Sunday, 26 of March of 2017

Economics. Explained.  

Category » Commentary for the Week

Politics May Alter the Economic Landscape

March 24, 2017

The economic data are encouraging.  In the U.S. consumers, business leaders, and investors are hopeful that the Trump administration will be able to reform health care, cut individual and corporate income tax rates, and provide regulatory relief.  As this column is being written the Trump/Paul Ryan health care plan appears to be at risk.  Even if it manages to get through the House, passage in the Senate will be even more problematical.  As this drama unfolds it is likely that currently lofty expectations will soon bump into reality.  The pendulum may swing in the opposite direction for a while.  But that is OK.  Neither the stock market nor the economy move in a straight line.  Zigs and zags are the norm.

We continue to believe that ultimately legislation will pass that produces meaningful change in health care, taxes, and regulatory relief, although we also believe that the final product will be less dramatic than expected.  We continue to expect GDP growth this year of 2.4% and 2.7% in 2018.  We have explicitly boosted this year’s growth rate by 0.1% and 2018 growth by 0.3% to reflect the likely impact of these legislative initiatives.  If the process bogs down or fails to pass we will have to ratchet down our expectations.  Thus, we readily acknowledge that politics will have a meaningful impact on our U.S. GDP forecast for the next several years.  But no not expect success or failure on any one piece of the package to significantly alter that expectation.  It will be a protracted process.

While keeping one eye on political developments in the United States keep your other eye focused on political developments in Europe, France in particular.  The first round of the presidential election will occur on April 23.  There are currently 11 candidates in the running.  If no one candidate gathers 50% of the vote, which seems likely, there will be a run-off election between the top two candidates on May 7.

The French election is of particular interest to Americans because of the rise in the polls of Marine Le Pen the leader of France’s National Front.  She calls for exiting the European Union, is anti-immigration, and wants to introduce tariffs as part of protectionist economic policies to put “France First”.  With GDP growth that is typically less than Germany, a 10.0% unemployment rate, a 24% youth unemployment rate, the highest taxes in the developed world, and terrorist activity on the rise, she has considerable appeal amongst disaffected working class voters in the rust-belt regions of France who feel they are being left behind and in areas with high levels of immigration.

At the moment she is running neck-and-neck in the polls with Emmanuel Macron.  They are expected to be the top two vote getters in the April 23 election.  But those same polls suggest that Macron will win in the runoff with a victory margin of 2:1 versus Le Pen.  However, pollsters’ credibility has been impugned in the past year given their failure to predict either the Brexit vote in June or the Trump victory in November.  Understandably, Europeans along with the rest of the world, are watching political developments in France closely.  A French exit would be the death knell for the European Union and send shock waves around the globe.

But suppose that Macron becomes the next President of France.  He is 39 years old and never held elected office.  He stands as an independent because he created his own party.  How effective will he be as a leader?

Either outcome is disquieting.  A Le Pen victory would likely signal a breakup of the European Union.  A Macron victory might be somewhat more comforting initially, but because an imminent breakup of the E.U. would be off the table for now the Euro is likely to rise.  A significant increase in the Euro would make European goods and services more expensive for Americans and Asians to purchase, reduce growth in exports, and act as a brake on European GDP growth which is just now emerging from the doldrums.

Our hope is that Macron wins and that E.U. officials take advantage of the apparent acceleration of GDP growth to find ways to diversify growth, strengthen the structure of the European Union, and introduce legislation liberalizing the excessive regulation of the labor market.  Failure to do so will only encourage the populist movement in the years ahead.

We are far more comfortable analyzing economic events around the globe but now, more so than usual, political events are likely to dominate the economic landscape.

Stephen Slifer


Charleston, S.C.

Oil Prices Should Continue to Slide

March 17, 2017

On March 7 oil market participants suddenly realized that that oil inventories had reached a record high level.  Almost overnight oil prices fell by $5.00 per barrel.  Our sense is that the $55 price in late February will probably turn out to be the high price for the year.  Why?  Because at that level U.S. producers turned on the spigot.  As supply began to rise inventories also began to climb.  That, ultimately, caused prices to fall.  A dramatic change in the oil market in the past seven years appears to have put an effective cap on oil prices at about $55 per barrel.

Gasoline Prices -- Crude

Since the turn of the decade technological developments in the oil market like hydraulic fracturing and horizontal drilling have allowed oil drillers to profitably pump oil from previously inaccessible locations.  As a result, U.S. oil production has essentially doubled during that period of time.  The oil industry has been turned topsy-turvy by these technological advancements which have dramatically and permanently increased the global supply of oil.

Gasoline Prices -- Production

As U.S. output surged by early 2015 inventory levels climbed to what were then record high levels.

Gasoline Prices -- Inventory Levels

Eventually prices fell from a high of $107 in late 2014 to a low point of about $28 per barrel.

Gasoline Prices -- Crude Monthly

As oil prices declined drillers found that many of their existing rigs could not be operated profitably and in 18 months they shut down 80% of the rigs that had been in operation in October 2014 when oil prices began to collapse.

Gasoline Prices -- Oil Rif Count

While the number of rigs in operation fell 80% oil production dipped by only about 12%.  How can that be?  Easy.  Oil producers became much more efficient and output per rig climbed from about 800 million barrels per day prior to the introduction of this new technology to 4,500 million barrels daily (the blue bars in the chart below).  To put that in slightly different terms, the oil drillers marginal cost of production fell from about $80 per barrel prior to the introduction of this new technology to about $45 per barrel currently – and their efficiency continues to climb by about 30% annually which implies even lower costs of production in the years ahead.

Gasoline Prices -- Productivity

Upon reaching a low point of $28 per barrel oil in the middle of last year prices have rebounded to about $55 per barrel.  Suddenly drillers found that they can once again produce oil profitably.  The number of rigs in operation has increased from a low point of 404 thousand to 789 thousand.

Gasoline Prices -- Oil Rif Count

And as the number of operating rigs has climbed oil production is back to within 5% of its previous peak.

Gasoline Prices -- Production

But that creates a problem.  A pickup in production of that magnitude has created a situation where oil inventories in the U.S. have surged to an even higher record level.

Gasoline Prices -- Inventory Levels

Given this backdrop it is perhaps not too surprising that prices have, once again, begun to fall.

Gasoline Prices -- Crude

Going forward it is likely that prices will dip further in the months ahead until such time as U.S. producers cut back production which may not occur until prices dip to $45 per barrel or even lower.  Furthermore, the peak driving season occurs right around the July 4th holiday and both crude oil and gasoline prices tend to peak at that time of year and then decline between July and December.

OPEC countries agreed to cut back production in December, but despite the cut in OPEC output U.S. production has surged and countered the OPEC decline.  As a result, inventory levels in the U.S. and around the globe have continued to climb.  That is not a sustainable situation. Production must shrink so that oil stocks drop back into closer alignment with demand.  Our sense is that prices will continue to slide until the pain gets so great that producers will ultimately be forced to slash production.  What we do not know is when that process will begin.  $45? $40?  $35?  $30?

What all this seems to mean is that the oil market today is vastly different from what it was just a few short years ago.  Instead of crude oil trading in a range from $80-110 per barrel, the new range seems to be somewhere between $30-60 per barrel.  U.S. production has change the entire industry.  And that is a good thing.

Stephen Slifer


Charleston, S.C.

Gathering Momentum

March 10, 2017

Since the election in early November the economy has shifted in a fundamental way.  Consumers, businesses and investors are the most optimistic they have been in years.  The stock market is on a roll and reaches a new record high level every few days.  Consumer confidence has surged.  Business spirits are soaring.  That newfound optimism is translating into jobs.  Given the timing of these dramatic changes it is evident that the source of this newfound enthusiasm is the election of Donald Trump.  Given that legislation cutting individual and corporate income taxes has not yet been introduced, and that the regulatory burden remains largely unchanged, it may be that the current degree of optimism is overstated.  Setbacks will undoubtedly occur as the year progresses, but there can be little doubt that the economy is gathering momentum, inflation is on the rise, and the Fed’s near-0% interest rate policy is a thing of the past.  What has yet to be determined is the extent of that improvement.  We believe the acceleration in GDP growth this year will be moderate, the core inflation rate will climb and rise a bit above the Fed’s 2.0% target, and the Fed will adhere to the 3-rate-hike plan it has previously suggested.

The stock market continues its ascent.

S&P 500 Stock Prices -- Short

That increase in the stock market is important because it is boosting consumer net worth.  During the course of the past year net worth climbed 6.3%, but in the two most recent quarters the stock market gain has boosted growth in net worth to a 9.2% pace.

Consumer Net Worth

Given the increase in net worth and the prospect of cuts in individual income tax rates later this year it is no wonder consumer confidence has risen to its highest level in a decade.

Consumer Confidence

Business confidence amongst manufacturing firms has risen almost 10 points in the past year.  In December 2015 this index stood at 48.0.  The manufacturing sector was in a slump and contracted for five consecutive months.  In February of this year the index stood at 57.7 with 17 of 18 manufacturing industries reporting growth in that month.  Orders are surging.  Production is picking up.  Employment is rising.  The turnaround is being fueled by the likelihood of reductions in the corporate tax rate later this year, and relief from the currently punishing regulatory environment.  The Institute for Supply Management believes the February level of the index is consistent with GDP growth of 4.5%.  While GDP will not rise that rapidly this year, there is no doubt that the manufacturing sector is on the mend.


Firms in the service sector are experiencing similar improvement and the ISM service-sector index has reached its highest level in more than two years.

NAPM -- Nonmfg.

As business sentiment has rebounded, so has hiring.  Private sector employment rose 224 thousand per month in the first two months of the year.  That compares to an average monthly gain of 170 thousand in 2016.   Employment in the service sector has been rising steadily for the past couple of years while the production sector – manufacturing, construction, and mining – was steadily contracting.  But now employment in those industries has begun to turn upwards.

Factory employment was hit by the 20% increase in the value of the dollar from mid-2014 through the early part of last year which caused adversely impacted growth in U.S. exports.

Trade-weighted dollar

As a result, factory employment fell for more than a year.  But in the past three months jobs in the manufacturing sector have risen by 19 thousand per month.

Payroll Employment -- Manufacturing

Employment in mining was clobbered by the decline in oil prices.  But oil prices have rebounded and mining employment has climbed back into positive territory.

Payroll Employment -- Mining

In the construction industry an extreme shortage of both single-family and residential housing and strength in commercial real estate have generated strong demand for construction workers.  However, builders have been constrained in their ability to hire because they have been unable to find an adequate supply of qualified workers.  Even so, construction employment has averaged about 25 thousand per month for a while.  The pickup in construction employment in January and February largely reflects the unusually mild winter weather and undoubtedly overstates the case, but employment gains in the industry appear to be on the rise.

Payroll Employment -- Construction

After several years of disappointing GDP growth it is encouraging to see so many leading economic indicators showing signs of life.  The exact dimensions of the upturn may be unclear, but the direction is not.  Look for the Fed to raise the federal funds rate to 0.75% at its meeting next week.


Stephen Slifer


Charleston, S.C.

Next Fed Rate Hike – March 15

March 3, 2017

Fed officials have hinted that the first of the Fed’s three expected rate hikes this year will occur on March 15.  That will undoubtedly encourage speculation that the Fed will raise the funds rate more than three times this year.  We are not yet prepared to go there.  It appears to us that GDP growth will accelerate somewhat this year and inflation should rise gradually.  If so, there is no compelling reason for the Fed to alter its basic game plan – three rate hikes this year followed by additional slow but steady increases in the funds rate in 2018 and 2019.

The sooner-than-expected rate hike has been influenced by a variety of factors.  First is the stock market.  It has risen 14% since the election.  Some argue that the stock market is overvalued.  But before one goes too far down that road keep in mind that the stock market reflects a discounted stream of future earnings.  If one believes that tax cuts, regulatory relief, and a resurgence of infrastructure spending are forthcoming, corporate earnings are likely to grow at a double-digit rate this year.  We believe that the S&P 500 index will continue to climb as the year progresses – but not necessarily in a straight line.

S&P 500 Stock Prices

Second, President Trump’s speech to the joint session of Congress was the most presidential of his short tenure in office.  The policies he advocates are the same ones he pushed during the campaign, but the tone was different.  In contrast to his other speeches he urged the American people and members of both parties to come together for the good of the country.  The possibility that our president can actually be presidential was highly encouraging.  He still must get Republicans and Democrats on board to implement policy changes and that will not be easy, but the change in tone was encouraging.

Third, in his speech President Trump said, “Since my election, Ford, Fiat-Chrysler, General Motors, Spring, Softbank, Lockheed, Intel, Walmart and many others have announced that they will invest billions and billions of dollars in the United States, and will create tens of thousands of new American jobs.”  Many of those pledges were almost certainly done to appease President Trump and ensure that he did not direct an angry tweet in their direction.  And some of that spending and many jobs may never materialize.  But it is hard to deny that something is happening that will boost investment spending, stimulate GDP growth, and create more jobs.

Fourth, business confidence is soaring  The Institute for Supply Management (ISM) index for manufacturing firms has risen in each of the past six months and now stands at 57.7.  That is the highest reading in more than two and one-half years.  These firms are seeing their order books rise, they intend to keep hiring for the foreseeable future, the backlog of orders has begun to rise, and virtually every firm has seen prices rising.  The index for non-manufacturing firms (which covers almost 90% of the economy) looks similar.   The ISM indicates that current levels for these two indexes are consistent with GDP growth of 3.5-4.0%. Something is happening.

NAPM -- Mfg . vs. Nonmfg.

Fifth, respondents to the ISM survey report that prices have risen in recent months and it reflects increases in commodity prices across the board.  Energy prices have climbed.  But so have non-energy commodity prices including agricultural raw materials, food, industrial metals, and industrial materials.  Something is happening.

Commodity Prices -- Energy versus Nonfuel

Sixth, the labor market continues to tighten.  Initial unemployment claims – a measure of layoffs – has fallen to 223 thousand which is the lowest level since April 1973 — 44 years ago!  Something is happening.

Initial Unemployment Claims

From the Fed’s viewpoint these developments provide assurance that the economy is truly gathering momentum.  The days of anemic 2.0% GDP growth are over.  The days when inflation was near 0% and a whiff of deflation was in the air are over.  The downside risk to economic growth has largely disappeared.  The time for 0% interest rates has come to an end.  The Fed recognizes this and has announced its intention to gradually raise the funds rate until it eventually reaches its so-called “neutral” level of about 3% by 2020.

We expect GDP growth to pick up gradually this year to 2.4% from 2.0% in 2016 and the core CPI to increase to 2.5% this year from 1.9%.  Those projections are roughly in line with what the Fed expects.  But in view of the developments described above, it is possible that the economy could expand more rapidly this year and inflation could be higher than expected.  If things turn out to be surprisingly strong it is prudent for the Fed to take advantage of the current positive economic environment and make its first rate hike of the year now.

Stephen Slifer


Charleston, SC

The Topsy-Turvy World is Returning to Normal

February 24, 2016

Since the U.S. presidential election in November economic optimism has picked up around the globe.  It is most evident in the United States, but stock markets in the United Kingdom, Europe, and Japan have all risen sharply.  Inflation has begun to climb.  Interest rates are headed higher.  Why?  Donald Trump.  Love him or loathe him, Trump’s proposals to sharply cut individual and corporate tax rates, relieve the regulatory burden on corporate America, and allow U.S. businesses to repatriate earnings at a favorable tax rate, have boosted confidence and energized stock markets from New York to Tokyo.  It is becoming increasingly evident that the protracted period of ultra-easy monetary policy around the globe is coming to an end.

In the United States the S&P 500 stock index has climbed 13% since the election and now stands at a record high level.

temp--stock prices

The tax cut/regulatory relief/repatriation of earnings combo has also lifted corporate spirits.  The YPO (formerly called the Young Presidents’ Organization) does a quarterly survey of business confidence amongst its 24,000 member CEO’s in 130 countries.  It then publishes confidence readings for nine regions around the globe.  In January confidence amongst members in the U.S. jumped 4.2 points to 64.6.  But global confidence also rose 3.0 points in January.  Confidence climbed in virtually every region – Asia, Australasia, Canada, the E.U., non-E.U. Europe, Latin America, and the Middle East/North Africa.   Animal spirits are re-emerging around the world.  And it is fairly clear that the catalyst for these changes was the election of President Trump.

temp--stock prices


The hope is that President Trump’s policies will ignite a long-awaited rebound in investment spending in the U.S.  Consumer spending will get a boost from the expected cuts in individual tax rates.  Government spending is likely to climb as defense spending gets a boost.  However, the stock markets and confidence today are probably inflated by overly optimistic expectations with respect to the magnitude and timing of the various fiscal stimulus measures.  At some point investors will hit a speed bump and the stock market will experience a correction.  Confidence levels will encounter a dose of reality.  But that is perfectly acceptable and should be expected.  The reality is that something good is going to happen.  Our forecast for GDP growth of 2.3% this year and 2.6% in 2018 assumes only a moderate amount of stimulus from Trump’s proposed policy changes.

Given that the U.S. is the world’s largest economy it is not surprising that a rosier U.S. outlook is going to have spillover effects elsewhere.  In Europe the Euro Stoxx 50 has climbed 13% since the U.S. election.

temp--stock prices

While stock investors have gotten caught up in the euphoria, confidence amongst YPO members in the E.U. gained 0.2 point in January to 60.9, the smallest increase amongst the nine regions surveyed.  Presumably these corporate leaders are wary given that three important elections will take place on the continent later this year and sentiment is shifting in the favor of the Euroskeptics and political parties with a populist appeal.  The risk is that an unanticipated election result could upset the current equilibrium and raise questions about the viability of the European Union.  While such an outcome still seems to be a relatively low probability bet, the reality is that pollsters have been dead wrong in anticipating the outcome of the Brexit vote in the U.K. in June of last year and Donald Trump’s election as president of the U.S. in November.

temp--stock prices


In France the hotly-contested presidential election will occur in April 23 with a run-off on May 7.   Far-right candidate Marine Le Pen leads in the first round of voting but is expected to lose in the runoff.  She calls for exiting the E.U., stopping free movement at the French border, and introducing tariffs as part of protectionist economic policies to put “France First”.

German Chancellor Angela Merkel has come under fire for her handling of the refugee crisis and her approval rating has steadily declined.  She is being challenged by the AfD (Alternative for Germany) a right-wing, anti-immigrant party whose support has been rising.

Italy’s Prime Minister Renzi lost a vote in December on constitutional reforms and resigned.  The loss was viewed as stinging defeat for the political establishment and a significant boost for the country’s surging populist movement just weeks after President Trump’s election in the U.S.

Confidence amongst YPO leaders in Asia rose 1.2 points to 61.2 in January.  But Asia includes China, Japan, India, and many emerging economies. Confidence amongst those countries often moves in different directions.

temp--stock prices


The Japanese stock market has risen 14% since the U.S. election.

temp--stock prices

Confidence amongst corporate executives in Japan rose 3.2 points in January.  This heightened optimism is largely the result of the depreciation of the yen combined with ultra-easy monetary policy.

temp--stock prices

China’s GDP outlook has changed very little in recent months.  However, Chinese officials are seriously concerned about Trump’s review of the “One China” policy that has been the cornerstone of China/U.S. relations for more than 40 years.  The relationship between the two countries has grown increasingly tense as Trump has indicated a willingness to impose 35% tariffs on some Chinese goods being exported to the United States.  At the same time, Trump has branded China as a currency manipulator as the yuan has depreciated by about 15% since reaching a peak of about 6.0 yuan to the dollar in January 2014.  Thus, the greatest danger to the Chinese economy in 2017 is probably political risk tied to its relationship to the U.S.

temp--stock prices

While confidence changes in the largest Asian countries were relatively modest, that was not the case for the emerging/developing ASEAN countries which include Indonesia, Malaysia, Singapore, Thailand, Philippines and Vietnam amongst others.  Confidence jumped 9.4 points in January to 62.0 which seems to reflect rising commodity prices – oil in particular.  The OPEC decision in late November to curtail output that caused the price of Brent crude oil to jump $10 per barrel from $45 to $55 was of particular help to Indonesia and Malaysia.

temp--stock prices

Expected changes in fiscal policy have justifiably rekindled animal spirits in the U.S.  GDP growth is clearly accelerating.  As oil prices in particular and commodity prices in general have rebounded, inflation has picked up and is very close to the Fed’s target.  The Federal Reserve has begun to lift short-term interest rates.  These same developments are occurring in Europe and Asia but to a lesser degree.  It is becoming increasingly evident that the protracted period of ultra-easy monetary policy around the globe is coming to an end.  The topsy-turvy world is returning to normal.

Stephen Slifer


Charleston, S.C.

Will Trump Derail the Fed’s Game Plan

February 17, 2017

For the past eight years the Fed has been the driving force behind the economic expansion.  But now President Trump has an unprecedented opportunity to re-shape the Fed’s Board of Governors.  There are currently two vacancies on the Board.  Fed Governor Dan Tarullo, who has been the Fed’s point man on financial regulation, intends to resign in the spring.  Fed Vice Chairman Stanley Fischer’s term ends in June.  And Fed Chair Yellen’s term ends in January of next year.  That means that President Trump will have the ability to appoint the next Fed Chair, Vice Chair, and three Fed governors within a year.  How might that alter the Fed’s conduct of monetary policy?  Probably very little.

The markets currently fear that President Trump’s push for wildly stimulative cuts in individual and corporate income tax rates will produce much more rapid GDP growth and trigger a re-emergence of inflation.  If so, the Fed would need to raise rates far more quickly than it currently envisions which could be the catalyst for the next recession.  That fear is overblown.  Despite changes in Fed leadership the Fed will continue on a slow but gradual path towards higher interest rates, the economy will continue to expand for several more years, and the expansion will ultimately go into the history books as the longest expansion on record.

As the economy swooned in 2008 the Fed lowered interest rates to a record-setting low level of 0%.  But now the Fed has decided the time has come to embark on a slow but steady path towards higher short-term interest rates.  Why?  Because it needs some leeway to lower rates at that point in time when the recession ultimately arrives.  The Fed envisions the federal funds rate reaching a “neutral” level of 3.0% sometime during 2020.  The direction of rates is clear regardless of who sits in the Fed Chair’s seat.

Fed Funds Rate -- Projected

The second step in the Fed’s easing process in the wake of the recession was “quantitative easing” whereby it purchased U.S. Treasury bonds and mortgage-backed securities.  In the process it flooded the banking system with more than $2 trillion of surplus reserves.  Those “excess reserves” represent the lending ability of the U.S. banking system.  If banks suddenly become willing to lend at the same time that consumers and businesses become more willing to borrow, those excess reserves could fuel an unprecedented, and highly inflationary, spending spree.  Ultimately, those surplus reserves must be extinguished.  One way to do that is to allow some of the Fed’s holdings of Treasury and mortgage-backed securities to mature and not be replaced.  But such action is as contractionary as its bond buying spree was stimulative.  To let securities run off at the same time that the Fed is raising short-term interest rates is not a good idea.  While the Fed needs to shrink its balance sheet, this process will probably not begin for another year.  But it is going to happen regardless who the Fed Chair might be.

Excess Reserves (Projected)

The most important pick for President Trump is obviously the Fed Chairman.  He could re-appoint Janet Yellen, but given his comments during the campaign about how she and the Fed were keeping interest rates artificially low in an attempt to support Hillary Clinton and the Democrats, the odds of that happening seem quite low.

The biggest challenges for the new Fed chair will be the speed with which interest rates will rise, and how soon the Fed will begin to shrink its balance sheet.  It is not going to sit idly by and let the inflation rate climb.  Why?  Because in the past the Fed has let inflation get out of control and it paid a price for doing so.  Inflation climbed to a double-digit pace in the late 1970’s as the Vietnamese War escalated.  The economy overheated and the Fed (under Arthur Burns) refused to raise rates high enough or fast enough to prevent an upsurge in inflation.  Ultimately, Paul Volcker had to push the funds rate above the 20% mark to break the back of inflation.  The Fed will not let that happen again – regardless of who is in charge.

Keep in mind also that while Fed governors and the Fed chairman may change, the Board’s staff does not.   These are people who have chosen a career at the central bank and are, in our opinion, extremely smart, capable and dedicated individuals.  We have the greatest respect for the Board staff and are quite comfortable having it oversee the process of implementing monetary policy.

Some would like the Fed to implement a “rules-based” policy whereby rate changes are determined by formula rather than what some see as a rather arbitrary decision-making process.  We strongly disagree with that concept.  Models are based on history.  As long as the structure of the economy does not change they may work well enough.  But the economy is dynamic and constantly evolves.  During the Great Recession consumers and businesses reassessed their attitude towards debt and are far less willing to hold debt today than at any time in recent history.  Technological changes have made the economy far more reliant on the service sector today than in the past.  Financial developments can result in never-before-seen instruments whose impact on the economy are unpredictable in advance.  Reliance on a simple model to determine the course of monetary policy would be a disaster.

In our view, tax cuts of some magnitude will be adopted this year.  However, with the prospect of $1 trillion budget deficits looming by the end of this decade President Trump will be unable to get Congress, or even Republicans, on board for untethered tax cuts.  Some offsets in the form of reduced government spending will be required to temper the impact of the tax cuts.  Hence, the economy will receive only mild stimulus this year, and the resultant increase in inflation should be relatively small.

Thus, regardless of changes in future Fed leadership, monetary policy for the next several years will not change much from what was described earlier – a moderate increase in interest rates followed by an eventual runoff of Fed holdings of U.S. Treasury and mortgage-based securities.  If those things happen gradually the expansion is poised to become the longest expansion on record.  It will hit the 10-year mark by June 2019.  If the Fed can engineer a record-breaking length period of expansion, why in the world would anyone want to tinker with the process?

Stephen Slifer


Charleston, SC

Trump Can Fix the Budget Problem – But Will He?

February 10, 2017

Within weeks President Trump will lay out his budget proposal for the next decade.  He has indicated his intention to cut individual and corporate income tax rates.   He also wants to increase defense spending and will not cut benefits for any current Social Security, Medicare, or Medicaid recipient.  But these proposals will increase the size of future budget deficits and add to Treasury debt outstanding which in just a few short years is expected to reach a dangerously high level.  However, there is a way for him to keep his campaign promises and not blow future budget deficits out of the water.

Current budget situation.  The budget deficit for fiscal year 2016 came in at $587 billion.  The best way to determine whether a deficit is “big” or “small” is to look at it in relation to the size of the economy.  Over the course of the past 50 years, the budget deficit has averaged about 3.0% of GDP.  This is generally regarded as a “sustainable” deficit.  By 2027 the deficit will climb to 5.0% of GDP and it gets significantly worse in the years beyond.  Why?  The baby boomers.

Budget Deficits -- as per cent of GDP (long)

Debt outstanding.  Every year that the government runs a deficit the Treasury must issue an equivalent amount of debt.  Economists look at the ratio of debt to GDP to determine the extent to which debt is a problem.   A ratio between 50.0% and 90.0% is generally regarded as sustainable.  Beyond the 90% mark investors become less willing to buy U.S. debt, interest rates rise, and the interest expense for the Treasury increases.  Currently, debt outstanding relative to GDP is 75.4%.  But given the steadily rising budget deficits the debt to GDP ratio is expected to climb to 89% by 2027 and 144% by 2047. That is a problem.  To put that in context, Greece has a debt/GDP ratio of 180%.

Debt Outstanding as Pct GDP -- Long

Tax Revenue.  Tax revenues currently are 17.4% of GDP which is roughly in line with the 18.0% average during the past 50 years.  President Trump wants to cut both individual and corporate income tax rates.   The proposed tax cuts would push that ratio far below its long-term average.

Budget Deficits -- Tax Revenue as Percent of GDP

To keep tax revenues roughly in line with their historical average what he could do is cut individual and corporate income tax rates and simultaneously eliminate most currently existing tax deductions.  Cut the rate but broaden the tax base.  This is exactly the policy prescription proposed by both the (bipartisan) Erskine Bowles Commission back in 2010, and the Paul Ryan-led House Republicans in their “A Better Way” proposal last year.  Trump can claim that he has satisfied his campaign promise to cut both individual and corporate income tax rates without worsening the looming deficit/debt problem.  It could be structured in such a way as to be roughly revenue neutral.

Government Spending.  As more and more baby boomers retire they begin to receive Social Security payments and become eligible for Medicare.  Today government expenditures as a percent of GDP are roughly in line with their 20% average for the past 50 years.  But as an aging population takes its toll, government spending as a percent of GDP will climb to 22% within 10 years and to 29% by 2047.

Budget Deficits -- Govt. Spending as per cent of GDP (long)

Trump has said that he intends to increase defense spending.  The increase in defense spending is not a particularly big problem because such spending only represents about 15% of GDP and the CBO has already incorporated a 23% increase in defense spending in its budget forecast for the next ten years.

Budget Deficits -- Components of Spending (2016)

But Trump has also said he does not want to cut benefits for any current Social Security, Medicare, or Medicaid recipient.  But, as noted above, these types of expenditures (known as “entitlements”) are poised to explode in the years ahead.

President Trump could help put U.S. fiscal policy on a more sustainable track by chopping these so-called entitlements.  Today such spending represents two-thirds of all government spending – double what it was 50 years ago.  Neither President Trump nor anybody else can hope to address the Treasury debt problem without shrinking such spending.  Trump has said he wants the Federal government to be smaller.  This is the place to start.

So how can he attack these entitlements without violating his campaign promise not to cut benefits for any existing recipient?

With respect to Social Security he could raise the amount of income subject to the Social Security payroll tax from its current level of $118,500 (or eliminate the cap entirely).  He could gradually raise the retirement age to 68.  Regarding Medicare he could suggest that the first $500 of spending by any recipient would not be covered, and then cover only 50% of all expenditures between $500 and $5,000.  Raise the eligibility age from 65 to 68. These changes are, once again, consistent with the Erskine Bowles Commission recommendations and the House Republicans “A Better Way”.  Given that Social Security and Medicare represent about two-thirds of all entitlement spending such changes would go a long ways toward shifting U.S. fiscal policy onto a more sustainable track.

President Trump’s upcoming budget announcement can remain true to his campaign promises while at the same time making a huge contribution to the future economic health of our country by reducing the size of the federal government.  It can be done, but will he do it?  Stay tuned.

Stephen Slifer


Charleston, SC

Budget Deficit

February 8, 2017

Budget Deficits

The Congressional Budget Office recently released its budget deficit forecast for the period from 2017-2027.  The budget deficit for fiscal year 2016 came in at $587 billion.  For the current fiscal year (FY 2017)  the budget deficit is projected to be $559 billion.  It will remain fairly steady during the next couple of years, but will begin to climb again about 2020 primarily as more and more baby boomers retire and begin to draw Social Security and become eligible for Medicare.  By 2027 it is expected to be $1.4 trillion.

It is important to remember that the U.S. actually had modest budget surpluses in FY’s 2000 and 2001.  And from 2002 to 2007 the deficits were consistently in a range from $200-300 billion.  The recent widening of the deficit  was largely the result of the extraordinarily deep recession that lasted from the end of 2007 through mid-2009.

The best way to determine whether a deficit is “big” or “small” is to look at the deficit in relation to the size of the economy, or the deficit as a percent of GDP.  Over the course of the past 50 years, the budget deficit as a percent of GDP has averaged about 3.0%.  This should be regarded as a “sustainable” deficit.  Unfortunately, by 2027 — a decade from now — the deficit will  climb to 5.0% of GDP.  That is too large and if something goes wrong it could be even bigger.  The goal should be to shrink it to no more than 3.0% of GDP during the course of the next decade.

Budget Deficits -- as per cent of GDP


While the normal budget forecasting cycle is 10 years, if one looks just beyond that 10-year horizon the situation gets significantly worse.  If nothing is done to correct the situation by 2047 the annual budget deficits will climb to 9.0% of GDP.

Budget Deficits -- as per cent of GDP (long)

None of these charts reflect policy changes that the Trump Administration would like to make.  We know that he wants to cut both individual and corporate income tax rates which, by themselves, would boost the budget deficit.  But he expects GDP growth to pick up to 4.0% within a few years which would (he hopes) generate enough tax receipts to offset the tax cut.  On the spending side he has said that he intends to increase defense spending.  But that is only about 17% of total government spending.  We do not know what the rest of the spending side will look like.  When his proposals are clearer, the CBO will score those policy changes.  We simply do not know enough to be able to come up with any meaningful estimate at this time.


Stephen Slifer


Charleston, SC

Unions Take It on the Chin – Again

February 3, 2017

Union membership continues to slide.  It declined 0.4% in 2016 to 10.7%.  This is not a new trend.  Union membership has been on a steady downtrend since 1945 when roughly one-third of employed people belonged to unions.  By 1983 when the Bureau of Labor Statistics began collecting data, there were 17.7 million union workers which represented 20.1% of the workforce. By 2000 that percentage had shrink to 13.4%, and now it stands at 10.7%.  Here in the Charleston area Boeing workers will vote on February 15 on whether or not to join the International Association of Machinists.  Boeing workers need to understand that they are fighting a trend that has been underway for 70 years.  Increasingly, workers across the country have decided that they are not getting their money’s worth from union representation and are opting out.

Union Membership

There are a variety of reasons for this decline. Automation is high on the list, as many labor-intensive jobs have been replaced by machinery.  The shift in the economy from being manufacturing based to services is another.  Unions have traditionally been strong in manufacturing with large plants, and weaker in the service industry with much smaller firms.  Indeed, in the mid-1970’s the manufacturing sector represented 25% of the U.S. economy.  Today manufacturing jobs are just 9% of the total.  Also, many traditional union jobs have been shifted overseas to take advantage of lower wages.

More recently union membership is under attack from a number of different states and cities as those governors and mayors have figured out they simply cannot afford to pay for gold-plated benefits packages that the unions successfully negotiated in days gone by.  The movement away from unions started in Indiana in 2012 but spread to Michigan in 2013.  Michigan was a huge blow for union leaders because it is generally regarded as the birthplace of the modern labor movement.  Then came Wisconsin in 2015.  In 2016 West Virginia became another right to work state and that was followed by Kentucky in January of this year.  In all, there are now 28 right-to-work states.  In right-to-work states workers may join a union if they choose to do so, but they are not obligated to join the union and automatically have union dues deducted from their paycheck.

States where union membership is the highest are New York at 23.5% followed by Hawaii at 19.9% and Alaska at 18.5%.  Since the year 2000 union membership in Hawaii and Alaska has declined slightly but, in contrast to the steady erosion in union membership at the national level, membership in New York and California has stayed quite steady.

Union Membership -- States High Pct.

At the other end of the spectrum, South Carolina has the lowest rate of unionization at 1.6%.  It is followed fairly closely by North Carolina at 3.0%.  Georgia and Florida are also near to the bottom of the totem pole with union membership rates of 3.9% and 5.6%, respectively.

Union Membership -- States Low Pct.

The biggest declines in union membership have occurred in states which have a large manufacturing presence — like Michigan, Wisconsin, Ohio, and Pennsylvania.  As a result of automation and outsourcing of jobs overseas, union membership in Ohio and Pennsylvania membership has fallen 3-5% since 2000.  The decline is far more pronounced in Michigan (7%) and Wisconsin (10%) which became right-to-work states in 2013 and 2015, respectively.

Union Membership -- States High Mfg.

Unions have been extremely successful in attracting higher wages and benefits for their members when compared to comparable earnings amongst non-union workers.

Unions -- Wages- Union vs. Nonunion

In 2016 union members earned $1,004 per week which is 25% higher than the $802 earned by non-union members.   Given these high wages it is not surprising that many companies are choosing to move to “right-to-work” states where union membership is not required.  Other companies are choosing to respond by moving operations offshore.  In some sense, the unions’ success is now leading to the steady contraction in membership.

That wage differential largely reflects gold-plated benefits packages for both pensions and health care.  But someone pays for those higher labor costs.  In the case of governments the burden is born by the taxpayers.  When economic conditions are less than favorable and state and local governments are forced to lay off workers to shrink bloated budget deficits, those governors and mayors have got to go after the unions and do what they can to trim those benefits and/or weaken union power.  They have had considerable success in recent years most notably in Wisconsin, Indiana, Michigan, West Virginia, and Kentucky.  With each successive victory other government officials work up the courage to take on the unions in their state or city.

Any way you slice it, union power is weakening in a hurry.

Stephen Slifer


Charleston, S.C.

GDP Growth Still on Track to Accelerate

January 27, 2017

Fourth quarter GDP growth turned out to be 1.9%.  While slightly less than the 2.2% pace that had been expected these early estimates tend to be revised upwards.   But that is history.  There is a new guy in town who is changing the rules and market participants expect faster GDP growth this year and next, a moderate pickup in the inflation rate, and somewhat higher interest rates.  In short, economists believe that the U.S. economy is emerging from the doldrums, inflation is edging upwards, and the Fed will be able to take the economy off the life support it has provided in the form of 0% short-term interest rates for the past eight years.  At long last the U.S. economy is on the cusp of returning to a more sustainable economic environment.

There can be little doubt that Trump’s proposed cuts in individual and corporate income tax rates, relief from a stifling regulatory environment, and allowing U.S. corporations to repatriate some of their overseas earnings to the U.S. at a favorable tax rate has everybody excited.

Consumer confidence has climbed to its highest level since July 2007.  And why not?

Consumer Confidence

The stock market has surged to a record high level.  The economy is cranking out jobs that are creating income.  Interest rates will remain low for the foreseeable future.  The likelihood of tax cuts is exhilarating.  Confidence is soaring!

S&P 500 Stock Prices

Confidence amongst manufacturing and non-manufacturing firms has climbed to a 2-year high.


Small business optimism has surged to its highest level since 2004.  Small business owners have been complaining about the punishing regulatory environment for years.  Big firms can hire an army of attorneys to determine whether they are in compliance.  Small business firms cannot afford that luxury and thereby operate at a competitive disadvantage to their larger counterparts.  For the first time in years small business owners are genuinely excited.

Small Business Optimism

To be sure these impressive gains in confidence are based on an expectation of policy changes that have yet to be enacted.  But with a Republican president and Republican control of both houses of Congress all of the policy changes described above are certain to be implemented to some extent.  However, the enacted legislation is likely to fall short of the current lofty expectations and thereby disappoint both consumers and business people.  But even with a  moderate setback in confidence the economy is poised to shift onto a faster growth track.

President Trump’s domestic agenda with respect to the economy is welcome news.  His trade policy is not.  He continues to talk about building a wall between the U.S. and Mexico, imposing tariffs on goods coming in from Mexico and China, taxing U.S. companies who want to shift their operations overseas, and re-negotiating NAFTA.  These are protectionist policies which will put the U.S. out of sync with the rest of the world and, ultimately, will hurt the very people who elected him in the form of significantly higher prices on imported products.

Trump believes that trade is costing the United States jobs as firms shift production to China and Mexico.  We contend that most of those manufacturing jobs have been zapped because of improvements in technology, not as the result of trade agreements.  However, we concede that some U.S. jobs have been lost through this mechanism.  But rather than worry about re-negotiating trade deals and imposing higher import duties and taxes, we would suggest that there is a better way to keep factory jobs in the United States.

Trump should focus on creating a much more business friendly environment.  How?  Through corporate tax cuts, eliminating much of the unnecessary regulatory burden, and allowing firms to repatriate their overseas earnings to the U.S. at a favorable tax rate.   All of those policy changes will presumably be forthcoming later this year.  Once enacted U.S. firms will have little incentive to shift operations and jobs to faraway places in the first place.  At the same time foreign firms should find the U.S. business climate much more conducive and look favorably on investments in this country which will create still more jobs.

Some members of Trump’s cabinet are supportive of this “better way” approach to trade but thus far their voices have not carried the day.  Trump’s early moves to kill the Trans-Pacific Partnership, begin construction of the wall between the U.S. and Mexico and impose a 20% tariff on goods imported from Mexico to pay for it are clearly discouraging.  But Trump is a skilled negotiator.  Furthermore, he has quickly become notorious about saying one thing one day and something entirely different a few days later (like his comments about the CIA and, more recently, about NATO).  Given that he has only been in office one week it remains to be seen exactly how his new trade policy will fall out.  Having said all that, his initial actions have been disquieting.

Stephen Slifer


Charleston, S.C.