Wednesday, July 22, 2015

Deleveraging still unfinished, Strong growth for US economy ahead after it

Is the U.S. economy stuck in an endless loop of sluggish growth and high unemployment? Many distinguished economists think so, and there is some evidence to support them. But looking at much the same data, I come to the opposite conclusion: The U.S. could soon experience a period of strong economic growth once deleveraging is over.

No doubt, the economy is now growing too slowly, at an annual pace of only 2.2 percent real gross domestic product in this recovery, which started in mid-2009. That's about half the speed you'd expect after the worst recession since the 1930s. And the sluggishness is global, with tiny growth in the euro area, a pattern of rising and falling economic activity in Japan, and a slowdown in China (where the official growth rate of 7 percent is probably twice the actual number). 

Many forecasters believe slow global growth will last indefinitely. They think developing economies are reaching the limits of easy growth based on emulating Western technology, while advanced countries are increasingly oriented toward services, with less scope for productivity gains. 

The pessimists believe that productivity growth -- it has averaged just 1 percent annually in this recovery, the slowest by far for any post-World-War-II cycle -- is destined for more of the same while the retirement of postwar babies and poor education and training constrain market supplies. 

This camp also points to increased government regulation, income polarization, and too much saving and not enough spending on a global basis as reasons for the slow growth. They note that these trends have been going on for decades, but were hidden in earlier years by the dot-com speculation of the late 1990s, the housing bubble in 1995-through-2005 years, the early-1980s-to-mid-2000s consumer spending spree, and the euphoria in the euro zone after its 1999 launch. 

I agree there have been some profound economic changes in recent decades. I attribute them largely to globalization, with more and more goods and services production shifting to economies with much lower labor costs. Not coincidentally, since the 1990s there have been much slower post-recession recoveries than normal for payroll employment. 

Many other reasons have been advanced for slow economic growth indefinitely. Harvard economists Carmen Reinhart and Kenneth Rogoff concluded in a 2010 paper that when central government debt exceeds 90 percent of GDP, the economies of developed countries contract at a 0.1 percent annual rate. Since people saw the Reinhart-Rogoff high-government-debt scenario playing out right before them, they believed that chronic slow growth was inevitable. 

Glenn Hubbard, dean of Columbia's business school and a former chairman of the president's Council of Economic Advisers, and Tim Kane, a former chief economist of the Hudson Institute now at the Hoover Institution, express even more basic concerns in their book "Balance: The Economics of Great Powers From Ancient Rome to Modern America." They believe great powers fall into the trap of "denying the internal nature of stagnation, centralizing power and shortchanging the future to overspend on their present."

Harvard's Larry Summers, the former U.S. Treasury secretary and National Economic Council director, is concerned with "secular stagnation." By that, he means chronic slow growth due to slow labor-force expansion and muted productivity growth. 

Then there's Robert Gordon of Northwestern University, who, in the tradition of Thomas Malthus, believes that all the big growth-driving technologies are fully exploited. He cites past marvels, including Edison's electric light bulb and power station, which spawned all manner of electricity use, from consumer appliances to elevators. He sees nothing to rival the economic impact of the automobile, telephone, phonograph, motion picture, radio, television, air conditioner, jet plane and interstate highway system. 

Computers and the Internet are essentially fully exploited, he and other techno-pessimists believe, meaning the 1891-through-2007 years of 2 percent annual output growth per capita are over. And with postwar babies leaving the workforce, America's lousy education system and growing income inequality, real annual GDP growth of only 1 percent is likely. The vast majority of Americans, he thinks, will see their incomes grow just 0.5 percent annually. 

The recent weakness in productivity is especially worrisome for slow-growth adherents. For only the third time in the last three decades has productivity suffered two consecutive quarterly declines (outside of recessions). Without productivity growth, the only way the economy can advance is by adding hours worked. Without productivity growth, the only way individuals can increase their real income is if others lose some of theirs. So productivity growth has social as well as economic significance. 

Many economists, including those at the Federal Reserve Bank of Atlanta, attribute slow productivity gains to subdued capital spending growth in recent years and the resulting aging of capital equipment. The Atlanta Fed researchers conclude that the rise in GDP in the recovery, weak as it has been, is due primarily to more hours worked and not more output per hour. 

A hotly debated academic explanation for slow capital spending is that real interest rates, as measured by Treasury yields, are too high to induce businesses to spend on new plants and equipment. And since nominal interest rates can't go below zero, real rates -- the difference between nominal rates and inflation -- can't be pushed into negative territory to encourage investment when inflation is essentially zero.

Real interest rates (as seen in yields on 20-year Treasury notes) have declined since the early 1980s: from a lofty 9.5 percent in August 1983, when investors feared more double-digit inflation, to 1.9 percent in December 1990, when disinflation set in. Since then, real rates have risen a bit, to 2.9 percent as of July 1, but have been negative on three occasions in recent years. 

One reason real rates have been weak recently is the global financial deleveraging that started in 2008. Banks worldwide, with pressure from regulators, are borrowing less, as are U.S. consumers. Then there's quantitative easing, first by the U.S. Federal Reserve and now by the Bank of Japan and the European Central Bank. When central banks conduct quantitative easing by purchasing large quantities of government bonds, it tends to push down interest rates.

Another reason given for weak real interest rates is the declining rate of population growth, a phenomenon normally associated with real rate declines. Then add in the polarization of income, which shifts money into the hands of big savers and away from lower-income, heavy-spending folks. The postwar babies have been notoriously poor savers. Now, the need to save like crazy for retirement reduces consumer spending, which further depresses interest rates. 

The same goes for the mountains of excess cash corporations are hoarding. When capital investment shrinks, it can't offset reductions in consumer spending, and that pushes interest rates and economic growth down. 

A fundamental concern among those who forecast slow economic growth indefinitely is that adequately trained workers won't be available even if jobs are offered. They believe the labor market is supply-constrained. The number of people out of work six months or more remains huge, and after six months, skills get rusty. Others never gained the ability to compete in today's global, digital world, which has favored a few who tend to have high incomes as a result.

Also, when the recent recession squeezed business revenue and decimated profits, many corporations eliminated their training programs to save money. Besides, with so many qualified people who were unemployed and available, why pay to train new ones?

With slow economic growth and no inflation, business revenue growth has been muted. So the route to profit gains has been through cost-cutting, and most business costs are ultimately for labor. Meanwhile, globalization and automation are eliminating many U.S. middle-income jobs. Real wages and median household incomes, as a result, have been flat in this recovery.

Pessimists also point to declining U.S. population growth, which is approaching zero, and the likelihood that the trend will persist. Adding to these concerns is the declining share of the population over age 16 that is in the labor force, i.e., either employed or actively looking for work. 

About 60 percent of the decline in this total participation rate since its February 2000 peak is due to demographics: Postwar babies are retiring and women are no longer entering the job market en masse. In addition, many working-age people don't see job opportunities and have dropped out of the labor force. 

In the future, employees will need to be much more productive to cover their needs and those of retirees. Otherwise, there will be intergenerational conflict when it comes time to split an inadequate economic pie. In the U.S., the ratio of those in the working ages -- 15 to 64 -- to those over 65 is projected to drop from 5.2 in 2010 to 2.9 in 2040. 

Monday, July 20, 2015

Bullish America and US stocks longer term [VIDEO]

Gary Shilling interview on Bloomberg and why Gary Shilling is bullish USA long term.

Monday, July 13, 2015

Slow growth wont last forever

I don't agree with the slow-growth-indefinitely forecasts.

I've long said that, until global deleveraging is completed, gross domestic product will continue to grow by about 2 percent annually. I've also noted that reducing debt levels after a financial crisis, especially one caused by a borrowing binge, normally takes about a decade. This episode is eight years old, and at the rate things are going, it may take longer than 10 years. U.S. household debt relative to after-tax income has fallen to 102 percent from 130 percent, but it's still a long way from the 65 percent norm.

Nevertheless, the process will end at some point, and I continue to believe it will be followed by rapid real economic growth of at least 3.5 percent a year. That growth will no doubt be fueled by today's new technologies, including computers, the Internet, biotech, telecom, semiconductors, robotics and 3-D printers. 

Note that the Industrial Revolution and railroads started in the late 1700's and grew explosively, but from zero starting points. It was only after the Civil War that they became big enough to drive the U.S. economy. 

Secular Stagnation

Productivity is a complex phenomenon. It comes in waves that are often unrelated to the current economic situation, so recent weakness shouldn't be extrapolated. Even in the Depression-era 1930's, output per hour rose at a healthy 2.4 percent annual rate, higher than the 2.1 percent growth of the Roaring '20s. Many of the tech advances of the 1920's -- electrification of factories and homes, increased use of telephones, the dawn of the radio era -- weren't exploited until the following decade, when they became must-have conveniences. 

In the current setting, companies may have compensated for anemic revenue growth by cutting costs so much that productivity growth, which normally would have been spread out, was concentrated in 2009-2010. Recent productivity weakness probably indicates that companies have reached the bottom of the cost-cutting barrel. The leap in profit margins since the recession has also topped out in the last two years; corporate profits have now begun to decline. So businesses will no doubt turn from reducing costs to promoting productivity. Companies will probably redouble these efforts if wage increases push up unit labor costs. 

At the same time, companies will probably increase research-and-development spending and reinstitute labor-training programs as the supply of unemployed skilled workers shrinks. The need for trained workers will be enhanced by the growing use of robots, which generates jobs in design, engineering, maintenance, marketing and logistics. 

Solutions to the current crisis in higher education may end up promoting productivity, as well. Students and their tuition-paying parents now know that a college degree no longer guarantees a job that pays well. In this regard, two education developments are encouraging. First, many colleges are emphasizing degrees in the STEM (science, technology, engineering and math) fields, where jobs are waiting. Second, German manufacturers have transplanted their apprenticeship program to plants in the southeastern U.S., where they coordinate worker training with nearby community colleges. American businesses are beginning to copy this model. 

As for the Reinhart-Rogoff argument -- that high government debt depresses GDP -- it's probably the other way around. Slow economic growth depresses tax revenue and raises government social spending, thereby causing bigger deficits and debt levels. 

The argument that growth is stymied because companies have cut capital spending may also be missing a larger trend. Much of the spending to build new tech and social-media companies, such as Google and Facebook, isn't counted as capital outlays. The brains of the entrepreneurs and developers substitute for capital spending. A high-tech startup in a garage or a college dorm doesn't register in government data the way a new auto plant does. Many successful startups didn't need much more than a laptop, and most of the money they raised went to advertising and marketing, not building factories.

Fed economists believe that the pricing of high-tech equipment may result in understated business investment. Not surprisingly, capital equipment prices have fallen 21 percent since the early 1980's. Furthermore, the correlation between capital spending and productivity is, contrary to the belief of the slow-growth advocates, weak to nonexistent. This is shown by the correlations between private, fixed capital investment and productivity with a series of leads and lags.

From the first quarter of 1948 to the fourth quarter of 1990, the strongest relationship was between capital spending and productivity growth three quarters later, which makes sense. But the statistical fit, according to my firm's research, was very poor. Even that weak relationship broke down between the fourth quarter of 1990 and the first quarter of this year. The best fit was between productivity growth now and capital spending 16 quarters later, which defies any causal explanation.

So there doesn't appear to be any meaningful statistical relationship between capital spending and enhanced productivity. Spending money on more machines doesn't do the job, suggesting that productivity flows mainly from new technology such as robotics, better management, more motivated employees, better logistics and, probably, dumb luck. 

The pessimistic argument that American corporations have been buying back stocks instead of investing in plant and equipment carries some weight, but dividend increases still leave the payout ratio (the percentage of net income paid to shareholders) for the S&P 500 at 42 percent, well below the long-term 52 percent average. It can be argued that low interest rates make low dividend yields (dividend per share divided by price per share) acceptable. In any event, the dividend yield for the S&P 500 index is now just 1.97 percent, well below the earlier 3 percent norm. 

True, government regulation is excessive, as the slow-growth advocates maintain. Since 1970, more than half of Americans have relied on government for meaningful income; in 2007, it was 58 percent, according to my firm's research. Yet voters haven't used the ballot box to accelerate their government goodies. 

Apparently, Americans still believe they can get further on their own merit than by pushing government to redistribute income in their favor. And if I'm right about a coming economic boom, they will have even less reason to rely on government largess. 

Originally published

US stocks recovery is over says Gary Shilling

The Fed’s QE drove U.S. stocks, but it’s over. Corporate earnings in this recovery have been based not on solid revenue growth but on profit margin increases that have flagged as underlying cost-cutting and productivity gains atrophied. 

In the portfolios I manage, I have shifted to European and Japanese stocks, figuring that the bulk of QE money will end up in equities, as it did in the U.S. In the last 12 months the S&P 500 is up 9% versus 12% for Europe’s Stoxx 600 and 38% for Japan’s Nikkei. China’s quasi-QE, plus the recent individual investor switch from real estate to stocks, has already hyped the Shanghai index, which is up 150% in the last 12 months.