Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / The Paradox of Productivity and Inflation
Transcript
- Lucas: If walking through the economy with us has made something click, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Luna: It keeps the ads off and lets us dig into the messy data without rushing. Thanks for keeping the lights on. Lucas: Let's get back into it. We have spent the last few weeks mapping out the mechanics of stagflation, from housing lock-ins to energy shocks. But today I want to drill into the most frustrating variable for policymakers right now: the productivity paradox. We are seeing technology advance at a breakneck pace, yet our real GDP growth has slowed to one point five percent annualized in the second quarter, while core CPI remains stubbornly high. Luna: Right, because you would think better tech means lower costs for everyone. Instead, we just have higher prices and slower growth. Lucas: Exactly. The classic economic theory suggests that if a company can produce more output with the same input, those savings should flow down to consumers in the form of lower prices or wages. But look at the latest numbers. Core CPI is sitting at three hundred thirty-seven, and nominal GDP is growing faster than real GDP. That gap tells us that a huge chunk of that economic activity is being absorbed by inflation rather than actual volume growth. Luna: So companies are getting more efficient, but they are choosing to keep the margin rather than cut prices? Lucas: That is the working hypothesis. It looks like pricing power is entrenched. When you combine that with the fact that average hourly earnings are creeping up to thirty-seven dollars, businesses are facing rising labor costs even as they automate parts of their workflow. They are passing those labor costs on to the consumer instead of absorbing them via productivity gains. It creates this weird feedback loop where inflation persists not because we lack goods, but because the benefits of efficiency aren't trickling down. Luna: It feels like the AI boom we hear about every day isn't actually changing the price of milk or gas yet. Lucas: Precisely. And this brings us to the tangible side effects we are seeing in specific sectors. Take the transport industry. There were headlines this week about transport companies sounding alarms on fuel prices. Even if logistics software optimizes routes, the cost of fuel itself is volatile. If your operational costs go up by two percent due to fuel, and your labor costs go up by one percent, you don't lower your shipping fee. You raise it. The inefficiency isn't in the algorithm; it's in the input costs that technology hasn't fixed yet. Luna: So the tech helps, but it's fighting against raw material and energy spikes that cancel out the savings. Lucas: It cancels them out and then some. Consider the agricultural sector. We saw reports earlier this week that France’s wine production is nearing a seventy-year low. That is a supply shock driven by climate conditions, not a productivity failure. But when you have supply constraints like that, combined with high energy costs for processing and transport, prices stay elevated. The scarcity value overrides any potential efficiency gains from modern farming techniques. Luna: Which means consumers are paying more for less, which drags down overall purchasing power and slows the economy. Lucas: Exactly. And this is why the job market data is so confusing to interpret. Unemployment is flat at four point one percent, and job openings are still above seven thousand two hundred. On the surface, that sounds strong. But if wages are rising only enough to match inflation, workers aren't gaining real purchasing power. They are just keeping up. So consumption doesn't expand; it just stays static. That is a hallmark of stagflation—growth is stagnant in real terms, but prices are still inflating. Luna: It’s a wage-price spiral without the spiral part, just a flat line of misery for the middle class. Lucas: I like that phrasing. A flat line of misery. And here is the kicker for investors and policymakers. The ten-year breakeven inflation rate is holding steady at two point three three percent. Markets are essentially saying, 'we expect inflation to remain around this level for the long haul.' They aren't pricing in a deflationary crash, nor are they pricing in hyperinflation. They are pricing in this slow, grinding status quo. Which makes monetary policy incredibly difficult. If you raise rates to crush demand, you risk pushing unemployment up sharply. If you leave them low, you let the inflation expectations become entrenched. Luna: So the Fed is stuck in the middle, watching the S&P five hundred hit new highs while the real economy feels sluggish. Lucas: Right. The equity markets are up, with the S&P five hundred at seven thousand six hundred fifty, largely driven by tech stocks that are benefiting from the very AI narrative we discussed. But the broader economy, represented by the Dow down one point four percent over the last five days, is showing strain. This divergence suggests that the benefits of the current economic cycle are highly concentrated in capital-intensive sectors, not in the labor-intensive sectors that drive broad-based prosperity. Luna: It really highlights how disconnected stock performance is from daily life for most people. Lucas: It does. And this leads us to the consumer sentiment angle. Goldman Sachs recently noted that consumer sentiment is in the dumps despite the solid macro numbers. They blame 'lower happiness,' but I think it's simpler than that. People look at their grocery bills, their insurance premiums, and their mortgage payments, and they see prices that are permanently higher. Even if the rate of increase slows, the level remains painful. That psychological anchor affects spending behavior. People start trading down, buying cheaper brands, delaying big purchases. That shift in behavior eventually hits corporate revenues, which might explain why we aren't seeing the explosive growth we expected. Luna: So the psychological weight of high prices acts as a brake on the very growth we're trying to stimulate. Lucas: It acts as a drag coefficient. Every dollar spent on essentials is a dollar not spent on discretionary items. And since many of the productivity gains are happening in sectors that serve other businesses—like cloud computing or enterprise software—they don't directly impact the consumer basket in a way that lowers the CPI. We need productivity gains in services, healthcare, and education to truly move the needle on inflation. Those are the hardest sectors to automate efficiently. Luna: Healthcare and education are notoriously resistant to efficiency drops. Costs just keep climbing. Lucas: They are. And until we see breakthroughs there, or a significant correction in energy and food prices, we are likely to remain in this window. The data from July shows core PCE price index up to one hundred thirty point seven. That is still above the two percent target. The Federal Reserve has been clear that they want that number down, but the mechanism to get it there is unclear. Rate hikes alone seem to be hitting the labor market hard without fully resolving the price stickiness in services. Luna: It feels like we are waiting for a supply-side solution, but we are stuck in a demand-side constraint. Lucas: That is a very sharp way to put it. We are constrained by demand because incomes aren't growing in real terms, but we are also constrained by supply because inputs like energy and skilled labor are becoming more expensive. It is a double bind. And for businesses, the strategy seems to be maintaining high margins rather than competing on price. We are seeing fewer price wars in retail and services than we did pre-pandemic. Companies have realized that customers will pay, even if they complain about it. That realization is baked into the current inflation data. Luna: So the lesson here is that inflation isn't just a monetary phenomenon anymore; it's a structural one tied to how companies allocate efficiency gains. Lucas: Structural and behavioral. It is both. And until either the labor market softens enough to force wage moderation, or a genuine supply shock reverses the cost curves, this environment is likely to persist. The question for the next quarter is whether the one point five percent GDP growth can hold up, or if the cumulative effect of high prices finally breaks consumer spending. Because once that breaks, the stagflation picture changes from 'slow growth' to 'contraction.' Luna: A dangerous pivot. One where the central bank has to choose between killing inflation or killing jobs. Lucas: Exactly. And given that initial jobless claims dropped to one hundred ninety-six thousand last week, they are probably hoping to avoid that choice for as long as possible. But the clock is ticking on the year-over-year data. We will see if that trend holds or if the underlying pressure finally cracks. Luna: We will watch the numbers closely. For now, it is a game of patience and careful navigation. Lucas: It certainly is. And that is where staying informed matters. We will keep tracking these shifts as they happen.