Thursday, 15 of November of 2018

Economics. Explained.  

Category » Miscellaneous

Small Business Optimism

November 13, 2018

Small business optimism fell 0.5 point in October to 107.4 after having declined 0.9 point in September.  The August level of 108.8  broke the previous record high level of 108.0 set 35 years ago back in July 1983.

NFIB President Juanita Duggan said,  “For two years, small business owners have expressed record levels of optimism and are proving to be a driving force in this rapidly growing economy.  The October optimism index further validates that when small businesses get tax relief and are freed from regulatory shackles, they thrive and the whole economy prospers.”

NFIB Chief Economist added that, “An unburdened small business sector is truly great for employment and the general economy.  October’s report sets the stage for solid economic and employment growth in the fourth quarter, while inflation and interest rates remain historically tame. Small businesses are moving the economy forward.”

In our opinion the economy is expected to expand at a rapid clip in coming months in response to a number of significant policy changes.  Specifically, we believe that the cut in the corporate income tax rate, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 15.5% rate, and the steady elimination of unnecessary, confusing and overlapping federal regulations will boost investment.  That, in turn, should boost our economic speed limit should from 1.8% or so today to 2.8% within a few years.

The stock market has retreated from its recent record high level.   However, jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  The housing sector is continuing to climb slowly.  And now investment spending has picked up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.5% in 2017 to 3.0% in 2018 and 2.9% in 2019 .  The core inflation will  climb from 1.8% in 2017 to 2.2% in 2018 and 2.4% in 2019.  The Fed will continue to raise short-term interest rates very slowly.  Accelerating GDP growth, low inflation, and low interest rates should propel the stock market to new record high levels in the months ahead.

Stephen Slifer

NumberNomics

Charleston, SC


Trade Deficit

November 2, 2018

The trade deficit for September widened by$0.8 billion to $54.0 billion after having widened by $3.3 billion in August.     Exports rose 1.5% in September.  Imports also rose by 1.5%.  The dramatic narrowing of the trade gap in the second quarter added 1.4% to U.S. GDP growth and lifted GDP growth in that quarter to the 4.2% mark.  In the third quarter the trade deficit widened sharply and subtracted 1.7% from U.S. GDP growth in that quarter and reduce GDP growth to 3.5%.

We attribute these rather volatile swings to the imposition of tariffs.  Exports surged 9.3% in the second quarter but declined 3.5% in Q3.   Imports did the opposite.  They declined 0.6% in the second quarter but surged 9.1% in the third quarter.  These quarterly swings and the corresponding impact on GDP are dramatic, but the impact on GDP growth for the year as a whole will be negligible.  To be specific we expect trade to have little impact on GDP growth in either this year or 2019.  Furthermore, the imposition of tariffs has not dampened foreigners willingness to invest in the U.S.  With tax cuts and deregulation boosting the pace of GDP growth in the U.S. and lifting the U.S. stock market, foreign investors find the U.S. an attractive place to invest  Capital inflows should continue apace.

We certainly support the notion of free trade.  Through trade American consumers have access to a much wider variety of goods and services at lower prices than they would otherwise.  But there are a couple of important points.  First, free traders (like us) assume that there is also fair trade.  That is the rub.  The Chinese in particular, and others, do not play by the same rules as everybody else.  Second, the yawning trade gap perhaps indicates that current trade agreements like NAFTA, as well trade agreements with Europe and Japan, were not well negotiated and allowed other countries to take advantage of the U.S.    One can make a case that the U.S. has been subsiding growth in other countries at its own expense for years.  Trump has decided that is true and has chosen to impose across-the-board tariffs.  Initially, the U.S. tariffs generated retaliation by many other countries and it appeared that a trade war was was underway.

But all of a sudden other countries began to believe that the U.S. could withstand a trade war better than anybody else and  foreign investors flooded into the U.S. stock and bond markets.  The dollar soared.  That money would be used to create new businesses, hire more American workers, and boost our stock market.  Elsewhere, the opposite was occurring.  Currencies were weakening, growth was slowing.  The U.S. was winning, the rest of the world was losing.  The question quickly became, how long could these countries withstand the pain?  The answer is apparently, not long.  A new agreement has already been reached with Mexico and Canada.  We are negotiating with Europe.  China, thus far, has not relented but we will see.

This has been a painful and perhaps scary process to see in action but, in the end, we may end up with both freer and fairer trade than we had initially.

Frequently exports and imports can be shifted around by price changes rather than the volume of exports and imports.  Thus, what is really important is the trade deficit in real terms because that is what goes into the GDP data.  The “real” trade deficit widened by $0.8 billion in September to $87.0 billion after having widened by $3.7 billion in August.

Increasing energy production in the U.S. is having a significant impact on our trade deficit in oil.  Since 2007 real oil exports have almost quintupled from $4.0 billion to $20 billion, while real oil imports have fallen from $42.0 billion to $32 billion. As a result, the real trade deficit in oil has been cut by about $26.0 billion or 70% in the past several years and is the smallest since the early 1990’s.  In March of this year the U.S. surpassed Saudi Arabia and Russia  and become the world’s biggest producer of oil.  By the end of the decade it should also become a net exporter of oil.  Very impressive!

The non-oil trade gap has widened significantly  in the past year to about $68.0 billion as non-oil exports rose 4.3% while non-oil imports climbed by 8.7%.

Stephen Slifer

NumberNomics

Charleston, SC


Corporate Profits

September 27, 2018

Corporate profits before tax with inventory valuation and capital consumption adjustments rose 3.0% in the second quarter to $2,242.3 billion after having risen 1.2% in the first quarter.  During the last year profits on this basis have risen 7.3%.  The IVA and CC adjustment deals with the difference in depreciation allowances used for accounting and income tax purposes.  Hence, changes in tax laws impact this series and it does not accurately reflect profits from current production.

Corporate profits before tax without such adjustments, or profits from current production, rose 4.2% in the second quarter to $2,197.2 billion after having risen 1.3% in the first quarter.  Over the course of the past year such profits have declined 0.1%.  However, we expect this series on profits to rise at a double-digit pace for the year as a whole.

The economy climbed at a 2.5% pace in 2017 and  we expect it to rise at a 3.1% pace in 2018, inflation will rise modestly, and interest rates will rise slowly but remain low.  In addition, corporate profits will benefit from a cut in the tax rate, and by a significant reduction in their regulatory burden.  As a result, corporate profits should climb at roughly a double-digit pace in 2018.

Stephen Slifer

NumberNomics

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

NumberNomics

Charleston, SC


Trade-Weighted Dollar

August 10, 2018

The trade-weighted value of the dollar, which represents the value of the dollar against the currencies of a broad group of U.S. trading partners has risen 4.3% from where it was at this time last year.

When you try to figure out the impact of currency movements on our trade, you have to weigh the movements depending upon the volume of trade we do with that country.  For example, our largest trading partners are:

With respect to the Chinese yuan the dollar has risen  about 2.4% over the past year.  A year ago one dollar would buy 6.67 yuan.  Today it buys 6.83 yuan.

The U.S. dollar has risen 3.1% versus the Canadian dollar during the past year.  For example, a year ago one U.S. dollar would purchase $1.26 Canadian dollars.  Today it will buy $1.30 Canadian dollars.

And against the Mexican peso the dollar has risen by 4.6% during the past year.  A year ago one dollar would buy 17.8 Mexican pesos.  Today it will buy 18.6 pesos.

The dollar has weakened by 0.1% against the yen during the course of the past year.  A year ago one dollar would buy 129.7 yen.  Today that same one dollar will buy 129.5  yen.

The dollar has risen 1.6% relative to the Euro during the past year.  A year ago one Euro cost $1.18.  Today one Euro costs $1.16.

Thus, the dollar has strengthened against almost every major currency during the course of the past year.  As a result, the trade-weighted value of the dollar, as noted earlier, has risen 4.3% during the past year.

Currency changes can affect the economy in several ways.   First, a rising dollar can reduce GDP growth of U.S. exports because U.S. goods are now more expensive for foreign purchasers to buy.  Similarly, a rising dollar can increase growth of imports because foreign goods are now cheaper for Americans to buy.  Fewer exports and more imports will reduce GDP growth that year.  A rising dollar can also reduce the rate of inflation in the U.S. because the prices of foreign goods are now lower.  A falling dollar will do the opposite — increased growth in exports, slower growth in imports, and a faster rate of inflation.

From October 2014 to January 2016 the dollar rose 22%.  That is a huge change.  The trade component subtracted about 0.5% from GDP growth in both 2014 and 2015.  A 4.3% increase in the dollar in 2018 is expected to reduce GDP growth this year by 0.3%.

The dollar’s recent strength is attributable to the widespread imposition of tariffs and sanctions by the U.S. which are believed to reduce growth in other countries more than they weaken growth in the U.S.  While changes in the value of the dollar relative to the currencies for our major trading partners have been noted above, it is also important to recognize that the combination of tariffs and sanctions has strengthened the dollar by 18.8% against the Brazilian real, and by 13.4% against the Russian ruble.  The emerging economies have been particularly hard hit.

Stephen Slifer

NumberNomics

Charleston, SC


S&P 500 Stock Prices

May 8, 2018

The S&P fell 10% after reaching a record high level in late January.   It has since recovered some of the earlier losses and is now about 7.0% below its earlier peak level.  But this should be regarded as a normal stock market “correction” and not as a harbinger of economic weakness ahead.

The catalyst was average hourly earnings data for January which rose 2.9% in the previous 12 months.  That was the fastest growth in hourly earnings thus far in the business cycle.  So the fear at that time was that, at last the economy is overheating, inflation has begun to climb and, therefore, the Fed will raise rates more quickly than it has penciled in for 2018.  Since then the market has worried that tariffs imposed by President Trump will reduce growth of exports and slow the economy.  It worried for a time about worsening relations between the U.S. and North Korea.  The same is true between the U.S. and Russia.  It worried when the yield on the 10-year note reached the 3.0% mark.  The market has found a lot to worry about, but the reality is that the economic outlook remains bright.

The economy is likely to increase 2.8% this year which is faster than the 2.6% increase reported for 2017.  That will put some upward pressure on the inflation rate, but the question is how much pressure.  Our sense is that it will be modest with the core CPI rising 2.4 in 2018 versus 1.8% last year.  That is fairly close to the 2.0% Fed target for inflation and unlikely to spur it to raise rates more quickly.

It is important to remember that wage pressure can be offset by gains in productivity.  If I pay you 3% more money and you are no more productive, my labor costs just rose by 3.0% and I may well choose to raise my prices as a result.  But if I pay you 3% more money because you area 3% more productive and I am getting 3% more output, I do not care.  In that situation I have no incentive to raise prices.  Thus, the appropriate gauge of upward pressure on the inflation rate from the seemingly tight labor market is labor costs adjusted for the increase in productivity or what economists call “unit labor costs”.

In the past year unit labor costs have risen 1.1% consisting of a 2.5% increase in compensation partially offset by a 1.3% increase in productivity.  For 2018 we expect labor costs to climb to 3.5%, but given the burst of investment spending (which is the primary determinant of growth in productivity) we expect productivity growth to climb to 1.5%.  Hence, unit labor costs this year should rise by 2.0%.  A 2.0% increase in unit labor costs will not put upward pressure on the Fed’s 2.0% inflation target.

People are watching the wrong thing.  They are watching average hourly earnings when they should be watching unit labor costs.  If it begins to climb to 2.5-3.0% then we have a legitimate chance of inflation climbing above the Fed’s 2.0% inflation target.  We are not expected to get there any time soon.

Stephen Slifer

NumberNomics

Charleston, SC


Business Inventories / Sales Ratio

May 8, 2018

Firms are always trying to keep their inventories in line with sales.  When the economy falls into recession, typically businesses do not cut back production as quickly as sales decline, so the inventory/sales ratio rises sharply  — which is exactly what happened during the 2008-2009 recession.  Then, as the economy recovers and sales once again begin to rise, corporate leaders are able to  get inventory levels into closer alignment with sales.

In February business sales rose 0.4% while inventories climbed by 0.6%.  As a result, the inventory to sales ratio was essentially unchanged at 1.35.  In recent months sales have outpaced inventories and the inventory/sales ratio has fallen.  A faster pace of sales will eventually require business people to step up the pace of production to build inventories  to ensure that they have adequate supplies on hand.  That seems to be happening now.

Stephen Slifer

NumberNomics

Charleston, SC


Split rated

And now for something really different, try this:

http://www.youtube.com/watch?v=eaNDQD_WFIE&feature=player_embedded