Plain English with Derek Thompson - The Biggest Economic Question of the Moment: Is This Peak Inflation?

Episode Date: July 8, 2022

The question everybody's asking on cable news right now is whether we're in a recession. I think there's an even more important question to ask: Are we at peak inflation? If inflation U-turns, it means the Fed won’t have to keep jacking up interest rates, won’t have to keep destroying demand, and won’t have to indefinitely pump the U.S. economy with tranquilizing drugs to break the fever. I believe peak inflation is right here, right now. In retail, Target and Gap are slashing prices on inventory. In the car market, used car sales are falling. In electronics, the microchip shortage looks like it’s easing. In international shipping, freight rates across the Pacific are declining. And most importantly, the price of oil, metals, wheat, and corn are all falling. Oil prices are falling really, really fast—and that tends to mean that gas prices will follow. Today’s guest is Noah Smith, the economic writer and author of the newsletter Noahpinion. We talk about the great disinflation, where it’s happening, why it’s happening, what it means for the future of the U.S. economy and politics. This episode was in high demand in our mailbox. And as always, keep it coming. Send your feedback and episode ideas to [e-mail]. Host: Derek Thompson Guest: Noah Smith Producer: Devon Manze Learn more about your ad choices. Visit podcastchoices.com/adchoices

What's up, everybody? Are you tuning in to the Challenge USA on CBS? Well, tune in to me, Tyson Apostle, as I break down each and every episode with my co-host, Amelia Weddemeier. I'm also a contestant on the show, which gives you all the insider scoop. Amelia, how stoked are you to do this?

Tyson, I'm freaking excited. I cannot wait to sit my butt down every single week to watch the show, then come here and recap it with you on the Ringer Reality TV podcast. If you turn on your TV, if you go online, my guess is you're going to hear a lot about a recession. Are we entering a recession?

When are we entering a recession? Are we in a recession right now? Is this it? Is it here? Am I in it? What I want to argue in this episode is that there's a more important question to ask right now. Because the answer to this question determines our entire economic future, the future of gas prices and growth and housing prices and stocks.

And that question is, are we at peak inflation? Is inflation finally, finally, finally going down? And I believe the answer to that question is yes. Peak inflation is right here, right now. I'm calling it. In retail, Target, and Gap are slashing prices on inventory. In the car market, used car sales are falling. In electronics, microchip shortages look like they're easing.

In international shipping, freight rates across the Pacific are declining, and most importantly, the price of oil, metals, wheat, corn, all falling. Oil prices are falling really, really fast, and that tends to mean that gas prices will follow. And if inflation is indeed doing a U-turn, that is huge news for the economy because it means the Fed won't have to keep jacking up interest rates, won't have to keep destroying aggregate demand,

won't have to keep pumping the U.S. economy with tranquilizing drugs to break the fever. The fever is already breaking. So to get a clearer read on inflation, which will also give us a much clearer read on everything else that's happening in this wacko economy, today's guest is Noah Smith, the excellent economic writer and the author of the newsletter, No Opinion. We talk about the great disinflation, where it's happening, why it's happening, and what it means for the future of the U.S. economy and U.S. politics. This episode was in very high demand in our inbox.

Thank you for that. And as always, keep it coming. Send your feedback and episode ideas to plain English at Spotify.com. I'm Derek Thompson. This is plain English. Noah Smith. Welcome back to the podcast. Hey, great to be back.

Good to see you again, man. Good to see you too, man. So I mostly want to talk to you here about the prospect of a break in inflation. the fact, the possibility of peak inflation. But since the media is so focused on recession fears right now, I thought maybe we'd begin there. Do you think the U.S. economy is in a recession right now and why? Well, so the word recession isn't well defined. The popular definition is two successive quarters of negative GDP growth.

But I think that there are times when that criterion does not make a lot of sense, and this might be one of them. So when economists talk about recessions, they just mean any deviation below trend in output. And in terms of that, I think, yes, we're going to definitely see a deviation below trend in terms of output. But I think that you see employment holding up very well. And that means people don't feel like there's a recession. You see consumption and capital expenditures holding up very well. So it doesn't feel like a recession to a lot of people yet. and yet I think we do have evidence that declines in aggregate demand are now at work,

thanks to the Fed and thanks possibly to some other factors. So even if it's not something like the 2020 recession or the 2008 recession, it could still be the kind of downturn that we saw maybe at the beginning of the century in 2000, 2001, where consumer demand was pretty strong. Unemployment didn't increase too much, But at the same time, you saw a pullback in investment, you saw trouble with inventories, you saw trouble with exports. And so technically, the U.S. economy entered a bit of a recession in that year. But it wasn't the kind of catastrophe we've experienced in the last two official downturns.

Exactly. And if I had to make a prediction, you know, of course, predictions are worth the paper they aren't printed on. I would predict that that 2001 recession is the closest analog first. what we're about to experience. Which tells me that, like, one of the more important questions here is not just, are we in a recession or are we not in a recession, but rather what's going on with inflation? Because inflation is really, really persistent. And the Federal Reserve has to destroy a ton of aggregate demand in order to stabilize prices. Maybe we could see a more significant crash. Maybe, you know, equities could continue to fall. The housing market could continue to fall. But if inflation is already starting to turn now, that seems really important in terms of charting the near future of the Fed.

So I'd like to just move into talking about disinflation. Right now, you look across markets, you're seeing just signs galore that prices are already coming down in wheat, natural gas, lumber, corn, Rolex watches, bored apes, and maybe most importantly, in oil. So I want to go through a couple of these categories and have you telling me what's going on with these prices. What's going on with oil prices right now? I mean, they're going down. Oil prices are determined by supply and demand. In response to higher oil prices, we have seen an expansion of capacity. The United States has increased oil production by about a million barrels a day relative to last year.

OPEC has increased oil production somewhat. and maybe running out of spare capacity to increase more. And so we've seen that. Russian capacity, Russia was the big decrease, right? Russia, Russian capacity really crashed after the Ukraine war began and sanctions initially hit. Russia has now worked at deals to rerout the oil it used to sell to Europe to India and China. And everyone expected this, because oil is very fungible. You can just pump it onto a ship, pump it into a tank, sail it across the ocean, wherever you want very cheap.

And so it was always pretty certain that Russia was going to just dive, instead of sending oil to Germany, it was going to sell oil to China, India. And that is exactly what is happening. But what happens is that those people start buying super cheap Russian oil, and they say, Saudis, we don't need your oil. Nigeria, Venezuela, whoever else we're buying from, we don't need your oil. We'll just buy cheap stuff from the sort of captive Russian suppliers. And so then those people say, well, okay, who will buy our oil? And then Europe and America are like, okay, we'll buy your oil. And so then, you know, the market sort of stabilize.

So that's the supply side. On the demand side, you've seen Fed interest rate hikes. And so I think that people seeing the Fed raising, you know, raising rates, hiking rates, that's going to reduce the demand for oil. So we've got a reduction in demand, you know, is sort of not an increase in supply, but at least a stabilization of supply. not a big decrease. And I think that those two things are probably what's pushing oil prices down. So we're seeing oil prices fall. West Texas Intermediate, for example, is down from about $120 a barrel

to less than $100 a barrel. If you do the quick, dirty math, that is a 20% decline in oil prices in just about a month, which should mean about a dollar off the price of gas, except the dirty math isn't very useful because gas prices are famously, as economists, say, up like a rocket, down like a feather. gas prices rise quickly and fall slowly. So does this mean people should expect gas prices to fall in the next few months? We just saw a gas price decline. Gas prices are already dropping. I don't know about 50 cents yet, but they are dropping somewhat, and it's kind of a little steep.

And the answer is yes. The answer is absolutely yes. There will be a feed-through to gas prices. And in fact, what we've seen, so now you've seen a meme on Twitter today called, dark Brandon. Have you seen that? I've not seen the drug Brandon meme, no. Brandon, of course, being the Nick Joe Biden's alter ego. And, you know, Joe Biden tweeted this kind of silly-sounding tweet like, hey, gas companies, you better drop your prices. And everyone was like, okay, that'll get them. And then it did. And then it did. So then meltdown in wholesale gas prices.

So wholesale gas prices went from, you know, just eyeballing this, what looks like, 425. or something, down to 337 in like a few days? So absolutely a 50% decrease in gas prices is reasonable. I would hope for a dollar or more. I think that's not unlikely. I mean, how important is this economically and, I mean, I want to say politically, the fact that it's important politically is probably self-evident. But is there a way in which lower gas prices then feed back through the system and increase

demand. Like if more people are like, oh my God, gas prices are down, then, you know, maybe there's going, that alone is going to stimulate economic demand that then makes gas prices go back up. So that's what I'm trying to figure out is like how stable this equilibrium is going forward. No, that's, that's, I think a popular misconception is that falling prices due to falling demand will then make people more eager to buy stuff and then demand will go back up. If this kind of thing happened, demand and supply shifts would not happen. It would be an impossibility. I mean, imagine going to the store and saying, you know, like loaf of bread for like five

bucks, I'm not going to buy that. And then the, you know, the baker says, oh, no, okay, well, I'll, you know, you're like, I'll give it to you for four bucks, and you're like, oh, actually, I'll pay five. No, because you would have paid five originally. So that's exactly why this idea of, you know, demand shocks create lower prices, which lead to demand decreases, create lower prices, which leads to demand increases. That can't be true. Demand is how much you would pay, you know, for a certain amount of stuff.

And there's no, and if demand falls, lower prices are the result of that, not the cause of something else. So just keep your mind. Whenever you sort of think of this kind of idea in your head, imagine the bread. Imagine saying, I don't want to pay $5 for bread, and then a price drop inducing you to pay $5 for bread. It wouldn't happen. That's good. I appreciate that.

That's a good education. Let's move on to another place that disinflation is clearly happening, which is in metals and food. What are the big metals and food prices that are falling now? In terms of food, we're talking about staple grains like corn and rice and wheat and those kind of things. Those are the most important food stuff. And of course, wheat was what got interdicted. So who grows the wheat?

Ukraine and Russia grow the wheat. Right? And so then they're not the only ones, but they're really big suppliers. And so they, you know, that's why everyone was always trying to take over Ukraine back in the day, like Germany or whoever, Austria, I don't know, because, and Russia, of course, because they had the wheat. And that Ukraine's flag is actually a wheat field. If you look at it, it is meant to represent a wheat field.

I didn't know that. It is the blue sky with the golden wheat below. It's just kind of funny because it's so oriented around wheat. The wheat got disrupted. And Russia is trying to steal. Wheat is so, got so pricey. Russia is trying to steal wheat from Ukraine and ship it out. And Turkey's stopping them.

But we can really substitute other grains. we can substitute corn for wheat. And when wheat prices went up, that also increased the prices of corn. But corn is mostly grown elsewhere, like the United States or whatever. And so corn growers could be like, bonanza time, let's grow more corn. And so corn prices have started falling. And in terms of metal, I would say that if you just watch copper and tin, that's a pretty good bellwether, there's some specialized metals like lithium that matter a lot for specific things.

like lithium matters for batteries, that you might want to keep an eye on if you want to keep an eye on specific sectors, such as the transition to electric cars, you want to keep an eye on lithium. But in terms of just looking at the broad overall, you know, market for commodities, I would say, just look at copper and tin. So we're seeing this harmonized decline in commodities. Oil is down. That's a biggie. Stuff we put in machines is getting cheaper.

Copper, tin. Stuff we put in our mouths is getting cheaper. Wheat, corn. one thing we haven't talked about is China. Second biggest economy in the world, and it has been sputtering a bit in the last few quarters. What is China's role in all of this? China was experiencing this rapid catch-up growth

that slowed in the 2010s, but kept going somewhat rapidly at six and a half percent. And then COVID hit, and it looked like China was going to take over the world. They bounced back really quickly from the initial COVID, but then this sort of insane overconfidence drove Xi Jinping to do a lot of stupid stuff. And one of the stupid things he did was crack down on the internet industry, the finance industry, and the education industry, and the entertainment

industry. And he cracked down on all those industries, which has left Chinese industry, just private industry just sort of cowed and not wanting to develop new stuff, unless it's really, really certain that Xi Jinping will, you know, sprinkle his fairy dust of approval on it. Next, he crashed the real estate sector and, you know, actually allowed it to crash before sort of a bunch of other party people came in and said, no, let's stabilize the real estate sector, but it's probably too late by now. So the real estate sector, which is 30% of China's GDP, is really, really hurting. And then also there's the zero COVID lockdown. So China sort of screwed its economy over for reasons related to domestic politics. And that is dramatically reducing the demand for

commodities. And now that's reducing demand on China's side. But remember, when China's demand goes down, that means commodities get dumped in a glut on the global market. it's an increase in supply for us. So their drop in demand becomes an increase in supply as far as the U.S. is concerned and other rich countries. And so that decrease in Chinese demand is helping us as well in that way.

And so all these things are happening, yeah, a combination of demand destruction and supply increase from a number of factors are just conspiring to push all these prices down. So one way that I look at the big picture here is we're coming out of a pandemic that has obliterated the world economy. We locked down our populations.

We shuttered the factories. We laid off so many people, the pilots. The whole world went into this medically induced coma. And when we came out of it, the global economy wasn't ready to supply the surge in demand. And so it sent prices all over the place. You got a lot of people screaming about inflation expectations becoming permanently unanchored, permanently unsettled, and that maybe we were headed. for a sequel of the 1970s, a sequel of stackflation. And look, maybe that's what we're going to get.

I can't see the future perfectly. But right now, if you study commodities prices, you are seeing the opposite. You are seeing disinflation. So tell me what happens next. How does all of this, all these stories that we've collected together, how does it affect the average American in the next few months. So people's direct consumption is going to get cheaper, right? You're going to get cheaper, gas, cheaper food. People are going to like that. They're going to be, you know, there's still be a little shell shock from the inflation. Their anger will still probably last for a year or more, maybe a year. But by the time the 2024 election rolls around, I think this is going to be over. You know, it might not be. Like, it's really hard to predict these things. But I think that the

burst of anger from expensive stuff, there's, let's not say I think it's going to happen, but I think there's a good chance that by 2024, this is all over, and whatever mild recession we've had is also over. It was important politically for the Biden administration to do that now, because when Carter waited to beat inflation until 1980, it caused a brief recession, and we weren't out of it by the time election rolled around and Carter lost because inflation wasn't down yet, but unemployment was up. So stagflation looked like it was peaking right as Carter went to re-election and got. crushed. But now, if you do it ahead of time, you have time to recover before the election.

Of course, it's going to hit the midterms, right? There was no stopping Republicans from taking the House back. But hopefully by 2024, this will be done. By the way, the other thing I was going to say is the other way that it feeds into lower inflation. By the way, disinflation means lower but still positive inflation, while deflation would mean actual decrease in consumer prices, which we're not going to see. But disinflation is what we want. And so the other factor here is that a lot of these commodities are inputs into production. Oil and gasoline are big inputs into production. Metals are big inputs into production. This reduces costs for producers. And so producers of everything from cars to TVs, whatever, whatever people buy washing machines. Of course, electronics, since chip prices

are going down, chips are very important now. these things, those are going to reduce consumer price gains. So consumer prices will still maybe go up, but it might be back to like 2% a year or something like that, and because their components are getting cheaper. Housing prices have also seemed to stabilize and even decline in some metros. You're seeing inventory begin to rise in a lot of major cities, which is really, really important. That is the statistic that calculated risk blogger Bill McBride is always, looking at, and he's one of my big go-toes on housing policy and housing economics, just walk me through what we're seeing in housing and why you think we seem to also be seeing disinflation,

not deflation necessarily, but disinflation. Right, but disinflation. This is almost certainly mostly a demand effect. And this is how we know demand, reduced demand, is playing a big part in what we see now. So the United States housing construction industry is very slow to respond. We don't build a lot of housing in this country. Now, we did start building more in 2021 and early 2022. We did build more. Housing starts really increased, but they didn't increase enough to really cause the kind of price moderation we're seeing now. Instead, it's almost certain that people are just buying less houses. And why are they buying less houses? Because mortgage rates went up like crazy. One other thing I wanted to ask you about, and you mentioned it a

little bit earlier, is the crypto bust and the stock market correction. Could that be disinflationary too? Like, in what way could people, you know, crypto bros losing a lot of money in the crypto market and, you know, families who are not invested in crypto at all, losing a lot of money in their 401ks in their stock portfolios, pull back on spending as a result of feeling a little bit less wealthy. Is that something that can happen?

There is some sign of a consumption wealth effect from stocks. In other words, when your stocks go down, you consume a little bit less. It's real. We can find it in the data,

and it's not that big. It is a real, but very minor factor, and it probably gets overblown a lot of the time. But research, so crypto, probably the same thing. crypto was never very liquid.

Crypto is not something where you could sell your crypto, get the money, and buy stuff. So it's purely psychological here. And purely psychological, you know, factors like this don't actually seem that important quantitatively. And so I think that in terms of crypto, I think, yes, it's probably having, you know, some effect. You know, people whose crypto went up, went right out and, like, you know, bought. bottle service at clubs or whatnot. But I think, yeah. So in other words, I do think there will be a chilling effect from the crypto crash.

It'll just be modest. So again, trying to put this all together. I feel like we're building up to not just one, but actually two very important ideas here. Point number one is that this might be peak inflation, period. This might be the moment that inflation comes down relatively permanently. Number two, it seems like the Federal Reserve is getting exactly what it wants. Like, exactly what it wants. Six weeks ago, you had people like superstar investor Bill Ackman, who was writing on Twitter

saying stuff like this. He said, quote, inflation is out of control. Inflation expectations are out of control. Markets are imploding because investors are not confident that the Federal Reserve will stop inflation. End quote. 5,000 retweets. 16,000 likes. That's a lot. Here we are now, six weeks later, seven weeks later. And I wonder whether

one lesson of this moment, this moment of peak inflation, is that people like Bill Ackman were just purely wrong, right? Like, in fact, the Federal Reserve has clearly turned the corner on inflation. And inflation expectations are not out of control at all. We do not seem to be going back to the 1970s. Do you think this is one of the hidden or not so hidden lessons of this economic moment? Yes. I think if you, I mean, inflation expectations are crashing across the board. Market expectations, which are what people are actually betting money on instead of just predicting in response to some survey. Of survey expectations are going down too. But market expectations where people actually bet on what inflation is going to be are going down, down, down at the five-year horizon and the 10-year horizon. And that means Bill Ackman was wrong.

and that stock crash was probably more about inflation being high and people thinking, oh my God, the Fed is going to have to raise rates a lot to control this and higher rates will just crash prices. So let's just sell which crashes prices. That's probably what happened. Although, who knows what makes stocks do the things they do, right? Like there's some sort of mass psychology coordination, bullshit, blah, blah, blah. Am I allowed to say bullshit on this podcast? You are allowed to say bullshit, yes.

Cool, because so much of the stuff. The stock market. Yeah. Exactly. So much of the stuff in the like finance econ world is bullshit. So, yeah, so I think that's what did it. It was the fear of, it was rate hikes, but more importantly, the fear of more rate hikes that crashed the market, not what Ackman is talking about.

So Ackman, full of it, or at least on that. I don't know Ackman nor generally, but that was a wrong prediction. One of the big picture question that I'd love your brain on is like, I know that a lot of people when they read the news have to sort of filter the news through a this is good or this is bad filter. And this is a complicated one because the fact that these prices are coming down is a sign that the Federal Reserve is destroying aggregate demand. And in the biggest picture, the destruction of aggregate demand is not like a purely good thing. It can mean that companies go bust. It can mean higher unemployment. It could mean all sorts of bad stuff. But at the same time, the destruction of

aggregate demand is having its intended effect, which is to relatively quickly bring down the prices of commodities and oil and foodstuffs and houses in expensive housing markets, which should be a signal that the Fed still knows what it's doing, and that we might not have to suffer years and years of heightened interest rates in order to break the back of inflation, which is good for everyone, good for stocks, good for the economy. So how in your mind you sort of cash out all of this this is good, this is bad sort of tug of war? Nothing is good for everybody. And so I think that overall this is good.

This is not, maybe not exactly, exactly the Goldilocks scenario, but it's dang close. It is the closest, the thing that we're now predicting to happen is actually very close to a Goldilocks scenario. A mild decline in output and employment, if any, and a major reduction in inflation. And if you bought a bunch of Coinbase and Shopify stock, then I'm sorry. You, you know, financial markets have risk, and that's what that means, right? If you bought a bunch of Bitcoin and ether, financial markets have risk. And so diversify your portfolio and, like, hold a reserve of cash just in case.

It's interesting because one bow you could tie on the episode is, you know, people say America is headed back to the 1970s. Gender norms and culture wars and abortion debates, political radicalism, and a lot of financial commentators have been saying the same thing, right? We're recreating late 1970s stackflation, higher prices for years and years. But that last bitches might be wrong. It's possible that we're headed back to the 1970s in every respect except for persistently higher inflation.

Our nation is in a very pessimistic mood. And it's in a pessimistic mood for one reason, which is political division. And for some people, the things they focus on will be different. Lots of people are now focusing on the Supreme Court, as I think they should. Other people are focusing on the possibility of a coup in 2024, which is real. That will crash the market. If you want to see the markets crash, wait until Republicans try to stage a coup, like a more serious ones.

They better not. Like, that's really bad. Everybody's real upset. Everybody just keenly feels that their country is not united, which is true. Our country is not. It's very disunited right now. and that's leading to a lot of threats, you know, and rancor and screaming,

continues screaming on social media, which is now where most Americans live on social media. And so I think that Rick Pearlstein, the historian, who, you know, talks about the 70s, has talked about, has hypothesized that people used their, people had a lot of unease about changing culture, the sexual revolution, all kinds of other big cultural changes.

and they expressed this as being upset about inflation. That's his hypothesis. And, you know, I don't think that explains most of it. I think that people are upset about inflation because their purchasing power goes down because their wages should keep up but can't keep up. On that note, and I think this is my last question for you, is it remotely possible that American political craziness

might recede as inflation receipts, that we're not just at peak inflation, but also that, like, looking back 50 years from now, as Rick Pearlstein has done for the 1970s, we see the early to mid-2020s as, like, a kind of inflection point in political insanity as well. I think the appetite of normies

for ongoing political, just bashing and, you know, war and whatnot, like the cold civil war, I call it, has waned. And just as the Supreme Court comes in and starts changing the foundations of our society, interest in politics, I think, is waning. You see a number of surveys show that, like, a growing number of people are trying to

tune out politics, which you can never really do, but you can try. And so I think that even as the real consequences of politics are now ramping up thanks to the Supreme Court, I think popular involvement in politics is now, is now a moderating, is now, um, that's like what happened in the 80s. Yeah, I think a lot of people have hit peak news, honestly. Yeah, I think that they got a lot of it under Trump. They certainly got a lot of it under the pandemic when the front pages of newspapers weren't just a kind of virtual reality story about something happening somewhere they weren't,

but were about their lives and policies that were affecting their lives. And I think that there's a certain amount of exhaustion from those five, six years when news was just so unbelievably oppressive and so consistently negative. And I do wonder where I kind of hope that we're at an era where people can begin to pay a little bit less attention to politics on a day-to-day basis because things get more back to normal. The disinflationary moment would be a huge piece of that. Noah Smith, thank you very, very much. Thank you. It's been great.