Last fall, it seemed that the world might be righting itself after two years of pandemic-induced upheaval. Unemployment was nearing historic lows; the stock market was up, and confidence was growing for a sustained economic recovery from one of the most dramatic shocks in our lifetimes.

Fast-forward to spring 2022. The economic landscape is complicated, and normalcy seems less within reach.

After a dramatic winter COVID-19 surge, the world traded pandemic worries for World War III fears as Russia launched an invasion of Ukraine on Feb. 24. Inflation continues unabated, prompting the Federal Reserve to embark on an aggressive interest rate-raising crusade. The inverted yield curve – a relatively reliable historical indicator – is flashing recession warning signs. Consumer confidence is down to recession-era levels.

“There is no question that the path of this expansion has become much narrower now compared to a year ago, perched precariously on a cliff with stagflation-like abyss on one side and a recession-depth gulf in the other,” explain Cal State Fullerton economists Anil Puri and Mira Farka, who presented their Spring Economic Forecast to business leaders, government officials, policymakers and students at Cal State Fullerton’s Meng Hall on April 22.

“In the short term, over the next 10-12 months, we expect continued growth, albeit a decelerating one, coupled with high inflation: an expansion with stagflation dynamics. … Our longer-term view, however, is decidedly more grim. The confluence of an escalating war, rapid rate hikes, unprecedented labor shortages, persistent supply disruptions, higher energy costs, a multi-decade spike in inflation and continued flare-ups in a once-in-a-century pandemic are bound to dim even the most Pollyannaish outlook.”

The Wind of Change Reverses Course

In 1990, amidst the fall of the Berlin Wall and the demise of the Soviet Union, the German rock band Scorpions recorded the mood of the moment with their song “Wind of Change.”

More than three decades later, the geopolitical wind is blowing in a new direction. Russia is again viewed internationally as an aggressor; war has returned to Europe, and the optimism of globalization is long past.

“[‘Wind of Change’] became a symbol of a more open, more liberal and more unified world, one where we ‘let your balalaika sing what my guitar wants to say.’ Alas, the winds of change have turned more ominous as of late, throttling the balalaika and stifling the guitar. Let’s hope it won’t last for long,” says Farka.

While Puri and Farka do not anticipate a wider war in Europe, they also don’t think the Russia/Ukraine conflict will end quickly, either.

And how long the war lingers on will have implications for the global economy. Russia is the world’s 11th-largest economy. Ukraine ranks 55.

But what the Russia/Ukraine region lacks in gross domestic product, it more than makes up for in world commodity exports. Russia accounts for one-tenth of global oil production and 17% of gas production. Europe particularly is heavily reliant on Russian energy. And it’s not all about oil: palladium, platinum, nickel, seed oil, barley and wheat are all major exports from the region that are interrupted due to the conflict.

From soaring gas prices to increasing food insecurity in developing nations to higher prices at the grocery shelves and restaurants, the economic impact of the war is hard-hitting and global.

Aren’t Western sanctions about to bring Russia to its knees, limiting the duration of the crisis? Puri and Farka say not so fast. While they acknowledge the impact of the corporate exodus from the Russian market and the country’s expulsion from the SWIFT international payment system, the economists question whether economic collapse is truly in the cards for Russia.

“All this is meant to deal a deadly blow to Russia leading to an instant immiseration of its economy. In reality, while serious, the shock is likely not fatal. To start with, the EU has declined to sanction Russia’s energy exports, given its vital dependence on them,” they say.

“Russia has spent a good portion of the last decade, since its annexation of Crimea in 2014, seeking to shield its economy from precisely these sorts of sanctions. … The worry is that this decoupling may lead to a broader and more permanent rupture of the post-Cold War world, reviving ghosts of past times of a ‘world of two halves.’ The rapprochement between China and Russia is a prime example. … None of this augurs well for globalization, which, in the span of a decade and a half, has endured a crippling financial crisis, trade wars, a virulent global pandemic and now a full-blown war.”

Stagflation Redux and COVID-19’s New Acts

An entire generation of business professionals have grown up and come of age in a world in which inflation is a back-burner issue compared to economic growth. Now, with inflation rising at an 8.5% annualized rate, the highest since 1982, rising prices are of concern to everyone. The “Great Moderation” supposedly wrought by a vigilant Fed and benign macro environment has come to an end.

Pandemic-induced pent-up demand and hordes of extra consumer cash due to government bailouts during the shutdowns have created unprecedented demand, while supply chain disruptions due to disease and war have caused a supply shock.

“The dawn of this year has ushered in a quasi-religious transformation of the Federal Reserve from perennial growth-hawks to ‘born-again’ inflation fighters. Gone are the days of ‘transitory’ inflation: Mr. Powell has finally come around to the view that inflationary pressures will not magically disappear anytime soon and certainly not on their own,” say Puri and Farka. “But history and conventional wisdom dictate that administering contractionary shocks to an economy that was set to disappoint in the first place may end up delivering darker outcomes than what most of us wish for.”

While growth will continue in the near-term, the economy is likely to be significantly different from what we have grown accustomed to.

“The future path of this expansion will likely be plagued by persistent stagflationary dynamics. Higher interest rates will take the oomph off the red-hot housing market, consumer demand and business investments, cooling off growth and general economic activity,” Puri and Farka report. “Things look bleaker in the longer term, beyond the next year or so, with recession risks running uncomfortably high. Though the national mood has decidedly soured on drastic COVID-19 restrictions, even moderate disruptions related to future virus flare-ups will add strains to an economy that is already being pummeled by energy price shocks and a deliberate cooling by the Fed.”

The OC Angle

In Southern California and Orange County, we can be thankful that we aren’t taking cover during air raids like millions are in Ukraine or confined to our homes due to COVID-19 lockdowns, as millions are in Mainland China. But world events are still generating a significant blow to the local economy.

Looking at the winter Omicron surge, the pattern of infection was similar to past surges, with Orange County faring better than its Southland peers. The BA.2 variant is making its presence known on the East Coast, and Puri and Farka agree that it is only a matter of time before it makes its appearance in Southern California.

Still, the good news is that with each wave of the virus, the economic and societal impact is more muted, thanks to better medical interventions and improved ways of slowing the spread without wrecking the economy.

But two years after the initial shutdowns, the Orange County economy has yet to recover fully.

“Even though the unemployment rate has fallen, the number of people employed is well below pre-pandemic,” report Puri and Farka. “In fact, employment numbers are lower across the board: by 676,000 for the entire state, by 56,000 for Orange County, 229,000 for Los Angeles County and 33,000 for the Inland Empire.”

The leisure and hospitality sector has been particularly hard-hit, still 17,000 jobs below its February 2020 high.

On the housing market, double-digit price appreciation has continued, with the median price in Orange County reaching $1.167 million in February 2022. Over the past 18 months, cumulative price appreciation has been 31.9% for Orange County, 16% for Los Angeles County, 27.5% for Riverside County and 21.6% for San Bernardino County.

Though great news for existing homeowners, the run-up in prices has exacerbated affordability concerns for new entrants into the market and made the California homelessness crisis worse.

What’s in the offing? Expect a stabilization – but not reversal – of high prices.

“As mortgage rates continue to increase, nearing 5%, home prices will cool off. We expect a rate of appreciation of around 3%-4% this year, far below the torrid pace of the past two years,” say Puri and Farka.

In the quarterly Orange County Business Expectations survey conducted by Cal State Fullerton’s Woods Center for Economic Analysis and Forecasting, Orange County business leaders ranked inflation as their most important concern, and 53.3% of business executives expected inflation to exceed 6% by the end of 2022. As for the ongoing labor shortage, executives are more sanguine, with the survey finding that two-thirds now expect the crunch to ease in less than a year. On the supply chain, 41.2% anticipate improving conditions in six months.