Economic Outlook 2023 with Former White House Senior Economist Dr. LaVaughn Henry

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Title, Wednesdays with Woodward (registered trademark), Webinar Series. 

An open laptop with the title screen sits next to a small potted plant and a red coffee mug with a white umbrella logo. Logos, Travelers Institute, Travelers. 

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JOAN WOODWARD: Hi. Good afternoon. And thank you for joining us. I'm Joan Woodward, President of the Travelers Institute. Welcome to Wednesdays with Woodward where we convene leading experts for conversations about today's biggest challenges, personal and professional. 

Before we get started, I'd like to share our disclaimer about today's program. 

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Text, About Travelers Institute (registered trademark) webinars. The Wednesdays with Woodward (registered trademark) educational webinar series is presented by the Travelers Institute, the public policy division of Travelers. This program is offered for informational and educational purposes only. You should consult with your financial, legal, insurance or other advisors about any practices suggested by this program. Please note that this session is being recorded and may be used as Travelers deems appropriate. 

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I'd also like to thank our webinar partners today, the MetroHartford Alliance and the Insurance Association of Connecticut. So now let's get started. 

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Text, Economic Outlook 2023 with Former White House Senior Economist Dr. LaVaughn Henry. Logos, I.A.C., Insurance Association of Connecticut, Travelers Institute (registered trademark), Travelers, MetroHartford Alliance 

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As one of our first programs in 2023, we decided to take stock of the economy, where we've been and where we're headed. After a year of rockiness around numerous economic indicators, we're all looking to make sense of these trends beyond the headlines and to figure out what it really means for our businesses and actually, more importantly, for our families. So will you be able to hire the workers you need in 2023? How long will inflationary pressures persist, again, both in your business and in your personal life, and much more we're going to talk about today. 

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Text, Speakers. Joan Woodward, Executive Vice President, Public Policy; President, Travelers Institute, Travelers. Dr. LaVaughn Henry, Former Senior Economist, White House Council of Economic Advisers. 

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So I'm thrilled and honored to welcome a special guest today, my long-time friend Dr. LaVaughn Henry to help provide perspective on it all. Dr. LaVaughn Henry has a Ph.D. in economics from Harvard University and has a long career in public service. Early on in his career, he worked on Capitol Hill for the House Budget Committee. That's where we first met nearly 30 years ago. He has served at some of the country's top financial institutions, including Fannie Mae, the Federal Reserve where he served as Vice President for the Cincinnati branch office of the Federal Reserve Bank of Cleveland. 

From 2019 to 2021, Dr. Henry served as Senior Economist on the White House Council of Economic Advisers. He is currently the Chairman of the Foundation of the National Association of Business Economists. He presents regularly on the outlook for the economy, monetary policy and the residential real estate market, all topics we're looking forward to discussing with him today. So he's going to kick us off with an opening presentation, and then I'm going to rejoin him to keep the conversation rolling. We're going to take your questions, of course. So don't wait. Put your questions for LaVaughn in that Q&A function at the bottom of your screen. 

So, first, LaVaughn you were a young rock star when I first met you. And now you're a distinguished rock star in the economics field. And I just want to thank you for your many, many decades of public service. So the virtual floor is yours. Welcome. 

LAVAUGHN HENRY: OK, my friends. So what I would like to do is talk about, as I said, the status and outlook of the U.S. economy. Now, as Joan did, I would also like to make a disclaimer that the views expressed herein are solely those of myself, the author, and also the presenter. All information upon which this presentation is based was obtained from publicly available sources that are considered reliable. OK? 

So why don't we get started and talk about what we will be talking about? And there, we're speaking of the presentation outline. First, the labor market. Cut to the chase, America strong. 

Then what's everyone speaking about now? Inflation, where we were in the past, where we are today, where we're moving toward in the future. Then move to the elephant in the room, that being personal consumption. Why do I term it as such? That's 70% of the U.S. economy. And so goes consumption, so goes our economy. 

Then let's speak about business performance, earnings and investment. Been somewhat of an underwhelming quarter. However, could be much worse. And the outlook is not that bad. 

And, finally, bring it back down, risk factors to the outlook. Progress always involves risk. We are in a risky period to move up or down. But, and you will come to see in my bias, I believe we're still heading up. So that all being said, my friends, let's move to our first slide, America Strong. 

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Graph title, The Labor Market: America Strong. Unemployment Rate and Earnings Growth. The unemployment rate and average hourly earnings are presented from December 1, 2012, to December 1, 2022. The unemployment rate starts at eight, then decreases to below four in January of 2020, then shoots up above 14 in June of 2020, then decreases steadily to the end of the graph. The average hourly earnings starts around two and stays below four until January of 2020 when it rises to eight, then drops down to one in April of 2021, then rises in 2022. Source, U.S. Bureau of Labor Statistics. 

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If we look at the path of the unemployment rate and earnings, what we see is that the unemployment rate is currently at a historical low of 3.4%, the lowest it's been at least in the last 10 years but specifically in the last 50 years, 50-plus years. 1969 was the last time we had to see such a low unemployment rate. And we're seeing average hourly earnings continue to rise despite pessimism from the broad population about the outlook. This is a strong labor market no matter how we cut it. 

Now, if we look farther, let's look at why are we seeing such strong movement. 

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Factors affecting the U.S. Labor Market. 

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Well, fundamentally, we are in a period of strong economic growth. The U.S. economy continues to grow. We saw 2.9% growth last quarter. That's the advanced read in the GDP after a growth in the third quarter and slight declines in the first two quarters of last year. So we're on a path of strong growth. 

As I said, unemployment remains low. Business investment. Companies are continuing to invest despite rising interest rates and increased uncertainty on the future path. Tax and regulatory policies are a mix. Yes, we are in a highly regulated environment. But in the near term, we have seen some substantial fiscal policy moves, such as the infrastructure bill, the CHIPS Act bill, and others that will help us grow into the future.

I can't say enough about consumer spending, the all-in-all important. And global competition remains strong. Now our trading partners are not as strong as us for a variety of reasons. But, nonetheless, we still continue to see expansion on a global basis. 

So, if we now look with respect to inflation, what everyone's talking about, where does that put us? 

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Graph, Inflation, Past, Present, and Future. The same years are represented with the percent of change from a year ago, ranging from negative 2 to 10. Four lines represent C.P.I. All Items, C.P.I. Core, P.C.E. All Items, and P.C.E. Core. The four lines stay relatively close to each other, dipping in 2015 and 2020, and rising steadily from April 2021. C.P.I. All Items peaks at July 2022 above eight. Source, US Bureau of Economic Analysis. 

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Yes, if we go back to the beginning of the pandemic, we have seen inflation rise substantially, peaking out at 9.1% in the summer of last year. We had not seen inflation advance at this rate and in this time period-- I mean during this short time period since the early-- the late 1970s, early 1980s. I'll tell my age there. I actually recall that because I was just starting out in college in economics. And I remember the period quite well. 

Well, let's see what we've seen since then. We have seen now four consecutive, if not five consecutive months, of declines in inflation. And that's key. That's key. Because as we've seen, the Federal Reserve bring to bear its many tools to pull back demand, to pull back economic activity to a more reasonable, sustainable level. We have seen us enter a period of disinflation. 

Now I want to make sure that we understand disinflation is not deflation. We are not seeing negative price growth. We're just seeing a slowing in the amount of growth, in amount of growth in prices. 

And if we look at the Fed's preferred measure, that being the Personal Consumption Expenditures Index, we're actually down to the area of about 5.5% inflation. But, still, that's not where they want to be. That's not where we need to be. There's still much heavy lifting to be done. Now, 

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Inflation, Past, Present, and Future. P.C.E. Inflation and Core P.C.E. inflation are predicted from 2017 to 2025. Source, Federal Reserve Board of Governors. 

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If we look at what the Fed is predicting in their series of their quarterly communications, which we will see an update next month, they're predicting over the course of the next two to three years a return to target inflation levels of 2% by 2025. And that's a range. If you look at the midpoint of their predicted range, they're looking for year-end levels of approximately 3, 3 1/2% and then moving down sequentially over the next couple of years. If you look at it on a core basis, pretty much in the same path moving out toward 2025 back to a period of stability. 

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Inflation, Past, Present, and Future. F.O.M.C. participants' assessments of appropriate monetary policy. Midpoint of target range or target level for the federal funds rate. From zero to 6% from 2022 through 2025 and then longer run. 

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The infamous dot, dot plot. And for those who may not know, what this is-- the Federal Reserve puts out once again in every quarter the summary assessments of the members of the Board of Governors and the presidents of each of the 12 Federal Reserve Banks, their expectations for midpoint estimates of the fed funds rate and as it adjusts into the longer term. So each one of those dots is a member of the board or the Federal Reserve Banks. 

And as you see, we have greater variation as we move out through time. But, nonetheless, we see continued decline, predicted decline, in the rate of inflation. And that's what you want to see. You want to see, sure, it go away tomorrow. Eggs be back to where they were a year ago. 

But adjustment takes time. Monetary policy takes time. Where does this show us moving to in the long term, out in the longer run? Back to the level of 2 to 2 1/2%. In the near term, 5%, 4%, 3%, moving down. 

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Text, Factors affecting U.S. and Global Inflation. 

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Now what's causing this inflation? Well, if we look at it, there are five major issues, the demand-pull inflation. We are consuming so much more than we were even pre-pandemic now. You may recall that we saw a significant rise in retail sales this morning. 

Cost-push-- this relates to supply chains disruptions and an issue with respect to globalization, reverse globalization, as we see costs-- operating costs rise for producers. Monetary inflation-- there was a lot of monetary accommodation during the period of the pandemic to keep us from going into a significant recession. And it worked. And now we’re pulling-- now they're pulling back. That matters. Exchange rate inflation and supply chains disruptions as we move forward. 

Now, if we look at the next-- I say elephant in the room, how are we doing on consumption that all-in important measure? 

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Graph, Personal Consumption, The Elephant in the Room. Real Personal Consumption Expenditures and Retail Sales Growth. December 2012 through December 2022 and the percent of change from a year ago from negative 20 to 60. Two lines represent Real P.C.E and Retail Sales. They stay around 1 to 5 until about June of 2020 and drop to about negative 18 then rise sharply. Retail sales peak at almost 50 in June of 2021, Real P.C.E about 25. They both drop quickly and by June of 2022 are between zero and 10. Source, U.S. Bureau of Economic Analysis. 

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Consumption is 70% of the American economy. I'd like to say that if you took consumption, just that segment, what we as American consumers do. It's 70% of the U.S. economy. That is approximately the size of the entire Chinese economy. 

And I say that because that's now the number two economy in the world. So that's how much power we as consumers have to dictate the future of the U.S. and the global economy. And as you can see, retail sales remain strong, back to levels, rising at levels as they were pre-pandemic. Again, I say this morning's number showed 6.4% in advance retail sales since a year ago, up from also December. And real personal consumption expenditures, again, very steady. 

Can this continue? We can hope. But at this point, it looks, given the strength of the aforementioned labor market and the other factors then put in place by fiscal policy, there is no on the near term [AUDIO OUT] show that consumption should be falling in any dramatic way with the exception of consumer sentiment. And we'll speak about that. 

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Graph, Inventory to Sales Ratio. The same years. 

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Now this speaks a little bit to the issue of cost-push and supply chain issues. For the longest, we were in a situation. We didn't have enough inventory to meet demand. We did not. 

As you can see, after the onset of the pandemic and the adjustment period soon thereafter, we saw inventory levels drastically decline. 

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They peak in April 2020 above 1.70, then drop to 1.35 in August 2020. 

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If you look here, we saw it decline to approximately 1.2 by the beginning of 2021 from a 1.4 ratio, which is approximately historically the norm. But since then, we've seen continued growth in inventories. 

And that takes pressure off of inflationary issues, inflationary factors, but also introduces, and we may speak about that later, other issues such as where you store this increased inflation. Because we are seeing, I mean, this increase inventory because we are seeing pressure on warehouse rates that can feed back and increase inflation from that standpoint. 

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Text, Factors Affecting Personal Consumption. Economic Growth, Low Unemployment, Rising Wages, Tax Cuts, Interest Rates. 

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So we've spoken about this. And why don't we stay on time and now move to business performance. 

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Graph, Business Earnings and Investment, "Somewhat Underwhelming but could be Worse." Corporate Profits and Investment. The same years with percent of change from a year ago from negative 30 to 60. In April of 2021, the Corporate Profits after tax shoot up over 50 from 10 in October of 2020. It drops down to 20 in October of 2021. 

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How are business profits and investments doing? Now even in this situation, in this environment of rising interest rates, we have seen business investment still stay strong. 

Through the most recent numbers, we're seeing gross private domestic investment rise at a little less than a 10% year-over-year rate. Profits having come down from astronomical levels early in 2021, now running at about 5% growth or thereabouts. So we're seeing movement down but still in the positive territory. 

Now, a lot of this, keep in mind-- now, also keep in mind that a lot of the profits that we're seeing are from sectors that really benefited from the reopening of the economy. But as we see increased fear, as we see higher interest rates, as we see increased consumer sentiment about will we be going into recession, how long will the Fed be making its adjustments, that puts risk into the conversation. That makes business step back and say, hey, do we need to be investing so much right now when we're not sure about consumer demand? 

So that's why we're seeing the movement down in profits. But as long as consumer demand stays positive, we have a strong labor market, and we do not see, in my opinion, a hard landing but rather a soft landing by the Federal Reserve, corporate profits should stay in the reasonable range. and hopefully soon thereafter, later this year, move up in a more stronger fashion. 

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Text, Risk Factors to the Outlook, "Progress always involves risk." 

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Now is there risk to this forecast? Well, definitely so, definitely so. The biggest risk is inflation. We are seeing what we have not seen in the last 50-- excuse me, 40 years, a period of high inflation but now a period of disinflation. 

We're seeing an aggressive Federal Reserve raising rates to address that issue of inflation but doing it so in a very thoughtful and prudent manner that's already achieving results. We continue to pursue solid trade policies. But it's been slowed. It has been slowed by issues between ourselves, China and other global parties. Remains political uncertainty what will happen on the Hill and internationally. 

And the global economic conditions still are fraught with uncertainty. I believe one of the biggest issues we have to deal with, and this is not new, is what happens with federal debt by the early summer and the shock. You can never rule out there being some kind of disaster, so natural disaster, let's say. 

So, my friends, what I'd like to say in summary is that if we look at the current situation that faces us, we are in a very solid position but an uncertain future. And that uncertainty belies what we've seen but a lot of what we might see in the future. Now our host Travelers Institute has put together a lot of questions for us. Hopefully I answer them correctly or at least reasonably. And I would like to turn back to my friend Joan. Joan? 

JOAN WOODWARD: LaVaughn, thank you so very much. I just love the cadence of how you speak. And you don't have to have a Ph.D. in economics to understand exactly where you're headed with each of these topics that are complicated. And so I love how you can explain it to folks like us that don't have a Ph.D. from Harvard. So thank you for that. 

And the content you delivered was really, just really interesting because, as you say, we're in such a period of-- historically, we haven't seen periods like this before. So thank you for that. And like I always do, I like to turn the tables on our audience before we get started into the discussion and ask them a couple questions. There's only two today. 

So the first question for everyone out there, if you could please vote, what economic factors or issues are you most concerned about in 2023? What are you most concerned about in your business? Let's just maybe stick to business at the moment. But, of course, it affects our personal lives as everyone knows. 

So the number one factor you're most concerned about. And it looks like from our results here, inflation. Over 50% of the audience has said inflation clearly, but geopolitical factors. 

I mean, there's so much that we don't control, right LaVaughn, in our country? There's so many other external factors out there that affect inflation or labor issues or supply chain. So what do you make of these answers? Obviously, it doesn't surprise you on the inflation front. But what surprises you here? 

LAVAUGHN HENRY: Well, what surprises me is that we had, and it's definitely not the primary, is that we had so many people concerned about labor issues when that is our strongest area in the economy right now, the labor market. But with inflation, sure, it's an unknown. Many of your audience, many in your audience probably was not alive at the time we last saw any significant inflation in this country. 

But something to also put out there in the ecosphere right now is that it doesn't turn on a dime when you talk about inflation, when you talk about how things will happen in the future. Coming off the inflation of the early 1980s, it took close to six years, almost a decade to get down. And we have similarities there. We have differences there. 

The other one, the geopolitical risk, that's an issue because we can't control that. We can't control what's happening. We can influence, but we can't control what's going to happen over in Eastern Europe. We can't control what Xi Jinping is going to do because he just wants to do it. And that all has an impact on a very globalized economy. So, no, I see those outcomes as consistent. 

JOAN WOODWARD: I'm going to guess that when someone chose labor issues here, LaVaughn-- I'm going to guess they're concerned about labor issues because they have to pay their employees more and because employees have more power now post-pandemic. The employee has the power, and wages are going up. So I'm going to guess that people chose labor issues were worried about that dynamic, not the fact that unemployment rate is at historic lows. 

LAVAUGHN HENRY: I agree. I totally agree. 

JOAN WOODWARD: Let's go on to the next question because we have one more question for our audience here. When do you expect inflationary pressures to subside? Do you think they're going to subside this year, later this year or do you think it's going to take until 2024 or later to subside? Let's see what our audience says. This is our last polling question. 

So we appreciate everyone participating. It looks to me like we only have about 20% of the audience thinking it's going to subside this year, LaVaughn. Is that consistent with what you're thinking? You said it took six years. 

LAVAUGHN HENRY: I think it's very consistent. As I just said, it's not an overnight thing. Plus, we are looking at some structural issues we were not looking at in previous periods. I think that's a very reasonable assessment. 

Now I wouldn't say that we'll see the Federal Reserve just continue to raise rates forever. And we'll talk about that. But I do believe that's a very reasonable expectation, 2024 or later. 

JOAN WOODWARD: OK. So now let's get into some questions. We talked about does this economic period in any way mirror any historical periods that you saw? You just said it took six years, almost 10 years to really get out of the inflationary pressures of 1980s. What does this period in time remind you of historically economically? 

LAVAUGHN HENRY: OK. Well, thanks very much, Joan. It reminds me of the period of early to mid-1980s, the quote, unquote "Reagan era," which was a solid era for our country. It was “Morning in America” in many ways. 

Similarities, going through a period of disinflation, coming off a high inflationary period of the late '70s, early 1980s. Two, similar in terms of economic uncertainty followed by strong economic growth. We had been in a situation we didn't really know much about. And the Fed was testing new ideas. 

Something also to put in context, we're right now at 475 on the fed funds effective rate. You know what the fed funds rate was back then? 19.1%, very different. And we're also similar in that there is declining unemployment. Very similar. 

Differences-- we are very much different in terms of labor market rigidity. There was very much rigidity in the early 1980s due to wage contracts, inability to move from sector to sector. Now that's not the case, plus the composition of our labor force. We used to be a production economy. We built things. 

Now we're a service economy. We do things that help in the process. Those are very different in how you move wages around, how you move people around. The regulatory environment, very different from then to now. That was a period of decreasing regulation, which helps to pull price pressures down. 

We are in some ways a period of rising regulation, not across the board. And some of these regulations really did work, a la Dodd-Frank. But at the end of the day, we're in a rising regulatory environment. And also the degree of international globalization, very key here. That in the '80s and '90s helped us to get the cost down. 

But now we're seeing some of our global trading partners pull back and want to do it different. And, hey, we have this other Asian competitor now that we did not have then. And we're bringing stuff back not in a massive way, but we are. So that helps push prices up. There are similarities, and there are differences. 

JOAN WOODWARD: Really, really interesting. Thank you for breaking that down. People do forget how high mortgage rates were back in the 1980s, et cetera. So I want to talk about what economic indicators our audience should look to when they're-- what are the things you keep a close eye on? 

A lot of people say, well, if the yield curve inverts, the difference between the 2- and the 10-year-- if the yield curve inverts, we're absolutely going to have a recession within 6 to 12 months. People say a leading economic indicator is the consumer confidence number. People feeling confident in their own economic situation, they're going to buy more things. Our GDP is going to go up. What do you watch? And what should my audience watch to see whether we're headed up or we're headed down? 

LAVAUGHN HENRY: Thanks very much. Well, we can never bank on anything, one single number telling us where the future's going to be. It just doesn't work that way because the yield curve has been inverted for a good amount of time now. It bounces in and out, but it's been inverted for a little while. Some people say, well, if you have two quarters in a row, that's a recession. That's really not how recessions get called. 

Let's look at the economic fundamentals. I can never say enough, personal consumption, retail sales. That's what drives this economy. If you start seeing consumers pull back in a significant way, that's the start of the process. If we start seeing the unemployment rate tick up in a substantial manner and non-form payroll employment start declining versus having these strong months, which is really off the chart, 517,000 last month, that's an indicator. 

If inflation starts to reverse-- like right now, we just came in. It was really weak, a weak decline, but still it's a decline from 6.5 to 6.4 month to month. If we start seeing that it sticks then around that level, then we may see the Fed get stronger and other measures, Institute of Supply Management, manufacturing survey. 

And most important in my humble opinion, listen to what the Fed says, these Federal Reserve statements. They're signaling where they're going to go, and where they go is where this economy is going to go. So look at the fundamentals. It's almost like if you want to make money in the stock market, listen to Buffett. Don't listen to whoever is the catch phrase of the day. 

JOAN WOODWARD: Long-term, long-term thinking. 

LAVAUGHN HENRY: Long term. 

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JOAN WOODWARD: We're in this for the long term. Good. We're going to move on because I have over 100 questions coming in now for you from the audience. But I want to focus on geopolitical risk. We both talked about it. Certainly in the U.S., the economy is impacted by what's going on overseas. 

Talk to me about three things, China and China with COVID and their incredible lockdowns they've had over the last three years, the fraught Chinese relationship maybe with Taiwan and how that could have potentially affect us, and then Russia and Ukraine. So I want to break it down into three different-- so let's talk about China and COVID and then China and the geopolitical risks with Taiwan first, or maybe they're funding-- now potentially funding the war in Ukraine or funding North Korea. Tell us why that impacts us. 

LAVAUGHN HENRY: OK. Here's why it matters in my humble opinion. China and COVID is almost like the never-ending story. We've seen it since 2020. And when China goes into its lockdown mode, that affects us by cutting supplies to the United States. 

Now I may be more hopeful here than fact. But I want to believe that Xi Jinping, the premier, learned that that hurts him also. So right now, we're in a phase where they're opening up again. But let's see how long it lasts. But it's an issue from the trade relations and also their relationships with some of our partners being frayed and trying to push into that. That's another issue. 

All right, and that leads to our Chinese-U.S. relations. Tale of two cities. We have the good. We have the bad. I totally agree with our president, President Biden, that we need to emphasize that we're seeking competition not conflict. Over the long term, no one wins with conflicts.

But if we can put trade policies in place that are respectful of both sides, we can both move better. It's kind of like making the pie bigger through a competitive means not through conflict. So let's see where those go. And, finally, the Russia-Ukraine war-- let's just call it what it is, the Russian invasion, the unjust war. 

We have to keep our finger on that, although it has not necessarily minimal, but doesn't have significant impacts on us from an economic standpoint today, except with the issue of keeping fuel prices higher than it otherwise would be. Let someone make a mistake and advance that war onto NATO protected territory. Then all issues become global. Then all issues-- 

Where do we go from there? I think overuse of the term “it goes nuclear” is ridiculous, but we cannot afford to have that war become a contagion in Europe. That concerns me. But I believe we definitely need to continue supporting Ukraine because it's the right thing to do from not just a geopolitical standpoint but from an economic standpoint. 

JOAN WOODWARD: OK. Thank you for that trip around the world, let's hope all those global hotspots do improve. I want to shift focus and go to Washington because you and I both live in Washington. And your government experience is golden. That puts you in a great place to talk about what's going on with the debt ceiling standoff. You've seen this movie before, I know. I have working on the House-- 

LAVAUGHN HENRY: Yes, we have. 

JOAN WOODWARD: --the House Budget Committee. So how does this get resolved? And if it doesn't get resolved, what are the grave implications for-- what if we breach the debt ceiling? Like people talk about the debt ceiling as if-- but there's actual consequences. 

And when would we expect that? They're saying maybe late June, maybe into July. How do you see this shaking out? And what would be your advice to Kevin McCarthy and President Biden to come together to get it resolved? 

LAVAUGHN HENRY: Excellent question. Now I've got to give a shout out to Marvin Gaye and Tammi Terrell because basically ain't no mountain high enough when it comes to discussing public debt. 

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Graph titled Ain't No Mountain High Enough for Public Debt. Total Public Debt in Trillions. The line starts in 1981 with a photo of Ronald Reagan at 1 trillion, George H. W. Bush in 1989 at 3 trillion, Bill Clinton in 1993 at 4, George W. Bush in 2001 at 6, Barack Obama in 2008 at 12, Donald Trump in 2018 at 20, Joe Biden at 28 in 2021 and 31 in 2022. 

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And we can't have this continuing to go up. An interesting thing here—public debt, the growth in public debt is a bipartisan issue. 

If we look at the last, was it seven presidents since 1981 when the debt was 1 trillion, which is now grown to 31.4 trillion, we actually see a split between the R's and the D's with the Republicans accounting for 57% of the growth in the debt and the Democrats 43%. And actually time in office accounts for about the same, 57% and 43%. So it's an issue of can we get to where we need to be without breaching that ceiling of 31.4? 

Why don’t we-- why wouldn't we want to do that? Because then everything goes over the edge. Interest rates will skyrocket. We would lose our debt rating that we have, which is supreme. So our ability to continue funding debt or even funding what we've done is brought into jeopardy. We would no longer be the world's gold standard. 

And at the same time, we would have to then start making substantial cuts to our budget in a dramatic way. So the debt ceiling matters. But it's not a topic that should be lightly played with on Capitol Hill that, ooh, let's just do it and see what happens. No, this stuff matters. 

Now in my humble opinion, both parties are right, and both parties are wrong. And I'm not trying to be political on this, but I'm just stating it as it is. I think that the D's are correct in their position that the debt ceiling is far too important to be negotiating with. It's far too important for long-term economic credibility. And it can be damaged by a short-term political stunt. I think they're wrong on the flip side of staking out a position that they will not negotiate. 

At the end of the day, you know as I do, Joan, everything's a negotiation in Washington, everything. On the R's, I think they're right in that we need to get a better handle on our discretionary spending as it grows in a substantive way that tames future spending and taxation, contain future growth in the debt. I think they're wrong saying that they will not pass a debt ceiling compromise unless the D's negotiate. 

So you may ask if they're both right and they're both wrong, how do we get to where we need to go? Well, here's my humble opinion. I think the answer can be achieved by looking back in the past at what we did before. Such an approach could be the establishment of a bipartisan and bicameral commission tasked with two primary missions. 

One is to discuss and develop legislation, policy and legislation, to deal with the entitlements, the solvency of the entitlement programs, Social Security and Medicaid. The second mission would be to develop policy and legislation that deals with discretionary spending and tax policy separable from the entitlements with an agreement that the commission would come to life post the passage of the debt ceiling agreement and sunset, i.e. come up with the conclusion, by the beginning, no later than the beginning of the 119th Congress, a la January 2025 with the goal of establishing policy, establishing the rules in that first six months after the new Congress takes office. That separates out the debt ceiling from the discretionary argument. And it deals with the issues of how we deal with the entitlement programs. So let's see if Washington does it. 

JOAN WOODWARD: I mean, we've had experience with--

LAVAUGHN HENRY: Yes, we have. 

JOAN WOODWARD: --bicameral, bipartisan commissions, the Erskine Bowles-Simpson-- Simpson-Bowles Commission or the National Entitlement Commission back when our friend Mark Weinberger, who was CEO of EY, just retired. He was head of that. And they really came up with deficit reducing and political cover. So the politicians have both, and so it does make sense. Great, great suggestion. 

LAVAUGHN HENRY: When you have everyone at the table, everyone's got skin in the game, that's how you get progress. 

JOAN WOODWARD: Great. Let's shift a bit because I have a lot of questions coming in about the real estate market. But, first, let's talk about what do you make of all these companies? 

Every day you wake up, turn on CNBC or at least I do every morning, and you see all the layoffs, a lot of the layoffs in these companies. And if we're laying off people, LaVaughn, that unemployment, that labor force number is going to start to swing and go the other way. Are you worried about these recent layoffs in a lot of these large companies? 

LAVAUGHN HENRY: I could be more worried than I am. And I'm not minimizing that because as a person who early in their career suffered through a layoff during an economic downturn, I understand their pain. However, what we're seeing in terms of layoffs right now is largely, but not 100%, but largely contained to the tech sector, which is a small sector in this economy. And the majority of the people, they are not being laid off. 

So that's one factor. Now when we start seeing contagion moving to other sectors of the economy, such as the big sectors, which are business and service employment, and leisure, hospitality, and retail and trade sales, different issues there, retail and home sales. That's a different issue. 

But we haven't really seen much of that yet. As I say, the market is very strong right now on the labor side. As long as consumption stays solid, I don't expect there to be a significant issue of layoffs broad based. 

JOAN WOODWARD: Great to hear it. So what are the shocks? Let's talk about the worst-case scenario. What are the shocks to our system that keeps you up at night? What are the things that we should look for? 

Obviously, if these layoffs become contagious and more manufacturing companies and other financial services companies start the layoffs. So that may be one shock. What are the other shocks that you think we should look out for or what are you worried about? 

LAVAUGHN HENRY: Any time we hear people speak of shocks, I remember a professor of mine in graduate school back at Harvard used to say, well, shocks aren't predictable. That's why they're called shocks. So myself being a person who always has an opinion and sometimes they're right, if I had to worry about a shock, my big shock would be something happens on the Hill and in the White House that they let the debt ceiling get crossed. As I say, that's what would send us over the edge. And then I would believe that recession is almost inevitable. 

JOAN WOODWARD: And, LaVaughn, let me stop you there. Let me just stop you there. So if we reach the debt ceiling, what happens the next day? What actually happens to our economy? Is it the Chinese stop buying our debt. We can't issue debt? What actually happens?

LAVAUGHN HENRY: We can't issue debt. That's the big issue right there. Keep in mind that-- I can't remember the percentage. But what is it? About a third of our budget is debt funded. I think it's about a third or somewhere like that. That very next day, we cannot fund any new or ongoing programs if we don't have the money already in the bank. 

So we immediately have a shock to outlays that help support this economy. We immediately have a shock to the credibility of our system. And, therefore, we see market yields rise significantly. So if that limit gets crossed, we have an immediate shock. 

Now does that mean that Social Security payments get stopped, Medicare gets stopped? Well, no, not immediately. But when politicians get-- and you know this. When they get pressed against the wall, they sometimes do some very strange things. So that's something to consider. That's just one of those you don't want to cross. 

Now the second one, I've already spoken to. If that war gets moved to NATO territory, that's a shock. That's a shock because that puts everyone in stall mode. 

And that means reduced international trade, higher energy prices, slower economic growth, not to mention all the people who get killed and die like that. But that's what happens. That answer your question, Joan? 

JOAN WOODWARD: Yeah, absolutely. That was the pessimistic shocks. But I think it's important for people to understand. If they're watching a news show and you're saying what would happen, the consequences if there is that kind of shock that hits our system. We have to move on, lots of questions around the housing market.

 A lot of people want to know-- so mortgage rates went from 3% year and a half ago or so to 6% plus. And during the pandemic, we had a shortage of inventory. So our prices, all the housing prices-- it was definitely a seller's market. So where are we today in terms of housing prices? Are they still going to be continuing to trend upward even with mortgage rates going up? 

Are people not putting their houses on the market because we have an inventory problem now? So they're not moving because mortgage rates are higher. How do you think about the Fed action with regard to the housing market because it's really been one of the most resilient during the pandemic? 

LAVAUGHN HENRY: Yes. Well, we actually in this country have a long-term housing problem. And we've had it for years. As the interest rates have moved up-- and that issue really becomes-- is an issue of affordability. It's affordability. And the affordability issue is the child of many bad decisions in the housing market and natural market phenomena. 

And the natural market phenomena is when we came out of the Great Recession in 2010 and thereafter, we had so many people leave the housing construction markets because of opportunities elsewhere in labor market because of rising rates. So builders pulled back. And we have never caught up with building houses at the rate you need to build houses to bring in new individuals to the housing market in an affordable way. 

So that started our shortage of housing, which has been now running for 10 plus years. And on top of that, now a rising rate environment, making the existing short supply of houses even more expensive to purchase. So what we've seen given just those two factors alone, and there are other factors that can go into, is a continued increase, a rapid increase, in the price of housing, which peaked in early 2022. 

And now we're starting to see some pullback because affordability has gotten so, so out of whack. And they are a number now that's less than-- it's running like 96-- but I won't go into what that means. But at the end of the day, what does that mean for the long run? It means young people will have continued difficulty getting into that first all-important home, either having to settle for a home that is less than their preferred level or just not going to home ownership whatsoever. 

And I am a big believer in the value of home ownership. If it wasn't for my parents going into a home when I was like seven or eight, I don't believe I would have gotten to where I am today because I know community matters, and housing and ownership matters. 

Now you could argue also that this is a short-term phenomenon. But we both been economists for a long time, Joan. Define short term, medium, and long term. Who knows? But there are some demographic shifts that can help this problem over the long term. 

Baby boomers, we are aging, pulling out of single-family ownership, maybe into homes. And some are passing away. That's almost inevitable. At some point, they all will pass away. Those are a lot of homes that come on the market. So if you just look at a mismatch there that older persons own the majority of homes-- well, if they're aging out of the cohort, that should put pressure on prices as we move pressures down as we move forward. 

Now cut to the chase. This year if we see 5%, and this number is just not pulled out of the air-- but I was looking at CoreLogic S&P Shiller number yesterday. They're predicting about 3% growth over the course of the next year, which is substantially below last year, which was 6.9%, which was substantially below what it was the year before, so a softening housing market. We could use that. It will make it more affordable, and more young people get into the market. 

JOAN WOODWARD: So a couple of young people have, since you were answering that question, texted me saying, so it sounds like Dr. Henry is telling us get in, just get in. We know interest rates are higher than you want them to be. Prices may still be too high. But if you get in now, it's better than waiting five years. Is that your view? 

LAVAUGHN HENRY: That is my view. Prices will always rise. It's really what happens on a real dollar basis that matters. But nominal prices will always rise.

In fact, I like to put money where his mouth is. Both of my sons purchased their first home last year. Yeah, it was a struggle. But they did it, and they're already seeing the benefits of it, both community and price wise. So things happen. Things matter. 

JOAN WOODWARD: Great. I'll have them talk to my four kids. 

LAVAUGHN HENRY: OK. 

[LAUGHTER] 

JOAN WOODWARD: So let's shift again because I have a lot of questions coming in from the audience on this topic, which is supply chain. And I know we spoke about China and the war. But in your view, do you think that the supply chain issues, the challenges, are starting to subside? We obviously passed the CHIPS Act, getting more domestic chip makers here in the U.S. Won't have to rely so much of offshore chipmaking. We saw the prices of used cars going up dramatically during the pandemic and a shortage of even buying new cars. So do you think these supply chain issues have subsided and we're headed down the path of normality? Or do you think this is a new phenomenon for the economy? 

LAVAUGHN HENRY: Well, I would like to be Pollyannish on this, but I can't be and be a valid economist. We're still muddling through. If you look at a recent survey that just came out, I believe, yesterday or a week ago, CNBC, they surveyed a-- can't remember the actual number-- of logistics managers. 

And the significant majority said that more than half they are still having significant supply chain issues, and they don't expect it to return to normal for their companies until 2024 and beyond, verbatim. Sixty-one percent of respondents said their current supply chain is not operating normally compared to 32% that said it's functioning normally. Question if they see a return to normalcy, 22% were unsure, 19% said 2023, 30% said 2024. 

There are still a lot of issues in the supply chain that have to be factored out. I mean, when we had things operating normally up until the point of the pandemic, it's because it took us years to get to that point. And that's what we have to remember. It took years to get to that point. You can't turn off an economy as big and as efficient and operating as soundly as the United States, and then in six months, turn it back on, say, OK, well, that's over. We're back. 

No, it takes time. Things take time. Markets change. People move in and out. And it takes time to get there. 

And we have a different geopolitical framework now we have to consider. And that's factoring into it all. So, no, we're not done yet. We're making progress, but we're not done yet. 

JOAN WOODWARD: OK. Shifting again, we want to talk about artificial intelligence, which is the hot topic now. George Watts of Hub asks the question what do you think of the economic impact of things like ChatGPT and other AI tools? Is this really a game changer in business? 

LAVAUGHN HENRY: I will tell you I personally love ChatGPT. This isn't a shoutout to just that tool. But those are the type of tools that can have substantial impact over the long run. People are worried. Oh, it's going to take my job. No, it's going to make your job easier. 

That's like saying-- that’s like when personal computers came into vogue in the 1990s. The typist got worried. Well, guess what? It made their job easier. Anything that's efficiency enhancing, that's productivity enhancing, in the long term benefits the market. It doesn't subtract from it. 

I think ChatGPT is a great thing. Now things can't just be willy-nilly, thrown out there without control. If they can pass medical boards and labor boards, we have to find a way to monitor this because this may be an extension, but we will end up being some of the dumbest people in the world if we just have computers answer everything and we don't really know the under outlying issues. So we have to find some way to control. But, no, I think it's a very solid addition to our market. 

[INTERPOSING VOICES] 

JOAN WOODWARD: Better than crypto. OK, that's a good line. ChatGPT, better than crypto. Rapid fire because we're running out of time. I want to get in a couple of last questions here for you. 

Giovanni Sharp of Lockton asked what is the economic outlook for the construction industry, the federal funding of these huge infrastructure products? Do you see that as inflationary? Do you see that as long overdue, or do you see that as essential in terms of rebuilding our infrastructure so we can prosper more as society? Which camp are you in or maybe all three? 

LAVAUGHN HENRY: I'm in the last two. I don't view it as necessarily inflationary because let's just put that on the back burner. It's what we need to be doing. Who hasn't driven over a pothole and lost a tire? I've lost a lot. Maybe I need to stop driving over potholes. 

But the long story short is we are significantly behind in the infrastructure in this country. It has to be done. I believe it will bring some key jobs that need to be done in this country by all classes in this country. 

I think that's so important because everyone has to participate in economic growth not just an elite few. So I am all-in for infrastructure. The faster we do it, the better we'll do it. And sooner we'll see the benefits from thereof. 

JOAN WOODWARD: I agree with that. I absolutely agree. I think it's the most economically efficient dollar Congress can appropriate is towards infrastructure spending. So we're in agreement on that. 

All right, LaVaughn, I have one actually really important question for you now. And this actually came in from a couple of viewers. But it is my personal question to an old friend. So there is an opening on the Federal Reserve Board currently. And given your ready experience at the Federal Reserve and all these other government agencies, I think you're perfectly positioned to take on that seat at the Federal Reserve. And I would like for you to comment on your level of interest. 

Clearly, you're more than qualified. And I think folks like you who could explain things to the American people in a way that we understand it-- again, I would nominate you if I was president. Can you comment on that at all? I know people don't like to comment on will I run for president or whatever, but there is that seat available. Would you be interested? 

LAVAUGHN HENRY: Well, Joan, let me say and all candor, and this is not the normal Washington way, yes, I would be very interested. I would be honored to even be considered. I'm a longtime fan of the Federal Reserve and what it does. I think it's one of the smartest things our government has ever put in place and kept its hands off of most importantly. 

And I've learned a lot through my time at the Federal Reserve and my maintenance of relationships with members of the Board of Governors and the presidents. In fact, the person exiting that seat is a longtime colleague of mine. We went to graduate school together and that being Dr. Lael Brainard. So, yes, I would be honored even to be considered. And thank you for asking that. I appreciate it. 

JOAN WOODWARD: Absolutely. I would nominate you for our president. Listen, we've come to the end of our session with LaVaughn. It's been incredibly, incredibly clear and interesting. And we'd love to have you back to update us in the future. 

LAVAUGHN HENRY: Whenever you want me to. 

JOAN WOODWARD: LaVaughn, thank you so much for your time and your energy. You put together the slides and all your talking points over the last couple of months. So we appreciate it. 

LAVAUGHN HENRY: Thank you very much. I appreciate everyone attending today. Trust me, I enjoyed this more than you. I have no doubt. And I look forward to doing it again. Thanks so much, Joan. 

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Text, Upcoming Webinars. 

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JOAN WOODWARD: All right, great. And, folks, I just want to remind you we do have a session coming up on ChatGPT on March 1, so a couple of programs that we want to make sure you have on your calendars. This is going to be really interesting. It's actually our two data scientists or chief data scientists in analytics is going to talk about what ChatGPT can do for your business, for the insurance sector, and in general. So don't miss that March 1. 

And then March 15, we're going to talk with the Department of Homeland Security's CISA, the Cybersecurity Agency, which was created a few years ago, about what's going on in the cyber threat landscape that they are seeing and how to protect your businesses. Cyber is also, as everyone knows, the top business concerns according to our risk index. So join us on March 15. 

And then I'm going to have, what I like to say, a leadership series conversation with the CEO, and this is on March 22, the CEO of Stanley Black & Decker. The President and CEO Don Allan will join me to talk about what's going on in the major manufacturing sectors globally and what he's seeing around the corner. Just a very insightful guy. And so we're thrilled that Don Allan will join us from Stanley Black & Decker. 

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So, my friends, thank you for joining us. We always really appreciate your input. Fill out our survey. Go to our website for all the replays. We'll see you again on March 1. Take care. 

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Text, Watch replays, travelersinstitute.org. Connect, Linked In, Joan Kois Woodward. Take our Survey, Link in Chat. Hashtag Wednesdays with Woodward. 

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