“…a comprehensive explanation of the modern economy.” - Julian Robertson, Founder, Tiger Management
The Economic Report – Week of Monday, August 1, 2022
MONDAY, AUGUST 1, 2022
Vast New Study Shows a Key to Reducing Poverty: More Friendships Between Rich and Poor (Claire Cain Miller et. al, New York Times) An expansive new study, based on billions of social media connections, has uncovered a powerful exception to that pattern that helps explain why certain places offer a path out of poverty. The study, published Monday in Nature, analyzed the Facebook friendships of 72 million people, amounting to 84 percent of U.S. adults aged 25 to 44. The new analysis — the biggest of its kind — found the degree to which the rich and poor were connected explained why a neighborhood’s children did better later in life, more than any other factor. The effect was profound. The study found that if poor children grew up in neighborhoods where 70 percent of their friends were wealthy — the typical rate of friendship for higher-income children — it would increase their future incomes by 20 percent, on average. These cross-class friendships — what the researchers called economic connectedness — had a stronger impact than school quality, family structure, job availability or a community’s racial composition. The people you know, the study suggests, open up opportunities, and the growing class divide in the United States closes them off.
Social Capital I: Measurement and Associations with Economic Mobility (Raj Chetty et. al, Nature) Here, we use data on the social networks of 72.2 million users of Facebook aged between 25 and 44 years to construct and publicly release new measures of social capital for each ZIP code in the United States. In a companion paper,, we also release data on social capital for each high school (secondary school) and college (university). As in previous research using Facebook data we use social network data as a proxy for real-world friendships rather than online interactions per se. As a result, our analysis does not shed light on the effects of online social networks themselves. We correlate our new measures of social capital with data on economic mobility—children chances of rising up the income distribution—across areas and analyse the mechanisms through which social capital and economic mobility are related. We find that the degree to which people with low and high SES [socioeconomic status] are friends with each other (which we term economic connectedness (EC)) is strongly associated with upward income mobility, whereas other forms of social capital are not. Figure 1a plots the mean SES rank of individuals’ friends against their own SES ranks. There is strong homophily, whereby individuals with higher SES are friends with higher-SES people. A one percentile point increase in one’s own SES rank is associated with a 0.44 percentile point increase in the SES rank of one’s friends on average. The relationship is almost linear between the 10th and 90th percentiles of the SES distribution, with a slope of 0.41 in that range. The slope rises to 0.98 between the 90th and 100th percentiles, which shows that the highest-SES individuals tend to have particularly high-SES friends. These estimates of homophily are similar (slope of 0.46 for full range, 1.02 between the 90th and 100th percentiles) when we restrict the analysis to an individual’s ten closest friends (defined on basis of the frequency of public interactions such as likes, tags, wall posts and comments). This result shows that our estimates are not significantly affected by the strength of friendships or the number of Facebook friends that people have. Figure 4 shows the relationship between EC and mobility non-parametrically by presenting a scatter plot of upward income mobility versus EC for the 200 most populous counties. Children who grow up in counties where low-SES individuals have more high-SES friends tend to have much higher rates of upward mobility. As an example, low-SES individuals have a much larger share of high-SES friends in Minneapolis (49%, corresponding to an EC of 0.98) compared with Indianapolis (32%, EC of 0.65). Correspondingly, children who grow up in low-income families have much higher incomes in adulthood in Minneapolis than in Indianapolis. In Minneapolis, children reach the 43rd percentile of the household income distribution on average at age 35 years (roughly US$34,300 in 2015), compared with the 34th percentile ($24,700) in Indianapolis.
Nancy Pelosi to meet Taiwan’s president on Wednesday (Demetri Sevastopulo + Kathrin Hille, Financial Times) Nancy Pelosi, Speaker of the US House of Representatives, plans to meet Taiwan’s president Tsai Ing-wen on Wednesday The US military has been preparing to protect Pelosi, who is flying on a US Air Force aircraft. Few experts believe China would try to shoot down her aircraft, but Chinese fighter jets could attempt to intercept her plane. This could trigger a dangerous situation because the US military would be compelled to intervene to protect Pelosi and her delegation. Beijing on Monday stepped up its threats. After its PLA conducted live-fire drills on Pingtan, an island in the Taiwan Strait, and other drills in the South China Sea last week, the China Maritime Safety Administration said there would be more exercises from Tuesday to Saturday in the area. “The Chinese People’s Liberation Army will not sit back,” China’s foreign minister spokesperson Zhao Lijian told reporters on Monday. One senior Taiwanese official said Taipei had not seen a marked increase in PLA activity in its vicinity over the past week, but China’s military had stepped up its movements around Taiwan in previous weeks, said people familiar with the situation. “They have been raising the pressure a lot recently,” said a second senior Taiwanese official. “They are sending both larger numbers of aircraft and ships and getting closer.” According to data from Taiwanese national security authorities, on July 24 the PLA conducted joint air and sea manoeuvres on three sides around Taiwan. These included an attack drone and a destroyer off its east coast, an anti-submarine warfare aircraft flying around its southern tip, and two fighter jets and a reconnaissance aircraft flying an incursion into the south-western edge of its “air defence identification zone”. The day after those movements — some of which have not been made public — Japan’s military said another type of Chinese attack drone had flown between Yonaguni, a Japanese island near Taiwan’s east coast. Data published by Japan’s military and Taiwan’s defence ministry also show that the PLA has stepped up activity around the southernmost islands of Japan and in Taiwan’s ADIZ since the second half of June.
Inflation Reduction Act: Preliminary Estimates of Budgetary and Macroeconomic Effects (Penn Wharton Budget Model Staff, U. Pennsylvania) PWBM estimates that the Inflation Reduction Act, as written, would reduce cumulative deficits by $248 billion over the budget window. The Act would very slightly increase inflation until 2024 and decrease inflation thereafter. These point estimates are statistically indistinguishable from zero, thereby indicating low confidence that the legislation will have any impact on inflation. We project no impact on GDP by 2031 and an increase in GDP of 0.2 percent by 2050. These estimates include the impact of debt and carbon reduction as well as capital and labor supply distortions from rising tax rates. As written, the Inflation Reduction Act contains a sunset for the Affordable Care Act (ACA) subsidies provision at the end of 2025. Under an illustrative scenario where that provision was extended indefinitely, the 10-year deficit reduction estimate falls to $89 billion. The impact on GDP remains zero through 2040. Table 2 presents PWBM’s projections of the long-run macroeconomic effects of the Inflation Reduction Act, as written, including the sunset of ACA subsidies at the end of 2025. A decrease in spending on prescription drugs combined with increases in revenues from personal income taxes and business taxes lead to a decrease in government debt, which declines by 8.4 percent by 2050. This decrease in government debt crowds-in investment in productive private capital. Nonetheless, this effect is offset by the effects of higher personal and business taxes, which discourage saving and investment. The net result is that private capital increases by 0.3 percent in 2040 and 0.7 percent in 2050. This increase in private capital makes each worker more productive, which is reflected in higher wages. Wages increase by 0.1 and 0.3 percent in 2040 and 2050 respectively. Each of the spending provisions in the Inflation Reduction Act has different economic effects. For example, the additional ACA subsidy benefits are transfers or payments to households, which reduces the incentive to work. This effect contributes to the 0.1 percent decline in hours worked in 2031, 2040, and 2050. PWBM also accounts for the positive economic effects of programs like infrastructure investment and carbon abatement associated with certain clean energy provisions, as described in a previous brief. These provisions lead to a slight increase in productivity. Overall, all the provisions taken together lead to an increase in GDP of 0.1 percent in 2040 and 0.2 percent in 2050.
Raise Taxes on Investment? Scott Sumner, The Library of Economics and Liberty According to the WSJ, the proposed “Inflation Reduction Act” will lead to higher taxes on business investment: The media often report this sort of policy change as representing higher taxes on “the rich.” But investment is a key factor in boosting productivity, which is what ultimately determines the living standards of ordinary workers. Taxes on investment have the effect of taxing future consumption at higher rates than current consumption, which reduces saving and investment and slows economic growth. I am trying to get up to speed on the rest of the bill. Price controls on the purchase of drugs by Medicare might be beneficial in reducing federal spending, or they might be detrimental in slowing the development of new drugs. More money on IRS enforcement might be beneficial in terms of reducing tax fraud, or it might be costly by adding to the number of aggravating tax audits. Environmental provisions might help to reduce global warming, or they might lead to wasteful pork barrel spending. In almost every case, better alternatives were available. Tax code simplification would make existing IRS resources go much further. A carbon tax is superior to a complex mixture of subsidies. I understand that the actual bill was the option that was politically feasible, but it is still disappointing to see so many missed opportunities. (I suspect the next GOP administration will restore expensing of investment.) On the brighter side, the carried interest loophole that benefits rich hedge fund managers was somewhat reduced in size. I’ve never understood the rationale for that tax loophole. And Senator Manchin suggests that there are vague promises to reduce regulatory barriers to new projects in areas like energy and infrastructure. I’m not optimistic that this will be a game changer, but it’s certainly a hugely important issue. Thus it’s nice to see an indication of at least some movement on that front. I don’t know enough to have a firm view on the overall bill. My instincts are usually to be skeptical of change, as almost everything Congress does seems to make things worse. I’m a utilitarian, so I favor funding all types of police as long as the extra resources produce greater benefits that exceed costs. Unfortunately, in the real world it’s hard to know what level of spending is optimal. In my view, the best way to reduce government abuse is to have fewer laws (especially regarding drugs), fewer regulations, and a less complex tax code.
Much Ado About Wages (Paul Krugman, Krugman Wonks Out) The fact that wages are different from other prices explains why serious discussion about the inflation outlook hinges a lot on what is happening to wages. Falling gas prices are giving Americans quick relief, and there are early indications that the Fed’s interest rate hikes are leading to falling prices or at least a sharp slowdown in inflation across much of the economy. But this disinflation won’t be durable unless wage increases come down. True, wages aren’t the only or even the most important driver of recent inflation. But we won’t be able to get inflation down to the Fed’s target of 2 percent if wages are rising at an annual rate of 6 percent, the way they appeared to be in late 2021 and early 2022. Wage growth doesn’t have to drop all the way to 2 percent — because producers can partly offset rising wages with higher productivity — but stabilizing inflation will mean getting wage growth down considerably. Goldman Sachs says 3.5 percent would do it. To be honest, I think that’s a bit optimistic. So how’s it going? Infuriatingly — but all too common these days — different statistics are telling different stories. You might think that we can look just at average wages. But that data was very distorted during the worst of the pandemic slowdown, surging because lower-paid workers were laid off in large numbers, then falling as they came back to work. It’s not obvious that anything similar is happening now, and the average wage has been showing a steady decline: There are, however, other measures. The Bureau of Labor Statistics produces the Employment Cost Index, which is supposed to correct for the kind of composition effects that distorted average wage numbers in 2020. The Fed prefers a version of the E.C.I. that excludes incentive payments (basically bonuses), also shown in the chart. And while it’s down a bit in the latest release, there’s less evidence of a sustained decline and it’s still running above 5 percent. All of which leaves things … unclear. But inflation looks harder to tame than I hoped it would.
Energy Prices May Keep Inflation High For Years (Gwynn Guilford, Wall Street Journal) The low inflation of the prior decade was in part due to relatively cheap energy, buoyed by the shale revolution and intensified by the market-share war among OPEC members in 2014 that flooded the market with oil, said Bob Ryan, chief commodities and energy strategist at BCA Research. Energy accounted for 4.1% of consumer spending from 2015 to 2019, on average—the lowest share for any five-year period since records began in 1929, outside the pandemic. High prices drove up energy’s share of consumer spending to 5% in June. Energy accounted for about a third of the 9.1% rise in consumer prices in the 12 months through June. That contribution could turn negative in the short-term if gasoline prices continue to fall. But over the long term, upward pressure is likely to persist. Consumer prices could increase by as much as an additional 4% by the early 2030s if higher carbon costs—from sources including taxes, other government policies and changing consumer preferences—are passed on to users, according to analysis by BlackRock Investment Institute. That could add 0.4 percentage points to inflation each year if the transition to net zero emissions by 2050 is smooth, the authors found. A faster shift would push up inflation more dramatically. Energy prices are likely to rise in large part due to constrained supply from slumping global investment in oil and gas exploration and development, which has fallen by nearly half since prices collapsed in 2014, according to BlackRock’s analysis. But renewable energy sources aren’t anywhere near the scale needed to fill the gap. And weak investment in mining and processing capacity for the raw materials used in solar panels, wind turbines, batteries and other renewables is making it hard for supply to keep up with demand, pushing up installation costs. The prices for power purchase agreements—long-term contracts for electricity generated by renewable systems—have gone up sharply in the last year, driven in part by high input costs, though also because permitting and the lack of grid infrastructure are causing delays. An index of the most competitive PPA prices, which broadly reflects the price at which renewable project developers are willing to sell, rose 5.3% in the second quarter of 2022 from a quarter earlier to nearly $42 per megawatt hour, according to LevelTen Energy, a renewable energy platform that runs PPA marketplaces in North America and Europe. Sluggish investment means supply of key minerals will struggle to keep up as demand accelerates during the transition. The International Energy Agency recently estimated that if the world were on track to meet Paris Agreement goals, demand would jump 40-fold for lithium and 20-fold for nickel and cobalt between 2020 and 2040. All told, the transition process would raise the global average cost of producing and delivering each unit of electricity by 25% by 2040, compared with 2020 levels, which could be passed on to consumers’ electricity bills, said Humayun Tai, senior partner who co-leads McKinsey’s electric power and natural gas practice.
Monkeypox Is About to Become the Next Public Health Failure (Scott Gottlieb, New York Times) Our country’s response to monkeypox has been plagued by the same shortcomings we had with Covid-19. Now if monkeypox gains a permanent foothold in the United States and becomes an endemic virus that joins our circulating repertoire of pathogens, it will be one of the worst public health failures in modern times not only because of the pain and peril of the disease but also because it was so avoidable. Our lapses extend beyond political decision making to the agencies tasked with protecting us from these threats. We don’t have a federal infrastructure capable of dealing with these emergencies. The Biden administration needs to get the C.D.C. back to its disease control roots, by transferring some of its disease prevention work to other agencies. The F.D.A. can handle smoking cessation, leveraging its regulatory toolbox. The National Institutes of Health can tackle cancer and heart disease. Focus the C.D.C. more on its core mission of outbreak response. And imbue the agency with the national security mind-set that it had at its origins. If the C.D.C.’s mission were more tightly focused on the elements required for handling contagion, Congress might be more willing to invest it with the robust authority to do that targeted mission well. Congress would need to reprogram budget lines to get it done, but someone needs to start that conversation. Time is running out. Diseases like Zika, Covid and monkeypox are a dire warning that dangerous pathogens are on the march. The next one could be worse — a deadly strain of flu or something more sinister like Marburg virus. We’ve now had ample notice that the nation continues to be unprepared and that our vulnerabilities are enormous.
Is the 2022H1 GDP Decline…Fake? (Matt Klein, The Overshoot) The price-adjusted value of the goods and services produced in the United States was 0.6% lower in April-June 2022 compared to the seasonally-adjusted peak in October-December 2021. Real Gross Domestic Product (GDP) has ostensibly been falling for two quarters in a row. But Gross Domestic Income (GDI), which is published by the same government agency that compiles GDP, implies that the U.S. economy has been growing continuously since the end of 2021. This disconnect is unusual, although there are precedents, especially around downturns.But for now, it poses a serious puzzle. Moreover, it’s not even the only thing amiss right now if you dive deep into the numbers. The main things to know: The drop in GDP seems to be driven by troubles in manufacturing and energy, but those numbers seem to be inconsistent with the Federal Reserve’s separate estimates of mining activity and motor vehicle output. Employee earnings and small business income were rising faster than prices, but not anymore. The impact on total national income has been more than offset by the withdrawal of government subsidies to businesses since the end of 2021. (Slowing growth in take-home pay may not feel good, but the indicator that reflects overall economic activity is the amount of income generated organically by the private sector.) Regardless of which measure you prefer, the pace of growth seems to be slowing, and some higher-frequency indicators imply that the economy may have already begun rolling over. The implication is that the brunt of the downturn is being felt by America’s manufacturers (and, to a lesser extent, its farmers and miners). After all, they are the ones who produce the goods that other businesses buy to hold as inventories and they are the ones most exposed to global competition both through imports and exports.
Drawdowns and Rallies (Dan Rasmussen, Verdad) Does this rally mean this contraction is over? Or is this a false signal preceding further losses? We looked at 50 years of bear markets in the S&P 500 to develop a sense of historical probabilities. The below chart shows how many days it took the S&P 500 to recover after it entered a bear market (a 20% drawdown) and the further drawdown from that point. Upon entering a bear market, it often takes the market a long time to claw back to positive and, with rare exceptions, there are subsequent severe drawdowns. If we are truly staging a recovery out of a bear market, it would be one of the fastest and least severe bear markets in history. Today, even after July’s rally, high-yield spreads remain elevated. Spreads today are still around 500bps, well above the 10-year median. And as we noted in a recent piece, spreads this wide tend to be very dangerous times for equity investors. Every equity drawdown of -30% or more has occurred within six months of high-yield spreads crossing the 10-year median of 430bps. As Ben Bernanke highlights, credit markets amplify and propagate shocks to the real economy. Within this framework, deteriorating credit market conditions—such as increases in insolvency and rising real debt burdens—feed back into the economy, which in turn worsen credit conditions. Investors may have sighed a breath of relief in July after months of pain. And perhaps we have already seen the market’s 2022 lows and this recovery will follow the rapid pace of 2020. But a broader set of base rates suggest there’s reason to be cautious, that risk is still elevated, and that we might yet experience an even more significant drawdown.
Venture Capital’s Silent Crash: When the Tech Boom Met Reality (Richard Waters, Financial Times) The scale of the most recent venture boom has dwarfed that at the end of the 1990s, when annual investment peaked at $100bn in the US. By comparison, the amount of cash pumped into American tech start-ups last year reached $330bn. That was twice was much as the previous year, which was itself twice the level of three years earlier. According to Coatue, one of a new band of “crossover” investors that moved from the public markets into the VC world, $1.4tn found its way into promising growth companies globally last year, half of it in the form of venture capital and half through IPOs. That single-year surge, it calculated, was nearly $1tn more than the average of $425bn a year raised over the previous decade. Only companies with an urgent need for capital have been forced into a full reckoning with reality, as investors putting in new money demand an up-to-date valuation. Klarna, the Swedish buy now, pay later company, sent shockwaves through the market for private fintech companies earlier this month when it raised money at a $5.7bn valuation — 87 per cent less than its venture capital backers judged it was worth a year ago. Yet that savage price cut merely echoed a turn that had already set in for similar companies in the public markets. Shares in Affirm, a US buy now, pay later company that went public early last year, have also fallen 87 per cent from a peak last November. Fast-growing fintech company Block is down 78 per cent, after $130bn was wiped from its market value. The new investors that set the tone as venture investments ballooned included SoftBank’s Vision fund, which ploughed $100bn into the market. Tiger Global, which spread its bets widely, at one stage held more stakes in $1bn start-ups than any other investor. Both have since disclosed shattering losses: the Vision Fund registered a one-year loss of $27bn loss in May, the same month it emerged that Tiger had lost $17bn. In venture, timing is everything. The median venture fund that was raised in 1996, when the first internet boom was just gathering steam, returned 41 per cent a year over its life, according to Greenwich Associates, which tracks fund performance. But the median fund raised in 1999, at the peak of the bubble, went on to suffer a loss of 3 per cent a year.
The Microchip Era Is Giving Way to the Megachip Age (Christopher Mims, Wall Street Journal) The pressure to continue making chips faster and our devices more capable is unrelenting, and the chip industry’s ability to keep pace by shrinking transistors to eke out more performance is running into technical barriers. Presently, most chips are around the size of a dime or a quarter, but some chips are now growing to nearly the size of a playing card, or in one case, a dinner plate. But these megachips can present engineers with challenges when it comes to managing the extra heat they create from all the calculations being performed in densely-packed circuits. And though they can be more energy efficient, their sheer size means they sometimes end up using a lot of power, too. Intel’s Ponte Vecchio chip, for example, is efficient on a per-calculation basis, but consumes 600 watts, nearly enough to run a hair dryer. If you are wondering why megachips aren’t yet in your mobile device, this is your answer. One extreme example is Intel’s recently-announced Ponte Vecchio graphics processors. Each is made up of 63 different chiplets. These chiplets, stacked on top of and crammed next to one another, have a total area of 3,100 square millimeters, and include 100 billion transistors. For comparison, the typical chip at the heart of a laptop measures less than 150 square millimeters, or about 1/20th the size, and has about 1.5 billion transistors—1.5% as many. Stacking chiplets also allows Intel to increase performance of its next-generation desktop and server chips without increasing their (two-dimensional) footprint, or their total power consumption, he notes. That might seem counterintuitive, but it helps to understand that the amount of power a chip uses is a design decision, and saving on power is one of the highest priorities of the industry. Stacked chiplets can allow engineers to squeeze more out of existing designs by economizing on the time and energy required for different parts of the chip to communicate. But when performance is the priority, chiplets can also be used to make microchips bigger—and more power-hungry.
Falling Food Prices Ease Upward Pressure on Global Inflation (David Harrison, Wall Street Journal) Falling prices for commodities such as wheat or corn are set to slow consumer food price increases, easing pressure on a major driver of global inflation. Supply problems caused by the Covid-19 pandemic sent the price of food soaring last year. Russia’s invasion of Ukraine in February of this year added additional pressure. The two countries combined accounted for 28% of global wheat exports last year and 15% of corn exports. Russia is also a major exporter of agricultural fertilizer, and Ukraine leads the world in sunflower oil exports. he onset of the war pushed up global food prices by 13% in March from the previous month, according to the United Nations’ Food and Agriculture Organization. Prices have edged down since, and in June, they were about 3% below March levels, though they remain higher than before the war started, according to the FAO. Futures markets point to continued price declines. Wheat futures prices are now roughly where they were before Feb. 24, when Russia began its invasion of Ukraine. Corn prices are at their lowest level so far this year.
The Upside-Down Housing Market (Joseph Politano, Apricitas Economics) America is still going to have to deal with an acute shortage of housing even if rising rates cause average home prices to shrink. Fundamentally, there is not enough construction to keep up with population growth, income growth, and household formation. Estimates for the shortfall of housing units range in the millions, and housing vacancy rates (a decent non-price proxy for demand) remain at historic lows. Even as real-time home prices appear to cool a bit, private sector measures of rent growth are decreasing but remain elevated. That’s going to feed through to inflation in the near future, and further improvements on the supply front are needed to mediate price growth. Rising mortgage rates may have turned the housing market upside-down, but the housing shortage remains.
Particle Physicists Puzzle Over a New Duality (Katie McCormick, Quanta Magazine) Last year, the particle physicist Lance Dixon was preparing a lecture when he noticed a striking similarity between two formulas that he planned to include in his slides. The formulas, called scattering amplitudes, give the probabilities of possible outcomes of particle collisions. One of the scattering amplitudes represented the probability of two gluon particles colliding and producing four gluons; the other gave the probability of two gluons colliding to produce a gluon and a Higgs particle. “I was getting a little confused because they looked kind of similar,” said Dixon, who is a professor at Stanford University, “and then I realized that the numbers were basically the same — it’s just that the [order] had gotten reversed.” He shared his observation with his collaborators over Zoom. Knowing of no reason the two scattering amplitudes should correspond, the group thought perhaps it was a coincidence. They started calculating the two amplitudes at progressively higher levels of precision (the greater the precision, the more terms they had to compare). By the end of the call, having calculated thousands of terms that kept agreeing, the physicists were pretty certain they were dealing with a new duality — a hidden connection between two different phenomena that couldn’t be explained by our current understanding of physics. Now, the antipodal duality, as the researchers are calling it, has been confirmed for high-precision calculations involving 93 million terms. While this duality arises in a simplified theory of gluons and other particles that does not quite describe our universe, there are clues that a similar duality might hold in the real world. Researchers hope that investigating the strange finding could help them make new connections between seemingly unrelated aspects of particle physics. There are now two big questions. First, why does the duality exist? And second, will a similar connection be found to hold in the real world?