Tuesday, 22 of January of 2019

Economics. Explained.  

Category » Miscellaneous

Small Business Optimism

January 8, 2019

Small business optimism fell 0.4 point in December to 104.4 after having declined 2.6 points in November.  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,  “Optimism among small business owners continues to push record highs, but they need workers to generate more sales, provide services, and complete projects.  Two of every three of these new jobs are historically created by the small business half of the economy, so it will be Main Street that will continue to drive economic growth.”

NFIB Chief Economist added that, “Recently, we’ve seen two themes promoted in the public discourse: first, the economy is going to overheat and cause inflation and second, the economy is slowing and the Federal Reserve should not raise interest rates.  However, the NFIB surveys of the small business half of the economy have shown no signs of an inflation threat, and in real terms Main Street remains very strong, setting record levels of hiring along the way.”

In our opinion the economy is expected to expand at a reasonably robust 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.

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.  Mortgage rates have fallen in the past couple of months from 4.9% to 4.5%.  And investment spending remains solid.  We expect GDP growth to be 2.8% this year after having risen 3.1% in 2018.  The core inflation should be relatively stable at 2.3% in 2019 after rising 2.2% in 2018.  The Fed will continue to raise short-term interest twice this year but the hikes will not occur until after midyear.  Accelerating GDP growth, low inflation, and low interest rates should re-invigorate the stock market in the months ahead.

Stephen Slifer


Charleston, SC

Corporate Leverage

December 13, 2018

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 third quarter of 2018 the ratio of corporate nonfinancial debt  to net worth was 37.9%.  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

December 13 2018

The S&P has fallen 9.5% after reaching a peak of 2,929 in mid-September.   The market appears to be concerned about a variety of factors.  The expansion is approaching its tenth anniversary which is geriatric, so some fear that the end of the expansion must be close.  It sees growth weakening overseas, particularly in China which is the world’s second largest economy.  It fears a trade war.  And it has seen the housing market fall steadily for most of the year.   The stock market is a leading economic indicator and when the economy is actually beginning to weaken the stock market will be one of the first places that slowdown becomes evident.  But, as they say, the stock market has predicted 10 of the past 3 recessions.  More often than not stock market gyrations are meaningless.  So which is it this time?  Our bet is that we are experiencing stock market noise.  The economic fundamentals in our view remain solid.

With respect to the Fed it is raising rates not to slow down the pace of economic activity but simply to get the funds rate back to a :neutral” level at which it is neither stimulating the economy nor trying to slow its down.  Currently the funds rate is 2.2%.  For years the Fed has believed that a neutral rate was about 3.0%.  Recent speeches by Fed officials suggest that it is rethinking the neutral rate and perhaps lowering it to 2.75%.  We should know more when it meets in mid-December.  Even if it eventually raises the funds rate to the 3.0% mark, the U.S. economy has never gone into recession unless the funds rate was 5.0% or higher.  It is not even close.  As a result, we suggest that the expansion will not end until 2021 at the earliest.

Trump initiated a trade war in February of this year by imposing tariffs on aluminum and steel.  Other countries retaliated.  Trump up-ed the ante by broadening the list of goods subject to tariffs.  A trade war was underway.  As investors around the globe tried to figure out which country might be in the best position to withstand a trade war, they concluded that country would be the U.S. primarily because trade is only 10% of our economy versus 50% or so elsewhere.  Investors flooded into the U.S. stock and bond markets.  The dollar has risen 9% since January.

The rising dollar has crushed emerging economies.  They purchase raw materials for their manufacturing sector.  But those commodities are all traded in dollars.  Hence, a rising dollar implies that their cost of goods sold has risen and they are less able to compete in the global market place.  As a result, their currencies have fallen.  Their stock markets have fallen 20-25% since January and slower growth does lie ahead.  In the case of China, the IMF expects 6.5% growth this year which would be the slowest growth rate since 1990 with even slower growth ahead in 2019 and 2020.  As growth in all emerging and developing countries has slowed, their leaders have sought trade deals with the U.S. to alleviate the pain.  So far deals have been negotiated with Mexico and Canada.  Europe seems close.  China is still a holdout, but if Trump applies tariffs to additional products and raises existing tariffs at the end of this year, our guess is that the pain will be so great that by spring the U.S. and China will reach some sort of accord.  Both will claim victory.  And the global outlook will not look so gloomy.

In any event, the tariffs imposed on U.S. goods should reduce GDP growth in the U.S. by just 0.2% in 2019.  Not exactly something the stock market should be too alarmed about.

Further, we believe the tax cuts and deregulation will boost investment spending for years to come.  That will in turn translate into faster growth in productivity. And that will raise our economic speed limit from 1.8% or so a couple of years ago to 2.8% by the end of the decade.

Finally, the housing market has slowed steadily throughout the year.  But the National Association of Realtors suggests that there is only a 4.3 month supply of homes available for sale.  Demand and supply are in balance when there is a 6.0 month supply of homes available.  If more homeowners put their houses up for sales existing home sales would be 5.8-6.0 million rather than the current 5.2 million.  The problem with housing is a supply constraint rather than a dropoff in demand.

We are well aware of the concerns being voiced by the stock market, but our conclusion is that it is nothing more than the usual stock market noise.

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 Deficit

December 7, 2018

The trade deficit for October widened by$0.9 billion to $55.5 billion after having widened by $0.9 billion in September.     Exports declined 0.1% in October.  Imports rose by 0.2%.  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 $0.7 billion in October to $87.9 billion after having widened by $0.9 billion in September.

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 $70.0 billion as non-oil exports rose 4.6% while non-oil imports climbed by 7.7%.

Stephen Slifer


Charleston, SC

Corporate Profits

November 28, 2018

Corporate profits before tax with inventory valuation and capital consumption adjustments rose 3.4% in the third quarter to $2,318.4 billion after having risen 3.0% in the second quarter.  During the last year profits on this basis have risen 10.3%.  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 1.1% in the third quarter to $2,220.5 billion after having jumped 4.1% in the second quarter.  Over the course of the past year such profits have declined 0.5%.  However, 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 2.5% pace in 2017 and  we expect it to rise at a 3.1% pace in 2018 and 2.8% in 2019.  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 both 2018 and 2019.

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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