Summary: 2014 was to be the year the US economy reached “escape velocity” from the slow 2.2% GDP growth since the crash. So far, as repeatedly predicted here, that has not happened. What might the second half of 2014 hold for us? The long-awaited acceleration, or more trend growth, or (what few economists expect) further slowing? Nobody expects a recession. Here’s some data that might help you prepare.
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In December 2013 there were widespread forecasts of a boom in 2014. On February 21, half way through Q1, I wrote:
The consensus forecast per Blue Chip Economic Indicators as of February 20 for US GDP: 2.7% in 2014 and 3% in 2015. But years of over-optimistic forecasts have made economists cautious, so their “whisper numbers” are higher than their official numbers. My guess is that 2014 will be another year of slow (2.2%?) growth. But, as always, surprises await us — good and bad.
I was a pessimist about 2014 in December through February. Now it appears I was too optimistic, since the first surprise of the year was Q1 GDP of -2.9%. Then most economists expected a big bounce in Q2. Now forecasts for Q2 look disappointing, but hope remains for the rest of the year:
- Q2: 3.1% (the Atlanta Fed’s NowCast is 2.7%). There were estimates as high as 5% earlier this year.
- 2H: 3.0%
- 2014: 1.6% (from Q4 to Q4)
The basis for economists’ hopes
The four horses expected to pull the economy are export growth, housing, business capex, and consumer spending (especially autos). Three of these are likely to be disappointing. The fourth looks strong, but might prove the weakest later in the year. Let’s take a quick look at each.
(a) Exports
With slow Q2 growth in both Japan and Europe, export growth might prove weak. The drop in Japan’s economy following the April sales tax increase has been far larger than expected.
(b) Housing
Hopes for housing were great, looking for growth in new home construction, existing home sales, and rising prices. Purchase mortgage applications are down 17% YoY NSA. Both permits and starts were weak in June, an ugly leading indicator. Worse, there are indicators that the market is weakening. See top-analyst Mark Hanson’s June 8 report (free registration required), far from the consensus opinion. For a specific example see his June 10 report about May activity in Phoenix; confirmed by this July 7 report by the Center for Real Estate Theory and Practice at AZ State U.
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(c) Capital Expenditures
Capex growth is the great hope, but has not appeared so far. Look at the trends (MoM, SA):
- manufacturers’ new orders: March +1.5%, April +0.8%, May –0.5%,
- industrial production: March +0.9%, April +0.0%, May +0.5%, June +0.2%.
The evidence suggests that CEO’s prefer to enrich themselves through stock buybacks, rather than focusing on building the firm through capex and workers (e.g., training, motivation). See the numbers by FactSet. It’s the Triangle Trade of stock options to stock to buybacks, to which CEOs devote not just corporate America’s cash flow but also its borrowing. See David Stockman explain how the buyback process works for IBM. See Gordon Long’s analysis of the math: “The buyback tax ruse“.
(d) Consumer spending
The trends show no sign of the expected boom. They’re slowing. MoM, SA:
- Consumer spending has not accelerated: March was 0.8%, April +0.0%, May +0.2%.
- Retail sales are slowing: March was +1.5%, April +0.6%, May +0.5%, June +0.2%.
- Vehicle sales have been the driver of consumer spending, and might be peaking. March was +4.2%, April +1.0%, May +1.0%, June -0.2%.
Now for the bad news. Auto sales have been driven by subprime lending (see the evidence here), a typical sign of a boom nearing its end as companies exhaust their usual customers. Even the New York Times has noticed; they point to one factor that might bring a hard end to this cycle:
In many cases, the examination by The Times found, borrowers ended up shouldering loans that far exceeded the resale value of the car. A reason for that disparity is that some borrowers still owe money on cars that they are trading in when they purchase a new one. That debt is then rolled over into the new loan.
Bloomberg reported that the average loan-to-value ratio on subprime auto loans was 114.5%. Fast Company explains another reason why this cycle might end badly:
According to the National Automobile Dealers Association, the average American spends around $30,000 on a new car or light truck. In contrast, Interest.com’s 2013 Car Affordability Study says that the average American can only afford to spend $20,806 on a car.
What comes next?
Predicting the future of the large and unimaginably complex US economy — embedded in the giant world economy — is difficult in normal times. During these extraordinary times, with monetary policy on a scale never before tried, accurate predictions might prove impossible.
Failure of the US economic engines to ignite now (after years of dashed hopes) might have unusual consequences. As Michael Hartnett (Chief Strategist, Bank of America Merrill Lynch) wrote on 12 September 2013 (red emphasis added):
Significant monetary stimulus, the end of fiscal austerity, a booming housing market, a cheap dollar, record corporate cash balances — if the US economy does not significantly accelerate in the coming quarters, it never will. We assume it will…”
Years of massive fiscal and monetary stimulus have given a healthy flush to the US economy. But the stimulus is fading as the budget deficit shrinks and the Fed slowly but steadily normalizes monetary policy (with QE winding down by October and the first interest rate increase expected in mid-2015). Now we need normal growth, but we might not get it. But few or no economists expect a recession in the near future (nobody expected GDP to fall in Q1).
I’ll stick with my guess of slow growth in the low 2%s for the second half of the year.
Looking further ahead, our longer-term prospects seem challenging, as described in these posts:
- The dilemma of the US economy: can’t take off & too close to the brink, 9 July 2014
- Has America’s economy entered the “coffin corner”?, 10 July 2014
Other recent forecasts and warnings:
- What can we expect from the US economy in 2014?, 21 February 2014
- Status report on the US economy: stand by for the boom!, 24 April 2014
- The next industrial revolution starts. Beware the Pied Pipers who lull us into passivity., 8 July 2014
See all posts giving forecasts here.
The US economy as most economists see it
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I guess it didn’t trickle down.
Just up?
Breton
Breton,
As I have said so often, America is well-governed. Just not in our interests.
Here is an out take from Hoisington.
Hoisington Investment Management – Quarterly Review and Outlook, Second Quarter 2014
Treasury Bonds Undervalued
Thirty-year treasury bonds appear to be undervalued based on the tepid growth rate of the U.S. economy. The past four quarters have recorded a nominal “top-line” GDP expansion of only 2.9%, while the bond yield remains close to 3.4%. Knut Wicksell (1851-1926) noted that the natural rate of interest, a level that does not tend to slow or accelerate economic activity, should approximate the growth rate of nominal GDP. Interest rates higher than the top-line growth rate of the economy, which is the case today, would mean that resources from the income stream of the economy would be required to pay for the higher rate of interest, thus slowing the economy. Wicksell preferred to use, not a risk free rate of interest such as thirty-year treasury bonds, but a business rate of interest such as BAA corporates.
As chart one attests, interest rates below nominal GDP growth helps to accelerate economic activity and vice versa. Currently the higher interest rates are retarding economic growth, suggesting the next move in interest rates is lower.
To put the 2.9% change in nominal GDP over the past four quarters in perspective, it is below the entry point of any post-war recession. Even adjusting for inflation the average four-quarter growth rate in real GDP for this recovery is 1.8%, well below the 4.2% average in all of the previous post-war expansions.
Fisher’s Equation of Exchange
Slow nominal growth is not surprising to those who recall the American economist Irving Fisher’s (1867-1947) equation of exchange that was formulated in 1911. Fisher stated that nominal GDP is equal to money (M) times its turnover or velocity (V), i.e., GDP=M*V. Twelve months ago money (M) was expanding about 7%, and velocity (V) was declining at about a 4% annual rate. If you assume that those trends would remain in place then nominal GDP should have expanded at about 3% over the ensuing twelve months, which is exactly what occurred. Projecting further into 2014, the evidence of a continual lackluster expansion is clear. At the end of June money was expanding at slightly above a 6% annual rate, while velocity has been declining around 3%. Thus, Fisher’s formula suggests that another twelve months of a 3% nominal growth rate is more likely than not. With inflation widely expected to rise in the 1.5% to 2.0% range, arithmetic suggests that real GDP in 2014 will expand between 1.0% and 1.5% versus the average output level of 2013. This rate of expansion will translate into a year-over-year growth rate of around 1% by the fourth quarter of 2014. This is akin to pre-recessionary conditions.
An Alternative View of Debt
The perplexing fact is that the growth rate of the economy continues to erode despite six years of cumulative deficits totaling $6.27 trillion and the Federal Reserve’s quantitative easing policy which added net $3.63 trillion of treasury and agency securities to their portfolio. Many would assume that such stimulus would be associated with a booming economic environment, not a slowing one.
Readers of our letters are familiar with our long-standing assessment that the cause of slower growth is the overly indebted economy with too much non-productive debt. Rather than repairing its balance sheet by reducing debt, the U.S. economy is starting to increase its leverage. Total debt rose to 349.3% of GDP in the first quarter, up from 343.7% in the third quarter of 2013.
It is possible to cast an increase in debt in positive terms since it suggests that banks and other financial intermediaries are now confident and are lowering credit standards for automobiles, home equity, credit cards and other types of loans. Indeed, the economy gets a temporary boost when participants become more indebted. This conclusion was the essence of the pioneering work by Eugen von Böhm-Bawerk (1851-1914) and Irving Fisher which stated that debt is an increase in current spending (economic expansion) followed by a decline in future spending (economic contraction).
In concert with this view, but pinpointing the negative aspect of debt, contemporary economic research has corroborated the views of Hyman Minsky (1919-1996) and Charles Kindleberger (1910-2003) that debt slows economic growth at higher levels when it is skewed toward the type of borrowing that will not create an income stream sufficient to repay principal and interest.
Scholarly studies using very sophisticated analytical procedures conducted in the U.S. and abroad document the deleterious effects of high debt ratios. However, the use of a balance sheet measure can be criticized in two ways. First, income plays a secondary role, and second, debt ratios are not an integral part of Keynesian economic theory.
We address these two objections by connecting the personal saving rate (PSR) which is at the core of Keynesian economic analysis, and the private debt to GDP ratio that emerges from non-Keynesian approaches. Our research indicates that both the “Non-Keynesian” private debt to GDP ratios, as well as the “Keynesian” PSR, yield equivalent analytical conclusions.
The Personal Saving Rate (PSR) and the Private Debt Linkage
The PSR and the private debt to GDP ratio should be negatively correlated over time. When the PSR rises, consumer income exceeds outlays and taxes. This means that the consumer has the funds to either acquire assets or pay down debt, thus closely linking the balance sheet and income statement. When the PSR (income statement measure) rises, savings (balance sheet measure) increases unless debt (also a balance sheet measure) declines,
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