The supply capacity of the U.S. economy may be ‘deeply scarred’: Economist

James Knightley, ING Chief International Economist, joins Yahoo Finance to discuss supply strains holding back U.S. growth and the rising inflation prices.

Video Transcript

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ALEXIS CHRISTOFOROUS: Consumers flexed their muscle in June, as they spent big on things like clothing, eating out, and tech gadgets. But will higher prices and a rise in COVID-19 cases in many parts of the country pour cold water on that spending spree? We're joined now by James Knightley, ING's chief international economist. James, thanks so much for being with us. I'd love to get your thoughts on those retail sales numbers we saw today, and what does it really tell us about the health of the economic recovery in the US?

JAMES KNIGHTLEY: Yeah. Their really, really good figures today. Markets and past sales, we've been looking for actually a slight fall today. But instead we get a decent rise. And it's pretty broad spread, and that gives us encouragement because with the reopening, with more opportunities to spend money differently, you don't have to go out and buy physical things, which count towards retail sales. You can go to restaurants, you can travel, you can visit-- you can do leisure activities as well. Those things aren't picked up in retail sales. So with that area of the economy [INAUDIBLE] clearly now, [INAUDIBLE] leave our homes and get out and about and do things. For that to be growing and for retail sales to also continue growing, that's a really positive story for consumers spending more broadly.

ALEXIS CHRISTOFOROUS: Now having said all that-- and of course, you did what I'm about to say before these retail sales numbers came out-- but I know last week, for the first time, ING lowered their GDP growth forecast for the first time since the pandemic started. What were some of the reasons behind that move?

JAMES KNIGHTLEY: Yeah. We're starting to see a few banks now revising down their growth forecast for the first time, which is-- it's not by much, but it's quite a significant story, I think. And it's not because of demand. We all can see the level of demand that is out there in the US economy, again, reinforced by today's retail sales numbers. I'm just concerned that the supply capacity of the US economy has been deeply scarred. We can see that in the lack of available workers. You can see it in the supply chain problems that are going on not just in the US but right around the world.

And that means that you've got demand up here, but if the economy can only supply down here, you're going to have missed growth opportunities. And I think that's the real story why we're lowering our growth forecast just a little bit, is that for all the vibrancy of the economy, we're just not sure that there's the capacity to fulfill that demand. And economics 101 therefore leads you to the next conclusion, well, if demand is up here, supply is down here. What does that mean for prices? And we are a little bit concerned, like your previous guest, that inflation could be a little bit longer lasting.

ALEXIS CHRISTOFOROUS: Right, which was going to lead me to my next question around inflation. Do you think that rising prices-- we already saw some of those rising prices in the month of June for sure, yet consumers were still out spending pretty strongly. But if those prices continue to move up aggressively, even if it's in the short term, you think it's going to be enough for consumers to pull back in a meaningful enough way to start to, maybe not kill the economic recovery, but at least push the pause button?

JAMES KNIGHTLEY: Yeah, I know. I think it's a really good point. I think there's some warning signs out there. We've had a little bit earlier today consumer confidence calculated by the University of Michigan. And it actually fell, despite better jobs numbers, despite the strong growth, despite incomes starting to pick up. And it was purely down to rising costs.

People are worried about the cost of housing, the cost of cars, other factors as well and if that dollar in their pocket goes as far as it did perhaps last year. So these issues are something that, it's certainly worth watching. But I would argue that, I think, we've seen so much stimulus thrown at the household sector. You look at the stimulus checks, you look at the ongoing extended unemployment benefits as well. This has contributed to a massive increase in household savings. Equity markets are roaring up. And as a result, that's really driven a $20 trillion increase in household wealth, as calculated by the Federal Reserve.

But if you look at what's in cash, checking, and time-savings deposits, that's increased $3 trillion as well. So there's a lot of cash ammunition still there that households are sitting on that I think can keep powering us on through this growth story. Certainly there's areas that look very toppish, like the housing market. How many more people are going to continue to want to pay a second-hand car prices at their current levels? But I think more broadly, consumer spending has still got a lot of legs to it.

ALEXIS CHRISTOFOROUS: Speaking of stimulus, child tax credits started to go out to many households here in the US yesterday. That could be another big boost for the economy in the coming months. I want to ask you another question about, as we look inside this retail sales report, one thing people didn't spend big on were cars. The price of cars, used cars as well, going through the roof. And it's hard for lots of folks to get the new cars because of the global computer chip shortage that we have right now. But were you surprised about that pullback in car sales? And what do you think the messaging is there, if any?

JAMES KNIGHTLEY: Yeah, no. I think it's a really interesting story. I was actually thinking we could see an even bigger pullback in the value of car sales because, again, it's comparing the volumes with values. The volumes is like the number of units sold. And according to the automakers, the number of units sold last month dropped from an annualized $17 million rates down to an annualized $15.4 million rate. Now we know prices are rising, but not significantly for new car prices. It's much more in the second-hand car market.

So looking at the retail sales numbers today for car sales, it's a drop. It's the second drop in a row. It's not demand related. We know that people want cars. You can see that from the fact that used car prices are up 45%. So clearly there is significant demand. It's once again down to the fact that supply chains are under real pressure. And you mentioned the semiconductor chips. That's a well publicized story, really, in that we know that there's semiconductor chips in anything from satellite navigation systems through to braking sensors.

So if you can't get hold of those, you can't make a car these days. And it's that supply-demand mismatch that's really, again, holding back output. Demand is there. It's just that the supply capacity cannot meet that demand. Hopefully that will be resolved and the US growth story can be even better. But I'm just worried that in the near term we are going to see more and more of these supply constraints holding back the growth potential for the US economy. And that's, as I say, why we're revising down our growth numbers.

ALEXIS CHRISTOFOROUS: If you had to pick one thing, James, that is the biggest hurdle or challenge for economic growth in the US at the moment, what would that be?

JAMES KNIGHTLEY: You highlighted the COVID-19 cases, that pick-up, and that could be an issue. I'm temporarily back in London right now, and we're going through a bit of a COVID boom it seems. The COVID cases peaked at about 100,000 per day. We're now above 50,000 a day. So despite the UK, which has got a far higher vaccination rates than the US does, you've still got significant COVID cases. There are still significant health implications from this.

So I don't think we can completely dismiss COVID-19. Vaccination rates in the US are high, but there's still clearly a risk, and the UK is a case in point for that. And there is the threat that new restrictions could come into place right across Europe, and that's going to be something that we need to look at in the US as well. Where Europe goes, the US could well follow if this continues.

ALEXIS CHRISTOFOROUS: We've seen that trend before, for sure. James Knightley, ING's chief international economist. Thanks for spending time with us today. Appreciate it.