♪♪ For the first time in a generation, inflation is back.

Gas and food prices are at historic levels, and everything seems more expensive than before.

How did we get here and where is our economy going?

Joining us today to make sense of it all is Sacramento Business Review chief economist Sanjay Varshney.

Sanjay, a year ago, we were worried about economic recovery.

Now, we're facing record inflation.

What happened?

So, the- What happened is that we... we threw everything we could possibly throw at the problem, uh, when we went into a major recession post-COVID.

Uh, you may recall, in 2020, uh, we had no clarity on where the economy was headed.

In fact, parallels were being drawn, uh, with the Great Depression, and we literally thought the world might come to an end.

And between Congress and the Federal Reserve, and I have to give them credit for that, they did everything in their capacity to ensure that we did not go into an abyss.

So, by my math, we threw roughly $10 trillion at the problem, which was COVID, shutdowns, making sure that households, businesses and everybody else in the economy was not left there to starve, uh, and have nothing to basically- you know, and have to worry about putting food on the table.

So, I think the $10 trillion money supply is now trickling through our economy and we are seeing what excessive money supply can do, in terms of inflation.

So, if you ask me, "What's driving inflation today?"

there are two things.

One, on the demand side, people have a lot of money in their pockets because, remember, $10 trillion was pumped into the economy.

And on the supply side, we still haven't recovered from the COVID days, where everything is back on the shelves the way they should be.

It's interesting in describing how much money we pumped into the economy.

Back in 2021, President Biden said- and this is a quote- "So, the way I see it, the biggest risk is not going too big.

It's if we go too small."

So, here... here's just kind of the question it raises.

Will the alternative of what we're facing today- of say, conditions of high unemployment and low growth- Would that have been worse for the American people than the current conditions we're experiencing?

Um, most likely, yes- is my opinion.

I think if we had not immediately dealt with the problem the way we did- and I- like I said, I commend both Congress and the Federal Reserve for doing so.

Uh, they did not take, uh, more than a year, like we did in the last round.

In 2008, 2009, Congress took more than 500 days to put a stimulus package on the table, and that stimulus package was only about $797 billion.

This time, Congress took less than four weeks and put as much money as they could on the table, and I think that was the right thing to do because this pandemic, uh, is really a first time that we are seeing in our lifetime, for most of us and our families.

So, you basically take any chances with it and basically have to deal with the consequences that could have been a lot worse was probably not the best way to do it.

Well, there are some, like former Obama White House economic adviser Larry Summers, who criticized the Fed and both administrations, but particularly the Biden administration for its last stimulus package, and predicted stagflation and recession in 2022 and beyond.

How do you respond to hawks, like Summers, who say that we shouldn't have touched anything at all and just let nature take its course?

You know, that's one perspective.

And I respect, uh, Larry Summers you know, for his track record.

Um, but I think, on the flip side, I can easily argue that monetary policy is more of a trial and error kind of a process that we... we- that plays out.

And in my opinion, I think what we are seeing right now is probably part of that process.

We have to be patient with it.

Uh, I think, um, we usually overshoot, both on the upside and on the downside.

So, while inflation has... has reared its ugly head- And I know people are concerned because, uh, in our lifetime, most of us have not seen 8.3, 8.5% inflation, because the younger generation certainly cannot relate to what happened in the late seventies or the early eighties when inflation was double digit, unemployment was double digit, uh, and things looked pretty bleak at that time.

Uh, but I think, on the flip side, we have to be patient because, like I said, what happened with the pandemic does not have a prior precedence- right?

-in terms of uh, you know, how things shaped up on what we can expect to happen.

So, if we are patient, my opinion is I think if we have the right tools and we use the right tools, inflation, uh, can be brought down.

And I think, uh, to a... to a certain extent, uh, the data is showing that inflation may have already peaked.

Hmm.

That's interesting.

There's another term that some of us haven't heard in decades- and I'm going to show my age now- the word "stagflation."

Can you remind us what, exactly, that is?

Yes, absolutely, because I was growing up at that time, uh, and... and, you know, the world was, like I said, not looking too bright at that time with double digit unemployment, double digit inflation in this country, and stagflation.

Stagflation, meaning that with high inflation, the economy actually is regressing and going backwards and shrinking, in terms of size.

And that's where I think Larry Summers' concern is right now, that if we are going to basically go in with seven or eight interest rate hikes by the Fed, which is extremely aggressive- And by the way, the Federal Reserve does have a track record, um, for all the right or the wrong reasons, for basically, uh, being accused of pushing the economy into a recession every time they have raised the rates excessively high in the past.

So, the fear is if they're going to normalize rates that quickly from 0% to over 2.5%, there's almost certainty, with that, that we are going to be in a recession.

And that's what Larry's point is that there's going to be stagflation.

That's interesting you raise that.

I was talking to a couple of CEOs last week, and one of them made the comment that he believed that we really need a harsh recession right now to rebalance asset prices and re- uh, just kind of reset labor markets before we can really stabilize the economy and get inflation under control.

What's your reaction to that?

You know, it is a... it is a view that, actually, I do subscribe to somewhat, and I'll give you a reason why.

If I step back a little bit and just go back to the last 20, 30 years, the United States- and not just the United States, I would say most central governments across the world- have big- have taken on lots of debt, and they have basically kept the interest rate environment extremely low, artificially or otherwise.

And in the process, every time the rates have been close to zero, in a way, the governments have basically resulted in artificially elevating the valuation levels for assets.

So, when you look at the stock market, uh, you look at the housing market, one can easily argue that the Federal Reserve's actions are directly responsible for creating some of those bubbles.

And we can go back and look at the bubble, for example, in 2008 and 2009, the housing bubble that burst.

Or we can go back and take a look at the tech bubble that burst in 2001, 2002.

So, having a reset, in terms of a harsh landing, and setting the economy back to zero again is not a bad idea because in the last two years, the downside of the government acting very quickly and the Federal Reserve acting very quickly is that people and economies and countries have gotten used to a lot of free money on the table.

And we know that that is not a sustainable position, uh, in the long run.

The United States of America cannot keep increasing its public debt, you know, forever, uh, and not worry about the refinancing of that debt and what it might look like for- you know, for the budget.

And- - I...

I'm glad that you brought that up, because, uh, a lot of us are wondering, what's the hangover from injecting $10 trillion into our economy and then all of the, uh, parallel actions that governments all over the world took, similarly?

What's the hangover and when is it going to happen to us?

Um, so, Scott, great question.

In the past, every time we had a hangover or we were about to have a hangover, the Federal Reserve and other governments stepped in very quickly and brought down the rates to zero again, just to make us feel good again.

Right?

This time, I think people are getting extremely nervous that the hangover is going to be for real because after a $10 trillion infusion of liquidity into the markets- and which, to a large extent, we all argue it's artificial because this is not real stuff- When that money gets- start getting withdrawn- and the Federal Reserve has... has made it very clear, starting this month, they are in fact going to begin quantitative tightening.

They're going to basically reduce, uh, their bond positions by 95 billion per month.

So, imagine picking out $1 trillion just through one tool in that toolkit.

That hangover could be extremely nasty.

And right now, I think that's a reason why the markets have sold off, and a lot of people are concerned.

The consumer sentiment has tanked completely and, uh, people are worried.

I mean, the people who are awake right now are getting worried about exactly how nasty that hangover is going to look like, after the party's over.

You talk about the toolkit that the Fed has, and you've mentioned the Fed a couple of times.

President Biden has said that taming inflation is now a top priority for his administration.

Realistically, though, in the short term, what impact or tools does the president have to affect inflation or even the broader economy?

Not much.

So, I think this is where the politics gets, uh, mixed up, uh, with reality and stuff for... for the wrong reasons.

Um, sometimes, when things are going great, uh, whoever is in office takes credit for it.

And when things get rough, whoever is in office actually gets blamed for it.

So, this is President Biden's economy.

Uh, it is his administration.

Uh, so, obviously, they're getting squarely blamed for the inflation issue, which is probably the most critical issue in the minds of the consumers.

In the short run, you're absolutely right.

There's not much that can be done because all of these things take, uh, time.

There's a lag effect.

So, no matter what the Federal Reserve does, uh, or what we do with the supply chain, for example, or with the manufacturing, uh, it does take a few months, or weeks sometimes, to show up in... in the actual economy.

But I think there are a couple of things that could be done, uh, in my opinion, and... and some of that is being done, to a certain extent, um, to... to make sure that we don't basically allow inflation, uh, to truly be permanently at elevated levels, uh, going forward.

And I'm- Like I said, I'm very confident, given the track record we have of how deflationary we were, uh, before COVID happened.

Uh, for the last decade plus, we were struggling to get inflation to get up to 2%.

So... so, what types of things are being done, or that could be done, which could help- So, yeah.

So, the Federal Reserve has already acted, uh, twice now.

Remember, they have already done two rate hikes.

We know for sure that there are three more meetings coming up in the next few months, and we'll probably see 50 basis points increase in those three meetings.

So, imagine, very quickly, we are going to go from zero to two and a half percent, uh, for the federal funds rate.

Right?

So, that is- That, in itself, is very quick action that the Federal Reserve has taken.

Quantitative tightening has al- is... is beginning this month, remember, so... so, that is going to take out a bunch of liquidity in the market al... al... also.

Um, last month's data shows that we saw the second largest decline in M2, which is a money supply that we all watch very closely.

So, we've already seen the second sharpest drop in money supply, which should show up in the inflation numbers, are going down, uh, very soon.

So, I think some of these things are already happening in the background in the economy.

So, let's bring this down to the street level.

How are these economic conditions related to inflation and these interest rates hikes- How are they showing up, and will show up, for the average family and impact their daily lives?

So, right now, I know that people are concerned about the prices at the pump.

People are concerned about the prices they're paying for groceries at the stores.

But I don't think we're at the point where people have stopped buying or people are no longer engaging in significant purchases just because, um, the prices have gone up so high.

So, people are shocked.

They- Obviously, we are going through our shock period right now.

- Is that because they're sitting on all this money still?

- What's that?

- Not to interrupt you, but is it because they're still sitting on all of this money from the stimulus?

- Exactly!

Exactly, because we still have a lot of liquidity in the market, in the form of people having tremendous savings.

So, we still have 5 trillion plus sitting on the sidelines in people's checking and... and savings accounts.

We still have excessive liquidity in the stock market, in many ways.

The unemployment rate is down to 3.6%, which is almost the same as pre-COVID, which is the best unemployment rate we have seen in the last 75 years.

Today's jobs report that came out still shows that there are roughly 6 million more jobs available than the number of people who are available to fill those jobs.

So, in general, people still have cash in their pockets.

150 trillion is the size of household wealth in this country.

So, people are still flush in money, which is a reason why they haven't reacted strongly.

While consumer sentiment has tanked, the spending hasn't tanked.

So, spending is still going up.

Uh, retail sales are still going up, which is a reason why we have confidence, somewhat, that if the Fed can engineer a soft landing whereby the economy still grows, spending does not go negative and does not come to a grinding halt, and in the meantime, inflation numbers come down to basically assure people that what we are seeing right now was just basically a temporary problem and not a permanent one.

So- And the last point that I would make is, uh, which we have not paid too much attention to, is the supply chain.

We have an oil shock going on because of the Ukraine war, uh, with the Russian invasion.

Uh, we have a shock to the commodities market because of that.

Um, we also have issues going on in China, where just today, for example, they finally announced that Shanghai is coming out from their lockdown after being in that state for almost two months.

So, these supply chains are probably going to correct themselves.

And just like, for example, we overreacted when there were- we could not find toilet paper on the shelves and we thought the world was going to come to an end, right now, we are similarly not accounting for the fact that eventually, when the supply chain does come into sink and the factories are humming again and all the things are finding their way to the shelves again and the ships that are waiting to be loaded and loaded off the ports of... of, uh, of Los Angeles or, uh, or some other cities- When everything comes back into sink, I'm actually fearful that we might see a glut on the other end because we might see excessive supply, demand has already shrunk, and then suddenly, we're going to be extremely deflationary again.

But... but is that... is that such a bad thing?

And let... let me give you one concrete example.

When it comes to housing, housing prices have escalated so much.

Not that they were good before the pandemic, but they've escalated so much that the average working family cannot afford to buy a home unless they took on one of those crazy loans that happened before the great crash of 2008-2009.

And even if that progression on pricing stopped today, they'd still be priced out of the market.

So, is a glut, which then causes, uh, price reductions and discounts, really such a bad thing as part of a great reset?

Not at all.

Uh, and that's why I said a reset might actually be a healthy thing to... to... to accomplish.

The housing market, I think there are two different stories going on in the background.

One story is nationally, housing has been the beneficiary of COVID.

Because interest rates came down to zero and the mortgage rates basically followed and stayed pretty low, we found that many families were able to afford homes, higher prices on those homes, and be able to refinance those homes more easily.

We also saw a lot of first time buyers step in.

So, the millennial generation, that typically has been blamed in the past for actually not being very good about household formation, still living in their parent's... parent's basements, actually came forward this time and almost 45 to 50% of the homes that sold in the last couple of years were first time homebuyers.

And the millennials can take credit for it because they were actually supporting the housing market.

And then, of course, because people had no money to... to spent elsewhere, because, you know, they could not go out to the restaurants, they could not travel on airlines, they took their savings and basically redirected into the housing market.

So... so, the housing market was an accidental... accidental beneficiary of COVID.

But I think what happened in Sacramento is a little different.

In Sacramento, we saw, for example, people who have much higher affordability, um, in the Sacramento market, vis-à-vis the Bay Area market where affordability was already priced out for the last several years.

Many folks left the Bay Area because they could work from home and they came to Sacramento and bought the homes that were much cheaper and drove the prices up.

You were absolutely right when you said that affordability got priced out, in a way, for many families.

By my math, from the last year, more than 80% of the households in Sacramento cannot afford the median house anymore.

And that number is getting worse.

And so, it's OK. For a Bay Area family who has a much higher income, because employment might still be in the Bay Area, when they come to the... to the Sacramento region, they find that housing is very attractive.

But the people who live here, who work here, whose incomes come from the Sacramento region, that were never spectacular to begin with because our household income, our per capita income is lower than the statewide average, you know, we are getting priced out because of this... of this mass influx from the Bay Area.

Le... le... let's go a little bit deeper into our region.

How is our economy faring, given these larger economic and macroeconomic conditions?

So, Sacramento, uh, got saved big time, uh, by a reason that we have always made fun of in the last couple of decades that I've been here.

We are a government town.

And thank God we are a government town when... when COVID struck, because the government of California was pretty stable.

You know, we did not see any massive layoffs or any furloughs and our overexposure to government actually allowed us to be a lot more stable compared to Las Vegas or compared to some other cities in the... in the country.

Now, the other thing that happened, and... and that's also helping our economy more recently, is that as people shift away from purchasing goods, they're spending more money on services.

And we are a much more service sector industry here in Sacramento.

So, once again, we got saved because of that.

Now, is that sustainable going forward?

And in my opinion, the answer is no.

So, we did OK the last couple of years.

Uh, we survived COVID better than most of the communities in the United States, but- And... and then, we also were the beneficiary of a lot of people moving here from the Bay Area.

The housing market actually benefited from that.

But this is not sustainable given who we are and what we are, going forward.

What's the biggest risk facing our region right now, economically?

So, there are two risks, I think, that we are facing right now.

The first risk is that the people who came here from the Bay Area are increasingly coming under pressure to return to the Bay Area.

So, in fact, this morning, Tesla announced that they want all the executives back in the office 100%.

So- And remember, the people who are here from the Bay Area, in most cases, are mid-tier to senior tier kind of folks, you know, and- from the technology companies in the Bay Area because that's- those are the kind of people who can actually be allowed to work from home.

These are the knowledge economy folks- right?

- who are- uh, who have a skill set that allows them to... to work from home.

Increasingly, we're going to find that, uh, some of these folks, uh, will either be forced to basically go back, or they'll be forced to find something else in the region, and that's where the challenge comes in, because, uh, the upward mobility was limited to begin with, pre-COVID, in...in...in... in our region.

And that mobility is going to be even more restricted given that the second population, our... our own domestic population that got priced out, is going to hurt more going forward because their cost of living went up, not because of just the housing prices.

You know, the apartment rents have gone up.

Mortgage, um, uh, payments are going to go up.

Uh, inflation is causing a huge dent on people's ability to spend money from the limited budgets or the same budgets.

Right?

So, I think all of that stuff is going to shake out.

And I think that is, um, probably making me quite pessimistic, uh, about the region's future, unless we see something change dramatically with the job mix that we have, uh, or the new industries that we can try and basically attract to the region, which we have not been able to so far.

Hmm.

And in our final moments, just a really short answer.

What is the most underrep... underreported, important story on the economy that you wish got more attention?

I think the most underreported story, in my opinion, is how the households who are truly at the bottom end of the wage distribution are getting impacted, not only because of COVID, but also because of the crisis that we're seeing in the... in the... in the financial markets, uh, uh, we are- what we are seeing with inflation, because the divide between the haves and the have nots has become wider and wider and actually COVID did not help.

COVID has made that divide even... even wider.

Um, the household wealth I was talking about is limited to the top 10% of the people, uh, in this country.

And in Sacramento, we have that same challenge.

We have a lot of households at the bottom and we're hurting really badly.

And those stories typically are underreported.

And I think we'll leave it there.

And that's our show.

Thanks to our guest and thanks to you for watching Studio Sacramento.

I'm Scott Syphax.

See you next time right here on KVIE.

♪♪ All episodes of Studio Sacramento, along with other KVIE programs, are available to watch online at KVIE.org/video.