Given the manic spikes and dives in the stock market, the near-inversion of the yield curve (I'll explain), the tanking of the price of oil, the Federal Reserve's rate hikes, chaotic leadership on trade policy (and everything else), and lots of buzz about the "r-word" (recession), it's a good time to evaluate the extent of risk factors in the current economy.
I'll briefly summarize what I view as the key points, but the bottom line is that for all the noise, the strong labor market and rising real wages will still power the expansion over the near term. Post-2019, however, once the current stimulus fades, growth is likely to slow, but precisely how much, no one knows.
The stock market is clearly on shpilkes (Yiddish for "pins and needles"), and it is seriously tarnishing whatever reputation it has left for a rational aggregator of forward-looking information. In theory, current stock prices should reflect expectations of future earnings of the companies in the indexes, but how could these values jump 1 percent on Monday and tank 3 percent — a huge sell-off — on Tuesday? They couldn't. Instead, they jumped when Trump tweeted out a truce in the trade war, and they tanked the next day when the Chinese essentially responded, "Yeah … that's not quite how it went down."
Look, I get it. As long as some traders, along with their algorithms, react to every tweet that springs from our dear leader's thumbs, other traders/algos have to play along. But the fact is that there is very, very little information in anything Trump says, and we'd all be better off, in the sense of less whiplash, if we agreed on this point.
Until then, from the perspective of the larger economy, I don't see the recent spike in volatility as a big deal. Somewhere in the noise is a signal reflecting the likelihood that growth and corporate profitability and likely to slow later next year, and that matters. Go ahead and watch the roller coaster if you must, but if it makes you sick, don't say I didn't warn you.
The market was also spooked by the flattening of the yield curve, meaning the shrinking difference between long-term and short-term bond yields. Such movements are driven by the Fed raising short-term rates and investors, worried about the near-term economy, demanding more long-term bonds (thus driving down long yields). Since yield curve inversions — long yields below short yields — are reliable predictors of future recessions (on average, a bit more than a year later), its flattening is not something you can shrug off.
But I think we're focusing on the wrong message from the curve. We tend to think of it in terms of "are we headed for recession or not?" If the curve inverts, that's bad; if not, we're cool. But what if growth slows yet doesn't cross zero? After all, falling from 3 to 1 percent GDP growth typically raises unemployment more than going from a little above to a little below zero.
The flat curve is thus sending the same message buried in the market noise: slower growth ahead.
Oil tanks: Though it's rallied a bit from its recent lows, the price of a barrel is down by about a third since early October, driven largely by a supply glut amid some weakening of global demand. Cheaper oil used to work like a stimulative tax cut in the United States. But now, according to the Wall Street Journal: "As the U.S. has risen to become the world's largest oil producer this year, a growing chunk of domestic investment, manufacturing output and employment has become tied to oil. Now, when oil prices fall, it risks hurting investment and hiring in important parts of the economy."
That said, in the short run, real wages are closely tied to the price of oil, and I predict that if gas prices stay low or fall further, real hourly pay for middle-wage workers will grow from its current rate of about half a percent per year to 1.5 percent, a big jump that folks will feel in their paychecks. In other words, falling oil prices are a double-edge sword, with upsides and downsides.
The wage story links up with the biggest driver behind the current expansion: the job market. For the next few quarters, we can very likely count on strong job creation, low unemployment and the fortuitous collision between rising nominal wages and slower inflation (due to cheaper oil) to power consumer spending, which is 70 percent of the U.S. economy.
The other edge of the oil sword may ding the business investment side of the economy — the interest-rate-sensitive housing sector is another negative in this investment mix — so we're into a bit of a tailwind/headwind dynamic.
The Fed: The Fed watches the stock market, but its client is the real economy — growth, jobs, wages, inflation, all of which look good to it right now (oil's real too, but it's a global commodity, outside the reach of a central bank). The most interesting and important variable in that mix is inflation, which has been far less responsive to labor market tightening than the Fed expected. Since price growth is so "well-anchored," the Fed could — I'd guess, would — pause its rate-hiking campaign if any of these headwinds start to look particularly threatening. But for now, it will keep tapping the brakes with rate hikes, no matter much shade the president throws at it.
Which brings us to Trump. He inherited a growing economy, and he temporarily juiced that growth with a lot of deficit spending. But the juice tapers out toward the end of next year, and his misguided trade war isn't helping (if anything, in tandem with tax cuts, it's leading to larger trade deficits). Both of those problems are behind a lot of nervousness that characterize this moment. More deficit spending is, of course, a possibility, but I guarantee you the new House majority will be in no mood for more Republican tax cuts.
So: tune out the market volatility, keep on eye not just on recession probabilities but on slowing growth, watch oil and its impact on real wages (+) and investment (-), and for Keynes's sake, don't listen to Trump!
-- via my feedly newsfeed
BERKELEY – It has now been one year since US President Donald Trump and his fellow Republicans rammed their massive corporate tax cut through Congress. At the time, critics of the "Tax Cuts and Jobs Act" described it as a cynical handout for wealthy shareholders. But a substantial number of economists came out in support of it.
For example, one prominent group, most of whom served in previous Republican administrations, predicted in The Wall Street Journal that the tax cuts would boost long-run GDP by 3-4%, with an "associated increase" of about 0.4% "in the annual rate of GDP growth" over the next decade. And in an open letterto Congress, a coterie of over 100 economists asserted that "the macroeconomic feedback generated by the [tax cuts]" would be "more than enough to compensate for the static revenue loss," implying that the bill would be deficit-neutral over time.
Likewise, in a commentary for Project Syndicate, Robert J. Barro of Harvard University argued that the tax cuts would increase long-run real (inflation-adjusted) per capita GDP by an improbable 7%. And Michael J. Boskin of the Hoover Institution endorsed his analysis in a follow-up commentary.
Finally, Kevin Hassett, Chairman of the White House Council of Economic Advisers, and Greg Mankiw of Harvard University claimed that the productivity gains stemming from the tax package would primarily boost wages, rather than profits, because foreign savers would pour investment into the US.
To be sure, these were primarily long-run predictions. But proponents of the bill nonetheless claimed that we would see enough additional investment to boost growth by 0.4% per year. That implies an annual GDP increase of roughly $800 billion, which would require annual investment to rise from 17.5% to about 21.5% of GDP. We cannot know how much the US economy would grow in the absence of the tax cuts. But, as the chart below shows, investment has not jumped to that level, nor does it show signs of doing so anytime soon.
This comes as no surprise. Back when all the aforementioned economists were issuing their sanguine predictions about the tax package's likely effects, neutral scorekeepers such as the Tax Policy Center were painting a more realistic picture. And unlike most proponents of the cuts, the Tax Policy Center's raison d'être is not to please donors or support a particular political party, but rather to make the best forecasts that it can.
The deep disagreement last year over the tax bill's potential effects anguished Binyamin Applebaum of The New York Times. "What does it mean to produce the signatures of 100 economists in favor of a given proposition when another 100 will sign their names to the opposite statement?" Applebaum asked on Twitter at the time. "How does Harvard, for example, justify granting tenure to people who purport to work in the same discipline and publicly condemn each other as charlatans? How are ordinary people, let alone members of Congress, supposed to figure out which tenured professors are the serious economists?"
We can now answer that last question. Scholarship is about the pursuit of truth. When scholars find that they have gotten something wrong, they ask themselves why, in order to improve their methodology and possibly get it less wrong in the future. The economists who predicted that tax cuts would spur a rapid increase in investment and sustained growth have now been proven wrong. If they were serious academics committed to their discipline, they would take this as a sign that they have something to learn. Sadly, they have not. They have remained silent, which suggests that they are not surprised to see investment fall far short of what they promised.
But why should they be surprised? After all, it would be specious to assume, as their models do, that investment can rapidly rise (or fall) as foreign investors flood into (or flee) the US. Individuals and firms do not suddenly ratchet up their savings just because the after-tax profit rate has increased. While a higher profit rate does make saving more profitable, it also increases the income from one's past savings, thus reducing the need to save. Generally speaking, the two balance out.
All of those who published op-eds and released studies supporting the corporate tax cuts last year knew (or should have known) this to begin with. That is why they have not bothered to investigate their flawed forecasts to determine what they may have missed. It is as if they knew all along that their predictions were wrong.1
For reporters still wondering which economists to listen to, the answer should now be clear. If there is one message to take from the past year, it is: "Fool me once, shame on you; fool me twice, shame on me."