Dr. Bruce Yandle's June 2023 Economic Situation Report

On this episode, Patrick McLaughlin, a Senior Research Fellow and Director of Policy Analytics here at Mercatus, chats about the latest economic situation report with Dr. Bruce Yandle, who is a Distinguished Adjunct Fellow here at Mercatus. They discuss Bruce's rollercoaster economy, subsidies and tariffs and how they fit into the bootlegger-Baptist theory of regulation, predictions for the remainder of 2023, Bruce's reading recommendations, and much more.

If you would like to connect with a scholar featured on this episode, please email the Mercatus Outreach team at [email protected].

Check out Bruce's report here.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

PATRICK MCLAUGHLIN: Hello, everyone. I'm Patrick McLaughlin, Senior Research Fellow at the Mercatus Center at George Mason University. I'm here today to do another podcast with Bruce Yandle, he has recently released another quarterly economic situation report, which you can find on the Mercatus website. Bruce, of course, you probably know, is a dean emeritus at Clemson University, longtime contributor to Mercatus, and longtime author of this report that we'll be talking about today. Bruce, thank you for joining me. It's always a pleasure to talk to you.

BRUCE YANDLE: Patrick. Same here. Good to see you. There's always plenty to talk about, isn't there?

MCLAUGHLIN: You keep us on our toes with your reports, that's for sure. Let's go ahead and jump into it. You begin your economic situation report by running through a rather unfortunate and long list of shocks starting with the 2008 recession, to COVID, the war in Ukraine, and more. Give us a few of your top-line takeaways on the effect that these shocks had on the economy and the ways in which we've responded to them.

YANDLE: Patrick, as I mentioned in the report, when I wrote that first sentence describing the series of shocks, it shocked me as I thought about our economy. That is the sentence, we go back to 2008, what is now called the Great Recession, which was a very severe recession. Then we start folding into it, COVID, reactions to the COVID, a shutdown economy, monetary efforts to cushion the effects of the shutdown economy, an economy getting back on its feet, Russia's invasion of Ukraine, disturbing world food markets, energy markets.

Then a walk away from world trade that began to bubble through this process, partly going back to the 2008 recession where there were a lot of blue-collar workers that were thrown out of their jobs. The idea that globalism and globalization was beneficial, even though at times painful, ceased to be accepted. Now, not just the United States but industrial economies worldwide seem to be in the mood to put rocks in the harbor to pull up bridges to become independent. Then along with all of this has come massive fiscal policy intervention as well as monetary policy intervention.

The first thing that I mentioned as I was thinking about this series of calamities, and it's hard to find anything comparable when we look at data going way, way back, there is so much intervention on so many levels that we even cease to use the word intervention anymore. If we say intervention, it implies that we have some kind of normal economy, private sector, and government comes in and intervenes. Now, government is endogenous to the economy. It's present at practically every margin, and it makes it hard to discern what is real, if that word has any meaning anymore, from what is artificial.

What is the result of stimulus versus what is the result of creativity and entrepreneurial talent? In a way, this paragraph was an awakening for me as I thought about these things, Patrick.

MCLAUGHLIN: The constant and consistent intervention has become the new normal. These conditions that you're describing, you paint them as contributing to a rollercoaster economy, in particular, a rollercoaster economy when you look at the money supply that's a steep rollercoaster in both directions, up and down, starting in the first quarter of 2020. You want to talk a little bit about what happened to the money supply back then and maybe what's been going on since?

YANDLE: Sure. That's a good place to start on the topic. Patrick, I visualize data that just happens to be my way of looking at the world. When I say visualize, I do a lot of graphing, and I use a lot of Federal Reserve economic data. They have a wonderful website for people like me who like to keep track of data, and with the website come graphics tools so that you can map various time series individually, and you can map them into each other. Now to the point, if we were looking at one of the popular measures of the amount of money working through the economy called M2, which includes bank deposits, savings accounts, smaller CDs, brokers accounts.

If you were looking at M2 and say, "Let's call that money," we're going to look at the growth of M2 in our economy on a year-over-year basis. For the fun of it, let's go back to 1950 and map that whole time series. If one does that, you're going to see something that occurred in 2021 unlike anything that you will see going back to 1950. You could go on back into World War II, and so we have something we haven't seen before. There was about a 25% year-over-year growth in M2. Most of us as citizens could feel it because it was a check that came into our bank. Practically, every adult citizen received something directly or in the mail, a check from the federal government. That shot him to the sky.

Then concerned about inflation, which followed, and by the way, we probably should say, Patrick, that the word inflation means inflating the money supply. The word does not mean rising price level. It has become that, it's taken on that meaning. What we are observing there with that huge growth in M2 is inflation of the money supply. The forecast always is that if you inflate the money supply, all of that money will get out and chase goods, and we'll see price level effects about 12 to 18 months later. With concern about inflation that begins to show in the CPI sense of the word, the Fed began to hit the brakes, running off money, money supply plummets, growth plummets.

That's the big rollercoaster that I was thinking about when mentioning the rollercoaster economy. As we were having greater than 20% growth, and then we get greater than 20% deceleration all within about 12 months. There's not anything like that in our history, in our monetary history. As we look back now, we got some good numbers today, as a matter of fact, on CPI growth for May coming in at 4.1%. It was at 9% in June of 2022. CPI growth year over year was 9% in June 2022, it's now down to 4.1%. It has been falling systematically ever since.

By the way, if we look a year back, money supply growth has been falling consistently 12 to 18 months earlier than the CPI change. We've got a rollercoaster, we can make some forecasts about what might happen, but we are living in a period that is different from something we have experienced in the past.

MCLAUGHLIN: CPI growth at 4.1%. Now, what would the Fed like to see that number be? Is that where they target 2%?

YANDLE: That's right. They have not let go of their 2% target. The Fed, they're meeting right now with one of their federal open market committee meetings when they make decisions about whether to nudge rates higher, hit the brakes some more or what. Some people expect they will pause a little bit right now, and they might take a lap and celebrate a number that is headed in the right direction. 2% is the number they would like to see, but there are always complicating factors, Patrick. Maybe that leads to unemployment nudge for economist if not for others. By the way, the Fed has 400 economists. Just imagine that.

If people get a little bit tired of listening to two economists talk, [chuckles] say, "How would you like to spend your life in a room with 400?" Not many people would vote for that, I don't think. Nonetheless, back to the point, the 2% target is still in the plan. The complicating factor that I was thinking of is, "What is money? Is cryptocurrency money? Is it a different kind of money from M2? Is it counted, or is it an additional way for people to transact? Should we be counting it?" It's not controllable in the same sense that other monies are controllable by the Fed.

I think there's a lot of action underway, particularly from the Securities and Exchange Commission to put a squeeze on cryptocurrencies. Maybe for many reasons. One of the reasons might be to be able to exert greater control over the money supply and maybe over inflation. There is a complicating factor that is out there. Another complicating factor is artificial intelligence. We have no way, I think, of being able as economists to measure the impact or the level of activity or probably most anything meaningful about what artificial intelligence is doing.

We do know that artificial intelligence is being used extensively. It is contributing to productivity increases. Those productivity increases can bring down inflation or at least contribute to bringing it down. We have a very lively economy with not only a lot of federal intervention into it, but a lot of invention and creativity still alive and well, thank goodness.

MCLAUGHLIN: You're one of the few people, maybe many, many economists do this, but generally, people don't dig into the minutes of the Federal Reserves' meetings, but you did. You looked into the March 20th and 21st meetings. I think you were looking to see what the Federal Reserves economist, the 400 economists, the brain trust there think about where the economy is going and their rationale behind their economic outlook. You do cut them some slack, on the one hand. On the other hand, you wish for something more from the Fed. Can you tell us about that?

YANDLE: Yes. In a way, Patrick, I wish for more from the Fed itself, that is from those major voices that we think of as the Fed, the Federal Open Market Committee, the key leadership. I wish for a lot more from them. As much as we seldom hear any discussion of money supply and money supply growth and its effect on the economy. In fact, I cannot recall an interview following a Federal Open Market Committee meeting when Chairman Powell makes mention of the growth of the money supply and the fact that occasionally there is a relationship between that and inflation. That is just not discussed. I wish it were. I just wish it were an item on the agenda.

When I read those minutes, what the Fed economists were expressing concern about was the effect of the run-up in interest rates on regional banks like Silicon Valley Bank, like Republic that were having to shut the doors, basically, because they run on deposits that occurred. When I say small regional banks, those are very large banks. They are not just large in the likes of Morgan, but the economists were expressing concern about what might be happening as interest rates run up, then the assets held by banks, required to be held by banks in federal government securities and government agency issue like Fannie Mae and Freddie Mac.

When you own bonds, we all know this, when you buy a bond at a time when the prevailing interest rate, let us say is 5%, and you pay hard money for that bond, and it's going to be throwing off 5%, and the interest rates of the world go up to 10%, your bond isn't worth what it used to be. Its value has to fall so that when it's value falls, its yield to the next owner will be 10%. You've just sustained capital losses, whether you take them or not is another question, or whether you mark your assets to market is another question. If you don't do either of those, you're whistling through the cemetery hoping that rates will come back down, and you will not have to declare bankruptcy.

In effect, the Fed economists were having a short discussion in those minutes about that factor and how continued efforts by the Fed to hit the interest rates breaks and run it up would then put more banks at risk in a mark-to-market bankrupt sense. Now, they didn't say this, but in a sense, the Fed itself is bankrupt. It's been a hedge fund operator now since 2008. That is the Fed went out and bought a lot of underwater bonds in order to strengthen the commercial banking system. Through time, those bonds began to pay off, and it looked like a pretty good thing.

Now, as interest rates have gone up, the Fed now by law pays interest to banks on excess reserves. There's a little better than $2 trillion sitting there in excess reserves. It's a 100% sure thing for commercial banks. They get a 5% yield on that. By having to pay that out now, as they have cranked interest rates up, the Fed's positive cash flow has disappeared. Instead of being able to send money to the treasury every quarter, they send an IOU which sounds like a business that is in danger of having to close the doors. Now, the Fed's not going to close its door. There's no such thing as bankruptcy for the Fed or for our country, but it just points to the dramatic effects that are playing through our entire economic system right now.

MCLAUGHLIN: Let's stay on this topic. There's some other stuff in the report that hopefully we'll have time to get to, but while we're talking about the Fed, I did want to ask the question, is there a chance that the Fed could be going too far in its attempts in raising interest rates or slow down the growth of the money supply and get us to the point where we don't have the Goldilocks landing, so to speak, but instead a much harder landing?

YANDLE: I think it's certainly possible for this reason, Patrick. If we go back to the discussion we were having about the growth in M2 and a relationship between that growth and growth in the price level, that's a relationship that has a pretty strong statistical basis through time. You might not want to bet your life on it, but you might not mind betting on it in a casino since the M2 growth hit zero in December last year. In December of 2022, M2 growth turned zero. It has been negative ever since. The money supply is at a lower absolute level than it was in December, and it has been falling ever since.

Now then, you'll say, "There's about a year and a year and a half lag between that and what we would expect to see in CPI-led inflation." That says, "About a year to a year and a half from now, all the things being the same, we should expect inflation to disappear." Then you might say, "What does that mean?" That means most likely that we will have a recession for at least six months, maybe not a severe one, but we will have a slowdown and the slowdown will come because the cookies are already in the oven. They taste like M2, they're M2-flavored cookies, and they're baking, and there's no way to turn the oven off.

We've got in the works a slowing economy. Now, back to your question, if the Fed continues to hit the brakes and run the interest rate up in an attempt to slow the economy when the monetary side of the economy is already slowing it, then we might get a double effect. Yes, I think it is possible that you could get too much Fed-oriented restraint in an economy where the money supply is already growing at a negative rate.

MCLAUGHLIN: That's probably scary for most listeners. It's certainly scary for me, but we can still hope for the best. The good thing about the Fed controlling the interest rate is it's easily changed, or is it so easily changed?

YANDLE: They can turn around in a hurry. We've seen it happen, and it can happen again, and it gets back to our opening conversation, we do live in a rollercoaster economy. Right now, we are sailing down, and it might hit hard, but next thing you know, we'll be sailing up in the air and having a hard time counting the cash that's coming into the bank, but it won't be worth as much as it was before. 

MCLAUGHLIN: There's other government interventions, of course, that are not so easily changed, namely regulations. You do talk about this. As you do in most of your reports, you talk about regulations and their consistent buildup. In this case, there's some specific examples you give talking about subsidies and tariffs and the related actions or the actions that came out of the Inflation Reduction Act, really. When you talk about these in your report, these subsidies and tariffs come out of this act of Congress, you mentioned the bootlegger Baptist theory of regulation. What are the origins of this theory, and what does it tell us about the Inflation Reduction Act and the electric vehicle regulatory landscape?

YANDLE: The bootlegger Baptist theory has been around 40 years now. I did a piece that showed up in Regulation Magazine back in 1983. At the time, I was at the Federal Trade Commission, and prior to that, I had been working in government with a small group that focused on regulatory reform. I had become aware that people in the private sector, as we called it then, who came in to see us were not always-- in fact, most of the time they were not adamantly opposed to regulation. They might want to tweak it a bit, but many of times, they were there to say, "Let's keep it, but let's make it fit a little bit better than it fits right now."

If we were talking about safety regulations, for example, OSHA, or if we were talking about automobile emission regulations coming from EPA there would be two groups of people that would be supportive of the rules, broadly speaking, the environmental community, if it was EPA, and consumer advocates, if it were safety and health, and then there were the industries themselves that were affected saying, "It's really not all that bad. In fact, it could be helpful, might run some of those no-good mom-and-pop shop manufacturers out of business, and they ought not to be in business in the first place." We would hear conversations like that.

Now as we get to the Inflation Reduction Act and the huge subsidies that are included in it for electric vehicles, which may be justifiable in an environmental context with respect to reducing carbon emissions, you can play with those numbers, but if you look at the fine print, and that's where the bootlegger Baptist theory helps to put a little light on the matter. It's the fine print, not the gold face, but the fine print. The fine print says that these subsidies in large will be available to electric vehicle manufacturers located in the United States who use batteries produced in the United States.

If you don't use batteries produced in the United States the subsidy level you will receive will disappear, head towards zero. In addition to that, in order to play in this subsidized field and get the benefits associated from the IRS, you have to employ union workers or pay what is called prevailing wages, and prevailing wages, those are a term of art that refers to what union workers get paid. To be a player, you've got to work with organized labor. Organized labor then is playing the role of the bootlegger in the bootlegger Baptist story. The environmentalists are there saying, "We need electric vehicles. Let's put an end to global climate change and all the horrors that may be associated with it," that's the moral appeal.

The bootleggers say, "By the way, let's do that and employ a lot of union workers." We see that one there. President Biden just made an initiative instituting tariff increases on aluminum and steel coming to the United States, which is something his predecessor did when he was first in office also. In announcing his rule for tariffs on aluminum and steel, President Biden says that the tariffs will be modulated so that the dirtier the steel production from another country, the higher will be the tariff. Our tariffs will be like emission fees that other producers will be hit by. That keeps out the foreign steel, and it also does something to make the environmental community feel better.

By the way, Mr. Biden says, "This is a promise I have made to those good union workers who have been my supporters." There are the bootleggers, again. Patrick, most recently, I brushed up against artificial intelligence and testimony before Congress a couple of weeks ago. Some of the daddy rabbits in that business who have done phenomenal things in a scientific sense express concerned about this Pandora's box that is now open and urged Congress to regulate so that you don't just want any old cat to come into the artificial intelligence world, you want to try to stay with the good cats, and regulating may be a way to make things better. It was another bootlegger Baptist example, at least it brought it to my mind.

MCLAUGHLIN: Make sure those fly-by-night operations don't enter the space.

YANDLE: Yes.

MCLAUGHLIN: As always, I do want to conclude by asking you about your reading recommendations. One of the books you highlight is the late Nicholas Phillipson's book called Adam Smith: An Enlightened Life. You said it taught you things about Smith and his life that you didn't previously know, which I find amazing. What were some of those things, and why are they significant?

YANDLE: Patrick, the older I get, the more I realize how huge the pool of ignorance is. All of us, you, and all the rest of us spend our lifetime trying to fill in and become more knowledgeable. We certainly can, but more often than not, as we become more knowledgeable we find ourselves in another room where we don't seem to know where the door is let alone how to turn on the lights. The interesting thing that for me that I learned from the book about Adam Smith was that Smith had a lifetime ambition to develop a theory of man, a theory of human beings, and how human beings built a life and survived in an unfriendly natural world.

His notions about trade, which, of course, represent the Bible to economists, The Wealth Of Nations shorthand or even Theory Of Moral Sentiments, those books become for most of us what Adam Smith was about, but he wanted a bigger story. He wanted to explain human beings, how they're organized, how they're able to survive, how do they get cooperation, and then trade becomes so important to his story that the spotlight focuses on that and away from his broader search. In a sense, I had the feeling, "Adam Smith really wasn't an economist." He certainly was in terms of laying a foundation that became what we call economics, but he started out with a much broader search in mind. 

Probably for most of us, for you, me, and most of everybody else who spends a little time in this field, the longer you spend in the field, I think the more you become interested, maybe even intrigued by broader questions of human behavior that seem to require interpretations beyond just economics, which sheds a lot of light. It was a big pursuit on his part that was interesting to me. By the way, something else that I found fascinating, he enjoyed rubbing elbows with ordinary people, maybe at a local tavern on a regular basis, and getting out and talking and listening to people talk about what's going on in the world. He seemed to be happy to get outside the halls of Ivy, as we use that expression, and just talk to ordinary people and listen to them.

MCLAUGHLIN: That might be something worth considering for many modern-day economists, getting outside of our own bubbles. I said I was going to conclude with that question, but I realized I didn't get your prediction for the second half of the year. We're almost halfway done with 2023. We've touched on the topic, but we were talking about the Fed's approach. Let's talk about the Bruce Yandle view. What do you think is going to happen for the second half of the year?

YANDLE: We've talked about a lot of the ingredients that have been chopped into pots, so to speak. I've been stirring that pot trying to determine what the outcome might be, and I give an outcome in my report. My expectation is that we will have negative real GDP growth in the third and fourth quarter of this year, 2023. If not then, fourth and first quarter of 2024. By negative growth, I'm speaking of less than 1% negative in that first quarter and maybe a little better than 1% negative in a subsequent quarter before we see positive growth again.

That's driven primarily by what I see with respect to money supply growth, and the lag therein before GDP gets born and develops. A slowing economy, but not a dreadful recession like 2008. A little bit of a rollercoaster, but not one that'll give you a nosebleed. Let's put it that way.

MCLAUGHLIN: For our listeners, if you want to see what Bruce is talking about, the money supply growth and how it's gotten negative and how prices tend to follow that, take a look at the report. It is online at mercatus.org. There's a nice figure showing that as well as all of the other content we discussed here today. Bruce, I want to thank you once again. It's always my pleasure.

YANDLE: Same here, Patrick. Great talking with you today.