[This article by Dr. Jim Hagerbaumer on interest rates and the markets is quite cogent and thoughtful and well worth reading.]
GDP growth is diving
Growth fell from 1.4% in Q4 to near zero in Q1. Yet the economy continues to add a quarter-million jobs per month. What is happening? What is the deeper perspective?
First off, good high-paying jobs have slowly been eviscerated by a series of damaging “free” trade agreements starting with NAFTA in 1995. These were negotiated in secret out of the eyes of the American public. One result is that the highly touted employment numbers have lost some of their meaning. For example, since the 2007 peak fully 1/3rd of job creation has been in restaurants and bars. Average wage $10.50 per hour.
Real income per person barely growing
From the last cycle peak, per capita real disposable income has risen only 3% or so. In other words, less than 0.4% per year. The damage during the recession has been hard to make up. The graph shows how the level of real GDP (blue line) and per capita GDP (red line) have grown this cycle. Since population has risen almost as fast as GDP, the average household is barely better off. This has been the poorest per capita peak to peak growth since the Great Depression! Eight years after the cycle peak in 1929, growth had averaged 0.1% per year. Not much different than the current cycle. Workers took it on the chin during the recent recession. Many jobs never came back, and labor force participation is still far below peak with little in the way of recovery. Also, during the recovery savers and retirees have taken it on the chin. Lost interest income due to ZIRP and the QEs has cumulated to over $3 trillion! Looked at this way it’s surprising consumers have spent as freely as they have.
Globe is debt-constrained
The predominant reason for the poor performance is too much debt. US households are not even close to being back in the comfort zone where they were before the housing bubble took off. To get a birdseye view of the stress prevalent today, note that 40% of student loans – the exponentially growing sector of debt this time around – are in arrears. This shocking statistic is linked directly to the paucity of good jobs. For the vast majority of households, spending via credit in excess of income is constrained far more than before the crisis. Moreover, most households taking on additional debt relative to income (job losers, etc.) have little recourse if they want to maintain their lifestyle. The entire globe is debt constrained in much the same manner.
Now for the other sectors starting with housing
The housing sector is a pale imitation of its former self. Naturally enough, the contraction in home building was an unintended consequence of the boom-gone-bust. Malinvestment in home building got stacked to the rafters during the boom. The housing sector is now so shrunken that even healthy growth adds only 3/10ths of a percent to real GDP growth. Moreover, home prices are again in a bubble around 1/3rd the size of the last bubble. The bubble is measured by proportioning home prices to per capita disposable income. Notice how poor per capita income comes back around to augment the bubble in home prices. Even with this new bubble, households who could take out home equity loans on rising home values aren’t biting like last time. The societal meme has changed to where people don’t want to get burned a second time. So this bubble isn’t feeding consumer spending like the last one did.
Productivity crunched by distorted incentives
Business investment is no longer a mainstay. From 2010 through 2014, investment contributed 3/4ths of a percentage point to overall growth. Last year the investment share got sliced to 0.2% … and it isn’t coming back any time soon. The unintended consequences of profligate Fed policy this recovery (a) helped juice the buildup of Chinese and other EM debt via the carry trade, (b) juiced the fracking industry in the US via artificially low interest rates on corporate borrowing, and (c) eventually resulted in an oil price bubble that finally burst because of oversupply and falling global demand. The plunge in oil prices brought the house down on business investment.
Let’s take this a level deeper to the dearth of net national savings. Savings has been eviscerated here in the 21st century by the upside-down Keynesian paradigm which lauds consumption over the far more important setting aside of sufficient seed corn to grow the future. This dearth is a major contributor to faltering productivity growth. After the temporary productivity kick coming out of the recession, permanent reality set in. Over the past four years productivity growth has fallen to just 1/2 of a percentage point (1/4th of a point the past two years). Observe that near-zero productivity growth for this long happened only once before. That was during the back-to-back 1980-82 recessions when the US was transitioning away from double-digit inflation. Today’s necessary transition away from excessive debt has not even begun yet! The ramifications of stagnant productivity – including weak GDP growth which makes the economy more susceptible to financial shocks – is not yet widely recognized. In fact blind belief that productivity will recover rules the roost. Glance at the chart and you see that once past its cyclic kick productivity growth falls and does not recover. The only real exception is the tech boom in the late-1990s, which was aided by fear-induced Y2K investing in computers and software ahead of the turn of the millennium.
Economies can go nowhere without productivity. Productivity can go nowhere without savings. Savings cannot be replenished when the consumer sector is borrowing too much, when corporations borrow to buy back stock instead of investing in capital formation, and when the ongoing trade deficit absorbs as much of domestic savings as it does. Seven years of ZIRP have distorted business and consumer incentives to these very ends. The private corporation Federal Reserve couches its policy in lip service toward the average American. But the data speaks for itself. The Fed has blown away any semblance of free market pricing. It has done so to bail out the big banks to which it is beholding because they are its shareholders. The linchpin of economic growth that would benefit all Americans – productivity – is the all-too-silent casualty.
The long causal chain that’s taken US net exports negative
Now for an even more complex causal chain. On the policy advice of prominent US economists, Japan has been digging its grave for a long time. The latest attempt to extract itself – negative interest rates. In 2008, Europe’s economy was devastated by the US-originated subprime housing fiasco. Along with having a politically-motivated common currency that clearly does not work to the benefit of Southern periphery nations, the eurozone debt buildup and its essentially insolvent banking system have driven rates negative there. Of course the ECB had choice, but this is the route they’ve taken to keep the euro currency intact. Negative rates shunt demand away from the currencies of negative rate countries. China, Canada, and Mexico are our three top trading partners. Over the past twelve months, the dollar has risen 5% against the yuan, 6% against the Canadian dollar, and 14% against the peso. The dollar is up against the currencies of each of the big three – eurozone, China, and Japan. The lagged impact of dollar appreciation on demand for US exports will extend through 2016 and beyond. Relative GDP growth differentials weigh even more heavily on US export demand than does dollar appreciation. For three years now, global growth has slowed relative to that of the US. One reason is the fracking miracle in the US. As for the rest of the world, Japan’s multi-decade depression is ongoing. Eurozone growth is hobbled for reasons mentioned above. EM growth has fallen a percentage point over the past two years as the carry trade has reversed. The carry trade was incentivized by US QEs, but now the piper must be paid. On trend, China’s growth is falling as a consequence of having to throttle back credit growth after the largest debt buildup in history. It was clearly unsustainable. The immediate upshot of this causal chain is that net exports in the US will subtract from growth for the rest of the year. Net exports were negative five of the last six quarters. Another upshot – ramped up fragility of the global financial system – will probably turn out to be even more important. Something in the system is going to break and precipitate the next recession – a recession which promises to be far more severe than the last.
- Just as the housing bubble gave a false sense that the 3.2% growth during most of the last expansion was sustainable, today the employment numbers are masking weaknesses in the 2.1% GDP growth of this expansion.
- Domestic over-indebtedness, increasing indebtedness to the rest of the world, global financial fragility, stagnant productivity, faltering net business investment, maldistribution of the capital formation that is taking place – all these are signs of an erosion of the pillars of growth that began even before the last crisis.
- Yet the US stock market proceeds on its merry way. Though this too is an illusion. And a reckoning is coming.
- In this environment there is no earthly reason why interest rates should rise.
Jim Hagerbaumer, Ph.D.