♪♪ Rising interest rates, war overseas and inflation are all contributing to declining consumer and business confidence.

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

Sanjay, any one of those conditions are typically a cause conc- for concern.

But together, is a recession inevitable?

Scott, it seems that way, that I think the recession is going to be here if it's not here already.

Uh, what we are seeing in Europe, for example.

Uh, we're already seeing major challenges.

And while, in the United States, most of us agree that the recession is not here yet, the interest rates at the levels where they are right now and where they're expected to go, and the inflation being extremely sticky and persistent, we are pretty confident that if the Federal Reserve stays on track and continues raising the rates as they have promised, the recession will be here.

You talk about the Federal Reserve staying on track.

Jerome Powell and his leadership of the Fed have been under a tremendous amount of scrutiny.

It seems that many observers have said that he was too liberal with regards to how, uh, low they kept interest rates before.

Is this an overcorrection on the part of the Fed?

Uh, I certainly think so.

I think the Federal Reserve is extremely sensitive to the fact that they were wrong on the inflation being sticky and persistent, because for the longest time, they kept insisting that it's going to be transitory.

The Federal Reserve, to a large extent, is also engaging in trial and error because we have never seen these kind of conditions before.

The COVID was not something that we were used to from earlier years.

The last time the Federal Reserve raised the rates higher than where we are right now, uh, that was prior to the 2008 crash, and also, if you go back to 1998-99.

Both of those resulted in the economy going into a severe recession, what we call a "hard landing."

So, the Federal Reserve, right now, wants to take that excess liquidity out of the system, and because they were wrong on inflation being persistent, they are now, I think, overcorrecting by not backing off from their promise to continue raising rates till they see inflation come down.

So, there's something that I hope you can explain because I'm puzzled about it.

You say that this could be an... an overcorrection on the part of the Fed.

At the same time, historically, we lionize the late Paul Volcker... Volcker- who was the head of the Fed in the late seventies, early eighties, or I should say late... late eighties, early nineties- who was merciless in raising interest rates.

Some of us can remember interest rates, you know- at least for consumers- 18, 20%.

Powell seems like he's following in the Volcker tradition, which then led to a stable economy and low inflation for years.

Why is that such a bad move now?

Couple of things that I think are different today, compared to the late eighties, uh, of the Paul Volcker regime, uh, that, you know, we remember very well and the rates that used to be in double digits at that time.

Today's problem is primarily because of the gigantic amount of liquidity that has been pumped into the system, not just, uh, in the United States, but we're talking about globally, by central governments and central banks.

When we talk about, uh, the conditions, for example, in the eighties, and how much free money was circulating in the system, the money supply, the money velocity- Those look very different, compared to where we are today, when we're talking about $10 trillion plus that was pumped into the system in the last two years because of COVID.

Hold... hold it.

$10 trillion plus?

- Yes.

- In excess capital?

Yes.

Um, and to just, again, put that into perspective, the most stimulus we provided to the U.S. economy at the peak of the 2008 crisis, when we had a major systemic failure in the banking system and the mortgage market collapsed, was less than 1 trillion.

So, 1 trillion during the 2008 crisis, more than 10 trillion in this current crisis.

So, is it natural for us to expect, uh, the Federal Reserve to actually have a lot of reservations about things that might have been OK in the eighties, but may not work today?

Absolutely.

Hmm.

So... so, let me... let me ask you, you talk with your colleagues, both here and abroad, on an ongoing basis.

What's the consensus, at least that you're hearing from your side of the table, as to what actions the Fed should be looking at in order to calibrate this so that we don't have a hard landing and we kind of ease into a less in... inflationary climate?

So, I think the Federal Reserve is probably extremely smart about what they are doing, except the fact that, from a communication standpoint, they cannot openly tell everybody that they are backing off from raising the rates.

Because, like I said, they have lost credibility, uh, the first round, re... regarding, you know, inflation being sticky versus transitory.

But if you look at the data, a lot of the data that seems to be backward-looking, you know- what we call "lagging indicators" of the economy- uh, would suggest that inflation has already peaked.

Uh, it takes a while.

There's a lag effect by the time some of these other data points are going to show up in inflation being lower from where we are right now, uh, housing being a major component, for example.

Uh, you know, if you look at fuel costs, transportation costs, many of those things are coming down in prices.

Um, if you look at commodities, for example, they have come down in price substantially.

It's just that when we look at the lagging indicators of inflation, we keep getting worried about the fact that maybe inflation is not moving fast enough.

But like I said, I think I'm very confident that, eventually, you will see a lot of slowdown in that inflation data, and that's probably going to be enough for the Federal Reserve to not stay on course for raising the rates as high as the market thinks they're going to basically do it at.

I...

I'm curious, though, if... if it does slow down, that, in itself, presents some... some array of risk.

Where is our economy most at risk, based on the trends and trajectory you're seeing right now?

So, right now, the economy seems to be doing fine.

Most of the data, including the labor market, which shows extreme strength- Um, based on the most recent report, there were 10 million jobs available in the economy and fewer than 5 million people looking for those jobs.

The unemployment rate, nationally, is only 3.5%.

So, the labor market strength has taken a lot of people by surprise.

If you look at manufacturing data, service data, all that remains very strong.

Retail sales are softening.

Housing market is softening.

But in general, if you asked, "What is the health of the economy right now?"

most of us, including myself, would agree that the economy remains very strong, based on current data.

But I have every expectation that if I wait for a few more weeks and a few more months, we will see a dramatic slowdown because we have seen a dramatic slowdown in spending by the consumer.

We have seen a dramatic slowdown in other indicators that seem to suggest that the Fed's actions of raising the rates, stopping the bond buying program, for example- All of that seems to be working already.

So, the rates have really raised the cost of capital across the board, not just for the businesses, also for the consumer.

So, I think, uh, my opinion is that, uh, if the Fed had to continue raising the rates from here and given the lag effect that we see usually, um, we would have gone too far and... and it... it would be enough to really cause a very hard landing for the economy, compared to the soft one that we are hoping to engineer.

Now, last time we were together, we talked a little bit about, uh, conversations that I had had with a number of employers throughout the country and how some of them cynically said, "Well, we actually want a nice, tough recession because we feel like- that we need to rebalance the tables in terms of the employee-employer relationship."

A lot of people want to stay with either virtual work or hybrid work, that sort of thing.

And, uh, I... I- Just for the record, I'm not taking a side in that particular debate.

But when you talk about that the employment and labor markets are still incredibly strong, what is it that is likely to happen long-term, with regards to employment and... and wage increases?

Because those, ultimately, are passed along to consumers, and right now, we are seeing in the labor markets increases that even go beyond inflation right now.

How is all of that going to work itself out?

So, um, uh, Scott, if you remember, I had made some predictions regarding the employment landscape, and I'm going to repeat them again because I still believe those to be true.

First, I think the employers eventually will require most of the employees to come back to work, uh, in the office.

So, that hybrid model that we thought would stay forever, um, is proving to be short-lived, because in the last several weeks, we have seen multiple employers- such as Goldman Sachs, Tesla, uh, Apple- announce that they want their employees back in the office and that work from home is no longer going to be allowed.

Um, the second thing that I had predicted for you was that as the employers start changing, uh, the nature of the hybrid model for their employees, you are going to see some massive layoffs also being announced, because with the strength of the economy losing steam, employers are getting ready.

They are very smart business people.

They are trimming down their budgets, and massive layoffs have already begun.

As of this morning, Intel just announced massive layoffs.

Uh, other companies have already done that in the last several weeks, and that include companies like Meta, for example, companies like Tesla.

So, we will see layoffs.

We will see employees being asked to come back to work in the office.

And that, in my opinion, is going to be the trigger point for changing the... the balance of the scale back in favor of the employers, versus what we have seen so far, where the employees could dictate their terms, their... their wages would remain strong.

So, the lowest decile, Scott, believe it or not, got a 20% plus raise last year, if you look at the employees in the lowest decile in the economy.

And if you're asking, "Why do we have inflation at eight plus- 8% plus?"

a primary driver of that is that we have had very strong wage inflation at the lowest, uh, points of the wage distribution.

And that is going to change.

So, you're not going to see employers continuing to pay 20%, you know, wage increases year over year.

But I... I- This is... this is the interesting thing about economics, because it's always good news, bad news- I would think that that lowest decile getting 20% real wage increases is exactly where we want those wage increases because they're the ones who, historically, in times of prosperity, have been left out.

So, I'm trying to figure out what's really good news and what's really bad news, because it does- it... it... it would seem that, actually, um, the medicine got to the right patients in this case.

But, I guess, what you're saying is, "There's always a cost."

When you ask the question, uh, "How come more folks are not coming back into the labor market?"

because the labor participation rate still remains low.

When you ask the question, "Hasn't that stimulus money run out?

Why are more people not feeling the pressure to come back to work and work longer hours?"

The answer is exactly that, that when you see the wage inflation being that strong, uh, that becomes a disincentive for many folks at those levels to want to come back into the labor market.

And right now, we know the employers are all challenged to find labor.

You know, you talk to the people from the construction industry versus the technology industry or any other industry, they all have the same challenge where they could not find enough employees at the wages that they were offering, and they were forced to offer higher wages.

So, if you ask the question, "When can inflation come down?"

We need to get infla- the wage inflation portion of the equation under control.

So, this is interesting because, um, this is an area with which, obviously, we all need to know more about.

But even with that 20% wage inflation, historically, the conventional wisdom is... is that if you rai... raised wages to a higher level, it would attract more people off the sidelines to come back into the job market.

You're saying, uh, essentially that the opposite- that the wage inflation actually is a deterrent to people coming back to work.

For... for what reason?

Because it would seem like, "Oh, good."

You know, "For $10 an hour, I won't come back, but for 15, I'm ready...

I'm ready to go to work."

Uh, can you help me understand that a little bit better?

Absolutely.

There was a very, uh, recent study, uh, in The Wall Street Journal that showed that because the lowest decile and the lowest quartile employees are getting substantially higher wages, compared to the next quartile up, in many ways, the middle class that we- the... the two quartiles in-between are actually working longer hours today and, in many cases, making lesser money, compared to the employees at the lowest quartile.

And so, the folks who are getting this 20% raise, in many cases, are working fewer hours because in... in... in, you know, in their minds, they're saying, "Well, we... we are buying ourselves more quality of life.

So, if we can actually make the same money or a little bit more money and work fewer hours, that's where we want to be."

And that's why the labor market is still very tight, because we are not seeing a... a... a... a huge number of people being forced to come back into the labor market.

But, like I said, that's changing, because as the landscape for the economy is changing, uh, I'm encouraged by the signs I'm seeing in the labor market that you will see the labor market change and tilt back in the favor of the employers.

Let... let's come a little bit closer to home.

We talk about hybrid work.

And one of the concerns that we've had over virtual and hybrid work has been how it's impacted our downtowns.

And let's talk about the Sacramento region for a second.

The conventional wisdom for the past, say, two years has been downtown will never bounce back, and that we're going to have, essentially, a... a empty set of... of office canyons in downtown Sacramento and that vitality is not coming back.

Do- That conventional wisdom, today, is it still applicable or, um, based on the comments you just made, can we see kind of a return to the normal we had before the pandemic?

It's a great question, Scott.

My opinion is that the larger metropolitan centers, such as San Francisco, New York, Chicago, will see a faster return of the employees back into the office.

And so, they are less vulnerable compared to a city like Sacramento, where a big chunk of the office space downtown is basically occupied by the state government.

And the state government is usually slower, compared to the private sector, because in this environment, nobody wanted to be politically incorrect and demand their employees come back into the office because that sounded like the employers were not supportive of the employees.

The... the first couple of employers that lined up and did that- for example, Tesla did it, Goldman Sachs did it- Now, you're seeing a bunch of companies in the private sector all lining up and saying, "You know what?

We also want our employees back in the office."

Now, that is not true of the government.

So, the government is still, I think, in my opinion, trying to be a little bit more sensitive, uh, to the employees and be a little bit more politically correct.

And therefore, they are not rushing the employees back to... to... to the office.

So, that's going to make Sacramento downtown much more vulnerable because we are a big government town, and office space downtown- it depends very heavily on the state employees and the businesses downtown depend, in turn, on the state employees doing business there.

Mmhmm.

Uh, overall, how has our regional economy been faring, uh, given the larger macroeconomic conditions that we're facing at this moment?

We have done great, uh, Scott.

So, Sacramento has actually been extremely resilient.

Um, we were not, uh, vulnerable like Las Vegas, uh, when the COVID, uh, you know, crisis, uh, struck.

Uh, so, we were not hurt by... by, you know, the service sector industry at that time.

Um, and then, uh, our market, given that it has a very large exposure to state government, once again, that became a huge positive for us and we did not take the same economic hit as other major, uh, economic centers in the country.

So, Sacramento looks great right now.

Um, was looking great.

Unemployment rate actually is below both the statewide average and the national average at this point in time.

But we remain vulnerable to the forces in play going forward, because as the economic landscape weakens and the labor market changes, Sacramento, once again, is going to be standing at the door wondering "Where are all those high paying jobs that we were supposed to bring in... into our, uh, you know, economic center?"

Because we don't have those right now.

Where do you think- If... if you were talking to the leadership of this region and they were trying to decide on what to prioritize that they should be focusing on, in order to, uh, improve the infrastructure of our economy going forward, what do you think they should be focusing on?

So, for us, I think this is a great time to reevaluate, you know, where the supply chains are.

Where are the competitive advantages on the... the supply chains?

Scott, I'm sure you're picking up the news that manufacturing is coming back to the United States.

Uh, there's a lot of different aspects of the supply chain that we were relying upon- on China, uh, Vietnam, uh, and some other, you know, uh, uh, uh, Southeast Asian countries.

We are trying to bring many of those things back into the U.S.. More recently, Intel announced a big chip fabrication facility in Ohio.

Micron similarly announced another, you know, major facility that they are building on.

So, I think this is a great opportunity for Sacramento to revisit where in the supply chain do we have a competitive edge, and can we bring in more manufacturing or can we bring in some other, uh, jobs into the region that we have not concentrated on in the past?

Now, that... that's interesting, given the fact that we hear a lot, especially in the national debates, about there being a... a... a drumbeat for California employers, particularly in the manufacturing sector... sector, to leave California for states like Texas, Nevada, others, uh, Arizona and... and... and others.

What do we need to do, in order to be able to actually sit in the game and compete successfully against those other states whose regulatory structures are a little bit different than our own?

Scott, I think the primary disincentive, uh, in my opinion, for both businesses and, um, individuals, uh, wanting to leave the state or doing- you know, wanting to live somewhere else or wanting to basically take a business someplace else, usually boils down to a couple of things, which is the cost of doing business or the cost of living.

And unfortunately... unfortunately, even today, California still hasn't addressed some of the major issues surrounding the cost of living and the cost of doing business.

Housing is extremely expensive and continues to stay expensive, in spite of weakening signs, like I said, in the economy, otherwise.

Homelessness is on the rise.

Crime is on the rise.

Uh, our taxes are much higher than everybody else's.

Our costs of energy are higher.

I'm sure you've been paying, uh, you know, attention to the news, where the rest of the country has been facing declining prices for gas and diesel at the pump.

California was exactly the opposite in recent weeks.

We have been seeing the prices still rising, even as I currently speak right now.

So, when you talk about the cost of energy, cost of electricity, all of these being way higher, significantly higher than the rest of the country, those become very strong disincentives because they raise the cost of production, or cost of providing a service, or cost of living for us, in ways that we cannot afford.

We have masses of poverty levels in California right now, which is the reason why we have homelessness, because we are getting priced out.

The people at the top, clearly, are not getting affected as much, but the people at the bottom, in spite of rising wages, cannot basically keep pace with the rising cost of everything else.

Well, I'm glad that you went there on that because, yeah, the whole issue of who's benefiting and who's not, when you look at replacing employees, younger people, that sort of thing, those are the ones who are among the groups that are most hardest hit by the cost of energy, housing, health care, and... and the like.

Are there any strategies that we should be thinking about, in our final moments, just to... to start to put on the table to try and address these things, so that we can retain more of the young people we need, for all of us older folks, to ultimately replace us?

It's a great question, Scott.

And the... the one thing that comes to mind immediately is that the state, rather than squandering the budget surpluses that they usually do, should start putting some investments into what I call "major skills retraining programs" and even some trade schools.

We have a wide skills gap that basically prevents our younger populations from holding jobs in the new economy that's emerging, whether it's robotics, artificial intelligence- And we are the technology capital for the world- don't forget that- with the Silicon Valley.

Unfortunately, our universities don't keep pace, when it comes to the most current skills that you need to fill those jobs.

So... so, the state should really be launching aggressive programs where they are retraining our younger generations to fill these higher paying jobs, because, in many cases, anything that has technology somewhere in it is paying higher wages compared to the pure service sector that we see.

So, I think those could make a huge dent in basically not only attracting young talent, but retaining young talent.

Hmm.

And I think we'll leave it there.

Thank you, uh, Sanjay, for your feedback, and we... we'll revisit this again sometime in the future.

Thank you.

All right.

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.