Lee, head of research at Fundstrat Global Advisors. It’s the most substantial shortfall in at least 50 years, on a percentage basis, according to his calculations.

The crunch threatens to stall America’s economic engine: Oil and gas stay in the ground because there aren’t enough workers to extract it; homes aren’t built because builders can’t find enough laborers. In Maine this winter, the state couldn’t find enough people to drive snowplows.



A labor shortage has hit the nation’s most productive oilfield, the Permian Basin in Texas and New Mexico. “It’s an emergency, a crisis actually. It’s causing major delays,” says Clint Concord, senior operations manager at Byrd Oilfield Services in Odessa, Texas.

Concord adds that he has been through several boom and bust cycles, but has never had such trouble finding and retaining good employees. For the first time, his company has been giving bonuses to workers willing to sign contracts. The key: They must sign noncompete clauses, to discourage them from jumping ship.

The problem is even hitting the local doughnut shop. Last month, Dunkin’ Brands Group CEO Nigel Travis called the labor squeeze his biggest strategic challenge. It’s not just going to make it harder for Dunkin’ franchisees to staff the 1,000 net new locations the company plans to open over the next three years. “It’s going to affect GDP growth, if it’s not fixed,” Travis said.

Gad Levanon, chief economist for North America at The Conference Board, a nonprofit research organization, says that most economists are projecting gross-domestic-product growth of 2% of less, on average, over the next decade, versus the 3% long-term average. Much of that gap is caused by the labor pinch, he argues.

Two other pressure points add to the pain. Millions of people have dropped out of the workforce, owing to factors such as disability, opioid addiction, and prison records that make it hard to snare jobs. The labor force participation rate, which measures the percentage of the adult population that’s working or actively seeking employment, has dropped to 63% from 67% in 2000.

Those who are working are sometimes pulling double duty, but it’s not showing up in the economic numbers. Since the recession, productivity has risen “more slowly than at any other period in U.S. history,” Levanon says. And the Trump administration’s plans to reduce immigration—both legal and illegal—could hamper another source of labor force growth.

Levanon has been waving red flags about the labor problem for years. The message, he says, has been overshadowed by another source of anxiety: robots. The assumption is that automation is about to replace millions of workers. But the robots probably won’t get here in time. (See article, “The Robots Aren’t Ready to Fill the Gap”.)

“A lot of the low-hanging fruit of replacing workers with tech already took place 10 to 20 years ago,” Levanon maintains. “Production workers were replaced by robots, and secretaries were replaced by personal computers. It turns out that to replace the next worker with technology is not as easy.”

The shortage raises two substantial concerns for investors. If employers are forced to boost wages more dramatically in a bidding war for staff, it could spark faster inflation and thus interest-rate hikes by the Federal Reserve—the fear that sparked last month’s stock market correction.  
 
 
On a longer-term basis, slower economic growth will hit asset prices. Although stocks can climb during periods of tepid economic growth—see, for example, the past nine years—that effect eventually diminishes. Today’s high valuations are largely a bet on growth eventually breaking higher.




The labor shortage is a unique sort of problem—easily predictable years ago but still a surprise. That’s largely because of the 2007-09 recession, which sparked a longer-than-usual employment slump. The jobless rate was above 5% for more than seven years, during which labor was cheap and abundant. Employers had little incentive to prepare for tighter labor markets by upgrading their machinery or processes, which might have boosted productivity.


“Normally in recessions, even a deep recession like 1980 to ’82, the economy snaps back quickly enough that businesses don’t settle into that pattern,” says J.D. Foster, the chief economist at the U.S. Chamber of Commerce.

The recession also caused many workers to delay retirement because their savings had evaporated in the stock downturn. That might have masked the shortage, but now retirements are picking up again.

Labor, of course, is still cheap by many measures—average hourly earnings have risen at an annual pace below 3% for more than eight years, lagging behind the gains in other recoveries. In addition, few people are quitting their jobs to take better-paying gigs.

That supports a counterargument: “The biggest evidence that there aren’t labor shortages is that you’re not seeing it in the wage growth,” says Elise Gould, senior economist at the Economic Policy Institute, a left-leaning nonprofit research organization. She says there may be shortages in some industries, but not on a widespread basis. “If they’re getting by without having to [raise wages], then there is no shortage.”

However, some big companies are starting to take action, announcing pay hikes—some in the form of one-time bonuses—since the tax cuts went into effect. Last week, Target (ticker: TGT) said that it would boost its minimum hourly wage to $12, a 9% increase from its prior minimum of $11, established by an earlier hike just last fall. In areas with particular shortages, pay boosts have been more generous; average compensation for carpenters in Houston jumped 57% in only three years, according to one wage survey.

New laws boosting minimum wages to $15—more than twice the federal minimum of $7.25—are starting to take effect in several cities and states.

Friday’s employment report showed annual wage growth slowing to 2.6% in February from 2.8% the month before, but those numbers don’t tell the whole story. Supervisors saw their pay growth slip, but nonsupervisory and production employees— who make up 80% of the workforce—saw wage gains accelerate. “Do not buy into the view that wages were tame” because the overall number looked weak, said David Rosenberg, chief economist at money manager Gluskin Sheff.

Higher pay will solve only part of this problem. In the longer term, demographics make a labor shortage a near certainty. The working-age population is set to grow just 3% by 2030, even as the total population expands by 9%, the Census Bureau projects.

Manufacturing has about 12.5 million workers today. By 2025, about 2.5 million will have retired in the preceding decade, says Carolyn Lee, executive director of the Manufacturing Institute, an arm of the National Association of Manufacturers. All told, the industry is looking at a two million-worker shortage by 2025.

Bayard Winthrop founded his apparel company American Giant on the premise that he could create high-quality clothes in the U.S., while offering workers competitive salaries. Some good early press led to a surge of orders, allowing Winthrop to open two factories in North Carolina.

But he and his U.S. suppliers ran into problems staffing their factories, leading to backlogs that caused customers to wait as long as six months for their sweatshirts.

“I never imagined that we were going to have a hard time spinning up our labor force,” he said.

“A big component of that is just a lack of available labor—skilled labor and unskilled labor.”

Winthrop says the company now starts its Christmastime production in April to ensure that labor shortages don’t set it back again.

The trucking industry already faces a shortage of 51,000 drivers, and that’s expected to more than triple by 2026, according to the American Trucking Associations. The shortage, and a spike in demand, is causing freight costs to surge around the country. A key gauge of spot trucking prices was up 31% in February, year over year, and those costs have become a frequent cause for griping by retailers and manufacturers on earnings calls. Truckers’ wages are rising, but are unlikely to draw enough recruits. “If it was just a pay issue, I think solving this would be a lot easier,” said Bob Costello, the association’s chief economist.

Tesla and others are building prototype trucks designed to drive themselves around the country. But anyone expecting robots to take over soon probably will be disappointed. “A robot will not replace a driver for a very long time,” says Costello. “We think it’s decades.” Indeed, there are worries that talk of self-driving trucks is sabotaging efforts to sign up new drivers.

“The last thing we can afford is for our rhetoric on driver assist or autonomous to get out in front of reality and start seeing enrollments and interest in the field drop before the technology is ready to really engage,” Derek Leathers, CEO of trucking company Werner Enterprises (WERN), said at an investor conference last fall.

The National Association of Homebuilders found last year that 82% of builders saw labor cost and availability as a major problem in 2017, up from 13% in 2011. Nine years after the recession, the pace of home construction remains more than 10% below normal rates, and there was just 3.4 months worth of inventory on the market in January, just above December’s record low of 3.2 months. Builders want to boost those numbers but can’t find the workers, observes Instinet analyst Michael Wood.

Companies have found unique ways to deal with the shortage. Sherwin-Williams (SHW) has created new paints that can be applied faster and dry more quickly. Some of its new products even dry at temperatures as low as 35 degrees, 15 degrees below the usual temperature needed for that process. That helps contractors work outside the peak summer season.

Even if painters were plentiful and more efficient, “they would still be on the job, waiting for the dry-wallers to finish, the roofers to finish, electrical,” Sherwin CEO John Morikis said on an investor call last fall. “It’s a much more macro issue than just the painting contractors themselves—a much larger issue.” For his industry and, increasingly, for the nation.

 Wage Inflation Coming. Does This Mean Spiking Interest Rates?

Dave, the plumber who saves us every six or so months when a leaking pipe, water heater, or toilet threatens to destroy our walls and ceilings, was here the other day. As usual he fixed the problem right away and charged us less than expected. We love this guy.

While he was working I asked him how business was going. He claimed to be swamped to the point of turning away jobs. I asked why he doesn’t hire more plumbers to leverage his client list. Because, he replied, there are no available plumbers: “If a plumber is unemployed today there’s a really good reason for it.” In other words the home maintenance part of the labor market is hot and getting hotter.

Today’s Wall Street Journal provides a broader confirmation of this anecdote:
Wages Rising at Small Firms 
NFIB survey shows businesses hiring more workers, but not as many as they’d like. 
Call them labor-force participation trophies, but they are very well-deserved. With many Americans still sitting on the economic sidelines, workers are increasingly earning raises from small businesses that can’t find qualified applicants for all the available positions.  
That’s the message of the latest National Federation of Independent Business jobs report, due out later today. 
The February survey of owners of small firms finds solid job creation, and historically high numbers of businesses lifting wages to attract and keep talent.  
Survey respondents reported a seasonally adjusted average employment increase per firm of 0.22 workers.  
NFIB Chief Economist William Dunkelberg calls it “a strong showing” and adds:
“Labor markets are very tight, for both skilled and unskilled workers. To address this problem, a net 22 percent plan to raise worker compensation, historically high. Thirty-one percent (unchanged) reported raising compensation to attract or retain employees, the highest since December 2000, the peak of the last expansion. Only an increase in the size of the labor force and an increase in the participation rate can provide relief from the impact of labor shortages. Firms will be hiring workers with less than the desired skill levels, forcing them to invest more in training.” 

As of January for the economy as a whole, the percentage of American civilians aged 16 years or older who were either working or seeking work was just 62.7%.  
This remains near the Obama-era low of 62.3% reached in 2015 and represents dreary 1970s-style participation in the labor forcé. 
Hence the trophies in the form of higher wages for the workers who are both able and willing to participate. The NFIB finds that 34% of all owners reported job openings they could not fill and 22% of owners cited the difficulty of finding qualified workers as their most important problem, exceeding the percentage citing taxes or the cost of regulation. 
As business owners continue to seek new workers, the NFIB finds hiring plans strongest in construction, manufacturing, transportation and communication. Mr. Dunkelberg calls it “an exceptionally strong outlook for job creation. The availability of qualified workers will undoubtedly moderate actual job growth.”

This is obviously good news for workers who’ve seen their wages stagnate since the 1990s. But it also means “wage inflation” is apparently about to become an issue. Because the Fed ignores rising prices for financial assets (that is, things that benefit the big banks and their favored clients) while focusing intently on grocery store prices and wages, a sudden spike in hourly pay puts extreme pressure on the Fed to raise short-term rates and sell off the bonds it bought to force long rates down during the Great Recession. The result? Interest rates might rise faster than most now expect.

A good interest rate to track is the 10-year Treasury yield, since so many other rates, including 30-year mortgages, key off of it. Already it’s up by about 100 basis points since last September. Hotter than expected wage growth will accelerate the trend.




Spiking interest rates translates into soaring interest expense for virtually everyone from governments that have to borrow to fund ongoing deficits and roll over maturing debt to home buyers who were pricing in a 3.5% mortgage when they started looking and are now confronted with 4.5% or higher. Put another way, everyone who has to borrow money is suddenly a lot poorer. Poetic justice for sure, but very bad news for financial market stability.


South America’s ‘Pink Tide’ in Transition

By Allison Fedirka


Leftist governments are staging a comeback in South America, right? The talk surrounding upcoming elections throughout the continent seems to suggest they are. Nostalgia for the days of economic prosperity in Brazil has lent credence to the notion that former president Luis Inacio Lula da Silva will run for president again. In Argentina, unpopular and painful economic reforms championed by President Mauricio Macri have breathed new life into rumors that citizens would prefer the populist policies of the previous administration. Other examples abound, but suffice it to say, the “pink tide” – South America’s peculiar brand of leftism – is in vogue again.

Or is it? It’s true that the left is alive and well. But the pink tide began to recede in 2015, and despite statements to the contrary, it’s still on its way out, not on its way in.

One Extreme to the Other

The pink tide came to be in the early 21st century. South America leaders mixed elements of populism and socialism into their governments. They lauded the working class, maintained a presence in many aspects of the daily lives of their subjects and regulated the economy. It was not a return to red communism; it was a paler shade of socialism. Hence the name pink tide.

The rise of the left was a result of two things: disillusionment with the ruling governments and higher commodity prices. The political climate of the time gave governments a mandate to more actively try to improve their citizens’ quality of life, renew economic activity and buck the country that so often told them what to do: the United States. Higher commodity prices gave these governments the money to fund large-scale social programs and spurred economic growth. With strong public and economic backing, leftist governments grew more popular, taking hold just about everywhere except Colombia.

But this newfound fervor would not last. Indeed, the political history of the past century suggests that countries tend to swing from one political extreme to the other. Policies that reflect whichever mode of government is in place are felt most acutely in economic management, and their economies depend largely on commodities. Indeed, commodities – particularly metals, grains and more recently, oil – are the ties that bind South America to the rest of the world. In the 1920s, the region traded openly and primarily with the U.S. and Europe. Commodity prices tanked when the stock market crashed in 1929, and countries began to seek other ways to nurture their economies. World War II complicated things for these countries, since South America traditionally purchased finished manufactured goods from Europe and the U.S. With their industries going offline or reverting to the production of wartime materials, the region had limited access to manufactured goods, and what did arrive was extremely expensive.

It was during this time that countries of the region began to look inward for solutions. They subsequently adopted import substitution models to manage their economies. This model requires a strong hand to regulate the import of finished goods, provide production subsides to increase domestic consumption and devise other programs that facilitate the development of national industry.

But the model never fully performed as advertised. Instead, it led to high government spending, debt and distorted markets. This continued into the heady days of the Cold War in the 1970s. Afraid that this would give communism a foothold in the Western Hemisphere, the United States countered leftist movements at nearly every turn, exiling, imprisoning or killing their members. The movements weakened accordingly.

By the time the Cold War ended in 1991, right-wing governments began to assume power throughout the region. Many South American economies had been in a precarious state. They were very far in debt, which they had trouble servicing, and in need of loans and investment. In what became known as the Washington Consensus, institutions such as the U.S. Treasury Department, the International Monetary Fund and the World Bank encouraged and promoted the adoption of fiscal reforms, privatization, market deregulation and opening to trade and investment in exchange for loans and investments. They honored the end of the agreement, but they were ultimately unsuccessful in transforming their economies. The right-wing, U.S.-friendly governments soon fell out of favor.

Conditions were ripe for a return to the left, a return we now call the pink tide. The era lasted roughly 10 years, which, uncoincidentally, were years of high commodities prices. It ended near the end of 2015.

Transitions

After that, open-market, internationalist, reformist governments came to power in several countries with center-left governments – most notably Argentina, Brazil and Peru. The trend continued last year in Chile, where right-leaning former president Sebastian Pinera was re-elected for a second term.

Few countries have been able to withstand the swing to the right. In 2017, Ecuador elected as president Lenin Moreno, who had served as vice president under President Rafael Correa.

Correa himself was a leftist, but Moreno has already distinguished himself from his predecessor. He inherited an economy in disarray after the collapse of oil prices, so he adopted new fiscal policies and a more pragmatic approach to managing the economy rather than continuing with hefty government spending and protectionism. He has also tried to align the economy with global markets by re-negotiating the country’s previously preferential oil contracts with China.

Bolivia held out a little longer than others, mostly because Bolivia’s economy managed to grow despite low commodity prices. Its primary commodity is natural gas – which accounts for about half the country’s exports – and the price of gas remained high when oil tanked in 2014. (It started to decline only toward the end of 2015.) The public didn’t start to turn against President Evo Morales until 2016. There had always been opposition to his rule, but the opposition gained a lot of momentum when Morales’ traditional allies in Venezuela and Brazil, preoccupied as they were with their own problems, were no longer strong enough to support him. The opposition held a referendum that banned Morales from seeking re-election in 2019, though the Supreme Court would not uphold the results. Protests subsequently broke out, and though Morales is still in power, the rising social discontent, the declining natural gas production and ideological isolation are challenging the government’s hold on power.

Then there is Venezuela, where government this month announced that presidential elections will be held in May, after the initial April 22 date was rejected by opposition parties. Mounting pressures are pushing the country toward some solution that involves the end of the current leftist regime headed by Nicolas Maduro. The most recent dialogue with the opposition has failed, and neighboring Colombia and Brazil have both beefed up border security to help prevent any more spillover of desperate populations moving to border towns and depleting supplies meant for the local populations.

Later this month the government will also start the first phases of its cryptocurrency, designed to help circumvent the U.S. sanctions that are restricting the government’s (and the national oil company’s) ability to conduct business and to access imports and U.S. dollars. Colombia already wants to propose a financial recovery plan for Venezuela that would be in line with carefully opening and deregulating the economy. Meanwhile, the United States has not ruled out further oil sanctions against Venezuela.

At GPF, we are not in the business of predicting elections; we are in the business of predicting geopolitical trends. So while we can’t say exactly when Venezuela and Bolivia will succumb to the pressures that felled their neighbors, we can say that eventually they probably will. After all, political transitions do not happen overnight.