This week, the Federal Open Market Committee (FOMC), the monetary policy making arm of the Federal Reserve, met and didn’t do anything. Well, I suppose the members of the committee discussed and overanalyzed any number of economic reports, treatises and data sets. Further, I am confident at least one person got a headache due to all of the mental gymnastics. However, where the rubber meets the road, and as far as you and I are concerned, it didn’t do anything substantial.
The reason why the Fed didn’t do anything is pretty straight forward. It doesn’t know what to do. If you don’t believe me, take Chairman Jay Powell’s word for it. Here are the words straight out of his mouth and right off the transcript:
“The new Administration is in the process of implementing substantial policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation. The tariff increases announced so far have been significantly larger than anticipated. All of these policies are still evolving, however, and their effects on the economy remain highly uncertain. As economic conditions evolve, we will continue to determine the appropriate stance of monetary policy based on the incoming data, the outlook, and the balance of risks.
If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment. The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer-term inflation expectations well anchored.
We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension. If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close. For the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.”
That excerpt is pretty well-crafted, isn’t it? How could you possibly argue with or possibly question the person who wrote it? To be sure, it is pretty sweet stuff, even if John Q. Public might not have any clue what it means.
So, let me give it to you straight.
- The primary gist of the first paragraph is “we aren’t exactly sure what is going to happen.”
- For paragraph number two it is “one the hand, but, then again on the other.”
- Finally, the last one ties it all together with the tried and true “we will just have to wait and see what happens.”
Voila. Now you know. Why use 240 words when 25 will do just as well? Am I right?
Yesterday, I said as much to a pretty sizable lunch crowd in Nashville. Yes, I was supposed to be talking to them about such things. No, I was NOT standing on a chair in a food court.
The verbiage I actually used was something along the lines of: “As you can tell from the color of my hair, I have been doing this a pretty long time. Simply put, I don’t remember the last time a U.S. President embarked upon a trade war with the rest of the planet while simultaneously trying to shrink the Federal government. At least not in any sort of meaningful way. So, it is understandable why everyone’s forecasts aren’t as tight as they would like for them to be. There simply isn’t a lot of historical precedent.”
I further added we should probably get used to a world without as much cheap, Chinese-made [stuff]. Then I challenged everyone with the following: “who among us hasn’t purchased something made in China, or some other third-world country, off of Amazon solely because it was cheap? You know, sort of like the impulse buys near the cashier at the grocery? You don’t need it, but you buy it anyhow.”
As an example, I used the Chinese-made gift I purchased my wife for Mother’s Day this year. It is a relatively thoughtful gift, but far from a necessity. If you were to slap a 100% tariff on that bad boy, Beth wouldn’t be getting it on Sunday. In fact, she wouldn’t get it on Monday, Tuesday, Wednesday, Thursday, Friday or Saturday either. She would never get it, because the thing was already fully priced for such an unessential, elastic item.
Now, multiply that little story by hundreds of millions of consumers, and millions of items. It starts to add up, doesn’t it? The problem is, it doesn’t add up to enough to ramp up production of a lot of this type of stuff in the United States. There just isn’t enough money in it, crazily enough.
In the off-chance Beth reads this prior to getting her gift, I am not going to disclose what it is. However, suffice it to say most of you reading this don’t have one and have probably never even thought about having one. With tax, and I don’t mind sharing this, it was right at $64. This means the product itself was around $55.
So what would it cost to make these Chinese-made elastic items in the United States?
- Let’s assume the manufacturer has a 100% markup from its COGS (cost of goods sold). Fair enough? If so, how many units would I have to sell in order to take home, say, $50,000 annually for myself? The math is $50,000/$27 per unit = 1,852. If you assume 240 working days a year, that means you would have to make, rounding up, 8 of these items a day.
- Now, what if I had to borrow, say, $250,000 at 8.00% in order to get my business started? That would be another 741 units per year ($20,000/$27 per unit), or 3 a day, just to cover the interest. To pay the loan back in, what, 3-years, you will need to figure a way to make another 9,259 units.
Of course, this little example doesn’t incorporate a lot of business-related expenses, pesky things like utilities and licenses, etc. So, I am low-balling these numbers like crazy. However, the minimum you could produce, by yourself, in order to “take home” $50,000 and pay back the bank is 17,037 of these mysterious items over 3 years.
That is right at 24/day or 3 an hour, assuming an 8-hour work day and, again, 240 workdays in a year. Again, one person doing ALL of the work, non-stop, to potentially take home $50,000/year.
Again, while that might doable, the chances are IF you are that good, you probably aren’t going to be messing around making $55 elastic items, let alone the one which I won’t divulge. Shoot, you are likely already gainfully employed making far more money than that.
As such, if these Chinese-made items are too expensive for U.S. consumers to buy, but not expensive enough for U.S. manufacturers to make, we will have to do without.
Catch my drift? Personally, I don’t think this is up for debate.
What is truly up for debate — and where the Fed is essentially shrugging its proverbial shoulders — is just HOW much these tariffs will cause consumer prices to increase. Clearly, this will have a negative impact on consumer demand. The truth is, the Fed doesn’t have a good inflation model for the Trump-era tariffs, because no one knows what they will end up being with major trading partners like China — or which products will ultimately be affected.
The members of the FOMC don’t know, and Jay Powell doesn’t know either. However, they DO know tariffs will have some sort of inflationary impact on consumer prices. They just don’t know how much.
The problem with the logic in Powell’s comments is he apparently assumes there is greater price inelasticity (must-buys) in the U.S. economy than actually exists. That the U.S. consumer will continue to purchase goods despite potentially significant price increases. Nothing could be further from the truth.
The Fed should be worried about inflation, to be sure. However, it should be AT LEAST as worried about a collapse in U.S. consumer demand due to President Trump’s so-called reciprocal tariffs. The reason being much of what the U.S. consumer purchases, in aggregate, is price elastic…even if we might fool ourselves into thinking it is a necessity.
In such a scenario, with a myriad of uncertain outcomes, is it any wonder the FOMC met this week and didn’t do anything?
I wouldn’t have done anything either.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.