Thu, 24 Jan 2013
Morningstar director of economic analysis Bob Johnson will be keeping a close eye on these potential headwinds in the year ahead.
Jason Stipp: I'm Jason Stipp for Morningstar. Our director of economic analysis Bob Johnson has talked before about what will be the drivers of the economy in 2013, but what about those red and yellow flags that should be on your radar?
Taking a glass-half-empty approach today, we're checking in with Bob to hear about some of those risk factors.
Thanks for joining me, Bob.
Bob Johnson: Great to be here.
Stipp: You've got five of them--things that should be on our radar as warnings or risk factors for the economy in 2013. The first one is not going to be a big surprise to anyone--you've talked about it before as being "the recovery killer." It's inflation. Why should inflation be on our radars? What are some of the pressure points there?
Johnson: First of all, the key number to watch is the CPI, and seeing what it is year-over-year on a three-month average. When we get over 4%, that has typically thrown us in a recession every time. And maybe there was a war or maybe there was a housing boom or something before it, but the thing that immediately proceeds and most directly forecasts a recession is a spike in inflation up to that 4% level, and it's worked like clockwork many times, and it's a warning signal we should never ignore.
The good news is that metric right now is at 1.9%. So, we're relatively safe.
Stipp: So we have some breathing room, but there are some specific underlying factors that lead to inflation that you are keeping a close eye on. And the first one is natural gas. And we've got … more natural gas production than we've had in the past in the U.S. Are natural gas prices headed higher, that you're worried about them?
Johnson: Well, I am worried about them because they are a meaningful part of consumer spending. It's kind of replaced fuel oil as a fuel-in-the-home choice, and so it's in everybody's budget. And the issue with natural gas right now is that we've finally had a more normal winter, where it's actually been cold, and it's finally driven up demand for natural gas a little bit.
At the same time, the drillers have at least temporarily put a little bit of a lid on drilling new holes right now because there's not a lot of demand out there and the prices are so low.
So, I think it's a problem that probably would correct itself. If prices get too high, then we'll see more drilling again. But on the other hand, I am a little bit worried right now that the days of cheap, cheap, cheap natural gas are probably behind us.
Stipp: What about gasoline that you put in your car? Are we seeing pressure on those prices?
Johnson: Yes, there will be two things pressuring that. I think with all the situations we've seen overseas, in Africa, and so forth in the last few weeks, certainly there's been a little bit of a spike in crude oil prices, and as the economies around the world have begun to pick up a little bit, too, those things have combined. So, [crude oil prices] are back up again in terms of the raw material, the crude oil, that goes into gasoline.
So far, gasoline prices haven't spiked yet; it hasn't worked its way through the refinery chain just yet. So, I'm afraid that the gasoline spike is yet to come, and will come like it has every spring for the last two or three [years].
Stipp: And a wild card--one that we were concerned about in 2012--is food, because lots of different factors can cause food prices to go up. It didn't hurt us as bad, maybe, as some feared in 2012. What's the outlook for 2013 on food inflation?
Johnson: We always start out the year relatively neutral in terms of our thinking, because obviously with the shortages last year, it means farmers will tend to plant more, and if the weather cooperates, we'll produce more, and we won't have much food inflation this year, and that's how we generally think about it.
But I'm already hearing from our agricultural analysts that maybe things aren't perfect in South America. There's certainly not a drought or disaster there yet, but they aren't necessarily wonderful. But if we were to have a bad problem here and they were having a bad problem in Europe and Asia, then we've got an issue. If we get multiple markets having problems again, and inventories are rather thin because of two bad years already, we're on a real edge here. And food is more important than gasoline--it's probably more like 10% of consumer spending. So it's a big deal if food prices go up a lot.
Stipp: And a quick side-note on food inflation, why wasn't it as bad from the summer drought as many feared it would be in the fall of 2012?
Johnson: Well, I think we got a little bit lucky. It came in spurts in different pieces. One month milk would be high, but then cattle prices would be very low because farmers were sending more of their cattle to market. Or then we'd have a bumper vegetable crop from Florida. It was an odd number of things where something would be really high but then something would go through the floor at the same time. So, we never got a one-month massive spike where everything was moving up at once.
Stipp: The last key thing on inflation that you'd be looking for are housing prices. I think we'd agree that we'd like to see housing prices moving up, but not too fast?
Johnson: Right. That's exactly right. I think they have been helping. They flow into the CPI in an unusual way. But in any case better housing could push inflation higher, and it will contribute to [push] us toward that 4% level; it's a little bit dangerous.
Stipp: So, the 4% [year-over-year inflation growth] level is the important thing to watch for. We don't want to see anywhere near there; that's definitely bad news for a recovery. Keep an eye on natural gas, gasoline, food, and housing.
Number two risk factor: Growth in China that's too fast.
Stipp: You're worried about too-fast growth in China. Everybody else is worried about the opposite?
Johnson: Right. I know. And just a few months ago everybody was talking about whether there was going to be crash landing or soft landing, and we got the GDP numbers out of China. They didn't slow; they actually started to grow faster again in the fourth quarter. They are talking about a better economy. They are talking about things turning over there. I don't think everybody is fully convinced yet. But I think the signs are pretty good that China has bottomed, and in fact, I'm more worried that they'll overdo the other way. They kind of opened up lending, reduced rates, and so forth, and I'm more worried that things get too strong, and it begins to push up copper, lumber, coal, food, and gasoline--all the stuff that got pushed up last time [China was booming]. And one of the biggest things when I talk about inflation being a real killer, well, China and emerging-market growth is what did that. So if they grow too fast and in too much of a commodity-oriented way, it's a very bad thing for the world economy.
Stipp: Speaking of inflation, someone who is charged with managing inflation is Bernanke and the Fed, and you say that there are some risks potentially surrounding Fed activity and why and how the Fed can move and continue its actions or not continue them.
What are you watching on the Fed, and what are some risk factors from Fed missteps perhaps?
Johnson: I think the Fed, everybody would agree, has had a very loose money policy, and however you want to measure money supply, it's up a lot, a lot of monitors would say, well the supply is up, it's only a matter of time until it hits the real world in terms of inflation. And I think what people miss there is that right now lending conditions remain very, very tight, and it's still very hard to get a loan, and almost all the Fed money that they put out there is sitting literally in banks un-lent.
And so the issue only becomes, and we will have to watch it very closely, is if somehow, something made lending go way up again: Maybe shareholders put more pressure on the banks, and the banks start lending willy-nilly again, and we start using up all those money that's out there, this dry powder, and we ignite inflation again.
Stipp: If we start seeing that, the Fed is going to have to raise rates. If they don't get that activity correct, that can also cause big problems?
Johnson: That's right. If you have this perception, if you had a good GDP growth, loan demand high and rates up, all of a sudden people are going to go, uh-oh, and I think that would not be a pleasant thing. I think it'd be a short-term thing, but it would spook the markets badly; we'd be down 5% or 10% in a couple of days in a scenario like that.
Stipp: Number four is also related to policy in how we handle the deficit in legislative action. Obviously the deficit is something that that we need to address, but you say it will be a mistake if we try to do too much too soon in addressing our deficit problems.
Johnson: Too much too soon is a big issue. I think right now with the tax increases that have been implemented so far this year, we are about at the level of what the economy can tolerate--maybe just a little bit more. But I think to come in here with one more big spending cut and tax increase all in one year could throw us back into recession.
Stipp: So, you're saying definitely we've got to address this deficit, but let's not take all the medicine in one year, because it's just too much for the economy.
Johnson: If I had to put one extra [risk] factor on here, I'd say [it's] that we do nothing about the deficit, either. We don't want it too much too soon, but we want to start systematically saying--maybe like the Fed did with the employment situation--when it gets down to a certain level, then we increase taxes or cut the spending or whatever. Somehow tie them together so that we don't have this willy-nilly shock hitting the economy.
Stipp: Number five, Bob, is related to one company that's been in the headlines recently, and not in a good way, and that's Boeing. The Dreamliner is grounded right now; they're looking into some issues. Give us a sense of how important Boeing is to the economy and what you're looking for here as a risk factor that could have an effect on the entire U.S. economy because of the problems they're having.
Johnson: It's over a couple of hundred million dollars per aircraft, that's apiece, and we're talking, maybe, 10 of those a month. So, we're talking big numbers here that come from that aircraft, and it supports a lot of the manufacturing economy here. It helps our exports out in a big way. How many [aircraft] Boeing ships in a month is a big deal to the trade balance--we always have to strip them out and figure out where they are at. And obviously a lot of those planes are these Dreamliners. So far, so good. Yes, they've had to cool the shipments for now, but they are actually still building, and they still need fuselages, and wings. They are still way behind. So all that construction of those parts will probably continue. My bigger worry is if they find some massive problem with the plane and that they have to redesign and stop production for a while. That would be painful.
Stipp: All right, Bob. There certainly are some bright spots for the economy coming up. There are definitely some risk factors that we want to keep an eye on, but we're lucky enough to have you helping us stay on top of all these things. Thanks again for joining me today.
Johnson: Great to be here.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.