Sunday, 18 of February of 2018

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Technology Is Keeping Inflation in Check

December 15. 2017

The “core” Consumer Price Index for November (excluding the volatile food and energy components) rose 0.1% which brings the year-over-year increase to 1.7% — somewhat below the Fed’s desired 2.0% pace.  Special factors can explain some of the CPI softness in the past year, but it is increasingly clear that technology is the primary cause of consistently falling goods prices.  In the past year goods prices have declined 0.9% while prices of services have risen 2.6%.   What is causing these widely divergent price movements?  Technology.

To be sure, special factors contributed to the overall softness of the core rate of inflation this year. For example, a price war amongst phone providers caused a double-digit drop in wireless phone prices.  At the same time, prescription drugs prices have slowed from a 6.3% increase in 2016 to 2.2% this year following President Trump’s threat to the pharmaceutical industry.  He wants to cut the prices of prescription drugs by allowing consumers to purchase such drugs overseas, and allow Medicare to negotiate prices directly with the insurance companies.  The combination of these two factors appears to have shaved about 0.2% from the CPI this year but, in both cases, the downward bias to inflation has run its course.

With respect to goods, the internet has played a big role in reducing those prices by 0.9% in the past year, Shoppers can instantly use their iPhone to compare the store price to a wide array of prices available at other online and brick and mortar stores.  If merchants do not price match, they risk losing the sale.  Thus, all retail goods merchants are constantly competing with the lowest price available on the internet.

Looking at specific items in the CPI prices have fallen for almost every major category.

  1. New car and trucks — -1.1%
  2. Used cars and trucks — -2.1%
  3. Appliances — -1.9%
  4. Audio Equipment — -11.5%
  5. Sporting goods — -1.3%
  6. Toys — -9.0%
  7. Information Technology Commodities (PC’s, software, and phones) -3.3%
  8. Books — -3.6%
  9. Televisions — -7.5%.

Prices for these items are widely available on the internet and can be used as bargaining chips with traditional brick and mortar retailers.

The downtrend in these goods prices has been accelerating in the past five years as Google searches and price comparison apps have  become more prevalent and easier for shoppers to use.  Merchants increasingly need to price match to close the deal.

Prices for services, in contrast, have risen 2.6% in the past twelve months.  Amongst services, there is an equally long list of prices that have been climbing.

  1. Rent — +3.2%
  2. Water, sewer, Trash Collection — +3.2%
  3. Medical Services — +1.6%
  4. Transportation Services (Car and Truck Rental, Auto Repair, Car Insurance) — +3.8%
  5. Public Transportation (Airfares, Bus and Train Fares) — -0.8%
  6. Recreation Services (Cable and Satellite TV Service, Pet Services, Admissions) — +3.5%
  7. Tuition — +2.4%
  8. Telephone Service (Wireless Telephone Service, Land-lines) –6.7%
  9. Miscellaneous Personal Services (Haircuts, Legal Services, Financial Services) — + 2.3%

Two comments about service sector prices.  First, rents are, by far, the dominant category and account for more than one-half of the entire service sector.  Given the on-going shortage of both homes available for sale and rental units, rents are destined to continue rising at a rate of 3.0-3.5%.    Second, the only price declines in the list above were telephone services, which reflects the price war between wireless phone providers which has largely come to an end, and public transportation which includes airfares.

So, what is going to happen to the inflation rate in 2018 given the disparate movements between goods prices and services?  The first thing that thing that should be noted is that goods represent about one-third of the entire CPI while services account for the remaining two-thirds. What happens to prices in the service sector is twice as important as changes in goods prices.

There can be little doubt that the downward pressure on goods prices will continue in 2018.  However, with a very tight labor market and the rising cost of materials, goods prices may not match the 0.9% drop that occurred this year.  In the service category, worker shortages may push prices upwards at a slightly faster rate in 2018 than they did this year, the price war between cell phone providers has come to an end, and rents should continue to climb at a rate between 3.0-3.5%.

Putting it all together, our expectation is that the core CPI should quicken somewhat from the 1.7% pace recorded this year to 2.2% in 2018.  While some pickup in inflation should be expected, it is not going to explode to the upside because of the continuing downward pressure on goods prices as iPhones allow consumers to find the best available bargain.

Stephen Slifer


Charleston, S.C.

The Year Ahead — 2018

December 8, 2017

It is impossible to overstate the importance of the corporate tax cuts that are on the verge of enactment.  Over the next few years the corporate tax cuts should accomplish the following:

  1. Raise the economic speed limit from 1.8% to 2.8%.
  2. Boost growth in wages from 1.4% to 3.5%
  3. Accelerate growth in our standard of living.
  4. Boost the inflation rate slightly from 1.8% to 2.3%
  5. Keep the Fed on track to raise rates slowly to the 3.0% mark but no higher.
  6. Propel the stock market to a record high level.
  7. Extend the expansion to 2022 or beyond.

Back in the 1990’s the economy grew at a 3 .5% rate and, as a result, we all came to believe that in the good times the U.S. economy should grow at a similar pace.  Since the current expansion began in June 2009 GDP growth has struggled to reach the 2.0% mark and economists endlessly point out how the current pace of expansion falls far short of growth registered at comparable periods of other business cycles.  The often-cited culprits are the Republicans, or the Democrats, or Obama, or the gridlock in Congress, or the Federal Reserve.  Or all the above.  Because growth is so anemic, the naysayers note that it would not take much of a shock to push the economy into recession.  They seem to live in constant fear that the next downturn is right around the corner.  But the pessimists are wrong.  The economy is alive and doing well, it is gathering momentum, and will continue to expand for many years to come.  We are in the midst of the longest expansion on record.

To understand why growth has been so slow relative to other business cycles we need only to look at what economists call “potential GDP growth” which is essentially the economy’s speed limit.  We cannot observe that particular number, but we can make a reasonable guesstimate by adding two numbers – the growth rate in the labor force and the growth rate in productivity.  After all, if we know how many people are working and how efficient they are, we can probably make a reasonable estimate of how many goods and services they can produce – which is what GDP is trying to measure.

Back in the 1990’s labor force growth was 1.5%, productivity growth was 2.0%.  Add them up and the economy’s speed limit 20 years ago was 3.5%.  The economy grew that quickly for a decade.  Not surprisingly, we have come to expect the economy to grow at a 3.5% pace in the good times which is why we are so frustrated by the 2.0% pace of the recent expansion.

But the economy today simply cannot grow at a 3.5% pace.  Labor force growth has slowed to 0.8%.  Why?  Because the baby boomers are retiring, and when they retire they leave the labor force.  Baby boomers will continue to retire for another decade.  Productivity growth has slowed to 1.0%.  Why?  Economists do not fully understand the reasons for this slowdown.  Our favorite explanation is that the internet came into existence in 1995.  In the early 2000’s the cloud and apps came along.  These technological advancements completely revolutionized the way that we communicate with each other.  As a result, productivity growth surged to 2.0%.  But nothing quite so revolutionary has occurred in recent years and productivity growth has slipped to 1.0%.  With labor force growth of 0.8% and productivity growth of 1.0%, the economic speed limit today is 1.8%.  Thus, today’s economy can expand at only about one half of the pace it registered during the decade of the 1990’s.  We are frustrated and disappointed.  Surely, we can do better than that!

To boost our economic speed limit, we have two choices – achieve faster growth in the labor force, or find some way to boost growth in productivity.  Because the baby boomers will continue to retire for another decade, we probably will not have much luck boosting growth in the labor force.  If we are going to raise the economic speed limit we must stimulate growth in productivity.

Corporate tax cuts to the rescue!

It is important to understand that productivity is closely tied to the pace of investment.  Investment spending collapsed in 2014 and did not grow for two years.  Part of the drop-off was tied to the collapse of oil prices.  When oil prices plunged from $104 per barrel to $25, drillers could no longer operate profitably 75% of the wells that were in operation at that time and they shut them down.  When they did that, they cut spending on oil drilling equipment and supplies.  They curtailed spending on oil exploration and research.  Investment spending in the oil sector was crushed.  More broadly, business leaders were frustrated by the political gridlock in Washington.  Why should they spend investment dollars when they have no idea what the economy might look like 1-, 2-, or 5-years down the road?  Investment spending ceased to grow for more than two years.  But oil prices are no longer at $25, they are at $57.  Now those same drillers can profitably operate many of the previously-closed wells.  Investment spending in the oil sector is on the rebound.

In November 2016 the American people elected Donald Trump as President.  Trump ran on a platform of creating jobs and boosting investment spending. He pledged both individual and corporate tax cuts.  He cut the corporate tax rate from 35% to 20%.  He is going to allow companies to repatriate earnings at a favorable 5.25% tax rate rather than 35%.  He is in the process of eliminating a wide range of confusing, overlapping, and unnecessary regulations.  He was going to “Make America Great Again”.  Within a month of the election many American companies announced that they were going to boost investment spending and create jobs.  The laundry list included sizeable job announcements by industry leaders like Walmart, Amazon, Sprint, Pizza Hut, even the on-line Chinese retail giant Alibaba.  Trump had not yet taken office!

Investment spending immediately began to rise.  First quarter growth jumped by 7.2%.  Second quarter was 6.7%.  Third quarter climbed 4.7%.  Fourth quarter growth is expected to be 5.5%.  After failing to grow for two years, investment spending has surged in 2017 to 6.0%.  Coincidence?  We are not fans of President Trump, but the timing of the investment spending acceleration is hard to dismiss.  Give credit where credit is due.  We expect investment spending to continue to climb at a 6.0% pace in 2018.

CEO’s say that they do not plan to use the tax cuts to boost investment spending.  Instead, they say they plan to increase shareholder dividends and buy back stock.  Nonsense.  The reality is that they have already begun to boost investment spending.  Big time.

Despite their rhetoric, corporate leaders today act as if the soon-to-be-enacted corporate tax cuts are going to boost growth in productivity, accelerate GDP growth, keep inflation in check, prevent the Fed from raising rates too sharply, propel the stock market to still higher record levels, and lengthen the current expansion by another five years.

Consider productivity growth.  In the past three years it has grown by 0.7%.  As investment spending has surged in 2017 productivity growth in the past year has quickened to 1.5%.  Coincidence?  We do not think so.  It is not hard to imagine that within a couple of years productivity growth might climb to the 2.0% mark.  That is our bet.

Now let’s re-calculate the economic speed limit.  Labor force growth of 0.8% combined with 2.0% growth in productivity raises the economy’s speed limit from 1.8% today to 2.8%.  That may not match the 3.5% growth rate registered in the 1990’s, but it is vastly improved over recent years.

Faster growth in the economy allows our standard of living to grow more quickly.  Economists typically measure standard of living growth by looking at real, after-tax, income per capita.  Take our income, subtract what we pay in taxes, adjust for inflation, and see what is left.  Today this measure of income is rising by 0.9%.  But if the economy grows 1.0% more quickly, that number will jump to 1.9%, which is slightly faster than the 1.6% trend rate of growth over the past 25 years.

Faster growth in productivity will also help to alleviate upward pressure on inflation.  At 4.1% the unemployment rate is below anybody’s estimate of the full-employment threshold.  As a result, labor shortages are becoming more apparent.  Wages are beginning to rise a bit more quickly.  The fear is that higher wages will cause firms to start raising prices, which will cause inflation to accelerate.  But perhaps less than you think because renewed growth in productivity can alleviate the impact of faster growth in wages.  Think of it this way.  If the firm you work for pays you 5.0% higher wages and you are no more productive, its wage costs have climbed by 5.0% and it might be tempted to raise prices to counter the higher labor costs.  But what if it pays you 5.0% higher wages because you are 5.0% more productive?  It does not care.  It is getting 5.0% more output.  Economists call wage pressures adjusted for productivity “unit labor costs”.

So, what is happening to “unit labor costs” currently?  In the past year compensation has risen 1.4%, productivity has risen 1.5%.  Thus, unit labor costs have declined 0.1%.  No wonder the seemingly tight labor market has not yet put upward pressure on the inflation rate!  The increase in wages has been countered by a commensurate increase in productivity.

But what about next year?  Wage pressures in recent quarters have begun to quicken.  We expect compensation in 2018 to rise 3.5%.  We expect productivity to climb to 2.0%.  Doing the subtraction implies that unit labor costs will rise 1.5%.  That is a faster rate of increase in unit labor costs than we saw this year, so there should be a bit more upward pressure on the inflation rate.  But the Fed has a 2.0% inflation target so an increase in ULC’s of 1.5% is perfectly consistent with its inflation objective.

Other things to consider when projecting the inflation rate for next year are the steady increase in recent months of commodity prices in general – not just oil.  Also, the shortage of apartment units is causing rents to climb by almost 3.5% which is a big deal because housing represents about one-third of the entire CPI.

The bottom line is that we expect the core CPI (which excludes the very volatile food and energy components) to increase 2.3% in 2018 after having risen 1.8% this year.  Last year was a little bit below the Fed’s 2.0% inflation target.  Next year should be a bit above target, but not enough to alarm Fed officials.

Putting all this together, we expect GDP growth to pick up to 2.8% (its potential growth rate) during the next couple of years.  Our standard of living will rise more quickly.  Our paychecks will get somewhat fatter.  Productivity will accelerate and thereby offset most of the increase in wages.  As a result, inflation in the years ahead should continue at a 2.3% pace which is roughly in line with the Fed’s target.

If that is the scenario that unfolds, the Fed should continue its gradual tightening until the funds rate reaches 3.0% by the middle of 2020.  That 3.0% rate is what the Fed believes is a neutral” rate which means that it is neither providing economic stimulus nor trying to slow down the economy.

So, when might this expansion end?  Historically the U.S. economy has never, ever, fallen into recession until the Fed has pushed the funds rate above that so-called neutral rate.  At the end of the most recent expansion in December 2007, the funds rate reached the 5.0% mark.


When might the Fed raise the funds rate to 5.0%?  We do not know!  By mid-2020 the funds rate has achieved a neutral rate of 3.0%.  If the economy is expanding at its potential pace of 2.8 it is not overheating.  The inflation rate should be 2.3% which would be just a shade above its 2.0% target.  Against that background, the Fed has no incentive to tighten further.  It should boost the funds rate to the 3.0% mark — but no higher.

When will this expansion end?  We do not know.  Because the funds rate will not reach the so-called neutral rate of 3.0% until mid-2020 it should last at least that long.  But in mid-2020 the Fed should have no reason to raise rates further.  This means that a 5.0% funds rate is nowhere in sight.  Could the expansion last until 2022?  2025?  Absolutely.  What we should be looking for are signs that the economy is overheating, and that inflation is moving substantially above the Fed’s 2.0% target.  Those two pieces are nowhere in sight.  The end of the expansion is likely to be least five years down the road.

This expansion is going in the history books as the longest expansion on record.  The current record-holder is the decade of the 1990’s which lasted exactly ten years.  The current expansion will reach that milestone in June 2019.  We are suggesting 2022 or even 2025 as likely end dates.  If the Federal Reserve can produce an expansion that lasts 13 years or longer, it certainly deserves high marks in our book.

All is well.  Enjoy the coming year.  Rock on!

Stephen Slifer


Charleston, S.C.



2018 Economic Outlook Conference

 2018 Economic Outlook Conference

In times of uncertainty whether you are running a business or planning your investments,

knowledge can be your most valuable asset.

Stephen Slifer, Owner and Chief Economist at NumberNomics  will provide insight regarding what to expect in 2018.

Why is growth so slow?  Will it ever accelerte?

When will interest rates begin to bite?

Why is inflation so low?  When will it accelerate?

Can Trump pass anything that will help?

When might the expansion end?

DATE:., Tuesday, December 5, 2017

TIME: 7:30 to 9:00 A.M.

PLACE: Daniel Island Club, 600 Island Park Drive, Charleston, SC 29492

COST: ..$40.00 includes breakfast

Stephen Slifer:  From 1980 until his retirement in 2003, Mr. Slifer was the Chief U.S. Economist for Lehman Brothers in New York City.  In that role he directed the firm’s U.S. economics group and was responsible for the firm’s forecasts and analysis of the U.S. economy.

Prior to that, he spent a decade as a senior economist at the Board of Governors of the Federal Reserve in Washington, D.C.  He has written two books about the various economic indicators and how they can be used to forecast economic activity.  He writes a regular bi-weekly economics column for the Charleston Regional Business Journal.

Proudly sponsored by:

Charleston Digital Corridor ……………… ..Charleston Regional Business Journal

Daniel Island Business Association ………Daniel Island Town Association

NumberNomics …………………………….. Wells Fargo Advisors

Baird ………………………..                      ..Trident Technical College


To Register:  Click Here

Bitcoin is a Bubble, But Its Technology is a Breakthrough

December 1, 2017

Bitcoin is new and exciting.  But bitcoin was developed in secrecy by a person or group of people whose identity remains unknown.  Its whole purpose is to evade regulation which makes it particularly appealing to the darker side of society – drug dealers, arm sales, terrorists, sex traffickers – which gives it a close link to tax evasion and organized crime.  While it is being billed as “money”, it is not.  It is neither a medium of exchange nor a store of value.  Bitcoin purchasers today are doing so solely because they seek the anonymity or because they believe the value of a bitcoin will be higher tomorrow.  Thus, it seems to us that bitcoin is more like a tulip than money and does not serve any socially useful economic function.  Having said that, the underlying technology on which it is based is revolutionary and could make identity theft by hackers far more difficult, and eventually eliminate the 2-3% transaction fee typically charged today on credit card transactions.  It is important to distinguish between bitcoins and the technological advancement that was used to create it.  One is useful, one is not.

The origination of the bitcoin is shrouded in secrecy.  It was developed in 2008 by some person or a group of people, using a pseudonym — Satoshi Nakamoto — whose identity remains unknown.   That is hardly a confidence-boosting start.

Bitcoins are being billed as a new form of “money”.  But money is supposed to be a “medium of exchange” which means that it is a widely accepted means of payment.  However, few legitimate businesses today accept bitcoin as a means of payment.  Money is also supposed to be a “store of value”.  But the value of a bitcoin is wildly unstable and its value can change by 10% or more in a single day.  It is hard to imagine any investor choosing to park a large portion of his or her assets in bitcoins given this extreme volatility.  Thus, bitcoins do not fit any conventional definition of “money”.

The appeal of bitcoin is that the technology on which it is based makes transactions largely anonymous which explains bitcoin’s appeal to the darker side of society.  Most illegal activities from drug and gun sales to prostitution and the sex trade are done in cash. But money laundering is challenging, and bitcoins offer the perfect opportunity to convert a mountain of cash into a useable form without alerting authorities.  But the illegal nature of these transactions is sure to encourage regulators to keep a watchful eye on the market and could lead them to impose regulations which would dampen its appeal.  It is also going to attract the attention of crime-busters like the FBI.  Silk Road was an online black market best known as a platform for selling illegal drugs.  It was shut down by the FBI in 2013 but, unfortunately, many Silk Road look-alikes have emerged.

While recognizing the downside of bitcoin, the blockchain technology on which it is based is revolutionary.  In today’s world transactions are cleared by banks which verify that the purchaser has the funds available and transfer the proceeds to someone else’s account.  Thus, transactions are controlled by banks.  But blockchain can be thought of as a giant private sector database that performs those transactions without the bank or any other central authority.  Once a transaction is recorded the bitcoin network it is encrypted by a formula that can supposedly be unlocked only through a trial-and-error process and eventually the bitcoin proceeds find their way to the seller.  The transaction is both anonymous and cost-less.  Those are powerful advantages.

As a result, central banks around the world are working feverishly to determine whether adoption of blockchain technology could make it harder for hackers to engage in identity theft.  Furthermore, in today’s world a merchant pays a 2-3% fee when a purchaser uses a credit card.  Bitcoin technology could eliminate these fees to the middleman.  Thus, bitcoin technology offers the opportunity to advance the financial payments mechanism into the 21st century.

As we see it, bitcoins have no socially useful economic function.  They are not money and they facilitate the ability of drug dealers, gun sellers, sex traffickers, and terrorists to finance their operations.  Bitcoins are only useful to speculators – hedge funds and high-speed trading firms in particular.  For these reasons, in our opinion, bitcoin has limited appeal.  But the blockchain technology on which it is based is revolutionary and will both enhance cyber security and make the current payment mechanism far more efficient.

Stephen Slifer


Charleston, S.C.

Oil Prices on the Rise – Where Are They Headed?

November 17, 2017

Crude oil prices reached a low of $42.50 in late June.  They have since climbed to $57 per barrel.  What has caused the recent run-up in prices, and what will crude and gasoline prices be in 2018?

Since mid-year it has become increasingly apparent that global GDP growth has accelerated in virtually every region.  In October the IMF raised its global GDP growth forecast for 2018 to 3.7% which would be the fastest pace of global economic activity since 2011.  The United States had GDP growth of 3.1% in the second quarter, 3.0% growth in the third quarter, and fourth quarter growth is projected to be about 3.5%.  This would be the first time growth has exceeded 3.0% for three consecutive quarters in more than a decade.  An acceleration of growth is evident in Europe where the IMF expects growth of 1.9% in 2018 – the fastest pace since 2010.  The IMF boosted its 2018 forecast for China by 0.2% to 6.5%.   It has similarly lifted its growth expectation for emerging market nations, Latin America, and Africa.  Thus, growth is accelerating all over the world and reflects a combination of tax cuts in the U.S., ultra-easy monetary policy in the U.S., the U.K., Europe, and Japan, and higher oil prices which have allowed many oil-exporting nations to emerge from recession.

As demand has risen, previously bloated oil inventory levels have declined almost weekly since early February.  Thus, the pre-September rise in oil prices from $42.50 to about $50 per barrel cannot be dismissed.  It is being driven clearly by a pickup in demand.

But the subsequent rise in crude prices from around $50 in late August to $57 began almost to the day when Hurricane Harvey struck the Gulf Coast.  Hence, one suspects that damage to production and refinery facilities in the region has been largely responsible for the additional price run-up.

Oil production statistics from the Energy Information Administration show that production plunged in late September but has quickly rebounded to a near-normal pace of 9.6 million barrels per day.  The IEA estimates that production will continue to climb to a record pace of 10.0 million barrels per day in 2018 (which eclipses the previous record of 9.6 million barrels per day set in 1970).  But will that be sufficient to satisfy demand and reduce prices?

The IEA expects crude oil prices to slip from their current level of $57 per barrel and average $51.00 in 2018.  But that is a forecast which may or may not prove to be accurate.  However, it strikes us as a plausible scenario given that much of the recent run-up in prices appears to be the result of a hurricane-induced interruption in supply which means that it is likely to be reversed.

With respect to gasoline prices the situation is similar.  Pump prices rose from $2.25 in the middle of this year to about $2.70 per gallon in the wake of the two hurricanes.  They are currently at $2.60.  The EIA expects gas prices to fall $0.15 further and average $2.45 next year.  For those of us in the low country prices are generally about $0.25 lower than the national average which works out to about $2.20 per gallon.

The recent run-up in both crude oil and gasoline prices is impressive and perhaps somewhat alarming.  While some of the rise since midyear reflects a pickup in global demand, a significant portion of the recent increase is hurricane related and will be reversed in the weeks and months ahead.  If that is the case oil will not be a problem for 2018.  But oil prices are notoriously volatile, and the EIA expectation of relatively stable prices next year reflects its estimate of the actual pickup in global demand, an estimate of the speed-up in production in the U.S., and some guess about the likely response by OPEC.  OPEC ministers will next meet in Vienna on November 30 and are widely expected to continue the previously-adopted production cuts through March 2018.  Thus, there are a lot of balls in the air and oil price movements may or may not behave as expected.  For now, oil prices are not expected to be a major factor in the estimates of either GDP growth or inflation next year but, as always, we will see.

Stephen Slifer


Charleston, S.C.

Tax Cuts Imply Bigger Budget Deficits – Or Do They?

November 10, 2017

Everybody is analyzing the impact of the House and Senate tax cut proposals.  The Congressional Budget Office estimates that the package will increase budget deficits by $1.5 trillion during the next 10 years.  Trump supporters claim that the tax cuts will stimulate the economy to such an extent that the additional tax revenues kicked off by faster growth will offset the impact of lower tax rates and that future budget deficits might even shrink.  Who’s right?  The answer seems to depend upon the method of scoring used to evaluate the various tax proposals, and the time horizon selected.

The non-partisan Congressional Budget Office is the official arbiter used by Congress to score the potential budget impact of any proposed changes in taxes or government spending.   It estimates that the proposed tax cuts will increase the budget deficit by $1.5 trillion over the next 10 years.  But it is important to understand that the CBO estimate must be calculated using what is known as “static” scoring.  What that means is that the CBO must apply the lower tax rates to its current estimate of GDP growth.  Not surprisingly, doing so reduces tax revenues and results in an expectation of larger budget deficits in the years ahead.  But that is an archaic method of calculation and results in a totally misleading conclusion.

Also, because Congress uses a 10-year time horizon when it produces its annual budget proposals, the CBO evaluates the impact of any tax or spending proposal using a 10-year window.  But there is nothing magic about 10 years.  Sometimes it is useful to examine these changes using a longer reference period.

While the CBO uses static scoring the economy is dynamic.  Lower tax rates will surely cause some behavioral changes.  What if businesses spend more money on investment?  What if they bring back some of the estimated $4.0 trillion of earnings currently locked overseas and invest it in the U.S.?  What if firms hire more workers?  Those are all reasonable expectations that will boost investment spending for years to come, increase the growth rate of productivity, and raise our economic speed limit from 1.8% currently to perhaps 2.8% by the end of the decade.  Faster growth increases tax revenues.

The Trump administration wants its tax cut proposals evaluated using “dynamic” scoring which takes into consideration the impact of both lower tax rates and faster GDP growth.   Using such a method, they believe that the additional tax revenues generated by faster growth will largely offset the impact of lower tax rates during the next 10 years.  And over a longer time horizon, say 20 years, faster GDP growth will boost tax revenues enough to shrink the projected budget deficits.

So,  wider deficits to the tune of $1.5 trillion over 10 years?  Or smaller budget deficits over a somewhat longer time frame?

Almost certainly tax cuts will trigger some of the behavioral changes described above which means that the CBO estimate that budget deficits will increase by $1.5 trillion over 10 years is way off the mark and misleading.

But only a die-hard supply-sider would conclude that lower tax rates will be revenue neutral during the upcoming 10-year time period.

Unfortunately, estimates of the impact from dynamic scoring vary widely and differ to a large extent upon the political persuasion of the organization making the estimate – which is exactly why the CBO is not permitted to use it.

For what it is worth, we believe that taking the growth effects of these policy changes into consideration the loss of tax revenues might be $0.5 billion during the next 10 years rather than $1.5 trillion. If one were to use a longer budget window we believe tax revenues will increase and actually shrink budget deficits beyond 2026.

We wholeheartedly support a cut in the corporate tax rate from 35% to 20%.  We support the idea of allowing U.S. firms to re-patriate overseas earnings at a favorable tax rate of 10% rather than the 35% rate they would have to pay currently.  And we support the notion of full expensing of investment.  Doing so would eliminate complicated depreciation and amortization schedules and substantially cut compliance costs for all American businesses.  It is the right thing to do and will certainly boost investment spending for years to come, raise potential GDP growth and, in the longer-term, shrink budget deficits.  We hope that our policy makers in Washington will not be distracted by the CBO’s estimate of $1.5 trillion less tax revenue over 10 years.  It uses an archaic and misleading method of calculation, and is constrained to a 10-year time span.  The positive effect of faster growth may accrue largely in the years beyond the normal budget window.

Stephen Slifer


Charleston, S.C.

Productivity Rebounding – Implies Faster Growth, Lower Inflation

November 3, 2017

After being stagnant for a couple of years productivity is finally on the rise.  We expect its recent pace to be sustained in 2018 which causes lots of good things to happen.  The economy’s economic speed limit will accelerate from 1.8% today to 2.8% or so in the years ahead.  Faster growth in productivity will boost wages to about 3.5%.  Faster income growth will raise the standard of living by 1.6%.  Finally, faster productivity growth will keep inflation in check.  Consider the following:

Productivity growth is closely tied to investment.  Give workers the latest technology or upgraded equipment on the factory floor, the same number of workers will be able to produce more output.  Investment spending was essentially unchanged in 2015 and 2016 as falling oil prices crushed investment in the oil sector and business leaders were frustrated by the gridlock in Congress.

But following Trump’s election things began to change.  In the month after the election many large companies vowed to create jobs in the U.S.  Amazon said it intends to add 100,000 new jobs, Walmart — 10,000, Sprint – 50,000, Pizza Hut – 11,000, and Chinese retail giant Alibaba says it will create one million new jobs in the U.S.

Then, corporate leaders became about excited about the possibility of a cut in the corporate tax rate, repatriation of overseas earnings to the U.S. at a favorable tax rate, and a significant reduction in the particularly onerous regulatory environment.  As a result, corporate confidence has soared.  The Institute for Supply Management’s (ISM) survey of conditions in the manufacturing sector reached its highest level since 2004.  The ISM survey for non-manufacturing firms looks similar.  Small business confidence has soared to its highest level since 2004.  Big firms, small firms, manufacturers, and non-manufacturing firms are all bursting with confidence.

Meanwhile the U.S. stock market has surged to a series of record high levels.  It has climbed more than 20% in the past year.  Stocks around the globe are climbing at an equally brisk pace.

Against this background, corporate leaders have begun to open their wallets.  After essentially no growth for three years, investment spending surged by 7.2%, 6.7%, and 3.9% in the first three quarters of this year.  If the corporate tax cuts and repatriation of earnings come to pass, investment spending will climb for years to come.  We anticipate a 5.0% increase in investment spending in 2018.

The ratcheting upwards of investment has caused productivity to rebound.  Following a couple of years with growth that averaged 1.0%, productivity rose 1.5% in the second quarter and 3.0% in the third (which happens to be the biggest single-quarter advance in three years).  Something different seems to be happening.

Faster growth in productivity causes lots of good things happen.  First, our economic speed limit accelerates.  That speed limit can be estimated as the sum of growth in the labor force plus productivity growth.  Currently the labor force is climbing by a reduced 0.8% pace as the baby boomers continue to retire.  Productivity is currently climbing at about a 1.0% pace.  Add those two numbers and it becomes clear that the economy’s speed limit today is an anemic 1.8%.  But suppose that the additional investment spending boosts productivity growth from 1.0% to 2.0%.  Now suddenly the sum of 0.8% growth in the labor force and 2.0% growth in productivity boosts that economic speed limit to 2.8%.  Trump believes his tax cuts will boost GDP growth to 3.0%.  He may not be too far off the mark.

Faster growth in the economy means that income will be growing more quickly.  Specifically, 1% faster GDP growth means 1.0% additional growth in income.  The most widely used measure of our standard of living is the growth rate of real, after tax, income per capita.  It is currently rising by 0.6% annually.  Tack on an additional 1.0% growth in income and suddenly it climbs to 1.6% which is close to its long-term growth rate.

If productivity grows more quickly compensation will also accelerate because workers have earned their fatter paychecks.  If employers boost worker compensation by 3.0% one might think that labor costs increase by 3.0%.  But what if workers are 3.0% more productive and the firm gets 3.0% more output?  The firm does not care.  Its workers have earned those higher wages.  In the last year compensation rose 1.4%, but in recent quarters growth has picked up.  We expect compensation to increase 3.5% in 2018.

Won’t the faster 3.5% growth rate in compensation lead to higher inflation?  Not really because of the pickup in productivity.  We expect compensation to increase 3.5% next year, but we also expect productivity to rise by 2.0%.  Thus, the increase in labor costs adjusted for the increase in productivity is 1.5%.  Economists have a name for this concept and that is “unit labor costs”.  This is the best measure of the upward pressure on inflation caused by rising labor costs.  An increase in unit labor costs of 1.5% is perfectly consistent with the Fed’s 2.0% inflation target.

Thus, in coming years we expect GDP growth to match its potential growth rate of 2.8%.  That allows worker compensation to grow more quickly and raises our standard of living, but it is not inflationary because of the largely offsetting increase in productivity (2.0%).

As we see it such a scenario could extend the expansion well beyond 2020.  We have often said that the Fed will raise the funds rate to a “neutral” rate of 3.0% by mid-2020.  But with the economy expanding at a rate in line with – but not exceeding – its potential growth rate, and inflation steady at the 2.0% mark, it will have no incentive to push rates any higher.  In the past the Fed has needed to raise the funds rate about  2.0% above the “neutral” to trigger a recession – or in this case about 5.0%.

Given this environment, there is no reason to think that this expansion will end in 2020.  It could go well beyond that date.  2022?  2025?  Sounds crazy, but is it?

Stephen D. Slifer


Charleston, S.C.

Global Growth on the Rise, Inflation Not Far Behind

October 27, 2017

U.S. third quarter GDP growth came in at 3.0% which was higher than expected despite the negative impact on consumer spending and housing from hurricanes Harvey and Irma.  This fits a recent pattern of stronger-than-expected GDP growth from virtually every corner of the globe which is almost certain to spawn a pickup in inflation.  If it begins to accelerate the markets will soon fear higher interest rates by the Federal Reserve, the European Central Bank, and the Bank of Japan.

With respect to GDP growth, we noted in an earlier column that the IMF recently raised its global GDP growth rate for 2018 to 3.7% which would be the fastest rate since 2011.  It boosted European growth for 2017 to 2.1% the fastest rate since 2010.  Growth rates for Germany, Italy, Spain and France were all revised higher.  GDP growth in China this year was boosted 0.2% to 6.8%.  Latin America GDP growth should climb to 1.2% for 2017 and 1.9% 2018 which is in stark contrast to the 0.9% decline for 2016.  This is because growth in Brazil is expected to turn upwards after a long two-year recession.  Growth is turning upward in many oil-exporting countries like Canada and Nigeria as  oil prices rise.  The reasons vary depending upon exactly where you look, but growth in virtually every region of the globe is turning upwards.

As growth has accelerated, stock markets around the world are surging.  The S&P 500 index hits a record high every few days.  It has risen 20% during the past year.  Some analysts believe that reflects an expectation that President Trump’s tax cuts will boost GDP growth and earnings in the quarters and years ahead.  While that expectation undoubtedly has contributed to the upswing, there is more to it.

Stock markets around the globe are doing the same thing.  The MSCI World Stock index has risen 23% in the past year.  It includes an increase of 17% in the Euro Stoxx 50, a 21% increase in the German DAX, a 28% increase in the Nikkei 225 index in Japan, a 25% increase in the Hang Seng index in Hong Kong, and a 27% runup in emerging market stocks.  It is a powerful move and it is everywhere.  President Trump’s proposed tax cuts cannot explain rising stock markets in every region.

Until recently GDP growth in the U.S. was picking up, but the rest of the world was limping along.  That is no longer the case.  Given a faster pace of global growth, a pickup in inflation cannot be far behind.

In the U.S. the inflation rate has consistently been lower than expected for the past several years.  The Federal Reserve still believes that the inflation rate will eventually reach its 2.0% objective.  Our sense is that the “eventual” pickup in inflation has arrived.  Consider the following:

First, wages have begun to accelerate.  They were stuck at the 2.0% mark for several years, but they have picked up to a 2.9% pace in the past year and in the last three months have accelerated to an even more impressive 4.3% pace.  Something seems different.  Given that labor costs represent two-third of a firm’s overall costs, a pickup in wages will likely lead to higher prices.

Second, manufacturers and non-manufacturing firms are paying significantly higher prices for their raw materials.  The Institute for Supply Management conducts a monthly survey of conditions in both manufacturing and non-manufacturing firms.  Shown below is the price chart for manufacturing firms.  The non-manufacturing chart is similar.  Prices are rising at the fastest pace since 2011.  And it is not just oil.  All 18 commodity groups were on the rise. We believe that the pickup in global GDP growth is pushing commodity prices higher.

The upward pressure on crude oil prices has been evident in recent months.  In late June crude was at about $42 per barrel.  Today it is $10 higher at about $52.  We are convinced this reflects the pickup in global growth that we have described.

Third, an acute shortage of available rental properties is causing rents to rise by 3.3%.  That is important because shelter represents about one-third of the entire CPI.

Fourth, the downward bias to inflation caused by a price war amongst wireless phone providers and a moderation in the price increases for prescription drugs has come to a halt.

Given all the above, it is abundantly clear that the long-awaited pickup in inflation has arrived.  We expect the core CPI to rise 1.7% this year but quicken to a 2.3% pace in 2018.

Given all the factors cited above, one might wonder why we anticipate only a moderate pickup in inflation.  The answer is basically technology.  When Amazon buys Whole Foods and prices on many items fall 20%, it lowers the inflation rate.  it appears to us that technological advances are keeping the inflation rate in check.

If the pickup in inflation is moderate the Fed will not be alarmed.  It has indicated its intent to let inflation run faster than its 2.0% objective for a while to counter the extended period when inflation was so low.  We think the pickup in inflation will be moderate.  We will see.

Stephen Slifer


Charleston, S.C.

The Fed Gets Criticized – But It Doesn’t Deserve It

October 20, 2017

A recent Wall Street Journal editorial blamed the Fed for “anticipating little growth impact from Mr. Trump’s deregulation or tax reform”.  It claimed that “new leadership at the Fed will be required because the current leadership believes that tax cuts are not pro-growth and the U.S. is fated to a long era of secular stagnation”.  I have great respect for the Journal, but in this this case its criticism is way off base.

For the record, I have a bias.  I began my career at the Board of Governors of the Federal Reserve many years ago.  I have found Fed officials – Fed Governors, Bank presidents, and staffers – to be some of the smartest, hardest working, and dedicated individuals I have ever had the pleasure to work with.  When something goes wrong the Fed always gets the blame.  When things go right it never gets any credit.  That comes with the territory.  But often the endless criticism is unwarranted.

The Fed is not to blame for our current slow-growth pace of economic activity.  It cannot control an Administration and Congress that have successfully managed to achieve fiscal gridlock and demonstrated an inability to produce policy changes that might enable the economy to grow faster.  It cannot control consumers who were burned so badly during the recession that they have chosen to be frugal and not spend more than their income.  It cannot control business leaders’ unwillingness to invest in a regulatory environment that is the most stifling in our history.  It cannot control the pace of technological advancement which has, in fact, left some workers behind.  Today’s economy is cranking out lots of new jobs.  But they are often highly skilled positions and some workers simply do not have the requisite skills.  Through a combination of education and apprenticeship programs this issue can be resolved, but it takes time.

It is hard to imagine what the Journal would have liked the Fed to do during the past eight years.  It lowered the federal funds rate to a record low level of 0% and kept it there for six years.  It adopted an innovative bond-buying strategy that flooded the banking system with reserves that could be lent to consumers and businesses.

Some might argue that the Fed kept interest rates too low for too long, and that the “quantitative easing” did not work.  But somehow that combination has produced an expansion that has endured for eight years and four months and is showing no sign of ending any time soon.  In June 2019 it will go into the history books as the longest expansion on record.  Sure, the pace of expansion has been slower than in other business cycles.  But what exactly could the Fed have done to produce faster growth?  The Fed is a very powerful institution but it only has so many policy levers to manipulate.  It can control monetary policy, but Congress also plays a role in determining the pace of economic activity via fiscal policy and Congress has failed miserably.  The Fed does not control fiscal policy.

Congress has created a regulatory environment that is so stifling business leaders have for years chosen not to invest in new buildings and technology.  It is not because corporate America does not have the cash.  It does.  It is not because businesses are not making money.  They are.  It is because businesses are stymied by more than 90,000 pages of often unnecessary, overlapping, and confusing regulations.  Rather than invest in the United States, corporate leaders would rather invest overseas where the regulatory environment is less stifling, use their cash to buy back outstanding shares of stock, or return the money to stockholders in the form of increased dividend payments.  The Fed did not do that.

To his credit President Trump is trying to eliminate many unnecessary regulations and create a more business friendly regulatory environment.  He has proposed sizable corporate tax cuts, immediate deductions for corporate spending on equipment, and a route by which corporations can return to the United States profits currently locked overseas at a favorable 10% tax rate rather than today’s prevailing 35% rate.  If Congress can actually pass such legislation it would unleash a wave of investment spending as an estimated $4 trillion of corporate profits find their way back to the United States and as corporate executives, filled with new found optimism, direct more of their current profits towards the latest technology and equipment.  Such spending would, in fact, boost potential GDP growth towards the 3.0% mark that President Trump has suggested.

Some may suggest that with the economy already at full employment this accelerated pace of GDP growth would be highly inflationary which would cause the Fed to raise interest rates more rapidly and higher than the Fed currently envisions.  But that is not necessarily the case. If faster growth is accomplished via enhanced investment spending, then potential GDP growth – the economy’s non-inflationary speed limit – would climb from 1.8% or so today to something close to the 3.0% mark.  That speed limit can be calculated as the sum of the growth rates for the labor force and productivity.  Today the labor force is growing by 0.8% and productivity is climbing by about 1.0%.  Add them up and today’s potential growth rate is about 1.8%.  But a faster pace of investment spending will boost productivity growth to perhaps a 2.0% pace.  Now the arithmetic becomes 0.8% growth in the labor force plus 2.0% productivity growth or 2.8% potential growth – 1.0% higher than today and close to Trump’s estimate of 3.0%.

How does the Fed respond to all of this?  Over the next three years the Fed has said it will gradually raise the funds rate from 1.0% today to the 2.75- 3.0% range that it believes represents a “neutral” level – one at which it is neither stimulating economic growth nor trying to slow it down. At the same time it will very gradually shrink its portfolio of U.S. Treasury and mortgage backed securities from $4.5 trillion today to $1.5-2.0 trillion which it believes will be the minimum level required to effectively implement monetary policy.  It will not matter much whether current Fed Chair Yellen, current Fed Governor Jerome Powell, past Fed Governor Kevin Warsh, or Stanford professor John Taylor is the next Fed Chair.  These people all know what the Fed needs to do over the next several years.  Differences between them vary only at the margin.

As for the Journal’s criticism that by currently projecting GDP growth of only about 2.0% over the next several years the Fed is somehow anti faster growth and would respond by vigorously raising interest rates if growth should accelerate, the Journal does not understand how those forecasts are produced.  The Fed must assume that current fiscal current policy prevails over the forecast period.  It cannot incorporate tax cuts and deregulation into its forecasts until they are Implemented.  Hence, it is currently projecting a a relatively slow growth environment for the next three years.  But if favorable tax and regulatory policy changes are implemented, the Fed will undoubtedly raise its forecasts.  Every one of the four likely candidates for the Fed Chair are well aware of the concept of “potential growth”.  If the economy’s non-inflationary potential growth rate rises, its GDP forecasts will climb as well.  And there will be no need for the Fed to vigorously raise interest rates to combat faster potential growth because it is being produced by additional investment, a faster growth rate for productivity, and is thereby noninflationary.  The economy will be able to sustain something close to 3.0% GDP growth and still achieve the Fed’s 2.0% inflation target with a funds rate around the 3.0% mark.

The Journal has it wrong.  The Fed is not opposed to faster growth.  It simply wants to see Congress do what is necessary to raise the economy’s speed it.  Once that happens its growth forecasts will rise and it will have no reason to combat it.

Stephen D. Slifer


Charleston, S.C.

Growth on the Upswing – It’s Not Just U.S.

October 13, 2017

While hurricanes will dampen third quarter GDP growth in the U.S, the pace of expansion elsewhere has been accelerating.  Undaunted by slower near-term growth, U.S. investors are convinced that growth will rebound in the quarters ahead and that economic activity elsewhere around the globe is on the upswing.  If non-U.S. growth accelerates, U.S. growth will get a lift as exports climb.  And if President Trump can deliver on tax reform – particularly for corporate taxes – the investment portion of GDP will accelerate as well.

In the United States, the S&P 500 climbs to a new record-high level every few days.  Indeed, it has risen 20% since this time last year.  And this is not just statistical noise.  There are solid reasons why corporate profits and the S&P should continue to climb.

Some of that upswing reflects an expectation that President Trump will be able to deliver on his campaign promise of tax reform.  The corporate world is getting particularly excited about a possible cut in the corporate tax rate from 35% to 20%, the immediate expensing of expenditures on equipment, and the re-patriation of overseas earnings at a favorable 10% tax rate.  Nobody knows what the final legislation might look like.  Our expectation is that a modest package will pass, and that it will stimulate GDP growth from 2.3% or so this year to 2.8% in 2018, and boost our economic speed limit from 2.0% today to 2.8% by the end of this decade.

Elsewhere around the globe growth is accelerating.  The IMF, for example, just raised its global GDP growth rates for 2017 and 2018 by 0.1% apiece to 3.6% and 3.7%, respectively.  The upward revisions may not seem impressive, but just keep in mind that these are the fastest global GDP growth rates since 2011.

The IMF lowered its projected rate of expansion for the U.S. by 0.1% and 0.2% for 2017 and 2018.  It had projected a considerable amount of fiscal stimulus coming from Trump’s tax cuts but, given the Administration’s current difficulty in passing legislation, they have lowered their growth expectations accordingly.  We never expected a lot of stimulus so we have not trimmed our forecasts.  Given that the IMF has trimmed its projected U.S. growth rates but raised global growth, growth elsewhere in the world must be looking better.  So where might that be?

Europe.  The IMF raised its projected GDP growth rates for Europe for 2017 and 2018 by 0.4% and 0.3%, respectively.  Its forecasts for Germany, Italy, Spain, and France were all revised higher.  European growth in 2017 is expected to be 2.1% which is the fastest growth rate since 2010 with roughly comparable growth likely for next year.  That may seem like relatively subdued growth, but potential GDP growth in Europe is only about 1.5%.  With that in mind, a couple of years of 2.0% growth is impressive.  Remember, this is a region that weathered the financial crises in Greece, Ireland, Portugal and Spain in the early part of this decade.  It survived elections earlier this year this where populist movements, particularly in France but also in the Netherlands and Germany, threatened to turn the political scene topsy-turvy and reduce the future pace of economic expansion.

China.  The IMF raised the 2017-18 forecasts for China, the world’s second largest economy, by 0.2% and 0.3%, respectively, to 6.8% and 6.5%.  GDP growth in China had been growing at a double-digit pace for years and peaked in 2007 at 14.2%.  Then government leaders decided to transform the industrial-based economy to a more consumer driven model, growth slowed to about 6.5%, and threatened to continue its slide to the 6.0% mark.  But growth in recent quarters squashed those earlier 6.0% forecasts and now GDP growth seems to be stabilizing at about 6.5%.

Latin America.  The October revisions to the IMF’s forecasts for Latin America for 2017 and 2018 were negligible with significant upward revisions to Brazil and Mexico largely offset by a darker outlook for Venezuela where growth is projected to fall 12.0% his year.   But look at the projected growth rates for the region of 1.2% and 1.9% for 2017 and 2018.  Those growth rates are not impressive, but they are in sharp contrast to 0.1% growth in 2015 and negative growth of 0.9% in 2016.  Growth in those years reflect the two-year-long economic recession in Brazil, as the Petrobras corruption scandal brought down President Dilma Rousseff, created a political vacuum, and snared dozens of high-level business people.  Reforms designed to ensure fiscal stability appear to have restored confidence and, hopefully, allow the country to achieve modest growth of 0.7% growth in 2017 and 1.5% next year.

The point is that GDP growth around the globe is on the rise and likely to produce the fastest global rate of expansion since 2011.  The reasons for the improvement vary by region.  In the U.S. it appears to be reflect an expectation that individual and corporate tax cuts will boost growth in the years ahead.   In Europe it is the cessation of a series of financial crises and a continuation of ultra-easy monetary policy by the European Central Bank.  In China it seems to reflect the fact that expected GDP growth of 6.0% in 2017 and 2018 was too pessimistic.  And in Latin America the two-year-long recession in Brazil appears to have finally come to an end.  While the reasons vary, the reality is that GDP growth in countries around the world is in sync and re-accelerating.  No wonder that global investor confidence is so high.  The MSCI All World Index has risen 20% in the past 12 months.  GDP growth seems to be picking up almost everywhere around the globe.  It is not just U.S.

Stephen Slifer


Charleston, S.C.