MainStreet Macro: The March Reset

This month, Main Street marks the one-year anniversary of the World Health Organization declaring the COVID-19 outbreak a pandemic, in a year that took our lives and the economy on a wild roller-coaster ride. In two short months, we went from the longest economic expansion in U.S. history to the most devastating downturn since the Great Depression.

What a difference a year makes. March has brought us an economy on the verge of a reset as the vaccine rollout picks up steam and a $1.9 trillion relief package begins its work.

Yet as the U.S. continues its climb to pre-pandemic GDP, the economy isn’t resetting to its pre-pandemic form. Things are different. As I said last week, the story of the economy’s evolution is still being written. Here are four structural changes likely to outlive the pandemic.

1. More stuff

Consumer spending is the growth engine of the U.S. economy, accounting for about 70% of GDP.  That hasn’t changed. Even as the pandemic raged, people shopped, and retail sales were one of the first economic indicators to roar back to pre-pandemic levels.

But while the level of consumer spending is about what it was a year ago, its composition has changed dramatically.  Spending on goods — from cars to work-from-home slippers — accelerated 10.4% in January from a year earlier.

At the same time, spending on services, such as spa treatments and concerts, fell 5.3% from a year ago as social distancing precautions remained in place.

The speed at which consumers rebalance their spending between goods and the much larger service sector will determine the sustainability of the economic recovery. It also will have implications for Main Street businesses tied to retail and services.

Source: St. Louis Federal Reserve Economic Research

2. Fewer workers and fewer women

Before the pandemic, the unemployment rate was less than 4%, a 50-year low.

After spiking to nearly 15% in April, it’s now a less-painful 6.2%. On its face, that progress compares favorably with the 2008-2009 financial crisis, when the unemployment rate held above 8% for three years.

The problem is that the official unemployment rate undercounts the many workers who have been misclassified as employed or were forced out of the workforce because of health or family concerns. Adding these MIA workers to the mix pushes the unemployment rate closer to 10%, the highest rate reached during the last recession in 2009.

As we marked International Women’s Day last week, a recurrent theme was the plight of women in the workforce. Women left the workforce at a rate four times higher than men in September of last year as daycares closed and schools shifted to remote learning. Many workers, especially women, were forced to assume new family responsibilities.

Here’s the wrinkle you might have missed: The slowdown in women’s workforce participation was well under way before the virus hit. Women’s participation peaked at 60.2% of the female population in 1999 and has been on the decline since the last recession. It’s now at 55.8%, compared to 57.8% just prior to the pandemic.

Whether or when women, early retirees, and workers in hard-hit industries return to the workforce could determine the health of the labor market and the productive capacity of the future economy.

3. Higher inflation

COVID-19 hit both supply and demand. Factories closed worldwide and consumer spending shrank. The basket of consumer goods and services used to measure inflation nose-dived to .18%   at the height of the lockdown from over 2% prior to the pandemic.

A glut that had long plagued oil prices helped drive the steep decline in headline inflation as people stopped traveling and global demand for fuels slowed. 

Last week, one measure of inflation reached a COVID-era peak of 1.7%, driven mainly by a rebound in gas prices. Main Street is getting behind the wheel again — even if only for a night out. (Restaurants reported a burst of hiring in February.)

But core inflation, which strips out volatile food and energy prices and is closely watched by the Federal Reserve, remains soft at 1.3%.

Inflation gets a bad rap, but it isn’t always a negative. Rising prices often accompany an improving economy as consumers spend more and companies pay more to retain and attract workers. Deflation, a harbinger of declining profits and wages, can be just as debilitating for the economy as high inflation.

A goldilocks inflation rate of around 2% is the economic ideal. But for the last 30 years, inflation has been too low. As economic growth accelerates, maybe even surges, it could rouse the inflation dragon from its slumber. That risk will be top of mind for Fed officials when they meet next week.

4. Bigger deficits

As I type, $1,400 checks are making their way to most Americans, thanks to the relief package Congress passed last week. Nearly $2 trillion dollars is a lot of money, even for a country as large as the U.S. In the past year, Congress has allocated over $5 trillion in COVID relief.  During the Great Recession, Congress passed $1.8 trillion in stimulus spending over a four-year period, not exactly chump change but still dwarfed by today’s spending in comparison.

And it probably won’t be the last time Congress throws money into the economy. Federal investment in broadband, infrastructure spending, and clean energy have bipartisan support and will likely be on the Congressional to-do list for this year.

Behemoth deficits are likely to stay with us for a while, but for now, that’s not a problem. U.S. debt is still the main attraction on the global stage and foreign demand for Treasurys is at a record high.

Spending more than you bring in is a capital offense for many Main Streeters, but governments aren’t businesses. They issue their own debt and can tolerate higher levels of levered spending — to a point. A large deficit will affect our ability to manage the skyrocketing social security and Medicare demands of an aging population later. The bill will come due.

My take

The secret to the longevity of the last economic expansion was tortoise-like growth and subdued inflation. The combination led to lackluster productivity gains, stalled corporate investment and tepid wage growth.  If that’s the future the economy is resetting to, Main Street might want to reconsider its urgency to get back to “normal”. 

Resetting the economy is not like rebooting a computer. The programs we close to fix a bug in the system might not reopen the same way.  Don’t expect everything to go back to the way it was before the pandemic.

Not all the changes wrought by the pandemic will be negative. Among the welcome changes are a greater appreciation for worker flexibility, more corporate sensitivity to the physical and mental health of workers, and more solutions-based leadership to close racial and gender gaps in wealth and income.

How the economy adapts will determine whether the March reset can trigger another decade-long expansion, one that might be even more productive and inclusive than the one we left behind.