Friday, October 28, 2016

The $3 trillion gap

Today we got the first estimate of third quarter GDP. The economy advanced at a 2.9% annualized pace, much better than the 1.1% annualized pace for the first half of the year. But it remains the case that the economy appears to have downshifted from the 4+% pace we saw in the second and third quarters of 2014; growth over the past year has been a miserable 1.5%. I think this has a lot to do with the tremendous amount of uncertainty surrounding the upcoming elections. People in charge of making big decisions are holding off to see if things are likely to improve next year—or deteriorate. Business investment remains quite weak, and the pace of job growth has slowed. The combination of years of bad policies (e.g., rising tax and regulatory burdens, income redistribution) coupled with uncertainty about the future equals a huge cost in lost output, which could be as much as $3 trillion this year alone.



The chart above illustrates just how miserable economic growth has been in the current recovery. Instead of averaging just over 3% growth per year, as it did from 1965 though 2007, the economy has only managed a 2.1% annualized pace for the past 7 ¼ years. The gap between where we are and where we might have been had this been a normal recovery is a bit more than $3 trillion, by my calculations. That's huge, and that's the measure of our discontent.


An economy can't grow if businesses don't invest. As the chart above shows, capital goods orders—the seed corn of future productivity gains—have been flat to down for the past 5 years.


The chart above tells the same story from a different perspective. Fixed private investment has been much weaker in the current cycle than it was in prior cycles.


Businesses have been making huge profits during the current expansion (see chart above), but not investing nearly as much as they could have. If we want a stronger economy we need to find ways to encourage businesses to invest more. Lower taxes—especially the onerous tax on overseas profits—could do the trick, and so would reduced regulatory burdens. Corporations have parked some $3 trillion overseas that could be brought back if tax burdens were sharply lower.



As the chart above shows, private sector jobs growth has slipped to a 1.5% pace over the past six months. With weak jobs growth and virtually no productivity gains, the economy is simply not going to be able to do much better than 1.5-2% going forward.


Not surprisingly, the bond market has figured this out. As the chart above shows, the real yield on 5-yr TIPS is -0.3%, and that is consistent with expectations that economic growth will be stuck at around 2% or so for the foreseeable future.

The problem with Hillary—leaving aside for the moment things like the mounting evidence of corruption and influence peddling surrounding the Clinton Foundation thanks to her careless handling of her email server—is that she does not understand the importance of incentives to economic growth and prosperity (and neither did Obama). Trump does. For all his flaws, he would be much more likely to pursue policies that could close our $3 trillion gap. Can we afford to not give him a chance? We'll find out soon.

15 comments:

Tyler Nation said...

Hi Scott, thank you for another great post. Over the past 6 months you've made it really clear that there aren't a lot of good medium to high yield options at the moment.

Here are some alternative investments that I am considering putting a small amount of my portfolio into (fun money).

1) Angel investments in silicon valley companies. I have access to some of these deals pre-series A and have yet to dip my toe into the water. Obviously these are boom or bust and when they are boom it takes a long time to see return of capital (so spreading a lot of small bets across good companies seems key, the classic VC model).
2) Lending Club. I have friends that make 8-10% a year by loaning money with this program.
3) Michael Burry approach, find ways to invest in the wine and food produced in water rich areas like Oregon and Washington (not sure of any easy avenue to make this bet, but I for one think water shortage is only going to become a bigger problem, might as well make a profit on that likely inevitable and depressing scenario).

Any thoughts on these 3 options would be greatly appreciated. I am a firm believer of keeping 90% of my portfolio invested in an S&P500 index, but am racking my brain for new ways to bring in money when the economy is at a gridlock as we continue to go deeper into unchartered QE waters.

Thank you again for your content and any thoughts you might be able to share on the above 3 options.

Tyler

Hans said...

Salient thread, Mr Grannis. It is a very large topic
to cover, however, an additional point would be the
massive increase in governmental unit spending.

Since the reign of LBJ, there have been only five, yes,
years wherein the federal budget decreased in the following
fiscal year by 1% or greater.

Until 1992, the Demcos controlled or split CONgress every
session. Unfetter domination for close to some 3 decades.
This is why Milhous Nixon said "we are all Keynesian now."

CONgress controls the purse and as such the future of this
Republic will be in their hands. There is little of any opposition
party, unless it is the minority party complaining about the
Repubcos not reaching across the proverbial aisle.

This general election, by an non-establishment candidate (not since
Ross Perot) has brought forth the issue of the Beltway corruption and
the rigging of the political system.

Hopeful, millions of average Americans now realize this fact and
will elect to exercise their civic duty to guard and maintain
our Republic's original political structure and not take it for granted
that someone else shall discharge their responsibilities as US
citizens.

May God always bless America, the bedrock and beacon for hope and liberty.

Benjamin Cole said...

Obama missed a great opportunity to reform the Democrats into a pro-business party, which he could have in his first term, just as President Bush missed an opportunity to reform our military after 9/11 for the much smaller threat of terrorism, as opposed to a cold war.

Hillary Clinton appears to have no business-economics sense.

Is Scott Grannis points out, American corporations are making plenty of money so I guess we will survive Hillary. But it won't be pleasant. And it could be a lot better.

Benjamin Cole said...

Obama missed a great opportunity to reform the Democrats into a pro-business party, which he could have in his first term, just as President Bush missed an opportunity to reform our military after 9/11 for the much smaller threat of terrorism, as opposed to a cold war.

Hillary Clinton appears to have no business-economics sense.

Is Scott Grannis points out, American corporations are making plenty of money so I guess we will survive Hillary. But it won't be pleasant. And it could be a lot better.

WealthMony said...

President Obama has had no interest in economic growth so as to enlarge the pie. His only interest has been in how that pie was distributed. It was impossible for him to reform the Democrats into a pro-business party because he is not pro-business. He is blind as to how the world really works. Being married to Bill, Hillary should know but apparently she is as blind as Barack.

No matter who wins the presidency, he/she will need Congress to get an agenda passed. That's not going to be easy.

Hans said...

"As Scott Grannis points out, American corporations are making plenty of money so I guess we will survive Hillary. But it won't be pleasant. And it could be a lot better."

Not so, Ben Jamin. Last year more business closed than open, according
to the founder of Home Despot. Mr Marcus, stated how he could not
start his company now due to Frankk-Dodd Act.

The example of his loan process (5 million) from a bank with absolutely no
balance sheet and across state lines, is now verboten. In other words, the
bank bought the concept of the business and not the failing balance sheet.

All of the legislation by Socshevikes, are designed not to helf
the economy nor the American people but to grow the power of the
state and police power as well; not too mention the growth of their
corrupt party.

Barrocko care is a prime example of this. This will all culminate
in the complete outlawing of private property and the complete collapse
of free enterprise.

WestEuroland, is today suffering this fate, with many not fathoming
that they are in a death spiral.

Jeopardy question: has had no interest in economic growth so as to enlarge the pie. His only interest has been in how that pie was distributed.

Answer: What is Obomba?

How astute you are WealthMony!

Look closely at the fine provisions of the TPP treaty! The facade
is open trade but with this comes world government and the imposition
of regulations on America without the approval of CONgress nor the
American people.

This of course includes open borders, which is a main tenets of
the International Socialist movement.

"No matter who wins the presidency, he/she will need Congress to get an agenda passed. That's not going to be easy."

The Repubco party of the last three decades has been a group of
girlymen - easy pushovers for the Demcos. The party has caves named
after them.

Hans said...

Hear is a all too typical example of
leftwing haters how these gang banger
deal with their opposition.

Sick and Sad. LVV Syndrome - Loud, Vulgar, Violent

https://www.youtube.com/watch?v=njN75nJdCAk&feature=player_embedded

The Cliff Claven of Finance said...

The charts at this bog are very good and also easy to read.

"The three trillion gap" chart is exceptional.

It seems easy to understand why 3% growth is better than 2% growth but most people see a 1 percentage point difference as tiny. When I explain that 3% is 50% better than 2%, their eyes glaze over.

Your chart explains why 2% growth is bad at a glance.

The only chart of yours I don't like is "Stocks Climb Walls of Worry".

The saying never made sense to me.

If stocks climb a wall of worry on the way up,
then do fall over the wall on the way down?

The people selling stocks may be worried.
But the people who buy their stocks must not be worried.
And the people buying new issues must not be worried.

The broad NYSE Composite Average has gone nowhere for two years.
That makes me worry.

Rich


Scott Grannis said...

Re "Walls of Worry." This is an old stock market adage. It's a way of saying that a true bull market is one wherein prices rise despite the market's concerns. If everyone were optimistic, prices would have already risen. Prices rise when the market realizes that it was too pessimistic; when the future turns out to be better than expected. My thesis since 2009 has been that the market has almost always been too pessimistic; that even though the economy was likely to experience a sub-par recovery, the economy would turn out to be somewhat better than expected, and therefore prices would rise. I think it's still the case.

The Wall of Worry chart illustrates that every selloff in stock prices has been accompanied by a rise in fear and uncertainty. When fears are allayed, prices rise. The market gets over its fears, climbing walls of worry.

William McKibbin said...

I predict that the US will experience severe deflation starting in 2017 that will linger for at least 3-5 years. Watch for stocks, bonds, real estate, and precious metals to endure 50-70% declines during this period. The coming Fed rate increases will have no effect on the collapse to come. Go to cash in your safe denominated in diverse hard currencies. Sell real estate that is unrented or dilapidated. Be prepared to defend you family and property from hungry city refugees seeking to survive. Watch out for squatters and take immediate action to throw on anyone who misses a rent payment. Finally, watch for the government to lead the US into overseas wars in an effort to cover up the devastation. The coming wars may erupt in the southern hemisphere in places such as Venezuela and Columbia. My guess is that the four horsemen will be riding hard across the Americas, so get ready and take cover!

PS: I hope and pray I am wrong -- Hillary will have her hands full trying to save the USA..

Hans said...

"I predict that the US will experience severe deflation starting in 2017 that will linger for at least 3-5 years. Watch for stocks, bonds, real estate, and precious metals to endure 50-70% declines during this period."

Poppycock, Dr McKibbin. As long as there is ample credit and a
expanding economy there will be no such events.

If you are right, I will personally nominate you for the
economic Nobell Prize.

NormanB said...

Hillary doesn't understand economic incentives but neither did or does Bill. Yet with a GOP Congress running the show Bill went along. That's all that Hillary needs to do to have a terrific economic Presidency. The $3T GDP can be lowered quite a bit and knowing that the USA is the most dynamic and productive economy in the world (China getting farmers to work isn't in the same categorey) our zero growth in productivity can be raised substantially. But if she does fight for the Liberal handouts then she'll be a failure. Here's hoping that Bill gives her some good advice on this.

Hans said...

"But if she does fight for the Liberal handouts then she'll be a failure."

If, if when, why she the figure head of the Free Lunch Party.

And what success has she ever been??

John said...

Mr. Grannis:

For your consideration, to what extent might the following existing factors have on tepid GDP growth?
1. Demographics, i.e., aging, downsizing Boomer generation,
2. Massive student loan debt,
3. Lower commodity prices, especially oil and nat gas.

Thanks

Scott Grannis said...

John: All three things likely contribute to slow GDP growth, but I think there are other things as well which are more important (e.g., tax and regulatory burdens and a general anti-business climate in Washington). The $3 trillion "gap" has been growing rather steadily for over seven years now, whereas cheaper oil prices have only been with us for the past two years. Student loans have been surging for over seven years, from $140 billion at the start of Obama's administration to now over $1 trillion; but the incremental growth every year has been only a small fraction of GDP, so I don't think that is a major factor. Demographics have certainly been a factor (aging baby boomers retiring), but demographics don't change dramatically from one year to the next.

To understand what has changed, consider that while business profits have been significant for the past seven years, business investment has been unusually weak throughout. That's significant in my book. Why has investment been weak? That is the question we need to ask. Apparently there are things going on which have discouraged businesses from taking risk, and which have sapped confidence. I trace those problems back to the onerous expansion of regulatory burdens (e.g., Dodd-Frank) in the wake of the Great Recession, and the huge burden of taxation facing U.S. corporations relative to those of other countries.

I'm also convinced that the huge increase in our federal debt burden, which began in late 2008, has been a signficant factor. In effect, our government has sucked many trillions of dollars out of the private sector over the years, spending it wastefully and redistributing it massively. This is equivalent to pouring the country's savings down the Keynesian drain. Resources have been squandered: that is the big problem.