The Lagging Economy

The Real Estate Espresso Podcast

The Lagging Economy

Spotify Google Podcast Apple Podcast Subscribe via RSS Leave a Review

Welcome to the Real Estate Espresso podcast, your morning shot of what’s new in the world of real estate investing. I’m your host Victor Menasce. The headlines on the Wall Street Journal have been marveling at the lack of inflationary pressure as the result of tariffs. The latest consumer price index announcement had the annualized rate of 2.7 percent against the backdrop of a weakening labor market. The last CPI print is definitely converging on the Fed’s 2% target for inflation.

We’re looking at inflation because the Fed’s interest rate policy is linked to balancing both price stability and maximizing employment. If inflation is too high, they raise rates in order to suppress demand and if unemployment is too high, they lower rates to stimulate investment. They have other tools as well, including monetary stimulus but we’ll just stick with rates for the moment. Of course, it’s not just the rates that affect the economy; it’s access to credit, which is infinitely more important.

We know that tariffs have been making headlines for most of the year. They’ve been in effect on a wide range of goods from many countries since April 1st and there have been several delays to the implementation of tariffs which were designed to incentivize new trade deals with the U.S. Some of these have concluded and others like Canada and China are still in process.

Well last Friday, the producer price index was published. This is for the month of July, and there are some key highlights here. The producer price index rose 0.9% month-over-month. That’s seasonally adjusted, after being flat in June, and up 0.4% in May. On an unadjusted 12-month basis, the index advanced 3.3%, making it the largest annual increase since February. But we also need to acknowledge that a 0.9% increase in a single month represents an annualized rate of 10.8% if it were to continue. That is a huge jump in a single month.

Now, of course, all of the mainstream media are blaming the jump on tariffs having impacted manufacturers but not yet consumers. The thinking is that companies are going to absorb the price increases, and not pass them on to the consumer, as the White House had requested. But this is a simplified way of looking at the problem. We need to dig a little deeper and look at the components of the Producer Price Index. There’s no doubt tariffs are a contributing factor, but it’s not the whole story. There’s got to be more.

(p>So if we break it down, and look at goods, we see that they increased 0.7% in July, less than the 0.9%, which was the average across the different components. The services component surged 1.1% and that’s the largest increase since March of 2022, so the services component is really surging ahead, and that has nothing to do with tariffs. So clearly, tariffs are not the entire picture.

Now when we break down the services component, we see that trade services were up 2% for the month, that’s a major contributor to the overall services growth. We have transportation and warehousing up 1%, and then other services excluding trade and transportation up 0.7. So specifically, the contributors within services were machinery and equipment wholesaling. Those margins jumped 3.8%. So we’re starting to see people in the supply chain increase their margins on the back of tariffs. After all, we’re not talking about the equipment themselves, we’re talking about the equipment wholesaling service sector.

There’s also the intermediate demanding index that encompasses upstream stages of production. This deals with both processed goods and unprocessed goods like raw materials. Processed goods were up 0.8% and the biggest component of that was diesel fuel, which surged 11.8%. Unprocessed goods were up 1.8% led by a 2.9% increase in unprocessed foods. These are things like raw milk that rose 9.1%. So we are seeing inflationary pressure mounting across multiple stages of production, from raw inputs to final goods and services. That suggests a potentially accelerating pass-through to consumer prices.

Now these tariff-driven costs appear increasingly embedded in the wholesale price, especially visible in goods and trade services and many analysts are linking this to the Trump tariffs. And when I consider that companies need to maintain profitability there are several ways they can do this. First, retailers might hold a line on prices for goods that have tariffs attached to them. Just like the White House requested, but eventually they will have to pass on those increased costs.

Now maybe they’ll get creative and charge more for things like warranties or software items that are not necessarily linked to tariffs directly. I think the cost pressure from tariffs and the incentive to bring manufacturing to the U.S. will have several effects:

Number one, any new manufacturing in the U.S. is going to take time to implement. In the meantime, companies will have to find other ways to cut costs. If and when they do eventually bring new manufacturing back to the U.S., it is going to be highly automated to minimize the impact of higher U.S. wages.

Number two, with the advent of AI, manufacturers will be looking for ways to eliminate other positions in the company to reduce head count and improve operating margins. So paradoxically, the drive to save costs will accelerate the adoption of AI in companies and speed up the elimination of jobs. Strangely it’s going to have the opposite effect that the White House was hoping for.

The White House is hoping to preserve jobs in the U.S. but by putting the squeeze on companies that import goods, they’re going to be forced to look for ways to cut expenses. Once those jobs are replaced by AI, they’re not coming back. It’s not like in your traditional recessionary cycle where companies shrink and expand and shrink and expand just with the economy. These jobs will never come back.

So if inflation ticks up as a result of tariffs, can the Fed do anything about it? Well, the answer is a resounding No. Interest rates won’t make the tariffs go away. Increasing costs for businesses won’t cause demand to fall enough to suppress prices. The economy’s teetering on the edge of a recession as it is so the Fed would be rendered completely impotent to bring price stability from an artificial imposition of tariffs causing prices to increase.

You see, these economic models assume normal economic behavior. If the model doesn’t explain the real situation on the ground, at a certain point you have to abandon the computer simulation and look out the window to see what’s happening.

As you think about that, have an awesome rest of your day. Go make some great things happen, and we’ll talk to you again tomorrow. Thank you.

Stay connected and discover more about my work in real estate by visiting and following me on various platforms: