Fed’s Beige Book Provides Insight on State of Economy

Beige Book Federal Reserve

Eight times a year, the U.S. Federal Reserve provides a summary of the economy around the country, called the Beige Book. Their latest observations are now in.

The Fed is best known for its open market committee meetings throughout the year, and they also make the news from time to time when they make significant alterations to their policies, such as their buying treasuries to stimulate the economy or to put the brakes on it.

A lot of work goes on behind the scenes to make this all happen and to keep the Federal Reserve abreast of the current economic situation, and they share some of these insights with the public through the publishing of what is called the Beige Book.

The latest version of the Beige Book just came out, and given the unusual state of affairs that we are still under, there’s been much more interest in these reports lately than usual. We’ll share with you some of the key points made in this latest issue.

It turns out that returning to work won’t be as easy as letting businesses open, due to the overreaching safety net that we have erected to protect them. The goal here was income replacement, and when the particular strategy for this was rolled out, many of us were concerned that many may not want to go back to work if the benefits that they are collecting from the government exceed what they were making at work.

We can’t blame the workers for not wanting to essentially take a pay cut to go back to work when they could just remain home and make more, and that’s exactly what the Fed is seeing happen right now. Even though the Fed sees the unemployment rate for May to be north of 20%, many employers are having a hard time filling open positions as they re-open, and it’s because they are offering wages below the floor of unemployment benefits.

None of this is any surprise, and back when the first stimulus bill was passed with these bloated benefits in tow, everyone knew that this was going to be an issue, even the left-wing politicians who pushed these higher benefit levels. Their thinking was that this would cause employers to pay more, but this just showed their ignorance about economics because it’s not just a matter of choosing to pay their workers quite a bit more, as this money doesn’t come from heaven and their businesses are generally already operating with significantly reduced revenue, where even paying the going wage is a struggle, let alone quite a bit more than the going wage.

What we’re left with is the unemployment rate being kept down on all fronts now, the usual one that occurs when business drops off, plus two completely artificial ones, those still not allowed to work by state decree, and those that won’t because we’re paying them more to stay home.

A lot of workers already have a reluctance to return to work due to safety concerns about getting infected with COVID-19, so it’s not even that we can just set the benefits a little lower than the market wage and expect this to be enough. There has to be enough of a difference to incent them enough to go back to work, although that’s still not the best approach as we need to revoke unemployment benefits altogether in situations where there is an opportunity to go back to work.

This creates a situation where we’re both adding to the national debt and using some of this money not to stimulate the recovery in the labor market, but also to stymie it. This is not an acceptable situation no matter how much it warms the hearts of some Democrats to see these workers make more money, as this needs to be achieved through legitimate means and not just by excessive handouts.

The current scheme, set to expire on July 31, will very likely stay in place as changes would involve a revision of any further bills, such as the $3 Heroes bill that was passed by the Democratic controlled House but was rejected by the Republican controlled Senate.

The Democrats want to go the other way and extend these benefits another 6 months, and if we do get another stimulus bill, it is likely that a compromise will need to be struck which will have these benefits extended for a while longer anyway and continue to serve to slow down the recovery.

Employers Need to Pay Less in Wages When Their Revenue Gets Slashed

You won’t have to worry about being able to hire enough people if your business goes under, and we’re starting to see bankruptcies among small businesses really start to pick up now, according to the Fed. Free market forces, without the existence of these benefits, would serve to lower wages according to the ability of these businesses to pay, where minimum wage laws in themselves serve as a much bigger burden than usual, laws that were designed to regulate wages in a healthy market and not one that has been beaten down so much.

We are seeing the dark side of minimum wage laws rear their ugly face, and the barrel of this gun points directly at employers, many of which may not be able to both pay this wage and stay in business. As we see these small business bankruptcies continue to pile up, we need to appreciate the role that these laws play in it, and although no one will be even asking for minimum wages to go down, we at least need to be aware of how they affect things.

When we add in the fact that we’re paying even more than this in benefits, more than employers can afford to compete with, this is not something that ends up helping the lower echelon of workers, as this will result in even more jobs lost from even more businesses going under. Whatever we decide, it needs to at least be from an informed perspective.

Even though people are saving more, bank deposits are down. The savings rate is based upon the percentage of people’s income that they set aside, but when you have this much less income overall, you can have both of these phenomena occur together even though they appear to conflict.

We don’t really want bank deposits rising, as from a macroeconomic perspective, we’d rather see them spending the money, so both the higher savings rate and the lower income leads to economic contraction, the opposite of what we’re looking to see right now. There’s little we can do about this though, other than just waiting for the employment numbers to pick up again and hope that this is not slowed down too much by the paying of these overly generous benefits.

We are moving pretty slowly in getting people back to work, as we’re told that only 10% of businesses that have laid off people during the lockdown have recalled workers. This is quite low given how many businesses have now gotten the green light to re-open under restricted conditions, and suggests that the part of this not directly related to the shutdown may be a lot bigger than many have imagined.

Overall, staffing levels are still down between 35% and 50%, depending on the region, and this is the number that we really want to pay attention to and the one that really needs to come back to close to normal. This number is much higher than the official unemployment rate but is a more accurate way to count those no longer at work from this, and numbers like this are startlingly high.

Bank defaults are up, which is a given under these conditions because it’s not that businesses are doing better now, and the doing worse part instead is going to lead to some loans not being paid back. The default rate would be massively higher if not for all the deferrals that lenders have agreed to, and this issue is being fairly well controlled so far, although this is not a defense against a borrower going under, as they have to stay alive long enough to resume their payments at the appointed time.

Business lending is up, but only due to all the PPP loans that have been granted. Consumer borrowing has declined notably, especially with credit card debt, and this indicates that people are spending less which has negative macroeconomic consequences. We don’t want people borrowing more when they can’t pay it back though, so their cutting back on borrowing is desirable for all concerned, and the real problem here goes back to the income reduction we’ve suffered with.

Wages are being reduced, and 20% of employers reported lowering the wages of workers to look to adapt to the crisis. This is exactly what we were talking about with minimum wages keeping employers from pricing labor in an affordable way, and when paying a certain wage no longer is affordable, there is no alternative but to eliminate the position.

Those making more than the minimum are certainly subject to these cuts though, thankfully for the businesses, and thankful as well for the workers even though they don’t usually get that it’s between their wages getting cut or their getting cut.

While the sheer number of people out of work right now is scary enough, there are even more people who would be out of work if not for PPP loans for businesses to keep these workers on. As this program runs its course and we migrate back to businesses having to fend for themselves to make their payroll, this has the potential to really bloat the unemployment rate and send the labor market and the economy reeling.

Some Businesses Have Been Hit Particularly Hard

While a lot of businesses have been particularly hurt by the lockdown, we wouldn’t think that hospitals would be among them, but hospitals have been slammed by this, having to stay near empty to prepare for a massive influx of patients that were not based upon projections of any reasonableness. At the same time, hospitals had to turn away all that business, all the so-called elective procedures, and this has resulted in pay cuts, reduced hours, and even a lot of lay-offs.

Banks are holding up pretty well so far, although the much greater amounts that banks have had to set aside to use to pay for the losses that they expect on loans has really impacted their earnings. This might end up being a bigger bomb than they are preparing for, and while they do have the Fed to rely on for help if things really get bad, all this red ink coming may have banks pay a pretty big price for all this.

The energy sector is paying an even bigger price, as production has been cut by half due to oil prices dropping so low along with the glut of supply right now keeping them down. Oil has come back a lot lately but nowhere near as much as they need to for many of these companies to survive.

Saudi Arabia tried to knock down the U.S. oil industry by flooding the market with supply and depressing prices a few years ago to the point where they felt that U.S. companies could not survive at these low oil prices. In this game of chicken, the U.S. market was able to stay in the game long enough for the Saudis to swerve, but the coronavirus is a much tougher opponent. The Saudis will get their wish now.

There is simply too much oil production going on these days anyway, where we just keep pumping it without any real regard to optimization, and when the price drops below what you need to stay in business, that’s the free market jumping in and wrestling you to the ground if you refuse to go down on your own.

With the cost of production in the U.S. being considerably higher than in countries that produce conventional rather than the shale oil that has allowed America to surpass Saudi Arabia as the biggest oil producer in the world, it is the Americans that are standing at the front of this battle. What will result is a Darwinian cull of production, a survival of the fittest, a lot of smaller U.S. shale companies are not very fit and won’t survive this.

This won’t be good for the U.S. economy, and is one of many effects that we have chosen to bear in reaction to our fear of COVID. When the full bill comes in for this, we will indeed discover just how big of an economic tragedy this is.

The damage has been done already, even though we will certainly add to it as we move forward and try to put this behind us. Hopefully one day soon, when cooler heads prevail, we will at least come away with the lesson of just how costly it is to shut down the country like we chose to, to let officials like Tony Fauci become the defacto ruler over us and punish our economy this much.

The economic impact of our response to this pandemic will be severe, and whether or not it was appropriate overall, when we weigh things properly, we at least need to weigh economic consequences and not just ignore them as we did.

The Fed’s Beige Book this time around does speak pretty loudly to just how bad things may end up in the end, and we need to brace ourselves for a bumpy ride for a while, especially for those who will remain in the cold when it’s over. There’s nothing like being out of work to spark discontent. It will take more than just lifting the restrictions to eliminate it, as the aftermath will leave many still out of work and their voices will be heard, as they need to be.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.