A massive GDP number

This is an audio transcript of the Unhedged podcast episode: ‘A massive GDP number’

Ethan Wu
The US economy in the third quarter grew 4.9 per cent. That’s inflation-adjusted, and that is simply bonkers.

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After a year or more of everyone fretting about recession, we’ve gotten it not just wrong, but it’s actually the total opposite. The economy is booming. Today on the show, we talk about the unstoppable engine behind it all: the US consumer. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio, joined today by one Robert Armstrong, who is calling in from his mother’s basement in Boston.

Robert Armstrong
In some sense, Ethan, in my head, I’m always in my mother’s basement. (Ethan laughs) That’s could be my problem but today I’m actually there.

Ethan Wu
Yes, the basement is a mentality, but today it’s not. Rob, just first off, we have to just say it, like, wow, right? Like, 5 per cent growth. Did anyone think we were going to be at 5 per cent growth in the third quarter of 2023? I mean, earlier this year, there are professional macroeconomic forecasters that thought we were going to be in recession in the third quarter of 2023.

Robert Armstrong
Yes, that was consensus a year ago, 100 per cent chance of recession. And we’re in a boom, an expansion. I remember you and I just a few months ago looking at the Atlanta Fed’s real-time GDP indicator and thinking it must be broken, right? We were, like, essentially banging on the side of the TV to get the reception to come in better. But it was right. The economy turns out to have been as strong as it appeared. And it appeared incredibly strong. There’s just a huge amount to talk about here.

Ethan Wu
Yes. To the credit of the econometricians at the Atlanta Fed, they got this exactly right. They said about 5 per cent two months ago, and it was just about 5 per cent. Now, of course, with any given quarterly GDP reading, there’s gonna be some anomalies, some idiosyncrasies, some stuff that will revert next quarter. But we gotta talk about kind of the core of this expansion, something that’s been true for some time now, which is the consumer. Real consumption in the third quarter grew 4 per cent. And that’s really been the story all along, hasn’t it, that the consumer can drag along any kind of moribund part of the economy as long as they’re able to spend?

Robert Armstrong
We can tell the story, Ethan, in the results of one company, and that company is Coca-Cola. Every quarter for like 12 quarters now, they increase prices 5 per cent from the year before. The consumer does not care, keeps drinking the bubbly sugar water like the price was exactly the same. It’s like, what, can they make Coca-Cola $10 for a can of Coca-Cola and we’ll still drink it? I don’t know! Like, where does this stop? It’s crazy.

Ethan Wu
It really is. And if you’re Jay Powell, you’ve got to be looking at this and saying, I don’t know what the hell is going on.

Robert Armstrong
Yeah, I think the faint thumping sound you hear is him banging his head on his desk (Ethan laughs) where it’s like I raised interest rates 500 basis points, I turn the volume up on monetary policy to 11 and the economy is like, what was that, Jay? I can’t make it out. Can you speak a little louder? They just don’t care. What is this guy supposed to do? Inflation’s above target. He’s got to get it down to 2 per cent. He’s done basically everything a central banker can do, and the economy is still flaming hot.

Ethan Wu
Yeah. Let’s break it down, right. So what has kept the consumer spending, I think, is the question that we wanna ask ourselves. And I think to answer that question, you gotta take it back to Covid. I mean, back then the Fed cut interest rates basically to zero and everybody that owns a house, which is like a 100mn-plus people in America, said, I’m gonna refinance at 2 or 3 per cent mortgage rates. And, you know, estimates are that generated kind of like hundreds of billions of dollars in incremental cash flow for households because they were just paying less on their mortgages. Those low mortgages have been locked in for a couple of years now, right? We have fixed-rate mortgages in this country. The mortgage interest burden is at one of the lowest points on record. And that’s on top of all this, the stimulus cheques that people got and just the fact that, you know, no one’s defaulting. We had incredibly low credit card delinquencies. Basically, everybody’s household balance sheet was like, really excellent.

Robert Armstrong
I have before me, Ethan, a chart of consumer credit card debt. And we rolled into the pandemic at about $860bn, and that in the pandemic we’re all stuck at home, not spending money, staring at our spouses mournfully. That fell by $100bn. And only now has that number returned to the pre-pandemic trend. So it was like in the last year or so, consumers have been able to spend freely on credit and they’re still just now getting back where they were in terms of indebtedness.

Ethan Wu
And I think on top of that strong household balance sheet story, there’s a story about the labour market, right? For some time we were printing like 600,000 jobs a month as the economy reopened. And, I mean, that kind of labour market strength went disproportionately to people at the bottom of the income distribution. We saw people quitting their jobs at unprecedented rates. We saw just incredible wage growth. And at that tight labour market, which is it’s still tight. It’s gotten more normal. It’s gotten kind of into the range of history more recently. But we’re still in a strong labour market by basically any measure. And you get strong wage growth across the economy. People are gonna keep spending those earnings.

Robert Armstrong
For me, it really is a wage growth story. I mean, to a first approximation without getting caught in the weeds on it, wages have kept up with inflation, right? So inflation has been bad, but people are getting raises and they’re spending the money.

Ethan Wu
And I’m glad you mentioned inflation because I think maybe that’s the third part of this is more recently in the last couple of quarters, as we’ve seen inflation get down to 4 per cent, 3 per cent, wage growth is at 4.5 and CPI’s at what, like, 3? So that means people are actually generating incremental earning power every single month. That’s different, right? Like for a while, it was wages are keeping pace, maybe falling a little bit behind. Now, wages are kind of well above the pace of price increases and again, keeps people spending.

Robert Armstrong
It says on my Financial Journalist Association membership card that I have to say something negative as part of any discussion of the economy. At the periphery, there are a few tiny little whispers of bad news. One of them is subprime auto loans. At the lower end of the credit spectrum, people are going delinquent on their auto loans at a pretty good clip where it’s somewhere like 6 per cent of auto loans or so are two months delinquent now. And that shows you that somebody out there in the American economy has gotten in over their head and that higher rates are telling on someone in the economy.

Similarly, the CEO of Citigroup, Jane Fraser, she has a huge credit card operation and she used the word crack. She said there are cracks in the lower end of the credit spectrum in terms of the quality of their credit card loans. We had the CEO of a big food company, ConAgra Group, that makes Duncan Hines cake mix, among other things, come out and say we’re seeing trading down in our basic goods — people are buying the less expensive one or less convenience foods, more kind of value-price foods. So there are whispers at the edge, but can’t emphasise enough, it’s whispers.

Ethan Wu
Absolutely. These are relatively minor cracks in the bigger picture, but I think it’s crow-eating time. We like to eat crow on the show. We got this wrong, Rob. I think we were both in the recession camp for some time.

Robert Armstrong
Absolutely.

Ethan Wu
That was just wrong.

Robert Armstrong
Yeah, it’s been a reckoning. I will say, our crow eating, we have a lot of company . . . 

Ethan Wu
Plenty of crow to go around.

Robert Armstrong
At the Crow Restaurant.

Ethan Wu
You have a crow.

Robert Armstrong
We’re dining at. Yeah. So clearly people got the severity of inflation wrong when inflation were rising. Everybody got the rapidity with which inflation would fall wrong and everybody got the recession prediction wrong. So let us do our individual mea culpas. Ethan, what mistake did you make that got us into this embarrassing situation?

Ethan Wu
I forgot my economics training. I forgot that high prices cure high prices. And I think you can see that in markets like housing, where because mortgage rates were super low, people that owned homes pulled back, right? And that supply constraint pushed prices up. But because prices were super high, a bunch of companies whose profession is building houses said we should just like build a lot of these and sell them as quickly as possible because prices are so high, right? And this is not a cure all, but it’s just worth remembering that market economies are dynamic and that supply and demand respond to price signals. And that’s what we’ve seen in certain chunks of the economy. I think that’s explained a good chunk of the resilience in some sectors.

Robert Armstrong
What I got wrong is I thought too much about demand and not enough about supply, which got my head in the wrong place when thinking about the inflation side of the story. So it’s very easy when you’re thinking about the economy to think it’s how much people want and whether they can get it. And so we all saw inflation go up so quickly and it was like, people have a lot of money. They want a lot of stuff. That’s gonna keep happening. There’s all these stimulus plans. Inflation is never gonna go down. It’s a crisis. But what I forgot was that more and more we now learn this was a supply-driven inflation spike and I wasn’t thinking about those bottlenecks. The difficulty of people getting what they wanted was contributing to prices. And when those bottlenecks went away, prices got a bit better. And it’s almost trivial to say economies are about supply and demand, but it’s easy to get hypnotised by one side of that equation and forget about the other.

Robert Armstrong
Yeah, and I think in some ways we’re sort of making the same point — you in the general and me in the specific. Any given price and quantity, any given inflation and GDP reading reflects a difficult-to-assess equilibrium of supply and demand. That’s what makes the economy so hard to read. But I think, you know, in past cycles, because supply disruptions have not been a major part of how the economy has chugged along, people have gotten used to thinking of fluctuations in demand. But this is a supply-driven world now, you know, especially with kind of an increasing number of climate issues affecting global supply chains or deglobalisation or whatever you wanna talk about. Supply matters again and we gotta all learn how to think about that in a systematic way. You know, it’s not just us, it’s the central banks too, it’s all the smart people in the economics community are gonna be thinking about how to think about supply for years to come.

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All right, Rob, thus concludes the crow-eating segment of the show. Back in a moment with Long/Short where I’m gonna talk about a different type of bird.

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Welcome back. This is Long/Short, that part of the show where we go long a thing that we love, short a thing that we hate. I promised a bird-related item, and here it is. I am short avian flu reaching the Antarctic. This is a story from The Guardian yesterday. There are cases of bird flu being detected in the region, which has never been there before. And scientists fear that penguins and seals have never been exposed to this type of disease before, and it’s going to be truly catastrophic. That makes me really sad, man. I’m sorry to be a downer.

Robert Armstrong
That is terrible. We have to stop that from happening.

Ethan Wu
We do. People respond to charismatic animals and the penguin getting bird flu might be a way to, like, get people to give a shit about what’s going on in the Antarctic.

Robert Armstrong
(Laughter) Yeah. When it happens to the cute animal, then you can expect political action.

Ethan Wu
That’s right. Rob, are you long something?

Robert Armstrong
I’m gonna be long Morgan Stanley and its new CEO, Ted Pick.

Ethan Wu
Pick. One more time. Pick.

Robert Armstrong
There’s a long-running drama about who James Gorman, who’s done a great job with the company, who is gonna succeed him? It’s Ted Pick. I think Morgan Stanley is really well-positioned. It’s got a great brand. It has a well-balanced business between investment banking and trading and wealth management. Wealth management is where everybody wants to be. I think the run of good luck that this company has had is going to continue under Mr Pick.

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Robert Armstrong
All right. I like your pick for a long, Rob. (Robert laughs) OK, thanks for being here. We’ll have you back soon, Rob, and listeners, we’ll be back in your feed with another episode of Unhedged on Tuesday. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to FT.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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