Tuesday, 26 of September of 2017

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Category » Commentary for the Week

Can Women Solve the Problem?

July 14, 2017

The economy’s speed limit has slipped from 3.5% during the 1990’s to 1.8% today.  That growth rate can be estimated by adding the growth rate of the labor force to the growth rate of productivity.  We have long argued that with so many baby boomers retiring that little could be done to stimulate growth in the labor force during the next decade.  Hence, the only viable way to boost potential growth was via increased corporate investment which would boost the growth rate of productivity.  But in a recent speech Fed Chair Yellen suggested that the U.S. could adopt policies designed to encourage women to work, boost labor force growth, and lift potential GDP growth in the United States.  Could potential growth rebound to the 3.5% pace seen in the 1990’s?  Perhaps.

Potential GDP growth represents the sum of two numbers – the growth rate of the labor force and the growth rate of productivity.   In the 1990’s the labor force was zipping along at 1.5%, productivity growth was 2.0%.  Add them up and the economy’s potential growth rate was 3.5%.  Today labor force growth has slipped to 0.8% while productivity has slowed to 1.0%.  Thus, potential growth today is 1.8%.  But it does not have to be 1.8% forever.  Policy measures can help.

With respect to the labor force side of the equation, when baby boomers retire they drop out of the labor force.  Given that the boomers will continue to retire for another decade we have argued that there is little chance for a pickup in the growth rate of the labor force.  Janet Yellen disagrees.

Citing a Cornell University study released in 2013 by Francine Blau and Lawrence Kahn, Yellen pointed out that between 1990 and 2010 the participation rate for women rose dramatically throughout Europe, but in the U.S. it was essentially unchanged.  For example, the non-U.S. average climbed from 67% in 1990 to 79.5%.  Furthermore, the pickup in female participation was widespread – Canada, Australia, France, Germany, Italy, and Spain all experienced a double-digit gain. Meanwhile, in the U.S. the female participation rate edged upward from 74% to 75.2%.  The survey included 22 countries.  In 1990 the U.S. ranked #6.  By 2010, it had dropped to a shocking #17.  Participation rates elsewhere not only caught up with the U.S., they surpassed it.

This result was no accident.  It came about because of family friendly policies designed specifically to incorporate women into the labor force.  Some women choose to drop out of the labor force to raise their offspring.  But others would like to work but the financial strains of doing so prevent that from happening.  Those women represent untapped potential GDP growth.

  1. Paid maternity leave.  In the U.S. employers must provide 12 weeks of unpaid maternity leave.  Elsewhere, maternity benefits were longer and usually paid.  During the survey period outside the U.S. these entitlements rose from 37.2 weeks to 57.3 weeks.   Having the right to get their job back almost certainly raises the job prospects who those women who leave the labor force during childbirth.  But several questions arise.  Does offering such a benefit encourage women to remain out of the work force longer than they otherwise would?  Does the employer benefit?  During leave time the employers must pay the person on leave as well as her replacement.  This raises the expected cost of employing women of childbearing age.
  2. Right to work part time. During the survey period many European countries adopted policies that give women the right to demand a change to a part-time work schedule.  Clearly this is a benefit to women.  But would employers be less willing to hire in a woman in the first place given that at some point down the road she could demand such a benefit?
  3. Publicly provided child care services. Such a benefit would be attractive to women because it reduces the cost of working outside the home.  And, unlike the part time benefit, it would not increase the employer’s cost of hiring women for part time positions.

Yellen noted that “policy differences – in particular, the expansion of paid leave following childbirth, steps to improve the availability and affordability of childcare, and increased availability of part-time work – go a long way toward explaining the divergence between advanced economies.”  And, “if the United States had policies in place such as those employed in many European countries, female labor force participation could be as high as 82%.”

But will higher labor force participation rates among women boost potential GDP?  Ms. Yellen thinks so. A Fed study concluded that between 1948 and 1990 the rise of female participation contributed about 0.5% per year to the potential growth rate of real gross domestic product.

So what might happen to potential GDP growth?  Suppose for a moment that the policies described above by Fed Chair Yellen boost labor force growth by 0.5%.  Let’s further assume that the combination of Trump’s proposed corporate tax cuts, repatriation of earnings, and a reduced regulatory burden boost productivity growth by 1.0% (which we have described in previous articles).  These policy changes would raise potential GDP growth by 1.5% from 1.8% currently to 3.3% or so.  That puts it back close to the glory decade of the 1990’s.  The economy may not be able to grow quickly today, but it can surely resume vigorous growth if our policy makers in Washington can get with the program.

Stephen D. Slifer


Charleston, S.C.

Gathering Momentum

July 7, 2017

GDP growth in the second quarter now seems likely to be 3.0% rather the 2.5% pace we had been projecting earlier.  This upward revision came about because of a strong employment report for June combined with upward revisions to the data for April and May.  Thus, the economy appears to have rebounded nicely from its anemic 1.4% first quarter pace.  Growth of this magnitude is sure to keep the Fed on track for another rate hike later this year, and the initial reduction in its holdings of U.S. Treasury and mortgage-backed securities in December.

For an economist, the single most important economic report for any given month is the employment report.  Not only do we discover the number of new jobs created each month, we learn how long people worked and how much they were paid.  This allows us to make reasonable estimates of GDP growth for the quarter, the monthly changes in industrial production and personal income, and refine our estimates of a host of other economic indicators.

As employment reports go, the June report was a barn-burner.  First of all employment for June climbed by 222 thousand.  Upward revisions to April and May data added another 47 jobs.  In the past three months employment has risen a solid 194 thousand.  Compare that to an average increase last year of 187 thousand.   At the very least employment gains are holding steady which is difficult to achieve given the apparent tightness in the labor market.

To satisfy demand for any given month employers always have the option of hiring additional workers or working existing employees slightly longer hours.  And, indeed, it appears that they used both options in June.  The workweek rose 0.1 hour to 34.5 hours.  That may not sound like much, but a 0.1 hour increase in the workweek represents a gain of 0.3%.  A 0.3% increase in private sector employment works out to 360 thousand.  In other words, if employers had been able to find the requisite number of bodies, employment in June would have increase by 582 thousand rather than the reported increase of 222 thousand.  That certainly creates a far more robust impression of strength in the labor market in June.  Keep in mind that the workweek for April revised upwards by 0.1 hour which has a similar effect and further enhances the outlook for GDP growth in the second quarter.

If we know how many people are working and how many hours they worked, we should be able to make a reasonable estimate of how many goods and services they produced.  That is exactly what GDP is trying to measure.    Given the upwards revisions to employment for every month in the second quarter as well as the upward revision to hours worked in April and the increase in June, the aggregate hours index – which combiners the employment and hours worked date — rose by 3.0% in the second quarter.  If workers are more (or less) productive, than the GDP increase for the quarter can be larger (or smaller) than that 3.0%.  Productivity was unchanged in the first quarter, but has risen 1.2% in the past year.  If productivity rises at all, second quarter GDP growth will eclipse the 3.0% mark.  If, however, it falls – which is always possible in any given quarter – you get the opposite result.  The first look at second quarter GDP will be released on Friday morning, July 28.   Given all of the above we have lifted our second quarter forecast from 2.5% to 3.0%.

If you are sitting in the Fed’s seat, you may have been disturbed by the anemic 1.4% growth rate registered in the first quarter.  But a rebound to a 3.0% pace in the second quarter should give you confidence that the first quarter result was an aberration.  That would imply GDP growth of 2.2% in the first half of the year versus a 2.0% increase last year.  While that does not provide a compelling case that growth is quickening (which happens to be our contention) it is, at the very least, continuing at a respectable pace.

We remain convinced that Fed officials will opt for one additional rate hike this year probably in September, which would boost the funds rate to 1.25%.  It could then follow that up with the first of its planned reductions of $6.0 billion in U.S. Treasury securities and $4.0 billion of mortgage-backed securities at its December gathering.

Stephen Slifer


Charleston, S.C.

The Pleasant Inflation Surprise — Will It Last?

June 30, 2017

At midyear it is useful to reflect on how the economy and inflation are tracking relative to what had been expected at the end of last year.  The biggest surprise, for us, is that the inflation rate did not accelerate in the first half of this year.    What’s going on?  Should the Fed postpone further rate hikes until the inflation rate begins to climb?  We believe that the failure of the inflation to climb is attributable to two separate one-off events the positive impact of which will prove to be transitory.  As a result, the Fed is justified in continuing on its path of gradual increases in the funds rate.

In our year ahead forecast in December we projected that the “core” inflation rate (i.e., excluding volatile food and energy prices), would rise from 2.3% last year to 2.7% in 2017.  The labor market was tight which seemed likely to push wages higher and lift inflation in the process.  The shortage of available homes and apartments was steadily lifting rents at a 3.5% pace.  And the cost of medical care was surging.   Instead, the core rate has backtracked and actually slowed to 1.7% in the first five months of this year.  Two factors are largely responsible for this surprising behavior.

First, a price war has broken out amongst the nation’s wireless providers and in the past year cell phone prices have plunged 12.5%.  A drop of that magnitude has shaved 0.2% off the core inflation rate during that period of time.  Mobile phone prices have fallen for eleven months in a row capped by a whopping 7.0% decline in March alone.  This means that the core rate today would be 1.9% rather than 1.7% in the absence of the cell phone price war.

Competition in this industry is ferocious and will get even more intense now that the federal government has auctioned off rights to more wireless spectrum to new entrants such as television providers Comcast and the Dish Network.  Spectrum, or airwaves, is what these companies use to deliver wireless calls.  The price wars began in April of last year when major carriers such as AT&T, Sprint and T-Mobile slashed rates on their unlimited calling plans.  The nation’s largest provider, Verizon, joined the fray earlier this year.  The last time this happened was in 1999-2000.  Eventually the price wars ended and prices stabilized for more than a decade.  Thus, the current drop in cell phone prices will prove to be transitory.

At the same time prescription drug prices have declined since the election.  In October of last year, prior to the election, prices were rising at a 7.0% pace.  Since the election prescription drug prices have fallen at a 1.0% rate.  The chart below tracks the year-over-year change in this series so the most recent price declines are not fully reflected.  During the election campaign Trump promised to drive down drug prices.  He talked about allowing consumers to import prescription drug medicines from abroad, and having Medicare negotiate prices directly with pharmaceutical companies.  His success thus far seems to stem less from legislation than fear of being called out by the president for price gouging.  Last year EpiPen maker Mylan and Valeant Pharmaceuticals experienced public outrage over dramatic price increases.  A Trump tweet could in a nanosecond put a company in his crosshairs with potentially damaging consequences to both its reputation and stock price.  One may not approve of the method, but intimidation seems to be accomplishing his objective.

So what does the Fed do now?  We believe it will view these recent price declines as temporary and continue on its slow but steady trajectory toward higher interest rates.  Remember, Fed policy is determined not only by inflation but also by the pace of economic activity as well.

As we see it the economy seems to be gathering a bit of momentum. After stumbling to a 1.4% pace in the first quarter GDP growth seems poised to rebound to a 2.5% pace in the second quarter with similar growth rates likely in the second half of the year.  GDP growth in Europe and Asia seems to be quickening as well.  The unemployment rate has dipped from 4.7% at the end of last year to 4.3% which is below almost anybody’s estimate of the full employment threshold.  Wage pressures are sure to intensify and, in the process, put upward pressure on the inflation rate.  There continues to be a shortage of available housing which is boosting rents.  That is not going away any time soon.  On balance the economy seems likely to generate upward pressure on the inflation rate later this year and in 2018.

The recent prices declines in wireless services and drug prices will not continue, but they are not going to rebound either.  In the case of wireless, following the extreme price drop in 1999-2000 prices leveled off for more than a decade.  Competitive pressure in the industry prevented prices from rebounding.

With respect to drug prices Trump has intimidated the entire pharmaceutical industry and it is being forced to behave.  Going forward prices will climb slowly but they are starting from a lower base.  In December we had expected the core CPI to rise 2.7% in both 2017 and 2018.  Today we expect that core rate to increase 2.0% this year and 2.5% in 2018.  The direction is the same, but prices will not rise as quickly as had been anticipated earlier.  Either way, the core rate is likely to exceed the Fed’s 2.0% inflation target by the end of next year which should keep the Fed on its path of gradual increases in the funds rate.  It still has a long ways to go before the funds rate reaches a “neutral” rate of about 3.0%, a level which it does not expect to reach until 2020.  Inflation may be better behaved than the Fed thought, but there is no reason to alter its current path to neutrality.  Higher rates will not begin to bite for several more years.

Stephen Slifer


Charleston, S.C.

The Debt Limit is a Sham

June 23, 2017

Here we go again.  Every year we go through the same useless exercise of raising the debt limit.  First, Congress votes to spend money.  Then, the Treasury tries to pay its bills but eventually bumps up against a constraint on how much debt it can issue.  It announces that the “debt limit” must be raised so that it can continue to pay its bills.   Finally, Congress is horrified!  It declares that expenditures must be slashed to curtail this runaway spending!

But wait a minute!  Congress authorized that spending when it passed its budget for that year.  In that process Congress authorizes each government agency to spend a certain amount of money.  If Congress believes that government spending is excessive – and it is – it should use the budget process to rein it in.  Congress should not vote to spend money, and then slap the Treasury’s hands when it is forced to borrow to finance the previously-authorized spending.  That makes no sense.  The debt limit is a superfluous piece of legislation that chews up endless days of negotiation and wasted time.  In the end the debt limit is raised.  Every year.  And it will be raised again this year.

The most important thing to know about the budget process is that when Congress approves a budget that will result in a deficit of, say, $500 billion, the Treasury must issue an additional $500 billion of debt to finance that deficit.  Thus, debt outstanding is cumulative.  It increases every single year that the U.S. government incurs a budget deficit – which is to say that it increases annually.  For the current fiscal year the Treasury faces an estimated budget deficit of $585 billion and will issue that amount of additional debt.  The Treasury estimates that it will reach the statutory debt limit by early September.

Each month, in addition to its regular bills, the Treasury must pay off maturing securities and the interest on the remaining debt outstanding.  If it cannot do so, it will default on its debt obligations.  That has never happened.  Why?  Because a default by the Treasury would be unthinkable.  If it becomes unable to pay its debts the Treasury would have to pay a higher interest rate on future debt because investors – both foreign and domestic — would demand higher interest rates given the possibility of default.  Confidence in U.S. Treasury debt as a safe haven in times of uncertainty would be shaken.  Foreign investors could reduce their willingness to buy U.S. debt.

Because the president and members of Congress are well aware of these potential adverse consequences the Treasury is not going to default.  Congress will raise the debt limit in the nick of time.

Increasing the debt limit has become an almost annual ritual.  It has been raised 72 times since 1960, of which 18 occurred between 2001 and 2017 and the Treasury has never defaulted on its debt.  And it is not going to happen this year.  Having said that, negotiations will continue right up to the last minute and make us all nervous.  Nancy Pelosi and the House Democrats say they will not increase the debt ceiling to finance tax cuts for the rich.  Senate Republicans want a vote on the debt ceiling in July, but that comes at the exact same time that it wants a vote on its proposed health care legislation.  In September the administration would like to turn its attention to its proposed cuts in individual and corporate income taxes.  These issues could become politically entangled.  We do not know exactly how this will play out but, most likely, at the last possible moment there will be a temporary increase in the debt limit.

The bottom line is, be prepared for some scary headlines during the next two months about a possible default by the Treasury on its debt obligations and a potential government shutdown.  The stock market could get hit.  Consumer confidence might decline.  But rest assured the Treasury is not going to default on its obligations and, once the debt limit is raised, the potentially nasty near term consequences will be quickly reversed.

We wholeheartedly support the notion of cutbacks in government spending in order to shrink future budget deficits which are projected to climb from $585 billion today to $1.4 trillion by 2026.  But Congress should have the courage to make the required spending cuts during the budget process.  Then eliminate the debt ceiling requirement entirely.  It is not only distracting, it is unnecessary.  It does nothing to actually constrain government spending.

Stephen Slifer


Charleston, S.C.

Fed Policy Not “Neutral” until 2020 – or Later

June 16, 2019

The Federal Reserve’s Open Market Committee met this week and, as expected, raised the funds rate to the 1.0% mark.  It continues to expect a slow but steady pace of additional rate hikes over the next several years, eventually pushing the funds rate to 3.0% sometime in the first half of 2020.  That part of the Fed’s “normalization” process has not changed.  But there is a necessary second step.  Following the Fed’s bond buying binge between October 2008 and October 2014, its balance sheet skyrocketed from $900 billion to its current level of $4.4 trillion.  It needs to shrink its portfolio dramatically and, at its meeting earlier this month, it laid out a game plan for how it intends to proceed.  It will be a very gradual, lengthy process which will drag on well into the 2020’s.  The Fed is not going to trigger a recession by shrinking its balance sheet too quickly.

As the Fed purchased its combination of U.S. Treasury and mortgage-backed securities, it flooded the banking system with surplus reserves which skyrocketed from about $0.1 billion in late 2008 to $2.25 trillion currently.  Because those funds represent the ability of the banking system to lend to consumers and businesses, they need to be eliminated to prevent a potentially inflationary spending spree at some point down the road.  The Fed will accomplish that objective by shrinking its balance sheet.  But how will it go about that?

Basically, the Fed has two options.  First, it could go into the market and sell some of its current holdings of securities.  Doing so would shrink its balance sheet quickly.  But the Fed is concerned that such action would be disruptive to the bond market and could push long-term interest rates sharply higher which would pose a risk to the ongoing expansion. That is not the desired outcome.

Second, it could accomplish the same objective by running off some of its holdings of U.S. Treasury and mortgage-backed securities by simply not replacing them when they mature.  But given that the Fed’s portfolio has an average duration of almost ten years, this will be a very slow process.

Once this program begins later this year (presumably at its early November meeting) it will initially run off $6 billion of U.S. Treasury securities per month for the first three months.  At the same time it will run off $4 billion of its holdings of U.S. agency and mortgage-backed securities.  Thus, at the beginning it will allow a total of $10 billion of its security holdings to run off for the first three months.  It then plans to increase that total amount by $10 billion every three months until it reaches a cap of $50 billion per month.  It would reach that limit at the end of its first year of implementation.  Doing the math, it means that the Fed’s portfolio will have shrunk to the desired level by the end of 2022.

Keep in mind that the Fed does not need to shrink its balance sheet back to the $900 billion level that existed prior to the recession.  It wants its portfolio to grow roughly in line with growth in nominal GDP, or about 4.0% annually.  That means that the desired balance sheet level at the end of this year will be about $1.3 trillion and it will grow at roughly a 4.0% pace every year thereafter to $1.6 trillion by the end of 2022.

If the Fed does what it is suggesting, the Fed’s balance sheet will have shrink by $2.8 trillion from $4.4 trillion currently to the $1.6 trillion target level during the next five years.  But that is not going to happen.

According to data reported by the Fed, it has only $1.5 trillion of securities maturing within the next five years, and an additional $0.4 trillion maturing between 5-10 years.  All the rest of its security holdings have a maturity date in excess of ten years.  Thus, more realistically, Fed holdings will not return to their target level until 2031.

The point is that the Fed will have a two-pronged approach towards “neutralizing” monetary policy.  First, it intends to use the funds rate as its primary policy tool.  The funds rate should reach its so-called “neutral” level by early 2020.  Second, it will gradually return its balance sheet to a desired level.  The Fed says that should happen within five years.  But given the maturity schedule of the securities held in its portfolio that process may not be complete until 14 years from now.  Thus, the Fed has made it abundantly clear that it is unwilling to let its policy become the catalyst for the next recession – at least not in the near term.  If inflation heats up and the Fed needs to cool the economy, its policy approach will change, but that is not going to happen any time soon.

Stephen Slifer


Charleston, S.C.

Steadily Tightening Labor Market Will Boost Inflation

June 9, 2017

Most economists believe the labor market is at full employment. However, it is at least possible that it is not yet there. But, however one wants to measure it, it is close and it is steadily tightening with each passing month. Hourly wages have risen less rapidly than expected thus far, but that is likely to change in the months ahead. As that transpires, there should be additional upward pressure on the inflation rate.

At 4.3% the unemployment rate is below virtually every economist’s estimate of “full employment” which is the point at which everyone who wants a job presumably has one. The Fed believes full employment is between 4.7-5.0%. But full employment is unobservable. Economists have to estimate it. Could it be lower? Sure. As low as 4.0%? It is a long shot, but yes. After all the unemployment rate was at the 4% mark for a long while prior to the 2001 recession with only moderate upward pressure on the core inflation rate.

In the past Fed Chair Yellen suggested that the labor market was not at full employment because there were still a large number of “underemployed” workers. There are two types of such workers. First, there are “discouraged workers”. These people would like to have a job but have been out of work so long they have given up looking. As one might expect the number of discouraged workers has been steadily falling and is now essentially where it was prior to the recession.

Second, additional workers are currently employed part time but would like full time employment. This series has also been steadily declining but remains somewhat above where it was going into the recession.

Yellen’s preferred measure of unemployment includes both unemployed and underemployed workers. That rate is currently at 8.4% which is lower than the 8.8% it was going into the 2007-2008 recession. However, going into the 2001 recession it was 7.4%. Is the economy at full employment using this broader measure of employment? Maybe. But one can certainly make a plausible case that the full employment threshold for this measure is lower than its current level of 8.4%.

The bottom line is that there is no “magic level” of full employment. Economists make guesses. Most believe the economy is already at full employment, but it is possible that is not the case. However, it is close and getting closer with each passing month.

Economists are so concerned with full employment because, once attained, employers will have increasing difficulty finding an adequate supply of workers. They will ask existing employees to work longer hours. They will require them to work overtime. Eventually they will offer higher wages and/or more attractive benefits to attract the workers they need. But those actions boost labor costs and, eventually, put upward pressure on the inflation rate. All of that is already happening to some degree.

The number of job openings today exceeds the number of hires. That has never happened before. Jobs are available but they remain unfilled. Why? Workers may not have the appropriate skills. Many may not be able to pass drug tests. Others may be content to receive welfare benefits and are unwilling to work. Whatever the case, jobs are available and employers are unable to fill them.

The nonfarm workweek is already quite long. There is little room for employers to further lengthen the workweek to boost output. They need bodies.

That is particularly true in the manufacturing sector where at 40.7 hours the workweek is far longer than the 40.0 hour workweek that prevailed prior to the recession. Factory officials may be asking their employees to work longer hours because they cannot find enough qualified workers.

Overtime hours are also quite high. Factory owners are running out of options to boost output. They need more workers and will have to pay up to get them.

As labor demand intensifies one should expect wage rates to accelerate and that is the case. They had been climbing steadily at a 2.0% rate a few years ago, but have recently climbed into a range from 2.5-2.8%.

After a first quarter slump the economy appears to be re-accelerating. That will create jobs and all measures of the unemployment rate will fall further. As unemployment rates decline wage pressures will intensify.
The final piece of the puzzle has to do with productivity gains and “unit labor costs”. If wages rise 3% and workers are 3% more productive, employers do not care. They are getting 3% more output. Labor costs adjusted for productivity are known as “unit labor costs”. This is the relevant metric for measuring the upward pressure on the inflation rate caused by tightness in the labor market. Thus far, unit labor costs are rising at a 1.0% pace which is perfectly consistent with the Fed’s 2.0% inflation target. But will unit labor costs remain benign?  Probably not.

Whether the economy has reached full employment or not, it is close and labor costs will be steadily picking up. Can productivity keep pace? That may be more challenging. As we see it, the direction for labor costs and inflation is clear. They are going to accelerate but the speed of ascent has yet to be determined, and that is critical for determining how quickly the Fed will need to raise interest rates in the months ahead.

Stephen Slifer
Charleston, S.C.

Economy Rebounding in Second Quarter, Needs Fiscal Policy Help

June 2, 2016

The economy seems poised to expand at a 3.0% rate in second quarter after an upward revised 1.2% growth rate in the first quarter.  If the second quarter estimate is accurate it means that the economy will have grown at a 2.1% pace in the first half of this year – little different from the 2.0% pace registered in 2016.  However, second half growth should quicken to 2.5%.  All of this seems likely to happen despite any support from the White House or Congress.

Senate Republicans are prioritizing health care legislation but acknowledge that they may not finish prior to the August recess.  The White House claims it is working hard to provide details for the one-page outline of a tax bill that it released in April.  It still hopes to have a tax plan enacted by the end of this year.  But the legislative calendar gets crowded after the August recess.  Congress must grapple with legislation to raise the debt ceiling and then agree on spending levels before the tax bill can be considered.  These important pieces of legislation keep getting pushed farther and farther into the future.  We still expect legislation on all fronts to ultimately be adopted, but they will most likely be watered down versions in order to pass the Senate with only a simple majority.

One might argue that the longer the delay the less likely that any of this legislation will be adopted.  Maybe.  But we would suggest that Republicans promised so much during the campaign that failure to deliver will almost certainly result in a significant loss of seats in next year’s mid-term election.  Thus, we feel quite certain they will come up with something.

For now the economy is doing OK and there is every reason to expect faster growth in the second half of the year.  That outcome will be largely determined by two GDP components – consumer spending and investment.  Trade and government spending should change very little.

Consumer spending.  The underlying fundamentals appear strong.  Job gains remain solid despite smaller than expected increases in April and May which seem to reflect employers difficulty in finding an adequate supply of skilled workers in an increasingly tight labor market.  The job gains support growth in household income.  The record stock market level bolsters consumer wealth. Consumer sentiment is the highest it has been thus far in the cycle.   Interest rates remain very low by historical standards.  We have every reason to expect household spending to continue to climb at a 2.5% rate both this year and next.

Investment.  The protracted period of sluggishness in the oil sector has come to an end.  Investment spending came to a halt during the recession as falling oil prices clobbered firms in the oil patch.  But oil prices have rebounded to a level that is encouraging some drillers to re-open previously closed wells.  The drag on investment spending from the oil sector has come to a halt and even turned into a moderate amount of stimulus.

The factory sector was smacked by a 20% increase in the value of the dollar between mid-2014 and October 2016.  That made U.S. goods more expensive for foreigners to purchase and sharply curtailed growth in exports.  U.S. firms in export industries suffered the consequences.  But the dollar has been essentially unchanged since the election so the drag on GDP from reduced exports growth has come to a halt.  Furthermore, after a long period of falling employment, factory jobs have been rising by about 10 thousand per month since December of last year.

In addition, the stock market has climbed to a record high level as both reported and expected future earnings have been on the rise.  The drag on earnings from both the oil and manufacturing sectors has disappeared.  Business confidence as measured by the various purchasing managers’ indexes is at a multi-year high.  Global GDP growth is showing signs of accelerating.  Interest rates remain low.  As a result, corporate earnings began to climb in the middle of last year and are likely to rise at a double-digit pace this year,

Against this backdrop it is easy to envision investment spending rising about 5% this year and next compared to no growth in 2016.

Trade and Government Spending.  The dollar has been relatively stable for the past six months so the trade component will, at most, subtract 0.1% from GDP growth in 2017.  A pickup in defense spending will be partially countered by spending cuts elsewhere so government spending might add 0.1% to growth.  Not a lot happening to either of these categories.

Thus, some pickup in GDP growth in the second half of this year is likely.  But to sustain a faster pace of spending and boost potential GDP growth from 2.0% currently to the 2.8% pace that we expect by the end of this decade the economy will need help.  It desperately needs faster growth in productivity which, in turn, depends upon steady growth in investment.  We are banking on the tax cuts Trump talked about during the election campaign, some repatriation of corporate earnings, and, hopefully, better health care.  We continue to believe that such legislation will be forthcoming, but the clock is ticking.

Stephen Slifer


Charleston, S.C.



No Weekly commentary This Week — Daughter’s Wedding

Hi all,

Sorry, no letter this week.  Our daughter is getting married in  Baltimore on Sunday.  That trump’s the weekly column!  Fortunately, it was  a quiet week.

Think happy thoughts!    Will be back in the weekly column business next Friday.



Economics and Politics

May 19, 2017

The firing of FBI Director James Comey and subsequent appointment of former FBI Director Robert Muller as a Special Prosecutor to investigate the Trump campaign’s ties to Russia clouds the economic outlook.  At the end of last year we specifically added 0.1% to GDP growth this year and 0.2% to growth in 2018 with an expectation that Trump’s tax cut proposals, repatriation of corporate earnings, and regulatory relief would boost investment spending and stimulate growth slightly in the near-term, and boost potential GDP growth from 2.0% today to 2.8% by the end of the decade.  Recent developments delay the possible implementation date of these hoped for policy changes, and it is easy to envision a scenario in which they do not happen at all.  Having said that the U.S. and global economic outlook appears to be strengthening.  Thus, we are not yet prepared to alter our GDP forecast despite Trump’s political woes.

The stock market selloff on May 17 was certainly justified.  The S&P had risen 15% since the election last November and a correction is long overdue.  However, the nearly 2% drop on May 17 appears to be nothing more than a single-day event.


The market had also become extraordinarily complacent.  As measured by the VIX index, market volatility fell in early May to its lowest level since 1993.  Following the favorable election outcome in France in early May the markets seemed to believe that they had nothing to worry about.

But President Trump’s firing of FBI Director James Comey and the subsequent hiring of Muller as a Special Prosecutor re-inserted risk into the equation for both the stock market and the economic outlook.  As we see it, it will be far more challenging for President Trump to enact the legislation noted above any time soon.  It is hard to envision any support from Democrats, and many Republicans could abandon ship.

But we do not want to impose judgment on President Trump.  Only two people were in that room and nobody knows exactly what was said.  We are supporters of the Trump policy initiatives — tax cuts, repatriation of earnings, and deregulation.  We are not supporters of the man himself.  He says, and we agree, that the mainstream press has not been particularly fair in their reporting.  It could be that there is less going on than we are being led to believe.  But we also recognize that things could be far worse.  We simply do not know.

One does not have to be a political analyst to recognize that the mid-year election campaign will begin early next year and the election itself is only 18 months away.  If Republicans lose control of the House of Representatives, Democrats will almost certainly initiate impeachment proceedings.  The Senate probably would not convict, but under those circumstances Trump’s agenda would never be enacted and he would be a one-term President.

But what if Muller does not find evidence of any significant wrongdoing by the president or his administration?  A lot of the current uncertainty disappears and a significant portion of his agenda could actually be implemented (although later than we had envisioned).

Certainly Republicans are aware that the midyear election is not far off and will double their effort to pass some of his proposed legislative changes.  If that happens our economic outlook would be largely unaffected.

In short, we believe it is premature to make significant revisions to our economic forecast at this point.  We continue to expect 2.2% GDP growth this year and 2.7% growth in 2018.  A couple of things to consider:

1.  The nearly 2% drop in the S&P 500 index on May 17 is not even remotely close to a stock market “correction” which is usually regarded as a decline of about 10%. A correction is long overdue and would be considered healthy if it were to occur.

2.  One reason the stock market is so strong is that corporate earnings were very robust in the first quarter and are on track for an easy double-digit increase this year.

3.  The strength in corporate earnings reflects in part a rebound in earnings from companies in the oil industry that were crushed as oil prices plunged in late 2014 and 2015. The rebound in oil prices has restored profitability to those companies.  It also reflects the continuation of extremely low interest rates.  While the Fed is gradually raising rates, the process will occur very slowly and gradually.  These two events are not going to change any time soon.  Thus, any stock market drop may be muted.

4.  The labor market continues to improve and is beyond the full employment threshold. The official rate is at 4.4%.  Even the broader measure that Yellen prefers is at 8.6%.  This labor market strength generates income which allows consumers to spend freely and keeps the economy expanding at a respectable clip.

5.  The global economy is gathering momentum.  Faster growth is evident in many countries to Europe – Spain, Germany, and the U.K. in particular.  Now that the French election uncertainty has passed, labor market reforms may actually occur in that country.  In Asia, GDP growth in China is holding steady at about 6.5%, but in India growth is rebounding to 7.5% which is the fastest GDP growth rate in the world.  Emerging Asian economies are benefiting from the rebound in commodity prices.  The IMF believes global GDP growth rate will accelerate from 3.1% last year to 3.5% in 2017.

Politics matter and we will follow developments in Washington closely.  But, for now, it appears that economic fundamentals “Trump” political events.

Stephen Slifer


Charleston, S.C.

Global Growth is on the Rise

May 12, 2017

Because the U.S. is the world’s largest economy U.S. residents tend to focus almost exclusively on the domestic economy.   But in today’s increasingly global environment what happens elsewhere matters.  The IMF believes that global growth will quicken from 3.1% last year to 3.5% in 2017 and that growth pickup is not attributable solely to the United States.  That means that central banks can begin to wean themselves away from the uber-easy monetary policy that has provided life support for the global economy during the past eight years and return to a more “normal” economic environment.  Here is a quick look at non-U.S. countries that are experiencing faster GDP growth.

GDP growth rates for our neighbors to the north and south, Canada and Mexico, are moving in opposite directions.

Canada.  The U.S. and Canadian economies are closely intertwined.  To the extent that the U.S. economy is getting a lift from the expectation of lower individual and corporate taxes, repatriation of overseas corporate earnings, and abatement from needlessly complex federal regulations, that helps the Canadian economy as well.  But the Canadian economy is also highly dependent upon exports of commodities.  Rising prices for both oil and non-fuel commodities provides a further lift to the Canadian economy.  The IMF projects GDP growth in Canada of 1.9% in 2017 compared to 1.4% last year.

Mexico.  Like Canada, Mexico typically benefits from faster U.S. growth.   However, Trump’s comments earlier this year about pulling the U.S. out of NAFTA and uncertainty about U.S. immigration policy have soured relations between the two countries.  As a result, the IMF anticipates that GDP growth in Mexico will slip from 2.3% in 2016 to 1.7% this year.

Latin America.  Like Mexico, most countries in Central and South America are concerned about President Trump’s trade and immigration policies which are weighing heavily on both confidence and growth expectations throughout the region.

The situation in Brazil, the region’s largest economy by far, is different.  That country is poised to end its 2-year long recession.  Rising oil prices have contributed to the rebound.  But, equally important, in January the Brazilian Senate ended a year-long impeachment process by removing from office President Dilma Rousseff who was embroiled in the scandal at the Brazilian national petroleum company, Petrobras.    Hopefully, this development will enhance the government’s ability to implement policy and strengthen the emerging economic upswing.

Europe.  European economic growth is accelerating.  European Central Bank Chairman Draghi noted this week that euro area GDP growth, which had been stuck in a range from 0.3-0.8% for 15 consecutive quarters, picked up to 1.7% last year and should repeat that growth rate in 2017.  The unemployment rate in the Euro area is the lowest it has been since May 2009.  There are numerous success stories.

Spain.  The Spanish economy plunged into recession in 2007-2008.  The situation continued to deteriorate and the economy suffered a financial crisis in 2012 that required a bailout package from the E.U.  But the Spanish economy has recovered vigorously.  Following 3.2% and 3.1% GDP growth rates in 2015 and 2016, the Spanish economy is poised to expand at a solid 2.5% pace this year.  That is a dramatic turnaround in a surprisingly short period of time.

Germany.  The economic data for Germany accelerated in the first quarter, but the YPO Global Pulse measure of CEO confidence in Germany surged in April.  That probably had more to do with the victory by Angela Merkel’s CDU party in the Saarland state’s election in March.  Her party’s 5-seat gain in that election increased her chances of victory in the federal election in September.

United Kingdom.  The government revised up its GDP forecast for this year by 0.6% from 1.4% to 2.0%.  Meanwhile, the unemployment rate dipped to 4.7% the lowest rate since 1975.

France.  The YPO Global Pulse confidence measure for France plunged 8 points in April as CEO’s got a case of the jitters ahead of the French presidential election.  But with the overwhelming victory by centrist leader Emmanuel Macron the possibility of France leaving the European Union has disappeared.  Hopefully Macron will be able to ease some of the currently stifling labor laws in that country and bring down the 10% unemployment rate.

Asia.  As the world’s second largest economy China gets most of the attention when economists discuss Asia.  But, in this case, growth in China is expected to be relatively steady at about 6.5% this year and slow gradually towards the 6.0% mark in the years ahead.  Thus far fear of Trump’s protectionist policies directed at China have not dampened growth expectations by any particular amount but they remain a concern.

India.  The real growth story in Asia comes from India.  After climbing at about a 7.5% pace in 2014 and 2015, growth will slip to 6.8% in 2016 as the result of a temporary cash shortfall as the government removed high value banknotes from circulation in an effort to curb tax evasion and graft.  But GDP growth has recovered quickly and could re-attain a 7.5% pace this year.  That makes India the fastest growing economy in Asia and one of the fastest growing in the world.

Emerging Asia.  The ASEAN nations which include Indonesia, Malaysia, Singapore, Thailand, the Philippines and Vietnam amongst others will benefit from rising commodity prices, but any resurgence in growth amongst those countries will be kept in check by the gradual growth slowdown in China which is their primary trading partner.

Conclusion.  Following Trump’s election last November the possibility of tax cuts, repatriation of corporate earnings, and relief from a stifling regulatory environment have rekindled growth expectations in the United States.  That same tendency is evident in many countries in Europe, Asia, and Latin America.  At the same time fears of rising nationalism have been dealt a series of blows in the wake of elections in Austria, the Netherlands, Germany, and France.  As those fears shrink into the background the gradual pickup in global economic activity should become more apparent.

Stephen Slifer


Charleston, S.C.