October 27, 2023

Thought of the Week:

One of the most captivating things about traveling across Italy is that ancient history is never further than a few steps away. Florence is home to the oldest stone bridge in Europe, and the same streets Dante, da Vinci, Michelangelo, and the Medici family strolled. In Siena, the Palio dates back to 1482, and is still run today; this year’s victors were the Goose and the Rhino. The Etruscans grew vines and made wine in Tuscany as far back as the ninth century BCE. And in Rome the Colosseum, Pantheon, and Forum all date back to the time of Caesar. Just last week, my wife and I stayed less than a pitching wedge away from the Largo di Torre Argentina, a square in ancient Rome. The square was home to the Theater of Pompey, where Julius Caesar was stabbed 23 times on the Ideas of March. I couldn’t help giving my wife an overly dramatic “Et Tu Brute” as we posed for pictures. While the bloodletting the GOP suffered this week on the road to electing a new speaker may not have been as literal to what 60 senators did to Caesar more than 2000 years ago, the three-week stretch it took Republicans to settle on Rep. Mike Johnson (R-LA) was more than embarrassing and raised questions about the Party’s ability to govern. So, what does Johnson’s election as Speaker mean? First and foremost, it means that a government shutdown next month is unlikely. Although Speaker Johnson is not well-known outside of Louisiana and Capitol Hill, unlike former Speaker McCarthy (R-CA), he has enough credibility with both the far-right and party moderates to survive compromise positions on key policy areas. In fact, Speaker Johnson has already endorsed a plan to pass a second continuing resolution (CR) in November to give Congress enough time to negotiate a full-year FY24 measure, which would ultimately avoid a 1% across-the-board sequester in 2024. Over the longer-term, Speaker Johnson faces less of a threat from a motion to vacate than did Rep. McCarthy (R-CA). The reason: his conservative credentials—including objecting to the 2020 election results—are impeccable and give him credibility with the far right; he is also well-liked by former president Trump. To receive a complete bio, policy profile, and key policy “cheat sheet” on Speaker Johnson, please contact the Washington office.

Thought Leadership from our Consultants, Think Tanks, and Trade Associations

Unlike Others, AEI Believes the U.S. Economy is Headed for a “Hard Landing.” Economic facts are rapidly changing for the worse, and the Federal Reserve should back down from its current mantra that interest rates need to stay high for longer to bring down inflation. If the Fed persists with its hawkish monetary stance, brace yourselves for an economic hard landing. Among the more disturbing new facts is the sudden loss of investor appetite for long-term U.S. Treasury bonds. Investors are increasingly concerned that the budget deficit is heading towards 8% of GDP at a time when the country is close to full employment. They are also concerned that given the political dysfunction in Washington, there is little prospect that the budget deficit will be reduced anytime soon. The question being asked is: who will fund the government’s long-term borrowing and at what price? The upshot of the change in sentiment is that in two months, the Treasury yield, which many other interest rates are benchmarked, has shot up from less than 4% to 4.75%, the highest rate in sixteen years. This spike has already caused thirty-year mortgage rates to jump to close to 8%, and it remains to be seen whether the housing and auto markets can withstand such high rates. Another major change are the cracks appearing in the banking system. Already, we’ve seen the second and third largest bank failures in U.S. history when Silicon Valley Bank and First Republic Bank failed. With long-term rates spiking, the banking system is bound to take another big hit to its balance sheet from falling bond prices. It hardly helps that we are expected to have a wave of commercial real estate loan failures next year when property developers have to roll over $500 billion in loans at markedly higher rates, at the same time they are suffering from high vacancy rates in a post-Covid world. The Fed should also pay heed to the rapid deterioration in the world economic outlook. China, the world’s second-largest economy, is experiencing its slowest economic growth in decades; Germany has already experienced three consecutive quarters of negative economic growth; and with the ECB raising interest rates at a time of economic weakness, it’s only a matter of time before the rest of the Europe succumbs to recession. All of this suggests that when setting interest rate policy, the Fed should be forward-looking and consider the major negative shocks at home and abroad with which the U.S. economy will have to face. Unfortunately, in clinging to a backward-looking, data-dependent policy, the Fed shows no sign of changing policy course anytime soon. By so doing, the Fed risks a harder economic landing than needed to contain inflation.

Capstone Predicts Resurgence of Labor Unions in Post-Pandemic World. Last week, California passed a $25 minimum wage for healthcare workers in the state. The shocking reform seemed highly unlikely when introduced but made headlines after relatively smooth passage through the legislature. Although it came as a shock to many, it should not have—California is known for aggressive policymaking and steadfast labor union support. In fact, with its robust Democratic alignment and substantial union presence, California has long been a labor union stronghold. Even in California, however, union membership has dwindled in recent years, and membership across the U.S. hit an all-time low of just 10.1% in 2022. Despite membership declines, fueled by the pandemic, union power has grown. The pandemic reinvigorated unions, triggering an outpouring of empathy for workers and their grievances, and once the pandemic eased, complaints turned to action. Unions and their members, emboldened by President Biden’s pro-union stance, began to organize and 2021’s “Striketober” brought one of the largest waves of multi-industry strikes in history. In 2022, the same year in which unions hit their lowest ever membership, they reached their highest public approval rating since 1965. Once-struggling unions found a winning playbook and are likely to replicate it. Within California, this means industry-targeted wage efforts, such as the new fast-food worker minimum wage enacted last month. Outside of California, states like Washington and Oregon, which are similar in terms of political leanings and ballot initiative processes, are likely the next battleground for union efforts. Businesses must prepare for a new reality: the pandemic was a tipping point for union influence. Labor challenges are not new, they’re just gaining attention. The trend appears enduring and businesses should expect increases in labor strikes and within healthcare and beyond.

Conference Board Still Sees Mounting Economic Headwinds Leading to Short/Shallow Recession Early Next Year. Numerous factors, including, elevated inflation, high interest rates, dissipating pandemic savings, rising consumer debt, lower government spending, and the resumption of mandatory student loan repayments will lead U.S. economic growth to buckle early next year, causing a short and shallow recession. Although consumer spending has held up despite elevated inflation and high interest rates, this trend cannot hold. Real disposable personal income growth is flat, pandemic savings are dwindling, and household debt is rising. Additionally, new student loan requirements will begin to impact consumers. As a result, overall consumer spending growth will slow towards yearend and contract in Q1-Q2 2024. Consumption will begin to expand once inflation and interest rates abate later in 2024. Although business investment bounced back in Q2 2023, this trend will also reverse as consumption softens and interest rates rise. Residential investment, which has already contracted significantly, should bottom out late this year,  then rise on lower interest rates and strong demand in 2024. Government spending, one of the few positive growth drivers for 2023, benefited from outlays associated with infrastructure legislation passed in 2021 and 2022. However, reductions in discretionary outlays in the Fiscal Responsibility Act, which averted the debt ceiling crisis, will limit overall government spending and act as a drag on growth later this year and early next. Progress on inflation will be made over the coming quarters, but the path ahead will be bumpy. Energy prices have been rising and may rise further due to conflict in the Middle East. Year-over-year inflation readings should remain near 3% and the Fed’s 2% target will not be achieved until the end of 2024. Labor market tightness has been remarkably persistent, but should moderate over the coming quarters. However, labor will hold up due to persistent shortages in some industries and hoarding in others, which should prevent overall economic growth from slipping too deeply into contractionary territory. Looking to late 2024, the volatility that dominated the economy over the pandemic will diminish. In the second half of 2024, the forecast is for growth to return to more stable pre-pandemic rates, inflation to drift close to 2%, and the Fed to lower rates to near 4%. The forecast is for real GDP to grow 2.2% in 2023 and 0.8% in 2024.

“Off the Record”

A growing number of analysts believe that the present Middle East crisis could weigh on President Biden’s reelection prospects. While the president’s term in office has largely been defined by two crises—the end of the pandemic and the Ukraine war—the current Middle East crisis looks difficult to contain and likely to escalate. Although foreign policy is rarely a defining issue in American politics, it is emerging as a weak point for Biden—one that former president Trump may be able to exploit. Biden’s low ratings on foreign policy extend back to the Afghanistan withdrawal and include illegal immigration across the southern border. Although President Biden remains a narrow favorite among Washington-based analysts to win reelection in 2024, a Middle East crisis that lasts into 2024, and possibly includes economic fallout from a broader regional war, would compound structural factors and a weak economic outlook that have already created a bad environment for an incumbent president seeking a second term.

In Other Words

“The people’s House is back in business,” Speaker Johnson (R-LA) after his election.

“It was worth it,” Rep. Gaetz (R-FL) after Rep. Johnson (R-LA 04) secured the Speaker nomination.

Did You Know

For the first time in decades, the nation’s capital will have no panda bears. The National Zoo announced that their giant pandas will return to China by November 15, following 23 years in the District. While the first panda in the U.S. traveled to Chicago in 1936, the National Zoo received its first two officially-sanctioned pandas—Ling-Ling and Hsing-Hsing—in 1972 after First Lady Patricia Nixon expressed her fondness for the animals.

Graph of the Week

The Treasury Department released its final monthly Statement for Fiscal Year (FY) 2023, showing a $1.7 trillion deficit for the year, with $4.4 trillion in revenue funding $6.1 trillion of outlays; removing the effects of the student debt cancellation that courts ruled illegal, the deficit totaled $2.0 trillion in FY 2023, double the $1.0 trillion deficit in FY 2022 and $493 billion higher than the $1.5 trillion deficit the Congressional Budget Office (CBO) projected in June. Although the FY 2023 deficit was lower than the FY 2020 and FY 2021 pandemic-driven deficits of $3.1 trillion and $2.8 trillion, respectively, it was nominally higher than any other time in history. As a share of the economy, the official deficit was 6.3% of Gross Domestic Product (GDP) and the effective deficit was 7.5% of GDP. As deficits remain high, debt continues to rise. Federal debt held by the public rose $2.0 trillion in FY 2023, from $24.3 trillion to $26.3 trillion. As a share of GDP, debt rose to 98% of GDP, more than twice the 50-year historical average of 47% and within eight points of the record 106% of GDP set just after World War II.

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