The Headwinds Facing Economic Growth - Second In A Series Of Three

The last post clearly showed the importance of continued high levels of real annual economic growth in America – real economic growth in the first six full quarters of Trump's presidency was twice the rate of growth of BO's final six full quarters.  A reversion to BO's policies of government encroachment & the 1.5% real annualized economic growth rate realized during BO's final six full quarters in office would amount to a loss of 24 years of job creation, increased compensation, & general prosperity for the American people compared to the level realized under President Trump's first six full quarters in office if sustained.

 

This post presents the potential headwinds that could hold back our expansion.  It is the second in a series of three posts on the economy.

 

Stanford economics professor John Taylor teaches that economic growth equals employment growth + productivity growth.

 

The first part of Professor Taylor's definition – employment growth – faces many obstacles.

 

First, the population of the U.S. rose only 0.6% in the past year ending July 1 – the slowest increase since 1937.  The problem with this low population growth rate is that it obviously retards economic growth as defined in Professor Taylor's above economic growth equation.

 

The November Jobs Openings & Labor Turnover Summary (JOLTS) issued by the Bureau of Labor Statistics (BLS) on January 8 showed there were 6.89 million job openings in America, a figure exceeding the number of unemployed people who are actively looking for a job by 870,000.  There have been more jobs openings than unemployed people looking for work since March.  This phenomenon is obviously hindering economic growth.

 

The demand for qualified temporary worker visa requests is illustrated by the overloading & crashing of the Department of Labor's website literally five minutes after it opened on New Year's Day.  The federal government allows 66,000 such visas known as H-2B each year – the website crashed @ the 100,000 request marker.  Employers obviously need more help.

 

Defense contractors are especially hard hit trying to find qualified welders, fitters, & mechanics – there are reports that Prime Contractors' recruitment drives rob their own suppliers' staffs of these tradesmen.

 

The federal government has offered retraining through its Trade Adjustment Assistance (TAA) program since the 1960s.  The program is open to workers the government determines lost employment due to overseas competition.  TAA has had limited success in that more than a quarter of the 16,375 workers who took the program in fiscal year 2017 could not find employment within six months of completing retraining & on average those who did earned 81.3% of their old wage in what is a classic example of what I have termed U7 unemployment in many previous posts – i.e., U7 is the unemployment rate that includes the total unemployed, plus all persons marginally attached to the labor force, plus the total employed part time for economic reasons, plus those employed full time who make a fraction of their former pay.

 

Accordingly, it is not hard to conclude that employers are having trouble finding & hiring qualified people.  Some people that I have talked to conclude that these last few percent of unemployed people really don't want a job.  But in any event having more job openings than unemployed people for several months shows a large headwind for economic growth in that we just don't have the people, qualified or not – another offense to the first part of Professor Taylor's above definition of economic growth.

 

As socialism has become more & more appealing, especially to millennials & Democrats, the American dream concept of getting a good education followed by gainful employment in the field of college study has waned for a significant portion of the citizenry.  The lure of a government guaranteed job for life, Medicare for All, & free college with forgiveness of college loans already incurred all convey the idea that there is no rush or that time is not of the essence.  Accordingly, far too many millennials are not taking, or are not qualified or capable of taking a productive place in society – they are starting later in life to build their own life thereby not making their best personal contribution to economic growth over a lifetime of productive work.

 

Next – the interest rate headwind.

 

After nearly a decade of following a zero interest rate strategy the Federal Reserve System (Fed) has raised their policy rate that banks pay for overnight borrowing from just about zero to a range of 2.25% to 2.50% currently & has also started to liquidate the assets on their record high balance sheet.  The Fed's inflation target is 2% meaning that a median income earner loses about $1200 in purchasing power per year.

 

As a result of the Fed's action the average interest rate on a 30 year fixed rate home mortgage rose to 4.87% in November before falling to 4.51% earlier this month – this rate is still substantially higher than the 3.95% in January 2018. The combination of higher mortgage rates & higher home prices due to low inventories of homes for sale means that people, especially first time buyers, whose incomes are not rising as fast as the price of housing, cannot afford to buy a house – these people are being priced out of the housing market.  It is hard for an economy to expand with housing (& interest rate sensitive autos) not participating.  Potential first time home buyers not buying furniture exacerbates the problem.

 

But housing & autos are only part of the increasing interest rate problem hindering the growth of our economy.

 

The Federal Reserve Bank of St. Louis reports that since 2008 the U.S. debt held by the public more than tripled from $5.1 trillion to just under $16 trillion.  During most of this time span interest costs were held down by the Fed keeping interest rates artificially low. 

 

But it is not just the higher interest rates on future budget deficits that are the problem.  During the next five years about 70% of the existing $16 trillion federal debt will mature & will  be refinanced @ these higher interest rates.  This is the opposite of a family refinancing their home mortgage @ a lower interest rate saving substantial money each month – the federal government will be refinancing Treasury obligations that mature while interest rates are going up thereby increasing the cost of the debt to taxpayers.

 

In 2017, interest costs on federal debt totaled $263 billion – paid @ very low interest rates.  The Congressional Budget Office (CBO) calculates that interest costs will rise to $915 billion by 2028 – paid @ increasingly higher interest rates.  This means that interest costs will rise from 7.9% of federal revenue in 2017 to 16.6% in 2028, both of which are bad enough.  Calculations based on data provided on CBO – Budget & Economic Data, 10-Year Budget Projections, April 2018, Table 4.1 (www.cbo.gov/publication/53651)

 

But wait.

 

Allen Buckley, writing in the WSJ, lets us know that the average interest rate on 10-year treasury notes for the past 200 years has been about 5%.  Doing the arithmetic of 5% interest on the current $16 trillion debt results in $800 billion annual interest costs – three times what was actually paid in 2017 thereby illustrating just how low interest rates have been manipulated.  Federal receipts in fiscal year 2017 were $3.3 trillion so the interest costs, if @ our historical average, would have amounted to 24% of revenue.  It is a point like this that will be the point when politicians & more importantly the citizenry, after ignoring them for decades, realize the importance of budget deficits & the national debt. 

 

It took a decade of rapidly rising deficits & very low interest rates, masking the dangers of debt, followed by a continuation of large deficits & rising interest rates to bring us to this point.  Just look @ the red portion of the bars, representing net interest on the graphic below, with the above understanding of the dynamic @ play regarding what is happening to the interest costs of our national debt & you will see that our danger point is even closer than indicated on the graphic which does include the growing liabilities of Social Security, Medicare, & Medicaid but does not include the enormous unfunded liabilities of Social Security & Medicare.

 

click on graphic to enlarge

 

Although low interest rates are preferred by investors a real Fed policy rate of zero is not consistent with 3% real annual economic growth so if this economic growth rate continues we can expect interest rates to continue to rise & bring with it all the problems mentioned above.

 

But American interest rates are not high by historical standards – they are high compared to those of our trading partners.  The last few years the European Central Bank (ECB) followed by the Bank of Japan (BOJ) pushed the large economies of both Germany & Japan into negative interest rate territory.  Last month the BOJ continued this policy by keeping short-term interest rates @ minus 0.1% & the target for 10-year government bond yield @ around zero.

 

But the real enemy in all or any of the government budget battles is not the deficit but rather spending.  Professor Friedman would rather have a budget of $1 trillion with a $500 billion deficit, than a budget of $2 trillion with no deficit.  He taught that the burden borne by the American economy is measured by what government spends & disposes of, not by whether it calls its receipts "taxes" or "proceeds from bonds."  The 2,232 page Omnibus spending bill signed into law in March 2018 not only violated Professor Friedman's principle but actually boosted spending by $300 billion over caps previously agreed to in the 2011 Sequester.

 

Most of 2018 was full of talk of trade wars, tariffs & retaliatory tariffs, & renegotiating &/or not participating in trade deals.  Specifically President Trump imposed tariffs on steel, aluminum, washing machines, solar panels, & $250 billion of imports from China & of course President Xi retaliated in kind.  Trump has also threatened tariffs on car imports & another $250 billion of China's exports. 

 

Trump also negotiated the United States-Mexico-Canada Agreement (USMCA) - a new NAFTA - with Mexico & Canada, & now needs Nancy Pelosi to approve it.

 

Most of the rest of the world is suffering an economic slowdown (by the third quarter of 2018 Germany's & Japan's economies had actually contracted) & these trade tensions are not helping & may be to blame.  Apple & FedEx have already warned that slowing growth overseas is hurting multinational companies.  In this regard Apple's recent announcement that it was forecasting a large downturn in 2019 sales of iPhones in China is a strong indicator of a slowing Chinese economy.

 

This trade uncertainty is also hindering business capital spending & investment – businesses want to know if they are investing into 25% tariffs or no tariffs.  It does make a difference & this is another headwind.

 

But in the process of levying tariffs on U.S. imports President Trump has exposed many of the one sided anti-American protective trade agreements that have been in place for decades – Trump has exposed protectionist measures that have imposed restrictions on U.S. products & services entering many poor countries, like China.  Accordingly, nations like China have been free, under these agreements, to meet their robust export demand without worrying about American competition.

 

Following the meeting in Buenos Aires in December China has generally committed to cut tariffs, buy more U.S. goods & services, reduce subsidies that Beijing pays to Chinese companies, ease restrictions on foreign firms operating in China, & further open sectors for foreign capital.  There is a 90 day temporary tariff truce that ends on March 1 if suitable agreement in detail is not reached – in which case Trump will raise tariffs, whose increases are suspended during the temporary truce, on another $200 billion of Chinese goods from 10% to 25% thereby deepening the slowdown in the Chinese economy.

 

Although China's middle class has started to grow & prosper China is still a very poor country that is very export dependent regarding increasing its wealth & prosperity.  If Trump totally levels the trading field & deprives China of the principal parts of the current one sided trade deals – namely, protective tariffs on imports to China, subsidies China pays to Chinese companies, & pressures China puts on U.S. partners into transferring technology to China against their will - China's ability to manufacture will be severely hindered.  Where then will the Chinese get the money to purchase American made products & services?  Who will America sell these products & services to if China is unable to buy them?  In short, we may need "unfair trade deals," like those described above, for the U.S. to have any trade @ all with poor nations in the global economy.

 

Another indication of a world wide economic slowdown is the drop in the price of oil – i.e., countries are not expanding if the price of energy is dropping.  Of course lower prices of gasoline @ the pump is a welcome sign for drivers.

 

In the past Saudi Arabia has virtually single handedly remedied OPEC's pricing problems by cutting production.  Its latest plan is to cut oil exports ultimately by 800,000 barrels per day starting with 200,000 to 300,000 barrels per day by the end of January with a goal of raising oil prices by over $30 per barrel to the $80 to $85 per barrel level.

 

In summary, some of the economic headwinds we are facing are caused by the U.S. just not having enough people to help the economy expand per Professor Taylor's definition while others are caused by government programs where 70% of a decade's worth of debt accumulation will be refinanced within the next five years @ today's higher interest rates thereby substantially adding to the country's interest costs.  The apparent global economic slowdown is an obvious headwind.

 

But the strong & healthy December jobs report released earlier this month presents a contrast to all of the above economic headwinds – it showed that businesses, owned & managed by people who put their money where their mouth is, have the confidence to keep hiring as they anticipate continued economic growth.  There are reports that some companies are even once again adding healthcare benefits to employee compensation packages in order to attract qualified workers – or rather drag discouraged workers & others marginally attached to the labor force back to work.

 

As described above the demographics of slow population growth presents a challenge for high economic growth but the productivity growth component of Professor Taylor's formula should be increased substantially by several features of the Tax Cuts & Jobs Act of 2017 along with several of the Trump administration's policies & practices – these features, policies, & practices, whose ability to counterbalance the above headwinds & propel economic growth forward, are the very points that'll be explained in the next post.