U.S. annualized real GDP growth of 1.2% through Q3 2011 was driven by personal consumption, accounting for 91% of it.  Yet only 44% of personal consumption growth was driven by higher incomes.  The other 56% was accounted for by unsustainable items: a decline in savings (36%) and the payroll tax cut (20%).  The latter will expire in two months time unless Congress acts to extend it again. Read more »

On September 21st the Fed announced that it would be selling $400 billion in short-term Treasurys and buying $400 billion in longer-term Treasurys to replace them – a maneuver titled “Operation Twist.” Atlanta Fed president Dennis Lockhart explained what it would mean for the economy: “It means lower interest rates – a lower cost of borrowing – across a whole spectrum of loan maturities.” Is he right? Well, China, Russia, and Brazil have conducted their own version of Operation Twist over the past several years, replacing roughly $330 billion in short-term Treasurys with long-term ones. The 10-year Treasury rate went sideways over that period, as shown in the figure above. Whereas the BRIC* Twist may have put some modest downward pressure on longer-term rates, other factors overwhelmed it. Don’t expect much from the Fed’s similar-sized version.

Read more »

In its most recent update to the Budget and Economic Outlook, the Congressional Budget Office projects robust GDP growth of 4.4% in 2014 and 5.0% in 2015.  This projected spurt is unexplained, but appears to have been reverse-engineered from the belief that the United States should return to the trend growth it seemed to be following prior to the financial crisis—as can be seen in the figure upper-left above.  There is precedent for this: after the double-dip recession of the early 1980s, strong growth in 1983 and 1984 quickly closed the gap between actual and so-called potential levels of output—as can be seen above, upper-right.  But the CBO would be wrong to assume that economic history is destined to repeat itself.  In the early 1980s, industrial capacity continued to expand throughout the recession, while the labor force remained at the same level.  The recent downturn, however, has seen declines in both industrial capacity and the labor force of 2% and 5%, respectively—as seen in the bottom figures.  There is little justification for believing that potential economic activity has continued to grow while critical inputs to economic activity—labor and capital—have shrunk.  If potential output has shrunk along with them, then the U.S. faces considerably greater fiscal challenges than the CBO’s analysis implies. Read more »

Weak economic data, a Washington debt standoff, a downgrade of U.S. federal debt, and rising European default fears helped send the S&P 500 stock index down 16% between July 22and August 6.  As the figure above shows, equity prices of late imply the worst earnings growth rate expectations in 25 years—such expectations even turned negative last week.  This dour outlook stems partly from renewed risk-aversion, which ironically redirected cash into downgraded U.S. debt, but it also reflects a sharp rise in concerns about where new profits will come from.  Operating margins and profits are near all-time highs, but revenues are still below their 2008 peak and real consumer spending has grown by only 2% over the past year.  Corporations currently have strong balance sheets and the lowest net debt-to-revenue ratio on record, but this is largely the result of cost-cutting which may have run its course.  In short, either stocks are very cheap or growth prospects very dim.

Read more »

The rapidly approaching August 2^nd deadline, as proclaimed by the U.S. Treasury, for raising Congress’s self-imposed debt ceiling is producing a flurry of deficit-reduction plans – or, more accurately, plans for having plans.  Whereas a U.S. default triggered by a failure to raise the debt ceiling is the worst possible way to address the country’s unsustainable deficits, as it would cause borrowing rates to soar and pummel growth prospects, raising the debt ceiling without a credible deficit-cutting agreement still poses real risks of imminent, damaging market turmoil.  This is because of the regrettable but real power of the credit ratings agencies, whose downgrade pronouncements trigger automatic selling and purchase-restriction directives hardwired into public and private investment fund guidelines.  S&P has announced that it needs to see a $4 trillion deficit reduction commitment over 10 years—consistent with stabilizing U.S. debt as a percentage of GDP—in order to sustain the United States’ AAA rating.  Speaker Boehner’s plan aims at only $3 trillion in cuts; Senator Reid’s plan at $2.7 trillion.  Rep. Ryan’s plan is, from a practical perspective, meaningless, as its big spending cuts don’t materialize until well after 10 years.  President Obama’s budget also falls well short of the mark, relying on wildly optimistic near-term growth forecasts to juice the GDP denominator (see the Geo-Graphic here).  As the spending graph above-left shows, both Ryan and Obama set the country off on a path of much higher spending than the average over the past 50 years.  In short, debt ceilings and ratings agencies may be stupid inventions, but they will drive us into a major economic crisis if Congress doesn’t take serious action now.

Read more »