The economy runs into its ‘speed limit’ in the U.S.: continuing to press the accelerator can be dangerous

Economy United States

The takeoff of the economy after the covid-19 recession has been more than remarkable. Growth forecasts for U.S. GDP this year and next haven’t stopped rising… until a few weeks ago. The economy may have reached its speed limit (speed limit). Stepping on the accelerator harder at this point will only serve, in the short term, to generate more inflation (a fine that can have a high cost) and aggravate some of the problems that are already affecting supply.

Shortage of materials and components, bottlenecks in key infrastructures for international trade, skyrocketing energy prices, difficulty finding workers in some sectors… The recovery in demand (globally) has been so rapid and sudden that supply is being unable to keep up.

In the end, in a crisis of this type, the demand ‘only’ needs the restrictions and confidence to be lifted to return in style (it must be taken into account that the government safety nets have ‘filled’ the pockets of consumers during the worst of the crisis), but the offer cannot go from zero to one hundred in such a short time.

Reopening, hiring suitable personnel and putting all the machinery to work to meet the current demand and part of the past (dammed demand) is not easy. For this reason, the supply tends to be more rigid in the very short term (especially after a period of stoppage such as the one caused by the covid) than the demand, as is currently being observed. Supply sets the limit speed (the capacity for long-term growth) and if demand exceeds it, what happens is that there is an increase in prices. 

This is known as the ‘speed limit effect’ or simply ‘speed limit’. The rating agency Fitch has titled its latest forecast report with precisely those words, which initiate a downward revision of the global growth of the economy. From Fitch “they expect world GDP to grow 6% in 2021, slower than the 6.3% growth forecast in June. Supply constraints are reducing the pace of recovery and have revised down the forecast for the US GDP by 2021 at 6.2% from 6.8% in June. A larger proportion of demand growth is being transformed into price increases and inflation forecasts have been revised upwards again.” If demand continues to be stimulated through expansionary fiscal and monetary policies,  the result may be stagflation.

World GDP is expected to grow by 6% this year, the fastest rate since 1973. But this rate could have been even higher if everything that is being demanded could have been produced (although the economy has not yet reached its potential GDP, the speed limit effect is preventing that ‘maximum’ GDP from being reached sooner).

In the case of the US, the expected growth of 6.2% hides even more exceptional rates in specific areas. US consumer durables spending increased 34% annually in real terms in the second quarter of 2021, leaving it 28% above its pre-pandemic level. “This rapid increase in the demand for durable goods would have broken even the most elastic supply curves of the industries… Still, it can be said that the boom in demand for durable goods has been so strong that the supply has not been able to follow the rhythm”.

The economy in the U.S.

Labor shortage

On the other hand, the labor shortage also appears to be largely due to the rate at which demand has recovered once the services sector has reopened. The reopening has ‘brought back to life’ the most labor-intensive branches of the service sector, such as leisure and transport, but now they have a problem finding workers

This is, in many ways, the ugly side of recovery. And it is that many of these branches of the service sector have already endured the worst part of the covid crisis and now they cannot find workers. Current health concerns (and public benefits) appear to be discouraging workers from returning to occupations where social contact is one of the pillars of work. This shortage is also triggering wages in the sectors that suffer the most, where wages are rising by around 10% a year right now, which in turn can further fuel demand itself and create a dangerous spiral.

A strong global recovery

Adding to the U.S. domestic problems is the global recovery, which has caused disruptions in supply chains. Semiconductors – chips that go into cars, game consoles, or household appliances – have been a key bottleneck. Supplier delays for US manufacturers have reached levels last seen in the 1970s, they say from Fitch.

“Auto production has been affected and shortages of goods are likely to persist well into 2022. Short-term inflationary pressures have intensified. The cost of inputs used by U.S. companies is rising at the fastest rate. in 40 years”, they warn from the rating agency. Keeping on the gas now can be an expensive mistake.

This week, Jerome Powell, Fed chairman, acknowledged that bottlenecks and shortages of certain inputs are not diminishing, putting further pressure on prices while weighing on real growth. The Fed had to use a tougher tone than expected in the face of rising inflation risk.

Danske Bank experts warn in a note that recent economic data has highlighted the risk of a stagflationary scenario in which growth weakens more than expected but high inflationary pressures continue.

While from the investment bank Natixis also warn that the pressure on prices could be beginning to sustain itself. In addition, the pressure on inflation could increase if the Biden Administration ends up getting the billionaire stimulus plans approved, which would give another boost to the demand for goods, services and workers (the infrastructures that Biden wants to renovate and build need a labor that is already very scarce).