It's ugly out there

But still better than the alternative

Photo by Jon Tyson on Unsplash

Hello,

Welcome to Known Unknowns, a market-friendly newsletter about an economy that feels like it is teetering on the edge.

Inflation Gets Worse

This is one weird economy. Inflation 9.1%!!!! And core is 5.9%!!! Many people think we are in a recession, but employment is high and they are spending like crazy. And you can’t buy Advil in person anymore in NYC. It is all locked up, and it is very hard to find someone who will get it for you. A trip to CVS feels like an exercise in bad Ayn Rand fan fiction.

I think this is what we call an overheating economy—people are spending and have jobs, but they aren’t happy. And even the people who changed jobs now regret it.

This is all because high inflation is really terrible. It is no surprise that it seems like every world leader is resigning. Yes, I know other things are going on in each respective country, but high inflation leaves very little margin for error when it comes to leadership. It means everyone in your country faces a big pay cut, loses wealth, and faces more uncertainty. And in some ways, it is worse than ever before because inflation was dormant for so long and came out of nowhere. The inflation we face today feels like it came from a series of policy errors (which is partially true).

And longer-term, high inflation has a way of exposing all our sins. The longer it sticks around, the more it seeps into expectations (and I am not comforted by consumer sentiment surveys or breakevens—they have a terrible track record), and then interest rates go up. It is not just the Fed’s fault interest rates will rise; on the long end of the curve, inflation expectations and inflation uncertainty are what determine yields. So why is the curve inverting then? I am not sure; perhaps bond traders believe inflation will go back to 2% soon. But bond traders aren’t psychic; they make wrong predictions a lot. And even if inflation moderates soon, which I think it will, I think the 2% stable inflation world is not coming back. Eventually, that reality will show up in interest rates.

 And higher rates mean all that debt we took on, especially corporate and sovereigns, gets expensive. And this will cause all sorts of problems, especially in developing countries.

Oh, and it turns out that QE, which we are still not sure does much to boost the economy, does shorten the duration of US debt. We could’ve locked in low interest rates when we went on our borrowing spree. But instead decided to take on interest rate risk instead. And what did that buy us?

Does Capitalism Have Any Fans Left?

In spite of it all, I still think markets are the best economic system. But I may be alone there. In the last year or so, I’ve been struck by how many economists I know who teach in business schools are dismayed that their students (MBAs!!) are skeptical of capitalism. Harvard Business School is even offering a class on reimagining capitalism (taught by an accounting professor—of course).

I don’t expect everyone to be a fan, but I thought we could at least count on business students. What’s more capitalist than dedicating your life to business?

For my Bloomberg column, I spoke to several professors and students about what changed. Some of it stems from more international and female students. It also comes from how the management consulting industry has changed. Before, if you worked at McKinsey as an analyst, you learned how to increase your client’s bottom line. Now, you help them achieve loftier (harder to evaluate) goals. If you desire a career climbing the corporate ladder these days, you can’t be seen as a Gordon Gecko type anymore. You need to sell companies on the idea you can make them ESG compliant and avoid HR issues. In that way, these capitalism skeptics may just be good capitalists. If Larry Fink sometimes sounds like an ambivalent capitalist (and capitalism has been pretty good to him), what can we expect of new MBAs?

Some students I spoke to are very concerned about market power and corruption, and many are very, very concerned about inequality. Which is kind of weird because graduates of top MBA programs tend to be in the top 5%, at least. Inequality is not such a big concern among Americans in the middle of the income distribution.

What struck me is that business students all seem to believe that the economy is inherently zero-sum. I am told many are even lukewarm about the idea of economic growth because they think it is by nature unfair or bad for the environment (business students believe this!). One student said he’d take less medical innovation if it meant cheaper drug prices.

Maybe that’s because the world they inhabit is zero-sum. They will all be in the top 5%, but competition is fierce for the top 1 or 2%. And it is harder to make lots and lots of money these days.

But still, these are our future business leaders. Is this a phase or a long-running trend?

The Data Can’t Tell Us Much Anymore

One thing I noticed on my vacation is how terrible Google Maps has become. Its time estimates are totally inaccurate, and it chooses some very strange routes. And even Google web searches aren’t as good as they used to be.

But this is what happens when the world changes. Pretty much all the technology we use these days is powered by data.

Even in our big data, machine learning-powered world, data is still from the past. And the world has changed a lot in the last two years. People work from home more, they eat earlier, and that means traffic patterns are different and less predictable.

Changing data has always been a problem in finance. It is one big reason why everyone missed inflation and the housing bubble. Our models don’t pick up on a risk if it has not happened in 40 years.

But this is an even bigger issue now because every decision we make is powered by data, and lots of our data is pretty useless. And that means many things will be less good and we’ll need to revert to the old-fashioned way and rely more on our own experience and judgment.

Until next time, Pension Geeks!

Allison