Tuesday, 16 of July of 2019

Economics. Explained.  

Category » Miscellaneous

Small Business Optimism

July 9, 2019

Small business optimism edged lower by 1.7 points in June to 103.3 after having climbed 1.5 points in May.  The August level of 108.8  broke the previous record high level of 108.0 set 35 years ago back in July 1983.  So while confidence slipped slightly in the early part of this year it has fallen from a record high level and still remains very lofty.

Chief Economist William Dunkelberg said,  “As expectations for sales gains and the general business environment faded, uncertainty levels increased.  Still, job openings and plans to create jobs remain historically very strong, and while it’s not as ‘hot’ as May, Main Street is still running strong.”

In our opinion the economy is expected to expand at a reasonably robust 2.6% pace this year.  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.

After falling 20% late last year the stock market recovered all of the earlier loss and established a new record high level.   Jobs are being created at a brisk pace.  The unemployment rate is well below the full employment threshold.  Mortgage rates have fallen in the past couple of months from 4.9% to 3.8%.  And investment spending remains solid.  We expect GDP growth to be 2.6% this year after having risen 3.0% in 2018.  The core inflation should be relatively stable at 2.3% in 2019 after rising 2.2% in 2018.  The Fed will has pledged to keep rates steady through the end of the year and may even lower them.  Moderate GDP growth, low inflation, and low interest rates should continue to bolster the stock market in the months ahead.

Stephen Slifer


Charleston, SC

Trade Deficit

July 5, 2019

The trade deficit for April widened by $4.3 billion in May to $55.5 billion after having narrowed by $0.7 billion April.  The $887 million trade deficit in goods for 2018 was a record high level.

If we ultimately get renewed deals with Canada, Mexico, the E.U., the U.K., and China (perhaps among others),  those agreements will call for those countries to open their markets, reduce tariffs, and import more goods from the U.S.   Thus, the trade gap may well shrink over time as exports climb.  But we are not there yet.

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.

Personally, we think the focus on the magnitude of the trade deficit is misplaced.  A $900 billion trade gap simply means that we bought more from foreigners than they bought from us.  As a result, foreigners accumulated $900 billion of dollars that will be re-invested in the U.S.   Those people might establishes businesses here in the U.S., hire American workers, or invest in our stock and bond markets.  It is not the magnitude of the trade deficit that bothers us.  But, as shown below one-half of that trade gap is with one country — China.  We do not have yawning trade gaps with Canada, Mexico, Europe, Japan, or OPEC.  If Trump is truly concerned about the magnitude of the trade deficit, he should have targeted those countries where it was the largest, namely China.  But he didn’t.  He chose to impose tariffs across the board which impacted our neighbors, friends and allies alike.  Not surprisingly, the imposition of U.S. tariffs generated retaliation by many other countries and it appeared that a trade war was underway.

But as the trade war got started investors around the globe tried to figure out which countries might fare best in a trade war.  Answer:  U.S.  Why?  Because trade is only 10% of the U.S. economy.  It is about 50% of everybody else’s economy.    Everybody loses in a trade war, but the U.S. may lose far less than others.

As other countries began to believe that the U.S. could withstand a trade war better than anybody else,  foreign investors flooded into the U.S. stock and bond markets.  The dollar soared.  That money would be used to create new businesses in the U.S., hire more American workers, and boost our stock market.  Elsewhere, the opposite was occurring.  Currencies were weakening, stock markets were falling, 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.  A deal with China may not be far off.   The pressure is clearly on both China and the U.S. to find a solution to their trade difficulties.  Growth is being hit in both countries by the standoff, but particularly so in the case of China.

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 $4.8 billion in May to $87.0 billion after  having narrowed by $0.6 billion in April.

Increasing energy production in the U.S. is having a significant impact on our trade deficit in oil.  Since 2007 real oil exports have quintupled from $4.0 billion to $21.0 billion, while real oil imports have fallen from $42.0 billion to $29.0 billion. As a result, the real trade deficit in oil has been cut by about $30.0 billion or 75% in the past several years and is the smallest since the early 1990’s.

In March of last 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 by about $6.0 billion  in the past year to about $69.0 billion as non-oil exports fell 2.1% while non-oil imports rose by 4.0%.

Stephen Slifer


Charleston, SC

Corporate Profits

June 27, 2019

Corporate profits before tax with inventory valuation and capital consumption adjustments fell 2.6% in the first quarter to $2,251.5 billion after having fallen 0.4% in the fourth quarter.  During the last year profits on this basis have risen 3.4%.  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, were unchanged in the first quarter at $2,181.1 billion after having declined 1.9% in the fourth quarter.  Over the course of the past year such profits have risen 3.3%.  We expect this series on profits to rise at about a 7.0% pace for the year as a whole.

The economy climbed at a  3.0% pace in 2018 and we expect growth of 2.6% in 2019.  Inflation will rise modestly and interest rates will remain low and steady.  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 a solid 7.0% pace in 2019.

Stephen Slifer


Charleston, SC

Corporate Leverage

April 2, 2019

Economists like to keep an eye on the amount of leverage amongst corporations.  When corporations take on huge amounts of debt in relation to their net worth, any economic downturn will be much more severe than it would otherwise be as corporations become unable to service their debt from cash flow.  However, in the fourth quarter of 2018 the ratio of corporate nonfinancial debt  to net worth was 39.5%.  This compares to an average ratio of debt to net worth since 1980 of 40.3%. There is no reason to think that the economy is at risk from excessive corporate borrowing.

Stephen Slifer


Charleston, S.C.


S&P 500 Stock Prices

March 15, 2019

The S&P fell 20% in the fourth quarter of last year.   The market appeared to be concerned about a variety of factors.  The expansion is approaching its tenth anniversary which is geriatric, so some economists fear that,for that reason alone, the end of the expansion must be close.  It was seeing growth weakening overseas, particularly in China which is the world’s second largest economy.  It feared a trade war could weaken growth further.  The Fed indicated that intended to raise rates twice in 2019.  And it saw the housing market fall steadily for most of last year.

But heading into 2019 growth the view has changed.  Growth overseas appears to have stabilized.  The Fed has said that it intends to leave rates unchanged for the foreseeable future.  Mortgage rates have fallen 0.5% since the end of last year and  home prices are declining.  These two factors should re-invigorate the housing sector in the months ahead.  Thus, the economic fundamentals in our view remain solid.  That change in outlook has allowed the stock market to rebound and erase nearly all of the fourth quarter drop.  Indeed, it is currently within 3.5% of an all-time record high level.

Given the positive combination of moderate GDP growth, low and still stable inflation, and the likelihood of no further rate hikes, we fully expect the stock market to reach another record high level, probably by midyear.


Stephen Slifer


Charleston, SC

Corporate Cash

December 13, 2018

Corporate cash holdings rose $49 billion in the third quarter to $2.62 trillion (above).  At 9.1% they are a shade lower than 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.   It is hard to make any meaningful analysis when a series is subject to sizable revisions.

Stephen Slifer


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


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


Charleston, SC

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