Monday, 24 of September of 2018

Economics. Explained.  

Have the Tax Cuts Boosted Tax Revenue?

September 21, 2018

The tax cuts have been in place for almost a year.  Trump tried to sell the notion that they would stimulate growth in the economy and generate enough additional tax revenue that budget deficits would disappear in the years ahead.  Most economists did not buy into that scenario.  They believed that the tax cuts would increase future budget deficits, perhaps significantly so.  With almost a year’s worth of data now available,  it appears that the tax cuts increased the budget deficit in year one, but their impact longer term has yet to be determined.

The tax cuts have clearly stimulated the pace of economic activity.  Following unimpressive 2.0% GDP growth in 2015 and 2016 the economy has picked  up speed.  Growth accelerated to 2.5% in 2017,  is expected to climb 3.1% this year, and likely to register 3.0% growth in 2019.  The tax cuts have clearly worked their magic and lifted the economy onto a faster growth track.

But how long will this growth spurt last?  Whether the tax cuts are deemed a success will depend critically on the longer-term prospects for GDP growth.  We think that the tax cuts and deregulation will result in a faster pace of investment spending which will lift GDP growth to a sustained 3.0% pace for the foreseeable future – the new normal.

Others suggest that the stimulus to investment spending will fade by 2020 and growth will revert to 2.0% — the old normal.  It is too soon to tell whether the tax cuts have permanently lifted the economy’s speed limit.

Can the recent data on tax receipts provide an early indication of which theory might be more accurate?  Not really.

The idea that faster economic growth will bolster tax receipts by enough that budget deficits will shrink did not work out well this past year.  Tax receipts should grow roughly in line with nominal GDP.  If nominal GDP grows 5.0%, tax receipts should climb by 5.0%.  That hasn’t happened.  It appears that nominal GDP growth this year will be 6.0%, but tax receipts will edge upwards by just 0.7%.  The economy grew more quickly this year, but the tax cuts took a significant bite out of tax revenue.

While the tax cuts negatively impacted the deficit in year one, if faster GDP growth is sustained won’t future budget deficits shrink?  Perhaps.

For the record, the budget deficit this year will climb from $665 billion to $800 billion .  The Congressional Budget Office projects budget deficits exceeding $1.0 trillion every year for the next decade.

But deficit data only have significance when viewed in relation to the size of the economy.  On that basis the budget deficit will be 4.0% of GDP this year.  Economists believe that a budget deficit that is 3.0% of GDP is sustainable.  Thus, the deficit currently is a bit high but not excessively so.  The CBO expects it to quickly climb to 5.0% of GDP in the years ahead which will be a problem.  But is it a lack of tax revenue or excessive spending that makes it so high?

Currently tax revenues are 16.5% of GDP which is somewhat  lower than the long-term average of 18%.  The CBO expects nominal GDP growth of 4.0% during this decade, tax revenues to grow somewhat more quickly than that, and reach 18.5% of GDP by 2028.

The CBO expects government spending to climb from 20.6% of GDP this year to 23.5% by 2028 which would be well above its long-term average of 21%.  The pickup in spending is driven by demographics.   The baby boomers were born between 1946 and 1964; they will retire between 2011 and 2029.  As they retire they begin to receive Social Security benefits and become eligible for Medicare.  Thus, the surge in spending is built in the cake.

But consider this.  The CBO’s estimates of tax revenues are based on nominal GDP growth of 4.0% in the years ahead, presumably consisting of real GDP growth of 2.0% combined with 2.0% inflation.  But suppose we are right and real GDP growth averages 3.0% during this period rather than 2.0%.  Tax revenues in the years ahead will grow 1.0% more quickly than the CBO expects, and the deficits will be about 1.0% smaller.  So rather than 5.0% of GDP, if the tax cuts boost potential growth to the 3.0% pace we expect, the deficits as a percent of GDP might be only 4.0%.  Prior to the tax cut legislation, the CBO projected budget deficits of 5.0% of GDP.  If the tax cuts stimulate potential GDP growth to 3.0%, then over the long-haul they will result in smaller budget deficits than would otherwise have been the case.  The tax cut, however, would not – as Trump hoped — boost tax revenues sufficiently that budget deficits disappear.

Future budget deficits currently look problematical.  We need faster potential growth to shrink them to a more manageable level.  Time will tell.

Stephen Slifer


Charleston, S.C.

Consumer Net Worth

September 21, 2017

Consumer net worth rose $2.2 trillion in the second quarter.  That works out to an annualized rate of increase of 8.4%.  Over the past year consumer net worth has increased 8.2%.

The growth in net worth reflects both the steady increase in stock prices during the course of the past several years, and the growth in home prices.

This high and climbing level of  net worth should encourage consumers to spend at  roughly a 2.5% pace in both 2018 and 2019.

Stephen Slifer


Charleston, SC

Corporate Cash

September 21, 2018

Corporate cash holdings  declined $2 billion in the second quarter to $2.67 trillion (above).  They continue to be  in line with their long-run average of 9.4% of non-financial assets (below).  The problem with this series is that every time the Fed adds data for a new quarter, the history of the series going back for years will also change, and the relationship between corporate cash and financial assets will get revised.  For example, previous data showed the ratio of cash/assets for the first quarter to be 10.2%.  Upon revision it was reduced to 9.5%.  It is hard to make any meaningful analysis when a series is subject to sizable revisions.

Stephen Slifer


Charleston, SC

Existing Home Sales

September 20, 2018

Existing home sales were unchanged in August at 5,340 thousand after having fallen 0.7% in July.  Sales currently at 0.2% lower than they were at this time last year.

Lawrence Yun, NAR chief economist said,  “Strong gains in the Northeast and a moderate uptick in the Midwest helped to balance out any losses in the South and West, halting months of downward momentum.  With inventory stabilizing and modestly rising, buyers appear ready to step back into the market.”

With both sales and the inventory of homes available unchanged in August, the month’s supply of homes available for sale was steady in August at 4.3 months.  Realtors consider a 6.0 month supply as  the point at which demand for and supply of homes are roughly in balance.  Thus, housing remains in short supply.  If sales were not being constrained by the limited supply it would almost certainly be at a 6,000 thousand pace.  Having said that, to sustain the current pace of sales with inventory in such short supply builders will have to substantially boost their rate of production.

Keep in mind that properties typically stayed on the market 29 days in August which is down 3.3% from 30 days a year ago.  More than 53% of homes that went on the market sold within a month.  This is one of the shortest lengths of time between listing and sale  since the NAR began tracking these data in May 2011.

The National Association of Realtors series on affordability now stands at about 140.0.  At that level  it means that a household earning the median income has 40.0% more income than is necessary to get a mortgage for a median priced house.  Going into the recession consumers had only 14% more money than was required to purchase that median priced home.  Thus, housing remains quite affordable and should continue to remain affordable throughout 2018 and 2019 despite the backup in mortgage rates because sizable job gains are boosting income almost as fast as mortgage rates and home prices are rising.

The housing sector will continue to expand in the quarters ahead.   Jobs growth is expected to remain solid which should boost  income.  Builders are trying hard to boost production to increase the supply of available homes which should slow the pace of price appreciation. Finally, mortgage lenders should become slightly less restrictive as the economy remains healthy and default rates decline.
Existing home prices fell 1.7% in August to $264,800 after having declined 1.6% in July.  Because this is a relatively volatile series we tend to focus on the 3-month average of prices which now stands at $271,700.  Over the course of the past year existing home prices have risen 4.6% and have generally been bouncing around in a 4.5-8.0% range.
 Stephen Slifer


Charleston, SC

Initial Unemployment Claims

September 20, 2018

Initial unemployment claims continue to fall to multi-decade lows.  Specifically, claims fell 3 thousand in the week ending September 15 to 201 thousand after  having  fallen 1 thousand in the previous week.  The 4-week moving average fell 2 thousand to 206 thousand which is the lowest level for this average since December 6, 1969 (when it was 205 thousand).

Ordinarily, with initial unemployment claims (the red line on the chart below, using the inverted scale on the right) at 206 thousand  we would expect monthly  payroll employment gains to exceed 300 thousand.  However, employers today are having difficulty finding qualified workers.  As a result, job gains are significantly smaller than this long-term relationship suggests and are currently about 190 thousand.

With the economy essentially at full employment, employers will have steadily increasing difficulty getting the number of workers that they need.  As a result, they might choose to offer some of their part time workers full time positions.  This series is a bit higher than it was going into the recession so they might have some success in finding necessary workers from this source.

They will also have to think about hiring  some of our youth (ages 16-24 years) .  But the April level for the youth unemployment rate today was the lowest on record (for a series that goes back to 1970) so there are not many younger workers available for hire.

Finally, employers may also consider some workers who have been unemployed for an extended period of time.  But these workers do not seem to have the skills necessary for today’s work place.  Employers may have to offer some on-the-job training programs for  those whose skills may have gotten a bit rusty.  But even if they do, the reality is that the number of discouraged workers today is quite low — it is essentially where it was going into the recession.

The number of people receiving unemployment benefits fell 55 thousand in the week ending September 8 to 1,645 thousand.  The 4-week moving average declined 20 thousand to 1,692 thousand.  This was the lowest 4-week average since November 17, 1973 when it was 1,686 thousand.  The only way the unemployment rate can decline is if actual GDP growth exceeds potential.  Right now the economy is climbing by about 2.8%; potential growth has probably picked up from 1.8% previously to perhaps 2.3% today given faster growth in productivity.  Thus, going forward  the unemployment rate should continue to decline slowly.

Stephen Slifer


Charleston, SC

Housing Starts

September 19,  2018

Housing starts jumped 9.2% in August to 1,282 thousand after having fallen 0.3% in July. Because these data are particularly volatile on a month-to-month basis, it is best to look at a 3-month moving average of starts (which is the series shown above).   That 3-month average now stands at 1,211 thousand.  Starts have cooled somewhat in recent months, but is that because demand has declined?  Or are constraints on production like a labor shortage and rising costs of materials the more likely cause?  We believe it is the latter.

Both new and existing home sales continue to trend upward but they are being constrained by a lack of supply.   Thus, the demand for housing remains robust.

The average home stays on the market for 26 days currently which is down from 100 days a few years ago.  One-half of the homes coming on the market sell within one month.  This statistic provides compelling evidence that the demand for housing remains robust.

Monthly  employment gains are about 190 thousand per month which is boosting income.  As a result, real disposable income (what is left after inflation and taxes) is growing at a 3.1% pace which is  somewhat above its long-term average of 2.7%.

Mortgage rates are at 4.5% which is quite low by any historical standard.

Housing remains affordable for the median-price home buyer.  Mortgage rates may have risen, but income has been rising almost as quickly, hence affordability has not dropped much.  At 140.0 the index  indicates that a median-income buyer has 40.0% more income than is necessary to purchase a median-priced house.

The problem in housing is not a lack of demand.  Rather it is a constraint on the production side.  Builders have had difficulty finding an adequate supply of both skilled and unskilled labor.  Construction employment has been growing by about 30 thousand per month but will be difficult for it to grow any faster.

There are plenty of homes that have already been authorized but construction has not yet begun because of builders inability to find workers, and because the cost of materials has risen so sharply in the wake of tariffs on steel, aluminum, and lumber.  Once supply constraints begin to abate we will see starts climb at a more robust pace as builders begin construction on these previously authorized houses.

Given the continuing strength in demand we expect starts to reach 1.3 million by the end of 2018 and continue upwards next year.

Building permits fell 5.7% in August to 1,229 thousand after having risen 0.9% in July.  Because  permits are another volatile  indicator it is best to look at a 3-month average (which is shown below).  That 3-month moving average now stands at 1,275  thousand which is somewhat below the fastest pace thus far in the business cycle (1,355 thousand) and continues to point towards steady improvement in housing.   The reason people look at permits is because a builder must first attain a permit before beginning construction.  Thus, it is a leading indicator of what is likely to happen to starts several months down the road.  If permits are at 1,275 thousand, housing starts should easily rebound to the 1.3 million mark by yearend.

Stephen Slifer

Charleston, SC

Gasoline Prices

September 19, 2018

Gasoline prices at the retail level rose $0.01 in the week ending September 17 $2.84 per gallon.  In South Carolina gasoline prices tend to about $0.25 below the national average or about $2.59. The Department of Energy expects national gasoline prices to average $2.76 this year.  

Spot prices for gasoline have been bouncing around for the past several  months and are likely to be roughly unchanged between now and yearend..

Crude prices recently have been bouncing around in a range from roughly $67-72 per barrel.   The Energy Information Agency predicts that crude prices will average $67.03 in 2018 but that may be too low.

The number of oil rigs in  operation has  been fairly steady in recent months at about 1,050 thousand.  Thus,  higher crude oil prices are encouraging drillers to accelerate the pace of production.  If crude prices remain above $60 per barrel this year or higher, we should expect the number of oil rigs in operation, and production, to continue to climb.

Production has surged to 11,000thousand barrels per day.  The Department of Energy expects production to average 10.7 million barrels this year but climb further to 11.5 million barrels in 2019.

To put those production levels in perspective, keep in mind that if U.S. crude oil production picks up as expected the U.S. will become the world’s largest oil producer by the end of this year.

How can the number of rigs rise slowly but production surge?  Easy.  Technology in the oil sector is increasing which allows producers to boost production while simultaneously shutting down wells.  A few years ago some frackers could not drill profitably unless crude oil prices were about $65 per barrel.  Today that number has declined to about $35 per barrel.  Six months from now that number will be lower still.

Oil inventories fell quickly for most of last year.    OPEC output was reduced at the same time that global demand picked up sharply.  While crude inventories have been sliding for a year, at 1,054 million barrels crude inventories are now roughly in line with the 2009-2014 average of 1,055 million barrels.  However, with demand likely to slightly exceed supply through the end of this year, stocks may well decline slightly further in the near term.

The International Energy Agency in Paris (IEA) produces some estimates of global demand and supply.  The agency reports that demand picked up somewhat in recent months and supply edged lower as production constraints have restrained output.  As a result the IEA now estimates that demand will exceed supply by about 0.5 million barrels per day between now and yearend. The IEA noted that Venezuela has cut production there to a multi-decade low, and now there is the prospect of further a reduction in global oil supply by yearend stemming from curtailment of Iranian oil exports.  If the IEA estimates of supply and demand are correct not only will inventory levels edge lower between now and yearend, prices could climb somewhat.

Stephen Slifer


Charleston, SC*

Homebuilder Confidence

September 18, 2018

Homebuilder confidence was unchanged in September at 67 after having fallen fell 1 point in August.  The December level of 74 was the highest for this series since July 1999 — over 18 years ago — and current confidence levels are somewhat below the lofty December level.

NAHB Chief Economist Robert Dietz said  “Despite rising affordability concerns, builders continue to report firm demand for housing, especially as millennials and other newcomers enter the market. The recent decline in lumber prices from record-high levels earlier this summer is also welcome relief, although builders still need to manage construction costs to keep homes competitively priced. Wages and subcontractor payments continue to rise as the labor market for residential construction sector remains tight.”

Traffic through the model homes was unchanged in September was unchanged at 49 after having fallen fell 3 points in August.  The December level of  58 was by far the highest level thus far in the business cycle.  Traffic volume remains high and an index level of 49 indicates that the number of people going through model homes was slightly lower in September than in August.

Not surprisingly there is a close correlation between builder confidence and housing starts.  Right now starts are lagging considerably because builders are having some difficulty finding financing, building materials, an adequate supply of finished lots, and skilled labor.  Starts  currently are at a 1.25 million pace.  They should continue to climb gradually in the months ahead and reach 1.30 million by the end of 2018 and 1.35 million by the end of next year.

Stephen Slifer


Charleston, SC

Florence Will Result in a Temporary Growth Slowdown

September 14, 2018

We have heard about Hurricane Florence for weeks.  The good news is that it did not come ashore as the Category 4 or possibly Category 5 storm that had been feared early in the month.  Rather, it hit Wilmington as a Category 1 storm.  The bad news is that it hit Wilmington as a Category 1 storm.  For those of us in Charleston we appear to have been spared from anything more serious than tropical storm conditions.  Unfortunately, our good fortune is someone else’s misery.  A hurricane of any size can be devastating for the area that is impacted.

However, this is not Hurricane Katrina that flooded New Orleans in 2005, Hurricane Sandy that blasted the east coast of the U.S. from Washington to Boston in 2012, Hurricane Harvey that crushed Houston in 2017, or even Hurricane Irma that lashed all of Florida, Georgia, and South Carolina last year.  In this case, Florence was a Category 1 storm that missed major metropolitan areas.

Presumably fearing the frequently erratic and largely unpredictable paths followed by hurricanes in other recent years and the sheer magnitude and size of the approaching storm, the governors of South Carolina, North Caroline, and Virginia issued evacuation orders as early as Tuesday, September 11, for a storm that did not make landfall until Friday, September 14.  In hindsight, the evacuation orders seem grossly premature.  For the beach areas along the coast from the Outer Banks to Charleston, the loss of almost all tourist business for a protracted period in a season that lasts 13 weeks was heartbreaking.  The early evacuation orders exacerbated the damage on these areas.  But by missing major metropolitan areas the economic slowdown will be hardly noticeable for the economy as a whole.

The first place to look for economic weakness associated with the storm will be initial unemployment claims which is a measure of layoffs.  Almost certainly claims will rise significantly from a 49-year low level of 204 thousand in the week of September 8 to perhaps 240 thousand within a week or two.

An increase in claims suggests that the employment report for September will reveal a slowdown from the 190 thousand per month pace in other recent months to perhaps 150 thousand in September.  That report will be released on Friday morning, October 5.  The nonfarm workweek should also slip from a lengthy 34.5 hours in August to perhaps 34.3 hours.

In mid-October retail sales for September could be relatively unchanged or even decline slightly.  Ditto for industrial production for that month.

The softness in employment, hours worked, retail sales and industrial production suggest that the overall pace of economic activity declined in September.  Third quarter GDP will consist of two robust months —  July and August – followed by a weak month.  Thus, Hurricane Florence will have had some modest negative impact on GDP growth for the third quarter.  Based on the presumption that September would have been another month of steady growth we were expecting GDP growth for the third quarter to be 3.1%.  But if we replace one month of that quarter with a much slower pace of expansion, we will shave that forecast by 0.2% from 3.1% to 2.9%.  We will see the first estimate of GDP growth for that quarter on Friday morning, October 26.

But all the indicators mentioned – payroll employment, hours worked, retail sales ,and industrial production — will then rebound in October and the economy will get back on track.  So, whatever GDP growth was lost in the third quarter should be recaptured in the fourth quarter.  Accordingly, we have raised our projected GDP growth for the fourth quarter from 3.0% to 3.2%.   That figure will be released in late January.

What does all this mean?  Simply that in the month of October we will see some relatively anemic-looking economic indicators.  That could create an impression that the pace of economic activity is softening a bit, perhaps in response to the Fed’s series of rate hikes.  In our opinion, such a conclusion is unwarranted and in the following month (data for October, released in November), the soft data will be replaced by equally strong reports.  Growth will simply have shifted from one month to another (September to October), and because those months happen to be in different quarters, GDP growth will also have shifted from one quarter to the next (from the third quarter to the fourth).  Don’t be fooled into thinking that the upcoming data are indicative of any long-lasting economic slowdown.  That will not be the case.

Furthermore, none of this will dissuade the Fed from raising interest rates again at its September 25-26 gathering.  Even the reduced 2.9% GDP growth in the third quarter exceeds their estimate of potential growth (which appears to be 1.8%), and inflation has now climbed back to its 2.0% target and is poised to move higher.  Look another modest increase in rates of 0.25% at that meeting from 1.75-2.0% currently to 2.0-2.25%.

Stephen Slifer


Charleston, S.C.

GDP, Inflation, and Interest Rate Forecasts

September 14, 2018

The first revision to second quarter GDP growth came in at 4.2% compared to an initial reading of 4.1%.  First quarter growth was 2.2%.

Hurricane Florence will probably trim third quarter growth by about 0.2%.  But whatever growth is lost in Q3 will be recaptured in Q4.  Accordingly, we now expect 2.9% GDP growth in the third quarter followed by 3.2% growth in the fourth quarter.  Growth for the year remains at 3.1%.

Consumer spending rose 3.8% after having risen 0.5% in the first quarter and we expect it to rise 2.5% in 2018.  The consumer and corporate tax cuts should lift the stock market to yet another record high level by yearend.  The increase in stock prices and rising home prices are boosting household wealth.  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  Consumer confidence is at a multi-year high.  Gas prices are expected to decline somewhat as the year progresses.  Interest rates remain low and are rising very slowly.

Investment spending climbed 8.5% in the second quarter after having jumped 11.5% in the first quarter.  However, investment spending was essentially unchanged for 2014-2016.  It appears that the prospect of corporate tax cuts, repatriation of earnings at a favorable tax rate, and a reduction in the regulatory burden is giving business leaders confidence to open their wallets and spend on new equipment and technology.  Not only will this boost GDP growth in the short term, if investment continues to climb it will boost productivity growth which will, in turn, raise the economic speed limit from about 1.8% today to 2.8% or so in the years ahead.

The trade gap narrowed by $58.7 billion in the second quarter after having widened by $3.1 billion in the first quarter.  This means that the trade component added 1.4% to GDP growth in the second quarter.  We expect the trade component to add 0.4% to GDP growth in 2018.

Nonfarm inventories declined $27.9 billion in the second quarter and subtracted 1.1% from GDP growth in that quarter.  Inventories never decline by that magnitude.  Inventory restocking in the final two quarters of the year should boost GDP growth by as much in the second half of the year as they subtracted in Q2.

Expect GDP growth of 3.1% in 2018 after having registered growth of 2.5% in 2017 as investment spending surges.  We then expect it to climb by 2.9% in 2019.

The inflation rate is gradually beginning to climb.  The economy is at full employment which finally appears to be boosting wages.  Both manufacturing and non-manufacturing firms are paying high prices for their raw materials so commodity prices are on the rise.  There is a shortage of available homes and apartments in the housing sector which is raising rents.  Thus inflation does, in fact, seem headed higher as the year progresses.   However, the pickup in inflation will be limited as internet price shopping will keep goods prices falling in 2018.  As a result we expect the core CPI to climb from  1.8% last year to 2.4% in 2018.  The overall CPI should also increase 2.4% this year.

Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 3.2% by the end of 2018 and 3.9% in 2019.  Mortgage rates should climb to 4.8% by the end of this year and 5.5% by the end of 2019.

With GDP likely to expand in 2018 at a rate slightly faster than its current potential and inflation expected to rise slightly above its target, the Fed will feel compelled to continue on a path towards gradually higher interest rates.  It needs to do so to get itself into position to lower rates when the time comes, but it appears to have the luxury of taking its time.  We expect two more rate hikes in 2018 which would put the funds rate at 2.3% by the end of the year.  It should rise further to the 3.2% mark by the end of 2019.  The Fed will also continue to run off some of its security holdings throughout 2018 and 2019.

Stephen Slifer


Charleston, SC