In his column at the Wall Street Journal Jason Furman has it about right:
Economic growth comes from two sources. First is a cyclical rebound in demand as the economy gets closer to full capacity (or even proceeds beyond it). Second is an increase in the economy’s underlying potential output—also called the supply side—driven by growth in either the workforce or productivity.
The trouble is that more than half of last year’s economic growth came from the cyclical factors, which have little left to contribute given that we’re at or near full employment. What this means is that absent much bigger productivity improvements, it will be a challenge for the U.S. to achieve sustained economic growth of even 2%.
He goes on to explain why rapid economic growth is unlikely—the Social Security actuaries have been predicting less than 2% growth over the next couple of decades for nearly 15 years.
That’s why I’m skeptical that fiscal stimulus is going to produce much growth at this point. We’re already at or near potential product and it will take reliable, sustained inputs to induce increasing productive potential not just a quick hit.
Then there’s that pesky supply and demand stuff. As the Baby Boomers die or downsize and sell their homes, the increased availability will provide downward pressure on housing prices that will persist for decades. There will be increased demand for health care services but that will be a drag on the private sector as well. The elderly have what amounts to a bottomless pocketbook for paying health care bills, the supply of health care is limited, and everyone else is in competition with the elderly for them. Of course prices will rise.
As long as wages are kept low by automation, offshoring, and competition from workers imported from abroad, paying more for health care means less available to spend on everything else.
If only someone could have envisioned the enormous flood of old people and planned for that future!
The article makes an error in assuming we are near or close to full unemployment. The labor participation is too low even considering demographic factors.
Then there’s trade; imports subtract from GDP and exports add to it. Getting our trade partners to buy more American goods would grow our GDP without excessively stimulating it.
Sadly, there is presently no politically possible way to do that. The pragmatic way to do it is reciprocity. We should just impose the same rules, requirements, subsidies, etc. our trading partners do. That would tend to increase prices and it would be the opposite of free trade. Add to that the Americans who benefit from our trade imbalance and you have the reasons the Washington consensus results in our running a permanent massive trade deficit.
Mysterious how Americans elected a President who seems pretty skeptical of the Washington consensus on trade.
We will see how it goes. One interesting thing on trade is how much our current “balance†since 2009 has been held up by fossil fuels. Fossil fuels is the one item that governments generally will not enact protectionist policies on.
Anyway, trade deficits cannot continue forever. Sooner or later the Chinese and Germans will deem it too risky to hold ever increasing amounts of treasury’s. It maybe we have already reached that point for the Chinese.
For the last 25 years the Chinese have been holding Treasuries rather than buying U. S. goods, services, or assets in what has been characterized as a “mercantilist trade policy”. The objectives have clearly been to create artificial demand, build up their own productive capacity, move workers from agriculture to manufacturing, and maintain high employment.
Increasing productive capacity via these mercantilist policies has just about run its course for them. They already have the capacity to supply the entire world with many products for decades to come. Over-capacity with no real prospect for the capacity being met. That’s what central planning can do for you.
They’ve also moved just about as many workers from agriculture to manufacturing as they can without reducing agricultural production. And the “One Child Policy” and demographics ensures that the total population of working age will decline for many years to come.
For new economic growth they’re going to need to rely on domestic demand which means that the strategy they’ve used for 25 years is reaching its expiration date. China’s holdings of U. S. Treasuries peaked in 2009 and are now at their lowest level in 7 or 8 years. I expect that to continue. Note that recently they’ve been purchasing more U. S. factories. I expect that to continue, too.
Food for thought.
Re: the dollar. From Deutsche Bank via ZH
Blame the dollar on yields
We are well into 2018 and our feedback from recently attending the TradeTech FX conference in Miami is that the market is still struggling to understand or embrace dollar weakness. How can it be that US yields are rising sharply, yet the dollar is so weak at the same time? The answer is simple: the dollar is not going down despite higher yields but because of them. Higher yields mean lower bond prices and US bonds are lower because investors don’t want to buy them. This is an entirely different regime to previous years.
Dollar weakness ultimately goes back to two major problems for the greenback this year. First, US asset valuations are extremely stretched. As we argued in our 2018 FX outlook a combined measure of P/E ratios for equities and term premia for bonds is at its highest levels since the 1960s. Simply put, US bond and equity prices cannot continue going up at the same time. This correlation breakdown is structurally bearish for the dollar because it inhibits sustained inflows into US bond and equity markets.
The second dollar problem is that irrespective of asset valuations the US twin deficit (the sum of the current account and fiscal balance) is set to deteriorate dramatically in coming years. Not only does the additional fiscal stimulus recently agreed by Congress push the fair value of bonds even lower via higher issuance and inflation risk premia effects, but the current account that also needs to be financed will widen via import multiplier effects. When an economy is stimulated at full employment the only way to absorb domestic demand is higher imports. Under conservative assumptions the US twin deficit is set to deteriorate by well over 3% of GDP over the next two years.
The mirror image to all of this is that the flow picture into both Europe and Japan has been improving dramatically anyway. We have previously written about the positive flow dynamics in Europe as the flow distortions caused by extremely unconventional ECB policy are starting to adjust. But the Japanese basic balance has also shot up to a 4% surplus in recent years helped by a big improvement in the services balance (Chinese tourists) and a collapse of Japanese inflows into the US: treasuries simply do not provide enough duration compensation any more. To conclude, embrace dollar weakness, it has more to run.
It’s like the old wisecrack that you don’t have to swim faster than the shark you just need to swim faster than the other guy. As long as Europe and Japan maintain present policies, U. S. bonds and equities will be more attractive than European or Japanese. This:
is putting a brave face on the situation.