Thursday, 19 of April of 2018

Economics. Explained.  

Category » Miscellaneous

Small Business Optimism

April 10, 2018

Small business optimism dipped 2.9 poionts in March to 104.7, but it fell from a record high level of 107.6 in February.

NFIB President Juanita Duggan said, ““It has been a remarkable 16 months for small business optimism.  Small business owners are so optimistic that they feel confident enough to raise wages and invest in their business, which grows the economy.”

NFIB Chief Economist added that, “Although expected sales and expected business conditions posted large declines, it was from historically high levels and this still left the overall index reading among the 20 best in survey history,”

In our opinion the economy is expected to gather momentum 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 been extremely volatile in the past month or two as market participants fret about the possibility of a trade war and increasing tensions with Syria and Russia.  However, jobs are being created at a reasonably robust pace.  The unemployment rate is below the full employment threshold.  The housing sector is continuing to climb.  And now investment spending should pick up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.5% in 2017 to 2.8% in 2018.  The core inflation will  climb from 1.8% in 2017 to 2.4% in 2018.  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 prior to yearend.

Stephen Slifer


Charleston, SC

Corporate Profits

March 28, 2018

Corporate profits with inventory valuation and capital consumption adjustments fell 0.1% in the fourth quarter to $2212.5 billion after having risen  4.3% in the third quarter.  During the last year profits on this basis have risen 2.7%.  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 without such adjustments, or profits from current production, fell 8.9% in the fourth to $2125.8 billion after having risen 3.5% in the third quarter.  Over the course of the past year such profits have fallen 5.8%.

The economy climbed at a 2.6% pace in 2017 and 2.9% in 2018, inflation will rise modestly, and interest rates will 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


Charleston, SC

Trade Deficit

March 7, 2018

The trade deficit for December widened by $2.7 billion to $53.1 billion after having widened by $1.6 billion in November.     Exports rose 1.6%.  Imports rose by 2.6%.  While a rising trade gap seems scary and some argue that it cannot be sustained, the reality is that it is financed by foreign capital inflows into the U.S.  Thus far foreigners seem quite willing to invest in the U.S.  And with the prospect of tax cuts boosting the pace of GDP growth in the U.S. and lifting the U.S. stock market, such capital inflows should continue apace.  Trump’s imposition of tariffs on all steel and aluminum imports is a step in the wrong direction.  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 the 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.  Thus, in our opinion, some sort of  punishment is appropriate.  But rather than imposing tariffs on all steel and aluminum imports (and possibly tariffs on other products) which hurts our neighbors and allies as well as the bad guys, we would support a more targeted approach.  Find the top 10 culprits and impose a 50% tariff on their imports of these products.

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 was widened by $2.0 billion in December to $68.4 billion after having widened by $0.9 billion in November.

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 quadrupled from $3.0 billion to $11.0 billion, while real oil imports have fallen from $20.0 billion to $17.0 billion. As a result, the real trade deficit in oil has been cut by about $12.0 billion or 66% in the past several years and is the smallest since the early 1990’s.  Most energy exports believe that by the end of the decade the U.S. will not only surpass Saudi Arabia and Russia  and become the world’s biggest producer of oil, but also become a net exporter of oil.  Very impressive!  And now with U.S. producers allowed to export oil, that could happen even sooner.

Significant strength or weakness in the dollar can impact the trade deficit for any given period of time.  For example, the dramatic 22% rise in the value of the dollar from October 2014 through the end of 2015 subtracted about 0.5% from GDP growth in both 2014 and 2015.  But the dollar has fallen about 6.5% in the past year.  As a result, we expect the trade component to have little impact on GDP growth in 2018.

The non-oil trade gap has widened significantly in the past year to about $69.0 billion as non-oil exports rose 11.3% while non-oil imports climbed by 4.6%.

Stephen Slifer


Charleston, SC

Trade-Weighted Dollar

February 6 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 fallen 8.0% 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 weakened  about 8.3% over the past year.  A year ago one dollar would buy 6.87 yuan.  Today it buys 6.30 yuan.

The U.S. dollar has weakened 5.9% versus the Canadian dollar during the past year.  For example, a year ago one U.S. dollar would purchase $1.31 Canadian dollars.  Today it will buy $1.23 Canadian dollars.

And against the Mexican peso the dollar has weakened by 9.1% during the past year.  A year ago one dollar would buy 20.3 Mexican pesos.  Today it will buy 18.4 pesos.

The dollar has weakened by 2.6% against the yen during the course of the past year.  A year ago one dollar would buy 112.9 yen.  Today that same one dollar will buy 109.9  yen.

The dollar has weakened 17.0% relative to the Euro during the past year.  A year ago one Euro cost $1.065.  Today one Euro costs $1.245.

Thus, the dollar has weakened against every major currency during the course of the past year.   As a result, the trade-weighted value of the dollar, as noted earlier, has fallen 8.0% during the past year.

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

Given a 6.0% drop in the value of the dollar in 2017 the trade component of GDP will add about 0.2% to GDP growth in that year.  The weaker dollar seems to reflect the perception that GDP growth in Europe is picking up more quickly than it is in the U.S. and, simultaneously an expectation that the European Central Bank will soon begin to raise rates.  It is not exactly clear to us that is the case.  GDP growth seems to be accelerating quickly both in the U.S. and Europe.  It is hard to tell if growth in one area is accelerating more rapidly than in the other.  The same is true with interest rates.  We know the path the Fed has chosen — a very slow but steady path towards higher rates.  The Europeans have not yet begun that process.  Once they start they will undoubtedly proceed with caution.

But now we have Treasury Secretary Mnuchin suggesting that a “weaker dollar is good for trade”.  That is in sharp contrast to the long-held notion that a strong dollar is good for the U.S.  A weaker dollar may benefit the U.S. in the short term by boosting GDP growth and helping to keep the inflation rate in check.  But the Treasury also has large and increasing budget deficits which are expected to once again surpass  $1.0 trillion in a few years.  If the dollar should begin an extended slide, foreign central banks (the Chinese in particular) could become somewhat less willing to purchase large amounts of Treasury securities.  But this president and this administration are known for saying one thing one day and something different the next.  We’ll see.  On balance, we expect the dollar to fall about 3.0% this year.  If that is the case, it will add little, perhaps 0.1% to GDP growth this year and, similarly, have a minor impact on the inflation rate.

Stephen Slifer


Charleston, SC

S&P 500 Stock Prices

February 6, 2018

The S&P has fallen about 8.5% since reaching the latest record high level in late January.   But this should be regarded as a stock market event not an economic event.

The catalyst was average hourly earnings data for January which have now risen 2.9% in the past year.  That is the fastest growth in hourly earnings thus far in the business cycle.  So the fear is that, at last the economy is overheating, inflation has begun to climb and, therefore, the Fed will raise rates more than the three times than it has penciled in for 2018.

The economy is likely to increase about 2.9% this year which is faster than the 2.5% 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 2.2 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 1.3% consisting of a 2.4% increase in productivity partially offset by a 1.1% increase in productivity.  For 2018 we expect labor costs to climb to 3.0%, but given the burst of investment spending (which is the primary determinant of growth in productivity) we expect productivity growth to climb to 1.8%.  Hence, unit labor costs this year should rise by 1.2% which is virtually identical to what it was last year.  A 1.2% 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 even close.

Stephen Slifer


Charleston, SC

Corporate Cash

January 4, 2018

Corporate cash holdings  rose $81 billion in the third quarter to $2.69 trillion (above) , and  continues to be quite high at 10.6% of non-financial assets (below).

As the recovery first began in mid-2009 corporate CEO’s needed to increase cash holdings for defensive reasons.  They had no idea if the expansion would be sustainable.  Similarly, they could not anticipate the likely pace of growth.  By the end of 2010 they appear to have become confident that they had ample cash on hand to weather almost any economic upset that might occur.  But given considerable concern about the high corporate tax rate, the inability to repatriate overseas earnings to the U.S., unhappiness about the onerous regulatory burden, and a failing health care program in serious need of revision,  corporate leaders have been reluctant to deploy these ample cash holdings.

But it is important to remember that all of these cash holdings — checking account balances, CD’s, holdings of government securities and municipal securities — all yield less than 1.0%.  It is not good management to have a considerable portion of your assets earning so little.   As we go forward and the stock market continues to climb and the economy continues to expand at a moderate pace firms should become more willing to invest.  The expectation of a cut in the corporate tax rate, an ability to repatriate earnings at a favorable 15.5% tax rate, relief from the onerous regulatory burden, has encouraged companies to loosen their purse strings by putting more money into technology or building  a new factory.  Nonresidential investment began to accelerate in the first quarter of last year and the pace has quickened from about 0% for the previous three years to 6.0%

The faster pace of investment spending has  caused productivity growth to accelerate from about 0% to 1.5% on its way to, perhaps, the 2.0% mark.  If that happens the economic speed limit will climb from 1.8% today to 2.8%.

Stephen Slifer


Charleston, SC

Business Inventories / Sales Ratio

January 4, 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 October business sales rose 0.3% but because the hurricanes caused a dropoff in production,  inventories declined 0.1% to satisfy the demand.  As a result, the inventory to sales ratio fell .01 to 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.

Stephen Slifer


Charleston, SC

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