Take Five with Dan Varroney: U.S. innovation an economic silver lining

0728 Ezine Danvarroney Panel

Dan Varroney, CEO of Potomac Core Association Consulting and author of Reimagining Industry Growth, is a sought-after expert on economic performance. You might have seen one of his frequent appearances on CNBC, Dow Jones MarketWatch, Bloomberg, and the BBC, and if you did so recently, he’s been sounding the alarm. With wages increasing by 5.1% and inflation rising at 9.1%, every consumer is being squeezed, and whether or not we reach the technical definition of a recession, he notes that energy prices are extraordinary by any standard. In this Take Five interview, conducted yesterday before the Federal Reserve raised interest rates and the U.S. Commerce Department released Q2 gross domestic product data, he comments on where the national economy is headed.

You have said the economy is looking as bad as it did in November of 1981, when consumers faced crushing inflationary numbers, but we haven’t seen the job losses yet. In fact, the most recent monthly jobs report was encouraging. Some have characterized this economic situation as a “full-employment recession” if indeed it meets the technical definition when the Q2 GDP numbers come out. How is that possible?

“What we should focus on is that jobs are a lagging indicator, not a leading indicator. The thing that we’re going to see as we get deeper into a recession is significant job losses. The other thing that we have started to see in the past few weeks is that weekly jobless claims are on the uptick. For instance, the number of workers filing for unemployment claims rose to a two-month high just this past week. So, we’re starting to see it around the edges, but job loss is a lagging indicator, not a leading indicator. It will happen as a recession deepens.”

Two weeks ago, both the Consumer Price Index and the Producer Price Index provided another jolt where inflation is concerned. As a result, do you expect the Federal Reserve to become even more aggressive in raising rates, perhaps beyond the 75-basis point increase announced yesterday?

“The consumer price index that came out recently, it was a 40-year inflation high, year over year, of 9.1%. So, the last time we saw that was, in fact, November of 1981 … But the indicator that I look at a lot is the Producer Price Index. Those are the input costs for producers. The fact that the PPI came in even higher than CPI, at 11.3%, is a fairly ominous omen. The reason is that the PPI gives us a sense that prices are going to continue to remain high as we move forward over the next month or two. So, while I look a lot at the CPI and inflation numbers, I also look a lot at the Producer Price Index. I think Fed Chair Jerome Powell later today will announce an increase of 75 basis points. It will be the second consecutive increase of 75 basis points. I think it’s appropriate when we look at why this is happening. The Fed is doing this to try to slow down and cool off the economy. The Board of Governors, the Federal Open Market Committee, absolutely realized that it’s costing the American people a lot in the food store, a lot in the clothing store, a lot at the gas pump, and they are trying to cool it down.

“My sense is each month they look at the numbers and they say whether or not they will continue to increase rates. They will announce this increase today [Wednesday] and over the next 30 days look at things like the CPI and the PPI and see where things go. However, what I would also add is that even the Federal Reserve has got to temper its strategy. Tomorrow [Thursday], the GDP numbers, the first reading of the GDP comes out for the second quarter. In the first quarter, we were –1.6 and we had a contraction. If the economy showed no growth or we had a contraction again, technically that is a recession. The Fed will be looking closely at what happens tomorrow and use that as some type of determining factor as to whether they pause rate increases or whether they reduce the level of [future] rate increases. So, tomorrow is an important day in their decision-making process.”

Editor’s note: This morning, the U.S. Commerce Department reported that GDP dropped by 0.9% during the second quarter of 2022, marking the second consecutive quarter of contraction. The figure could still be revised upward or downward as more data comes in.

“The issue, when you look at it, is we’re a 70% consumer-driven economy. When you look at inflation and how severe and how crushing it is, and how we’re all being squeezed with everything we buy, everywhere we shop, and at the gas pump, this is a clear picture as to why the economy contracted in the first quarter and why it likely contracted in the second quarter.”

Some suggest that as long as we continue to transition away from fossil fuels and keep them more expensive — which impacts the cost of virtually everything — it doesn’t matter what the Fed does to tame inflation. Inflation will continue to rise.

“Here is something I’m going to say, and this is not controversial. Understand that I’m a strategist. I work in the strategy universe, and that means I’m data-based and I’m strategy-based — not politically-based. But here is the issue: I work with a lot of different industries and a lot of different industry trade associations. One of the things we do is build strategies and roadmaps. In other words, what is the industry trying to achieve and how do we get there? When we think about clean air and clean water, make no mistake about it, the American people lean heavily in that direction. The issue is what is the best strategy to transition us and get us there? When people ask me whether that is a criticism or a critique, I say not at all. It’s a strategy observation. If we’re looking to take the economy from where we are to where we want to be, what’s the best strategy to get there?

“From my perspective, one of the things we could do to work with industries like the oil industry and other elements of the energy sector is ask how can we reduce the carbon footprint as we build this transition? To me, I would call it a strategic transition that has strategies and a roadmap that takes us from where we are to where we want to be. There is a certain reality to all of this. You just don’t transition from one form of energy to another. There are a lot of implications. For example, are there ample and sufficient charging stations for electric vehicles? From everything I’m learning, there are not. What I’m also learning is the oil industry has already, in the last number of years, reduced its carbon footprint. Not to where we know it needs to be, but there have been reductions.

“My larger point is there needs to be a planned transition. In other words, this can’t be ‘we’re just going to do it.’ For example, is it time to revisit nuclear as an option because nuclear energy is clean? It does not have a carbon footprint. It’s far safer today than it was back in the 1970s. The technology is far more advanced. Natural gas has got a very low carbon footprint. There are things like clean coal, so in my mind, we’ve got a number of options and we should look at this strategically. In doing so, we should have strategies and a roadmap to take us there … Energy powers the U.S. economy, and to give you an example of input costs, the cost of diesel fuel is one of the things that raises the cost of food to where it is. Energy touches every bit of the U.S. economy. You can’t make clothes, and you can’t process food without touching energy. You can’t go to work without energy. You can’t turn on the lights. You can’t run the air-conditioning and the heating without some form of energy.”

It’s in the cost of production for everything.

“Yes, absolutely. That’s why when I saw the Producer Price Index year over year increase at 11.3%, I said to myself, ‘I’m not sure that inflation is going to be tamed.’ I’ve read different news accounts where people think that inflation has peaked, so, my first question is, how do we know that? What additional data do we have to support that? Then I saw the Producer Price Index numbers come out and I said, ‘So, if the input costs are up year over year by 11.3%, that is foretelling that we may be looking at high inflation for a while yet.’ So, I’m not convinced it has peaked yet. I’m hoping it has peaked. When I see the PPI numbers come down, then I’ll say we’re heading in the right direction.”

This sounds like an unprecedented situation. How bad could this get when the usual tools used by monetary and fiscal policy makers — such raising interest rates or deficit spending — might not have the desired effects?

“I think it could get really bad. Let me give you an example of some bellwethers. We all have not only phones, but we’ve got mobile phones. Last week, I believe, AT&T reported that its customers are starting to fall behind on their bills. As their costs continue to increase, consumers are feeling squeezed, and they are stretching out the time in which they pay bills. That’s a big challenge. The other thing we’ve seen is that as savings rates have fallen from 8% a year earlier to 4 or 4.5% now, some 62% are using their credit card more to pay for higher gasoline and food prices. Consumer confidence is falling. I think this recession could be severe. We need to see these interest rates increases slow the economy down, but we could be looking at another 12–18 months of this.”

Chip makers like Texas Instruments and Intel are already in the process of building more semiconductor plants in the U.S. to deal with the chip shortage, and Congress is working on a bill to incentivize domestic chip production, but that’s not the only part of the supply chain disruption and resulting material shortages. To what extent will this situation, which relates to the pandemic lockdowns, cause the U.S. and others to bring home more of the manufacturing that has gone overseas?

“There are a few things that I want to point out. There was a belief or a perception that it was the pandemic that caused the supply chain disruptions, but there were supply chain challenges pre-pandemic. I got with my research person and my team and said, ‘Look, we need to understand whether this was a COVID thing,’ and this was not just a COVID thing. There were supply chain disruptions before the pandemic. The issue is what are we going to do about it? I did an op-ed piece in Fortune and I talked about the supply chain. The interesting thing is we have to be more innovative, and a lot of what I’m suggesting is that industries form pre-competitive alignment and pre-competitive solutions to think about what they can do together.

“One of the things we identified in our research is that the retail company American Eagle has literally built a platform that I would call the equivalent to a ‘frenemy’ network where they allow people to utilize their supply-chain platform. I’ve been advocating in a number of articles that I’ve written that industries come together under the banner of industry trade associations to identify pre-competitive solutions. They can’t talk about pricing because that’s anti-trust, but one of the things we need to do is onshore or reshore. So, we need skilled and educated workers. We need transportation. So, how can we build through an industry trade association a strategic partnership that helps us reshore? Have companies successfully reshored? Absolutely, but if we’re serious about a more significant reshoring effort, we’ve got to come together in strategic partnerships and come up with pre-competitive solutions.

“Back to this chip issue. There are minerals in Ukraine that aren’t coming out that are part of chips, the microprocessors. So, if we are going to make chips in this county, do we have the environmental will to do the mining and make the long-term commitment to produce those natural minerals so we can make those microprocessors in this country?”

In terms of the economy, are there any silver linings out there?

“Yes, here is what the silver linings are. We still live in the most innovative and the most productive economy in the world. We are the envy of the world. When you look at the collaboration and the innovation that we’ve had, everything from the light bulb to automobiles, the polio vaccines and now the COVID vaccines, we have innovative capacity in this country to overcome absolutely anything we want. The question is how we identify the things we need to do innovatively that will make this country even more efficient, even more effective, and will employ even more people and make the economy especially strong again.”

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