The U.S. economy contracted 0.9 percent in the second quarter of 2022 https://www.bea.gov/data/gdp/gross-domestic-product. That follows a 1.6 percent contraction in the first quarter of 2022. The back-to-back quarterly drops in gross domestic product (GDP) fit the definition of what many people consider to be a recession. I contend that the economy is in a recession. However, the official arbiters have not yet defined the slump as such. The argument against my assertion is that the negative GDP prints have been caused by inventory reduction. For example, inventory changes subtracted two percentage points from the second quarter’s GDP.
Paycheck to Paycheck
As of June 2022, 61 percent of Americans live paycheck to paycheck, according to Lending Club https://www.pymnts.com/consumer-finance/2022/report-36-of-consumers-earning-250k-now-live-paycheck-to-paycheck/. The silver lining of that grey cloud is that many of those people are living that way by choice. I hope you clutched your pearls and gasped when I said that because the idea that someone is choosing to live paycheck to paycheck is gross. That’s not what I mean. Many of these people (certainly not all) are buying too many avocados and soy lattes (**slowly raises hand**), living in too much house (or too many houses), going on too many vacations, or “engaging with financial products.” In other words, they’re spending their extra money or investing it into real estate, stocks, and bonds.
Silver linings aside, I fear that it will get worse. Among all U.S. consumers, average savings dropped from $11,274 in May 2022 to $10,757 in June, according to Lending Club. That is still high, but a 4.6 percent monthly drop is concerning. It may not sound like much until you annualize it at 55 percent. This reduction in savings is not sustainable.
The balance sheets of American households are in much better shape than they historically have been. It is estimated that they hold $2.5 trillion of excess savings https://www.brookings.edu/research/bolstered-balance-sheets-assessing-household-finances-since-2019/. However, inflation is high enough and job creation is slowing enough that this extra cushion could disappear in about 15 months (that is a back-of-the-envelope calculation on my part). That seems like a long time. But do you think consumers wait until they’re completely out of money before they stop spending? Or do you think they’ll see that savings are getting low and, in response, curtail spending? If they cut back on spending, that prolongs the recession.
The Inflation Reduction Act
I typically do not opine on pending legislation because it often gets rewritten or shot down before it is signed into law. However, Congress will likely pass the so-called Inflation Reduction Act of 2022. I’ll spare you all the details, but I don’t see any material inflation relief from the Act.
Here’s the gist of the legislation. It is considered a slimmed-down version of the Biden Administration’s Build Back Better agenda that was proposed but not passed last year. It taxes large corporations and wealthy individuals to raise $750 billion throughout the next decade. Some $450 billion will address climate change and pay for lower health insurance premiums for Americans benefitting from the Affordable Care Act. The remaining $300 billion will reduce the federal government’s budget deficits.
I am cynical about the ability of this Act to reduce inflation. However, overall, I’m not mad about it. I mean, it’s hard to be upset at the idea of cleaning the environment and helping people get much-needed health care. If the government takes my money anyway, please put some of it toward those goals. However, it is misleading to package it as an inflation tool.
One of the problems regarding the Inflation Reduction Act’s capacity to reduce inflation is who is getting taxed. About $313 billion of the $750 billion raised would come from a new 15 percent minimum tax on “book income” (the income corporations publicly report to investors, but not necessarily to the IRS). I’m not mad at that either; those loopholes should have been closed long ago. However, CNBC reports that half of those taxes will be shouldered by manufacturers. Much of the current inflation has been caused by companies’ inability to make more goods. Placing restrictions on those companies, financial or otherwise, is a problem for inflation, not a cure.
The Act should not affect inflation through the middle of this decade. By 2031, the Act is projected to reduce the consumer price index (CPI) by 0.33 percent. Not 3.3 percent, but 0.33 percent. That’s the equivalent of dropping the price of a $5 gallon of gasoline by 1.7 cents. The most immediate way the Inflation Reduction Act reduces inflation is by slowing economic growth.
I suppose it doesn’t make any economic difference what you call the legislation. Still, it reveals that the White House has no plan to combat inflation. Investors need to be more prepared that the Federal Reserve is the only group truly fighting inflation right now. That will keep pressure on the U.S. economy since they can’t fix things like supply chain issues. Net-net, it all makes me less bullish and more concerned that there may be more economic and stock market pain in the months ahead.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures: https://berkshiremm.com/capital-ideas-disclosures/ Direct inquiries to Allen at AHarris@BerkshireMM.com.
