Friday, November 1, 2019

The weakest recovery and the longest expansion

If it weren't for Trump's trade wars and a dearth of business investment, the economy would be in excellent shape. As it is, growth continues along the moderate 2% path that it has followed for more than 10 years. It's been the weakest recovery ever, but also the longest business cycle expansion. And with no obvious excesses or systemic problems in view, it promises to continue. 

Chart #1

The Q3/19 GDP report—1.9% annualized growth—makes the current expansion the longest on record. Chart #1 shows the quarterly annualized growth rate of both nominal and real GDP. To be sure, 2% growth isn't a barn-burner, but it's impressive given the degree to which the manufacturing sector has been hit by Trump's tariff wars.

Chart #2

Since the recovery started just over 10 years ago, annualized GDP growth has been 2.3%; in the past year it was 2.0%, and in the most recent quarter 1.9%. As Chart #2 suggests, for most of this past year the market has been expecting growth to slow, and indeed it has. That is reflected in the more than 100 bps decline in the real yield on 5-yr TIPS since late last year. At today's real yield of a mere 0.05%, 5-yr TIPS appear to be priced to the expectation that real GDP growth will average about 2% per year going forward. Not surprisingly, Chairman Powell recently chimed in with a similar view, saying the FOMC expects moderate growth of about 2%.

Chart #3

Chart #3 compares real economic growth with private sector jobs growth. Not surprisingly, the two tend to move together: more jobs means more growth. The recent slowdown in GDP growth is reflected in a similar slowdown in jobs growth (the October jobs report was much better than expected, but it didn't do much to change the trend growth rate of jobs, which has been declining so far this year).

Both jobs and GDP have suffered from a lack of business investment, which likely has a lot to do with the uncertainties surrounding international trade. Private sector jobs currently are growing at pace of about 1.3% per year. If jobs grow at least 1% per year and productivity registers at least 1% per year (which it has in recent years), then 2% real economic growth is sustainable. (Jobs growth plus productivity growth is a decent first approximation for overall economic growth.) For growth to move higher, we would need to see a pickup in business investment, which not only creates jobs but improves the productivity of existing workers. A resolution to the tariff wars would undoubtedly prove a catalyst in that regard.

Chart #4


Demographic factors (more and more boomers are retiring) likely also play a part in this year's slowdown. Employers continue to complain that their biggest problem is finding qualified workers. Chart #4 shows that more small business owners than ever before report that "job openings are hard to fill."

Chart #5

But it's not like the economy is running out of available workers. As Chart #5 shows, the labor force participation rate (the percentage of the working age population who are either working or looking for work) looks to be increasing, albeit slowly. People who had been on the sidelines are being enticed to return, perhaps because they see better opportunities. Or in the case of not a few retired baby-boomers I know, they have decided that working is better than just sitting around watching TV. Regardless, there are still almost 6 million people out there who officially are looking for work, according to the BLS.

Chart #6

Chart #6 compares actual growth in real GDP to its long-term trend. (Note that this is plotted using a semi-log scale for the y-axis; a straight line on this chart thus corresponds to a constant rates of growth.) By only averaging 2.3% per year, the current recovery—the weakest in history—has resulted in a $3.4 trillion "shortfall" of growth relative to what might have been had the economy rebounded to its long-term trend as it did after every prior recession. Had this been a "normal" recovery, real median family income might have been almost 18% higher (~ $1000 per month) than it is today. 

Chart #7

Chart #8

Charts #7 and #8 show two measures of business investment. Both show that investment in the current business cycle has been weaker than in previous business cycles (especially in real terms, as Chart #7 highlights). Weak investment is likely major factor behind the economy's unimpressive 2% growth rate. Which is unusual, because corporate profits have been unusually strong in the past decade. 

Chart #9

What other factors might be restraining the economy's ability to grow? The size of government ought to top anyone's list. In the past 12 months, the federal government spent a staggering $4.5 trillion, almost 21% of GDP, and 8% more than the same measure a year ago. Even more staggering, though, is the composition of that spending: 72% of what the federal government "spent" in the past year ($3.2 trillion) was in the form of transfer payments (see Charts #9 and #10). That's money that is spent on things like healthcare, social security, income security, and interest payments on debt (as of last June the annual interest on federal debt outstanding was a little over $600 billion, or 13.3% of federal spending). Only 28% of federal spending was for goods and services (i.e., true purchases). Think of purchases as a proxy for what it costs to run the government, while transfers are basically entitlements—spending that is determined not by the budget process but rather by eligibility. 

Chart #10

Note how the growth in transfer payments has surged relative to the growth of purchases since the early 90s. As Chart #10 shows, since 1970 transfer payments have more than doubled relative to total spending. By far the biggest role of the federal government in today's economy is that of an income transfer agentNeedless to say, with $3.2 trillion per year (and growing) on autopilot, the potential for fraud and waste is ginormous. It's safe to say that the huge size of government transfer payments acts as a drag on overall economic growth and efficiency. And it's only going to get worse unless changes are made to entitlements eligibility (e.g., raising the social security retirement age and/or indexing social security payments to inflation rather than wage growth). 

These are problems that have been and are going to be with us for a long time. In the meantime, it's reassuring to note that financial market conditions look quite healthy:

Chart #11

The threat that an inverted yield posed to the economy (a threat I discounted long ago), has now disappeared. As Chart #11 shows, the Treasury yield curve is now positively-sloped (the 1-10 spread is about 20 bps today), and the real Federal funds rate is essentially zero. The Fed is not tight, and their recent decision to lower their target rate, while overdue, was welcome. The Fed has now caught up to the market and things are thus looking copacetic.

Chart #12


The real yield curve is actually a better thing to look at, and here too things look good. The blue line in chart #12 is a proxy for the overnight real rate, while the real yield on 5-yr TIPS is the market's estimate of what the overnight real rate will average over the next 5 years. Both are identical. By lagging the market's expectation of falling real rates for most of this year the Fed had been threatening with policy arguably "too tight." But now the Fed is neutral. A sign of relief.

Chart #13

Swap spreads (see Chart #13) are my favorite leading and coincident indicator of systemic risk, financial market liquidity, and fundamental economic health (the lower the better). Swap spreads are now low both here and in the Eurozone. Things could hardly be better.

Chart #14

Chart #14 shows Credit Default Swap spreads, a highly liquid and generic indicator of the market's confidence in the outlook for corporate profits. Spreads are quite low, which means the market is confident that the outlook for profits—and by extension the outlook for the economy—is healthy.


8 comments:

Fred said...

Excellent points but I do take issue with your arguments on transfer payments. I've been paying the max into SS and Medicare for almost 34 years. Am I not entitled to get some of that back? I don't see it the same as food stamps or other govt hand outs. Perhaps you can convince me that wealthy people ought not to get as much in SS and Medicare but they do pay more into the system.

Benjamin Cole said...

"Or in the case of not a few retired baby-boomers I know, they have decided that working is better than just sitting around watching TV."--Scott Grannis. Needs no amplification. The couch was sagging anyway.

Speaking of entitlements, do not forget the VA is now a $200 billion baby, and doubling every 10 years. A mercenary military is very expensive, and veterans are probably the most powerful and well-organized of interest groups. Nancy Pelosi has said, "On veterans' policy, we defer to the VSAs." What is a VSA? The Veterans Service Organizations, or lobby groups organized by state and congressional district. Disability pensions are rife, and military employees qualify for full pensions and free medical care for life after 20 years on the job. The Koches can throw money around, but the VSAs can bring the votes.

Frankly, I think federal spending is unstoppable (see above, the VA is just another cog in the system), and so is borrowing.

We just have to hope that money-financed fiscal programs work. Or, QE while running federal deficits.

Interestingly, BlackRock, the world's largest equity investor, and Pimco, the world's largest bond manager, and Ray Dalio, the world's biggest hedge fund manager, have all recently endorsed money-financed fiscal programs, aka helicopter drops. So has former Fed Vice Chair Stanley Fischer.

Here is what the Dutch money manager ING said yesterday:

"The monetarist era is over

Central bankers have been the first to recognize that the effectiveness of monetary policy in managing demand and stabilizing economic cycles has reached its limits. The problem is that many politicians and academic economists remain in denial"

https://think.ing.com/opinions/the-monetarist-era-is-over/

Well, following macroeconomics is always interesting. I never thought Wall Street would call for the helicopter drops.

But then, who thought a reality TV talk show could be President of the US?

Why watch TV? Reading the newspapers and blogs calls for much more suspension of disbelief.



Scott Grannis said...

Fred, think of social security as a tax masquerading as an annuity, with politicians calling the shots instead of actuaries, and without any assets to back up future liabilities. It’s a modified Ponzi scheme. It’s the worst deal in the world for the average person. Everyone, especially the rich, gets shafted.

pgrommit said...

The sluggish growth seems to validate the Rogoff/Reinhart study that showed that recoveries from a financial crisis were less robust that those after garden variety inventory recessions.

The chart showing the slow and steady pace of GDP and job growth of the last 10 yrs. would be a great shock to anyone depending on the Maddows of the far-left and Limbaughs of the far-right to tell them what to think. It has come during periods where each party has controlled the White House and congress.

steve said...

So the million dollar question is "why has this recovery been so tepid?" I believe it is because the US government and the Fed intervened with bailouts and QE to squelch what should have been a perfectly "normal" financial storm. Rather than a complete cleansing of excess we got a partial cleansing and therefore have enjoyed a partial recovery. That's NOT capitalism but you can bet your bottom dollar it will be the new normal moving forward.

Flying Robot said...


The CBO seems to agree with your transfer payment discussion as well, suggesting the stimulative impact of that spending is reduced at least 20% vs the direct purchases of goods and services. I do think there is more to the discussion, but the evidence for this seems reasonably strong.

My concurrent perception is that the recovery has also been tepid because private employment growth has been tepid, and private employment growth has been tepid (in both 2003/2004 and this recovery/expansion) because employers are more cautious than ever about hiring. Labor, particular if not very specialized, has less and less value relative to cost, and carries extended commitments. I think both globalization (via the internet in particular) and automation have contributed to the ability of companies to moderate (& mitigate) their hiring of US workers. Also, old tech and retail companies zombie along, but can't gain any new traction. They are in survival mode, as disruptive new companies rapidly scale.

One could argue that the lack of direct purchases of goods and services are driving the employment effects we are seeing, but I believe it's reasonable to conclude that there are several causes at work here.

leo said...

About Philly Fed State Leading Index, do you think is it a good crystal ball, a good leading index? not as good as truck tonage index?

Kman said...

"Employers continue to complain that their biggest problem is finding qualified workers."

maybe not at the wages hey want to pay :-)

Scott we maybe coming up on unchartered territory. If the spending composition looks like this in an expansion, how might it look in a downturn (considering the debt situation).
Troubling ???

Rising transfer payments and entitlements have been on the agenda for a while and probably take center stage in the future....considering the maturing and ageing demographics and a mature economy. The solution wll be to cut the military spending, hard to do but will eventually have to be get done. The millenials and tik tock generation are gonna veer left and I suspect the spending priorities will reflect that. Just a hunch. There is enough to go around ( for now).