Those Stubborn Facts: A High Cost of Easy Money?

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debt, interest rates, monetary policy, bailouts, stimulus, Those Stiubborn Facts, The Wall Street Journal, capitalism, zombie companies, Ruchir Sharma, corporate finance

Share of publicly traded companies in the U.S. that were zombie companies*, 1980s: 2 percent

Share of publicly traded companies in the U.S. that were zombie companies, “by the eve of the pandemic”: 19 percent

*”[C]ompanies that, over the previous three years, had not earned enough profit to make even the interest payments on their debt.”

(Source: “The Rescues Ruining Capitalism,” by Ruchir Sharma, The Wall Street Journal, July 24, 2020, https://www.wsj.com/articles/the-rescues-ruining-capitalism-11595603720 )

 

(What’s Left of) Our Economy: Trade War(s) Update

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Argentina, Bloomberg.com, Brazil, business investment, China, CNBC, consumption, currency manipulation, debt, Democrats, digital services tax, election 2020, EU, European Union, export controls, Financial Crisis, France, Huawei, internet, investors, manufacturing, production, steel, steel tariffs, tariffs, Trade, Trade Deficits, trade enforcement, trade war, Trump, Wall Street, Wilbur Ross, Xi JInPing, {What's Left of) Our Economy

The most important takeaway from this post about the current status of U.S. trade policy, especially toward China, is that it may have already been overtaken by events since I began putting these thoughts together yesterday.

What follows is a lightly edited version of talking points I put together for staffers at CNBC in preparation for their interview with me yesterday. I thought this exercise would be useful because these appearances are always so brief (even though this one, unusually, featured me solo), and because sometimes they take unexpected detours from the main subject. .

Before presenting them, however, let’s keep in mind this new Bloomberg piece, which came on the heels of remarks yesterday by President Trump signaling that a trade deal with China may need to await next year’s U.S. Presidential election, and plunged the world’s investors into deep gloom. This morning, however, the news agency reported that considerable progress has been made despite “harsh” rhetoric lately from both countries. It seems pretty thinly sourced to me, and the supposed course of the trade talks seems to change almost daily, but stock indices are up considerably all the same.

Moreover, even leaving that proviso aside, what I wrote to the CNBC folks yesterday seems likely to hold up pretty well. And here it is:

1. The President’s latest comments on the China trade deal – which he says might take till after the presidential election to complete – seriously undermines the claim that he considers a deal crucial to his reelection chances because it’s likely to appease Wall Street and thereby prop up the economy. Of course, given Mr. Trump’s mercurial nature, and negotiating style, this latest statement could also simply amount to him playing “bad cop” for the moment.

2. His relative pessimism about a quick “Phase One” deal also seems to reinforce a suggestion implicitly made yesterday by Commerce Secretary Wilbur Ross when he listed verification and enforcement concerns as among the obstacles to signing the so-called Phase One deal. I have always argued that such concerns are likely to prevent the conclusion of any kind of trade deal acceptable to US interests. That’s both because of China’s poor record of keeping its commitments, and because the Chinese government is too secretive and too big to monitor effectively even the most promising Chinese pledges to change policies on intellectual property theft, illegal subsidies, discriminatory government procurement, and other so-called structural issues.

3. Recent reports of the United States considering tightening (or expanding) restrictions on tech exports to Chinese entities like Huawei also support my longstanding point that the US and Chinese economies will continue to decouple whatever the fate of the current or other trade talks.

4. In my opinion, the President is absolutely right to play hard-to-get on China trade, because Chinese dictator Xi Jinping is under so much pressure due to his own weakening economy, and because of the still-explosive Hong Kong situation.

5. I’ll be especially interested to learn of the Democratic presidential candidates’ reactions to Mr. Trump’s latest China statement, as well as the announcement of the reimposed steel tariffs on Argentina and Brazil, and the threatened tariffs on French “digital services” [internet] taxes. With the exception of Massachusetts Senator Elizabeth Warren and Vermont Senator Bernie Sanders, the candidates’ China policies seem to boil down to “Yes, we need to get tough with China, but tariffs are the worst possible response.” None of them has adequately described an alternative approach. The reactions of Democratic Congress leaders Nancy Pelosi in the House and Charles Schumer will be worth noting, too. The latter has been strongly supportive of the Trump approach in general.

6. The new steel tariffs, as widely noted, are especially interesting because they were justified for currency devaluation reasons, with no mention made of the alleged national security threats originally cited as the rationale. Nonetheless, I don’t believe that they represent a significant change in the Trump approach to metals trade, because the administration has always emphasized the need for the duties to be global in scope – to prevent China from transshipping its overcapacity to the US through third countries, and to prevent third countries to relieve the pressures felt by their steel sectors from Chinese product by ramping up their own exports to the US. Obviously, all else equal, countries with weakening currencies (for whatever reason) will realize big advantages in steel trade, as the prices of their output will fall way below those of competitors’ steel industries.

7. Regarding the tariffs threatened in retaliation for France’s digital services tax, they’re consistent with Trump’s longstanding contention that the US-European Union (EU) trade relationship has been lopsidedly in favor of the Europeans for too long, and that tariff pressure is needed to restore some sustainable balance. In this vein, I don’t take seriously the French claim that the tax isn’t targeting U.S. companies specifically. After all, those firms are the dominant players in the field. Second, senior EU officials have started talking openly about strengthening Europe’s “technological sovereignty” – making sure that the continent eliminates its dependence on non-European entities in the sector (including China’s as well as America’s). The digital tax would certainly further the aim of building up European champions – and if need be, at the expense of US-owned companies.

By the way, this position of mine in no way reflects a view that more taxation and more regulation of these companies isn’t warranted. But it’s my belief that these issues should be handled by the American political system.

Also of note: Trump’s suggestion this morning that the French tax isn’t a big deal, and that negotiations look like a promising way to resolve the disagreement.

Finally, here are two more points I wound up making. First, I expressed agreement that the President’s tariff-centric trade policies have created significant uncertainties in the economy’s trade-heavy manufacturing sector in particular – stalling some of the planned business investment that’s essential for healthy growth. But I also noted that much of this uncertainty surely stems from the on-again-off-again nature of the tariffs’ actual and threatened imposition.

As a result, I argued, uncertainty could be significantly reduced if Mr. Trump made much clearer that, whatever the trade talks’ fate, the days of Washington trying to maximize unfettered bilateral trade and investment are over, and a new era marked by much more caution and many more restrictions (including tighter export controls and investment restrictions, as well as tariffs), is at hand.

Second, at the very end, I contended that President Trump deserves great credit for focusing public attention on the country’s massive trade deficits in general. For notwithstanding the standard economists’ view that they don’t matter, reducing them is essential if Americans want their economy’s growth to become healthy, and more sustainable. For as the last financial crisis should have taught the nation, when consumption exceeds production by too great a margin, debts and consequent economic bubbles get inflated – and tend to burst disastrously.

(What’s Left of) Our Economy: Those New GDP Numbers Keep Showing Healthier Trade-Related Growth Progress Under Trump

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debt, GDP, gross domestic product, inflation-adjusted growth, real GDP, real trade deficit, recession, recovery, Trade, trade deficit, {What's Left of) Our Economy

So much data were released yesterday morning on the U.S. economy’s growth rate – not only the initial read on the second quarter of this year, but revisions going back to 2014 – that it’s impossible to explore all the results and their implications in one post. As a result, I’ll focus today on the main messages being sent by how the tariff-centric Trump trade policies are affecting growth.

In a nutshell, the big takeaway for me was that, despite the sizable increase in the inflation-adjusted trade deficit in the second quarter of this year (to an annualized total of $978.70 billion – the second biggest ever, after the $983 billion mark hit in the fourth quarter of last year), the economy kept indicating that it can grow – and pretty strongly – without racking up big increases in trade gap. In other words, the United States is regaining the ability to expand at acceptable rates without getting deeper into hock. 

Still, there’s a major uncertainty hovering over these results: Signs continue that they’re being distorted by what’s called tariff front-running (accelerating purchases of imports in order to avoid announced or threatened duties), and the consequent effects on building and reducing business inventories. And since tariff threats hang over not only hundreds of billions of dollars of goods imports from China, but rhetorically anyway over automotive imports from all over the world, import and inventory levels could well remain volatile. Moreover, don’t forget the potential effect on exports: If President Trump carries through with tariff threats, foreign economies are likely to impose retaliatory levies on American goods, and curb these sales.

So far, though, so good.

As in recent reports on trade and the gross domestic product (or GDP – what economists define as “the economy”), this post will compare the economy’s growth rate with the growth rate of the trade deficit during two recent similar periods of time – the statistical year (e.g., four straight quarters) during which growth was fastest when former President Barack Obama was in office, and the statistical year during which growth has been fastest so far during President Trump’s administration.

Even with the latest revisions, the fastest statistical Obama growth year was between the second quarter of 2014 and the second quarter of 2015. Adjusted for inflation (the most closely followed GDP measure), the economy grew by 3.35 percent over those four quarters – just a little less than the 3.37 percent previously estimated. And during that period, the real trade deficit rose by 21.34 percent (a little more slowly than the 21.55 percent previously estimated).

Before today’s revisions, the fastest Trump era growth stretch took place between the first quarter of 2017 and the first quarter of 2018. But that 3.18 percent after inflation growth has now been downgraded all the way down to 2.65 percent. But growth between the second quarters of 2017 and 2018 has been revised up – to 3.20 percent. So there’s a new Trump growth champ.

But even though the Trump growth spurt has been only a little slower than its Obama counterpart, the story with the trade deficit was strikingly different. For during the Trump spurt, the gap widened by only 6.34 percent. That’s less than a third as fast as under Obama.

In other words, constant dollar growth under President Trump has taken place while piling up much less debt than similar growth during the Obama years. And growth that’s less reliant on debt is growth that’s a lot healthier and more sustainable.

Trump-era growth looks all the more sustainable upon realizing that during Mr. Trump’s administration so far, robust growth (at least by recent standards) has been much more self-reliant than during the Obama administration – at least until very recently. The table below shows the annual (calendar year, from fourth quarter to fourth quarter) real growth rates during the Obama and Trump presidencies starting in 2010 (the first full calendar yer of the current economic recovery); the growth rate of the after-inflation trade deficits, and the ratios between these two figures for each year:

Obama yrs          real GDP       real trade deficit      deficit growth to GDP growth

10-11:              1.61 percent       0.85 percent                         0.53:1

11-12:              1.47 percent      -0.92 percent                       -0.63:1

12-13:              2.61 percent     -8.89 percent                       -3.41:1

13-14:              2.88 percent    23.36 percent                        8.11:1

14-15:              1.90 percent    21.83 percent                      13.07:1

15-16:              2.03 percent    10.87 percent                       5:35:1

Trump years

16-17:             2.80 percent      5.90 percent                       2.11:1

17-18:             2.52 percent    11.22 percent                       4.45:1

The table shows that only once (between 2012 and 2013) did the Obama-era economy display any ability to grow faster than the humdrum rate of two percent with the trade deficit’s growth restrained. (In fact, it shrunk significantly.) Once growth accelerated (the following year), the trade shortfall exploded, and its rate of increase, along with those ratios, stayed high even as growth itself cooled notably.

Moreover, without pronounced tariff front-running, the 2017-18 Trump trade deficit figure and the resulting ratio both would likely have been much lower. And economic growth looks even more self-reliant, and therefore healthier, so far this year, as the follo  wing table shows:

                               real GDP      real trade deficit     deficit growth to GDP growth

4Q 18-1Q 19:       3.06 percent    -3.97 percent                       -1.30:1

1Q 19-2Q 19:       2.04 percent     3.68 percent                         1.80:1

The Trump record looks even better when presented on a rolling four quarters basis, starting with that peak Obama growth period between the second quarter of 2014 and the second quarter of 2015, and ending with the last such period – between the second quarter of 2018 and the second quarter of 2019:

                              real GDP      real trade deficit      deficit growth to GDP growth

2Q 14-2Q 15:    3.35 percent      21.34 percent                       6.37:1

3Q 14-3Q 15:    2.44 percent      30.60 percent                     12.54:1

4Q 14-4Q 15:    1.90 percent      21.83 percent                     11.49:1

1Q 15-1Q 16:    1.62 percent      11.72 percent                       7.23:1

2Q 15-2Q 16:    1.34 percent        9.59 percent                       7.16:1

3Q 15-3Q 16:    1.56 percent        2.42 percent                       1.55:1

4Q 15-4Q16:     2.03 percent     10.87 percent                        5.35:1

1Q 16-1Q 17:    2.10 percent       6.92 percent                        3.30:1

Trump

2Q 16-2Q 17:    2.16 percent    11.71 percent                        5.42:1

3Q 16-3Q 17:    2.42 percent      9.50 percent                       3.93:1

4Q 16-4Q 17:    2.80 percent     5.90 percent                        2.11:1

1Q 17-1Q 18:    2.86 percent     6.34 percent                       2.22:1

2Q 17-2Q 18:    3.20 percent     0.06 percent                       0.19:1

3Q 17-3Q 18:    3.13 percent   15.44 percent                      4.93:1

4Q 17-4Q 18:    2.52 percent   11.22 percent                      4.45:1

1Q 18-1Q 19:    2.65 percent     6.76 percent                      2.55:1

2Q 18-2Q 19:    2.29 percent   15.07 percent                      6.58:1

Though the figures fluctuate significantly, the difference under two different presidents at roughly the same phase of the same economic expansion is at least as significant. To start, the only time that annual real growth under Obama topped three percent during this stretch, the inflation-adjusted trade deficit soared 6.37 times faster. Under Trump, the economy has enjoyed two such periods. During the first, the real trade deficit barely budged. During the second, it rose 4.93 times faster than the economy.

During these Obama years, the after-inflation trade deficit’s annual growth rate slipped under ten percent three times. Real annual GDP growth never bested 2.10 percent during any of them. During the Trump years, sub-ten percent annual growth for the real trade deficit has occurred five times. Real annual GDP increased during those years at rates between 2.42 percent and 3.20 percent. The worst Obama ratio has been 12.54 percent. The worst Trump ratio has been 6.58 percent (coming during the most recent statistical year, and possibly indicating tariff front-running). 

Has President Trump managed to reduce the U.S. trade deficit as such, or made the U.S. economy, and especially strong growth, completely self-sufficient, and therefore free of debt dependence (in terms of parts of the economy where this is feasible, as opposed to, say, tropical fruit)? Of course not. The nearly $20 trillion American economy is obviously a supertanker that isn’t turned around easily or quickly. But it’s clear that whereas the United States was moving ever further from those goals before Mr. Trump was inaugurated, it’s now moving closer. Just as clear: If the President stays the course on tariffs (much less increase and/or broaden them), progress will likely continue.      

(What’s Left of) Our Economy: New Reminders of Why Growth’s Quality Mustn’t be Ignored

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an economy built to last, business investment, capex, CBO, Congressional Budget Office, debt, Financial Crisis, GDP, growth, manufacturing, NABE, National Association of Business Economics, tariffs, Tax Cuts and Job Act, Trade, {What's Left of) Our Economy

For years I’ve been beating the drum about the need for American to pay as much attention to the quality of growth generated by the economy as they pay to the rate of growth itself. And in just the last 24 hours, two great examples have emerged of how ignoring the former can produce worrisomely off-base policy conclusions.

To repeat, the quality of growth matters because even growth that seems satisfactory, or even better, on a quantitative basis can be downright dangerous if its composition is wrong. Go back no further into the nation’s economic history than the last financial crisis to see why. Excessive reliance on intertwined housing, personal consumption, and credit booms nearly led to national and global meltdowns because, in former President Obama’s apt words, America became a “house of cards” overly dependent for growth on borrowing and spending. And he rightly emphasized the need to recreate an economy “built to last” – i.e., one based more on investing and producing.

In numerous posts, I’ve documented how little progress the nation has made in achieving this vital goal. And new reports by the Congressional Budget Office (CBO) and the National Association for Business Economics (NABE) valuably remind of one big reason why: This crucial challenge remains largely off the screen in government, business, and economics circles.

The new CBO study is its annual projection of U.S. federal budget deficits and federal debts, and the agency helpfully describes in detail the economic assumptions behind these forecasts. One key finding concerned the impact on American growth of the Trump administration’s various tariffs on certain products and U.S. trade partners.

Largely echoing the conventional wisdom, CBO predicted that if the levies remained unchanged, the tariffs would “reduce U.S. economic activity primarily by reducing the purchasing power of U.S. consumers’ income as a result of higher prices and by making capital goods more expensive. In the meantime, retaliatory tariffs by U.S. trading partners reduce U.S. exports.”

Specifically, according to CBO, “new trade barriers will reduce the level of U.S. real GDP by roughly 0.1 percent, on average, through 2029” – although its economists acknowledged that the estimate “is subject to considerable uncertainty.”

So that sounds pretty like a pretty counter-productive outcome for the President’s trade policies. But check out what else CBO said about the short-term impact of new U.S. tariffs. “Partly offsetting” the negative effects of those rising prices, along with the damage done by retaliatory foreign tariffs, the levies will also

“encourage businesses to relocate some of their production activities from foreign countries to the United States….In response to those tariffs, U.S. production rises as some businesses choose to relocate their production to the United States. In the meantime, tariffs on intermediate goods encourage some domestic companies to relocate their production abroad where those intermediate goods are less expensive. On net, CBO estimates that U.S. output will rise slightly as a result of relocation.”

In other words, the Trump tariffs will lower overall growth a bit, but more of that growth will be generated by domestic production, rather than by consumers and businesses purchasing more imports – primarily financed of course with more borrowing, and boosting debts. For anyone even slightly concerned with the quality of growth, that could be an acceptable price to pay for a healthier American economy over the long run.

Over the longer run, CBO speculates that the tariffs will reduce private domestic investment and productivity (and in turn overall growth), though it admits that this outlook is even more uncertain than that for the short run. Moreover, it’s easy to imagine public policies that could negate considerable tariff-related damage. For example, if the trade curbs do indeed undermine productivity in part by reducing the competition faced by domestic businesses – and therefore reducing their incentives to continue to improve – more overall competition could be restored through more vigorous anti-trust policies. So the tariffs could still result in growth that’s somewhat slower, but more durable.

The NABE’s January survey of members’ companies painted a pretty dreary picture of another Trump initiative – the latest round of tax cuts. As reported by the organization’s president, “A large majority of respondents—84%—indicate that one year after its passage, the 2017 Tax Cuts and Jobs Act has not caused their firms to change hiring or investment plans.”

As a result, even though the sample size was pretty small (only 106 companies responded to the organization’s questions), these answers significantly undercut tax cut supporters’ claims that the business-heavy reductions would lead to a capital spending boom.

Yet a closer look at the results offers greater reasons for (quality-of-growth-related) optimism. And they represent some evidence that the tariffs are achieving intended benefits as well. In the words of NABE’s president, “The goods-producing sector…has borne the greatest impact, with most respondents in that sector noting accelerated investments at their firms, and some reporting redirected hiring and investments to the U.S.”

This goods-producing sector includes manufacturing, and its outsized reaction to the tax cuts makes sense upon considering how capital-intensive industry has always been. In addition, manufacturing dominates U.S. trade flows, so it makes perfect sense that the tariffs’ jobs and production reshoring impact has been concentrated in this segment of the economy.

And once again, the bottom line seems to be more growth spurred by more domestic production – which can only improve the quality of the nation’s growth, and the sustainability of its prosperity.

Of course, the best results of new American economic policies would be the promotion of more and sounder growth. But as widely noted, big debt hangovers resulting from financial crises make even pre-crisis growth rates difficult to achieve even when quality is ignored – as the specialists quoted in this recent New York Times article appear to admit. So in order to achieve the best long run results, Americans may need to lower their short-term goals and expectations somewhat. That greater realism – and sharper focus – will surely come a great deal faster if important institutions like the CBO and the NABE start paying them at least some attention.

(What’s Left of) Our Economy: What Free-Trading Economists Can Learn from Main Street

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Alan S. Blinder, consumers, debt, economists, free trade, income, producers, Trade, {What's Left of) Our Economy

So you think that, even after the global financial crisis and ensuing painful recession predicted by hardly any leading economists, American leaders should keep taking this profession seriously on key issues like trade? Then you need to check out this new article by Alan S. Blinder.

It’s especially striking because Blinder is about as big in economic circles as they come, occupying a full professorship at Princeton University and having served as second in command at the Federal Reserve. But if he’s right – and by definition, someone like him should know – the consensus among economists about trade  stems from views about national economies that should disqualify those holding them from shaping policy.

According to Blinder, here’s how economists generally view an economy’s purpose: “to churn out the goods and services that people want, efficiently and at low prices, so that standards of living will be high. That’s why, for example, the Soviet Union failed and we succeeded.”

What about the public at large? “[T]he citizenry seems more attracted to the producers’ perspective: The fundamental purpose of an economy is to provide jobs.”

Thus when it comes to international trade, “Almost all economists favor open trade. It gets Americans cheaper and sometimes better goods, and enhances the efficiency of our economy. Trade isn’t, we insist, mainly about creating jobs or destroying them. It’s about deploying the labor of every nation where it is most productive. Economists see imports as the rewards for trade, exports as the cost.

“Public and political opinion often takes just the opposite perspective. Exporting is seen as the good part of trade—it creates jobs. Importing is a problem—it destroys jobs.”

The key term here is “producers’ perspective” – which, if you think about it for more than a moment, inescapably entails far more than the “jobs” on which Blinder somewhat condescendingly fixates. Of course, workaday folks are thinking first and foremost of their ability to earn income (overwhelmingly through jobs, since most aren’t wealthy heirs and heiresses). But a genuine producers’ perspective must involve all of the institutions and wherewithal needed to create jobs – i.e., a nation’s wealth-creating base.

Blinder does state that economists prize a nation’s ability “to churn out…goods and services…efficiently and at low prices, so that standards of living will be high,” and that by “deploying the labor of every nation where it is most productive,” trade contributes to this goal. But the consumers’-first devotion he attributes to economists points to a crucial truth: Such economists count heavily, at least, on low prices, not incomes, to create and even increase those high living standards.

Which is largely why, as Blinder and so many of his economics colleagues have written, they’re so indifferent to trade balances, and especially to trade deficits. Otherwise, they’d have to explain how economies significantly and/or chronically in the red – and thus by definition way short of earned income – can secure the resources needed to keep living standards at an acceptable level, much less raise them, without heavily borrowing, or selling off big chunks of their assets.

In other words, what Blinder is really saying is that economists believe that the consumption-led model of a national economy is sustainable, independent of whether that economy can generate enough income (from production) to pay for its spending responsibly (i.e., without running up excessive debt). What the public believes is that, without adequate sources of earned income (from a healthy production base), an economic system not only can’t produce jobs or high living standards. It can’t be viable in the first place.

Blinder is famous in part for what he calls “the Lamppost Theory, which holds that “Politicians use economics the way a drunk uses a lamppost—for support, not for illumination.” But their consumer-centric views raise the question of why responsible policymakers would use free trade-cheerleading economists for any reason.

(What’s Left of) Our Economy: What’s with Those Financial Markets?

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bonds, bottom-line, budget deficits, central banks, correction, debt, Federal Reserve, Financial Crisis, financial markets, Great Recession, interest rates, leverage, monetary policy, profits, stocks, tax cuts, top-line, {What's Left of) Our Economy

Heckuva week on the world’s financial markets, eh? This post isn’t intended to provide any investment advice, but rather to shed some light on what strikes me as the most interesting question posed by the stock market correction and the related spike in bond yields: Why is it happening as evidence keeps emerging that the world economy (including America’s) is entering its best stretch of growth since the last (Great) recession ended in mid-2009?

Right off the bat, in the interests of full disclosure, the vast majority of my investments are in bonds (mainly munis) and bond proxies (high-dividend stocks whose share prices are relatively stable, so that their main value is spinning off income). This means that my main hope is that bonds keep doing well (notwithstanding their recent slump).

That said, it seems clear to me that the answer is that investors are worried that the stronger growth seen globally isn’t sustainable. Indeed they seem fearful that it’s about to come to an ugly end because the world’s central banks look more determined than in many years to at least limit the easy money conditions they created to fight the financial crisis (and ensuing recession), and to try to spark something of a recovery.

This kind of monetary policy tightening – or even a further slowdown in or halt to the loosening, which is what’s most likely in the near future – could create a pair of closely connected economic and financial dangers. First, slower growth could imperil the sales and profits of companies that issue stocks, which could depress their prices. And P.S.: Despite the record central bank stimulus, growth has been unimpressive enough. How much tightening is needed to tip the economy back into recession?

Of course, businesses all around the world have performed magnificently in boosting profits in a slow-growth environment, and this also goes for non-financial companies that haven’t been able to enjoy the full benefits of borrowing from central banks at super-cheap rates and lending at higher rates. But precisely because growth even during the recovery’s best periods so far has been sluggish despite the gargantuan stimulus, much of the profit improvement has come from improvements in the bottom line, keyed by cost-cutting (including keeping the lid on employee paychecks). Top-line growth – that is, stronger sales of products and services – has been more difficult to come by.

Since costs can’t be cut completely, and possibly not much further, a growth slowdown could greatly reduce these firms’ potential to increase profits going forward, and turn them into much less attractive buys for investors. And tighter monetary policy, including raising interest rates, historically has been pretty effective at slowing growth.

Just as important, low interest rates per se have super-charged stock prices. The reason? They greatly depress the total return on bonds, and thus greatly boost the appeal of stocks.

Of course, this raises the question of why central banks would take such actions, or even think (out loud) about them. The reasons are that they’re worried that all this easy money will ignite a new round of dangerous inflation, and that they’re concerned that, because money has been so cheap for so long, borrowing consequently so easy, and mistakes therefore so easy to withstand, too much capital has been poured into risky investments. Central bankers are rightly concerned that this “mal-investment” eventually could imperil the entire financial system and hence the real economy just as it did during the previous decade. So they’re hoping they can wean the world off this sugary diet.

The challenge they face is making sure “the patient survives,” or doesn’t become gravely ill again. After all, the previous decade’s financial crisis showed that when dubious investments reach a certain level, creditors can start doubting borrowers’ ability to repay or even service their debt even when the cost of money is very low. When they start to pull in their bets, panic can easily set in – and did.

These dangers become much greater when the cost of money starts to rise, which is exactly the situation the nation and world are in now. Just one indication of heavily indebted businesses are: According to Standard & Poor’s, one of the financial ratings agencies, in 2007 (just before the global bubble burst), 32 percent of the world’s non-financial companies were “highly leveraged” (i.e., up to their ears in debt). The latest figure? Thirty seven percent.

This corporate debt, of course, is relatively easy to service and manage when interest rates are very low. In a higher rate environment? Not so much. And don’t think creditors don’t know this. So that’s another reason that companies could start looking less appealing to investors, and if major debt servicing (much less repayment) problems emerge, credit channels could start seizing up just as they did ten years ago. On top of this prospect, all else equal, rising rates tend to be trouble for stock prices, as more and more investors decide to opt for (higher) guaranteed returns on bonds rather than riskier equities.

P.S. If you’re wondering whether higher rates could significantly increase the debt burden on the U.S. government, even without the immense new borrowing that will be needed thanks to the Trump administration’s tax cuts and the new big-spending Congressional budget compromise, the answer is, “You bet!”

Not that reasons for optimism about stocks in particular can’t be identified. Because the big ramp up in federal budget deficits that’s on the way will inject massive new resources into the economy, more growth will result. In principle, that new growth could convince the Federal Reserve to speed up its tightening – but perhaps not enough to offset the fiscal boost. Moreover, anyone who’s positive that the Fed will keep tightening in the face of either future stock market turbulence and/or weaker economic growth hasn’t been paying attention to its record in recent decades. The central bank has been, in the view of many, all too willing to keep the economic party going at all costs, and may well do so again.

One more bullish possibility for stocks – as they did during the previous decade, the leaders of stock-issuing companies decide to use most of their tax cut windfall to buy more shares of their own stock. The result would not only would prop up the share price, but in many cases boost their own compensation (which not so coincidentally is often based on that share price).

The most vexing aspect of both the investment and the economic situation is that, even though both may suffer in the short run, both urgently need to end their addiction to central bank stimulus and create the kind of foundation that will promote healthier, and thus longer-lasting (even if not faster) growth. Moreover, the longer the addiction lasts, the worse the cold turkey experience.

Because I doubt that either the Federal Reserve or the rest of the U.S. government has the spine to administer the needed policy medicine, I remain pretty bearish long-term on both the markets and the real economy, and will stay very conservatively invested. But the short term can be surprisingly long lasting; in fact, I’m surprised that the Fed’s high wire act has lasted this long. So I’m anything but an infallible guide to either. I’m just trying to be prepared for major trouble – whenever it decides to arrive.

 

(What’s Left of) Our Economy: Why the Trump-ers (So Far) Aren’t Wrong About the Dollar

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bubbles, consumption, currency, debt, dollar, exchange rates, finance, Financial Crisis, growth, inflation, investment, protectionism, Steve Mnuchin, Trade, Treasury Department, Trump, {What's Left of) Our Economy

The economics, finance, and business worlds are kind of up in arms over U.S. Treasury Secretary Steve Mnuchin’s suggestion earlier this week that a weaker U.S. dollar would be good for the American economy.

I say “kind of up in arms” because Mnuchin’s remarks were more nuanced than generally reported; because financial markets in particular seem to be on steroids and have barely reacted; and because he took pains afterwards to profess his confidence that, despite its recent falling value, nothing fundamental had changed to undermine the greenback’s historic appeal to investors. Indeed, just a little while ago, President Trump stated that he “ultimately” wants to see a strong dollar. 

I say “up in arms” to some extent because, the President’s newest words notwithstanding, no American Treasury Secretary has ever said anything remotely like this in public for decades; because Mnuchin’s original words looked suspiciously consistent with what the establishments in these interconnected economic worlds abhor as the Trump administration’s protectionist instincts on trade policy (because all else equal, a weak dollar promotes U.S. exports and curbs U.S. imports); and because dollar strength (and the big U.S. trade deficits it’s encouraged) has long been a cornerstone of the global economy, and a major growth engine for the numerous countries that rely on selling to Americans to promote their own output and employment. (Hence many of them fiddle around with their own currencies’ values to make sure they can sustain these strategies.) Many strong dollar proponents also claim that a weaker American currency could dangerously stoke inflation (especially by boosting import prices) and deter investment inflows into the United States.

But two crucial points are Missing in Action in the tumult sparked by Mnuchin’s remarks. One should be obvious but can’t be repeated often enough, especially in these current overwrought times: You can have too much and too little of a good thing. An overly weak dollar would cause major problems for the U.S. economy. So would an overly strong dollar. Therefore, the key is not to assume either extreme (especially in the absence of any evidence that they’re around the corner) but to figure out a dollar level that achieves the best combination of benefits.

The second has been much less much widely recognized even in calmer periods, but it’s closely related to my longstanding point about the importance of the quality of American growth. As I’ve written frequently, growth based largely on production and the growing incomes it generates place the economy on the soundest foundation. This approach may not always produce the fastest growth, but it fosters the growth that tends to last longest, and that’s least likely to inflate bubbles that then collapse into economic and financial crises).

Such disasters, as we should have learned, stem from growth largely based on borrowing and consuming – i.e., on shopping sprees that eventually can’t be paid for responsibly, and can only continue by racking up enormous debts. And other than legitimate (though clearly overblown nowadays) concerns about inflation, that’s a main reason why folks in finance – and everyone on their payroll in the U.S. government and the rest of Washington – like the strongest possible dollar. Until the merry-go-round stops, they make tons of money by lending to those borrowers.

Here’s where the dollar’s value comes in. A strong-ish greenback tends to result in that borrowing and consuming brand of growth. A weak-ish dollar tends to result in the healthier kind of growth. And as indicated by this chart showing the change in the dollar’s value (also called the exchange rate) against other currencies, only looked at over the shortest possible period could the dollar nowadays be called weak or even weakening. Over a much longer period, it’s obviously still well in “strong territory.” 

And it’s no coincidence, as I’ve also written, that although the U.S. economy seems to be making some slight progress toward creating healthier growth, it still has way too long a way to go – especially given that the current recovery from the crises and the painful recession that followed is now more than eight years old.

The lessons, then, look clear. If you only care about the fastest growth possible regardless of its makeup or the longer-term consequences, and/or if you think finance should be the dominant part of the American economy, you’ll join the chorus of critics scolding Mnuchin for even hinting that some further dollar decline wouldn’t be a disaster for the nation. If you’d like the economy to steer clear of near-meltdowns like the one experienced just about a decade ago, you’ll be applauding what still looks like a subtle call from him for a somewhat weaker dollar.

(What’s Left of) Our Economy: Smart Phones, Dumb Economy?

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cell phones, consumers, credit, CreditSesame.com, debt, deflation, inflation, Maria Lamagna, Marketwatch.com, millennials, smartphones, telecommunications services, {What's Left of) Our Economy

I’m always wary of drawing conclusions about the American economy from what I see in everyday life for reasons that should be obvious. All such anecdotes should be viewed suspiciously because individual observations or incidents are much more likely to result from randomness or unique circumstances than to reflect a genuine trend. And I’d be the last to claim that my own experiences have ever been representative of anything larger.

Still, it’s undeniably, and understandably, gratifying when some actual data seems to bear out something that’s had me (figuratively) scratching my head for some time. It’s the seeming tendency of folks who at least appear to be well into the lower depths of the “99 percent” of non-uber-wealthy Americans owning what look (to my admittedly non-expert eye) like state-of-the-art smartphones. Although all sorts of reasonable explanations are possible, a recent survey of consumer finances at least has supported my suspicion that something genuinely peculiar – and not so encouraging – really is going on here.

First, let’s examine some of the extenuating circumstances. Prices for smartphone services have been falling steadily – and steeply over the last few months, thanks largely to the spread of unlimited data plans. Just check out this chart:

Younger consumers in particular also have shown some tendency to value buying experiences (like the extraordinary connectivity provided by modern personal communications) over goods. Some of these millennials and others in the post-baby-boom categories (especially students) may be getting help from their families – and that doesn’t necessarily raise red flags. More disturbing, however, are the odds that many of the young are avoiding or deferring goods purchases (especially big ones they used to make in the twenties and thirties, like cars and homes) because they simply can’t afford them, and are therefore substituting relatively cheap indulgences like phones with every conceivable bell and whistle.

Nonetheless, that consumer finance survey – from the Credit Sesame website – sadly suggests that many low-income earners who use smartphones of some kind (it’s not possible to say that they’re the latest and greatest) literally can’t afford them. Instead, they’ve bought them with seriously over-extended credit.

According to Marketwatch.com reporter Maria LaMagna, Credit Sesame examined the finances of 5,000 consumers and found that those whose cell phone accounts are considered delinquent were carrying an average balance of $887. I couldn’t find any information about what percentage of the 5,000 consumers analyzed were carrying such cell phone debt, but here’s a reason to think that the share carrying significant amounts is pretty big: phone service companies don’t usually report customers’ payments histories to credit bureaus until the collections process formally begins. I also wish that the article indicated how credit card-related debt has changed over time.

But it’s hard to believe that a reputable site like Marketwatch would have reported these numbers had they been more the exception than the rule. And the amounts of cell phone-related debt are especially striking given how services are now cratering in price.

It’s entirely possible that cell phone debtors will take advantage of these price plunges to pay up and stay fully paid up. In principle, the companies could start cracking down, too. But there’s also a real chance that the debtors will simply start paying their minimums on time, and that the service companies – currently engaged in price wars determined to get and keep customers practically at all costs – will keep treating them leniently (and milking them as cash cows for as long as they can). Raise your hands if you think this is any way to run an economy for any serious length of time.

Our So-Called Foreign Policy: Why Robert Gates is a Flawed National Security Guru

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2016 election, Bill Clinton, border security, China, Crimea, debt, Donald Trump, export controls, George W. Bush, Hillary Clinton, Iran-Contra, Middle East, NATO, NATO expansion, Obama, Our So-Called Foreign Policy, Putin, Robert M. Gates, Ronald Reagan, Russia, terrorism, The Wall Street Journal, TPP, Trans-Pacific Partnership, Ukraine

The Wall Street Journal op-ed staff’s decision to publish Robert M. Gates’ article last Friday on how he sizes up the two major presidential candidates’ qualifications for the Oval Office makes sense only by the degraded and often mindless standards of the American political, policy, and media establishments.

Sure, as the tag line ostentatiously noted, “Mr. Gates served eight presidents over 50 years, most recently as secretary of defense under Presidents George W. Bush and Barack Obama.” As a result, I’m certainly interested to know his views – and especially that, although Democratic nominee Hillary Clinton has a deeply flawed record, Republican Donald Trump is “beyond repair.” You should be, too. But should anyone regard Gates as the last word? I’m not convinced – nor should you be.

For starters, one of the presidents Gates served was Ronald Reagan – as a big player in that administration’s reckless and downright looney scheme (the so-called Iran-Contra affair) to evade Congress’ ban on supplying anti-communist Nicaraguan rebels with profits made secretly by selling arms to Iran’s terrorism-sponsoring, hostage-taking ayatollahs. Gates also seems to regard George W. Bush’s disastrous foreign policy presidency as standing within the bounds of acceptability. Hello?

At least as unimpressive, though, is Gates’ judgment regarding current foreign policy issues. Here are three examples. First, the former Bush and Obama Secretary of Defense warned that:

“Every aspect of our relationship with China is becoming more challenging. In addition to Chinese cyberspying and theft of intellectual property, many American businesses in China are encountering an increasingly hostile environment. China’s nationalist determination unilaterally to assert sovereignty over disputed waters and islands in the East and South China Seas is steadily increasing the risk of military confrontation.

“Most worrying, given their historic bad blood, escalation of a confrontation between China and Japan could be very dangerous. As a treaty partner of Japan, we would be obligated to help Tokyo. China intends to challenge the U.S. for regional dominance in East Asia over the long term, but the new president could quickly face a Chinese military challenge over disputed islands and freedom of navigation.”

True indeed. But then he upbraids both Trump and Clinton for opposing President Obama’s Pacific rim trade agreement, a position that he argues (despite presenting no evidence) “would hand China an easy political and economic win.” Indeed, Gates dredges up the know-nothing specter of China responding to Trump-ian tariffs with a trade war against America that it could well win because of all the U.S. debt it holds and because it’s “the largest market for many U.S. companies.”

Apparently he’s unaware that China’s debt holdings are a small fraction of the outstanding U.S. total, that the PRC remains much more important to American multinational firms as an offshore production platform than a final customer (which explains why the United States runs a huge trade deficit with Beijing), and that without adequate access to the American market, China’s export-focused economy and political stability would face mortal danger.

Worse, as chief of Mr. Obama’s Pentagon, Gates pioneered a relaxation of American export controls that greatly expanded China’s access to America’s best commercially produced defense-related knowhow. Talk about feeding the beast!

Gates’ critique of the Clinton, and especially Trump, Russia stances should inspire no more confidence. According to this supposed national security guru, “neither Mrs. Clinton nor Mr. Trump has expressed any views on how they would deal with Mr. Putin (although Mr. Trump’s expressions of admiration for the man and his authoritarian regime are naive and irresponsible).”

As Gates notes, under Putin, “Russia [is] now routinely challenging the U.S. and its allies. How to count the ways. There was the armed seizure of Ukraine’s Crimea; Moscow’s military support of the separatist movement in eastern Ukraine; overt and covert intimidation of the Baltic states; the dispatch of fighter and bomber aircraft to avert the defeat of Syria’s Assad; sales of sophisticated weaponry to Iran.

“There is Russia’s luring the U.S. secretary of state into believing that a cease-fire in Syria is just around the corner—if only the U.S. would do more, or less, depending on the issue; the cyberattacks on the U.S., including possible attempts to influence the U.S. presidential election; and covert efforts to aggravate division and weakness with the European Union and inside European countries. And there is the dangerously close buzzing of U.S. Navy ships in the Baltic Sea and close encounters with U.S. military aircraft in international airspace.”

But actually it’s Gates who’s leaving the biggest questions unanswered. Does he now view the targets of Putin’s aggression as vital U.S. interests that merit a defense guarantee that could expose the United States itself to nuclear attack? When exactly did Crimea and Ukraine, which are so close to Russia that they cannot possibly be defended by Western conventional forces, attain this status? Why were American presidents going back to 1945 wrong to take exactly this position (including all of those he served)?

Indeed, what’s changed since Gates himself recognized this reality, and warned former President George W. Bush that the NATO expansion pushed by him and his predecessor, Bill Clinton, would needlessly provoke the kind of Russian push-back now underway? And if Gates hasn’t reversed himself on Russia, why is he so scornful of Trump’s evident interest in cutting a deal with Putin?

Gates is non-partisan, but no better, when it comes to the Middle East. He accuses the two candidates or failing to define “what the broader U.S. strategy should be toward a Middle East in flames….” But his critique of Trump is especially off base. According to Gates, the Republican candidate has “suggested we should walk away from the region and hope for the best. This is a dangerous approach oblivious to the reality that what happens in the Middle East doesn’t stay in the Middle East.”

But he misses the essence of Trump’s position, which is defending America from threats emanating from the region at America’s borders – which are relatively controllable – versus in that terminally dysfunctional, faraway region – which is completely uncontrollable. Gates can legitimately disagree with this approach (which I have repeatedly endorsed), but he can’t legitimately claim that it doesn’t exist.

Gates’ critique extends to several other current flashpoints, but what’s especially revealing to me is how this supposed diplomatic sage completely mis-identifies the biggest foreign policy question facing America’s leaders and the public. It’s not, per his formulation “how [the next president] thinks about the military, the use of military force, the criteria they would apply before sending that force into battle, or broader questions of peace and war.”

As I’ve been writing since the mid-1980s, that kind of thinking puts the cart before the horse. (Here’s a good summary of my first lengthy article on the subject, which unfortunately is not available in full on-line.) America’s main foreign policy challenge is figuring out its principal overseas interests, and basing its decisions on using force on the importance of those goals. Otherwise, debates on going to war and other uses of military power will be conducted in a strategic vacuum – which already too often has been the case.

Given Gates’ wealth of experience, it’s fine for The Wall Street Journal – or any other news organization – to grant him a prominent forum from time to time. How much better it would be, however, for editors and reporters and pundits to ask him, and themselves, if he’s ever displayed any learning curve.

Following Up: More on the Price of Economic Dependence

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Andrea Wong, Bloomberg, Cincinnati Zoo, Cold War, debt, defense manufacturing, Donald Trump, energy, energy independence, Following Up, gorilla, Harambe, Middle East, oil, oil embargo, OPEC, Richard M. Nixon, Saudi Arabia, Stephen Hawking, Treasury Department, William E. Simon

Especially given some genuinely clownish performances over the last 24 hours, it’s a great pleasure – and relief – to report that not all journalists think it’s newsworthy what Donald Trump thinks of the Cincinnati Zoo gorilla shooting, or what physics giant Stephen Hawking thinks of the presumptive Republican presidential nominee.

For instance, there’s Bloomberg news’ Andrea Wong, who’s just written a terrific story about decades of American financial relations with Saudi Arabia that vividly portrays the risks the country runs when it develops heavy dependencies on imports of crucial products – in this case, oil. It nicely reinforces the message of Saturday’s post about the blind spot Americans too often display when it comes to safeguarding their economic independence.

At the same time, a careful reading of the Bloomberg piece strongly indicates that much of the vulnerability and weakness U.S. officials perceived during that 1970s period when the crucial bilateral decisions were made were just that – perceptions. Even worse, they were arguably perceptions that were seriously off base, and the underlying potential problems were entirely avoidable.

Setting the stage skillfully, Wong makes clear that American leaders could be forgiven for not exactly feeling like world leaders when they launched a far-reaching initiative to keep Saudi money flowing into U.S. government coffers: The Arab members of the Organization of Petroleum Exporting Countries (OPEC), the global oil cartel, had embargoed sales to the United States in response to America’s military aid to Israel during the Middle East war of the previous year. Oil prices had quadrupled. As a result, “Inflation soared, the stock market crashed, and the U.S. economy was in a tailspin.”

Wong might have added that American politics and government was in turmoil as well. In July, 1974, when a Treasury Department team was sent on a crucial mission to Saudi Arabia (as part of a larger Middle East and Europe trip), Richard M. Nixon’s impeachment and removal from the presidency was barely a month away.

In Wong’s words, the mission’s assignment was to “neutralize crude oil as an economic weapon and find a way to persuade a hostile kingdom to finance America’s widening deficit with its new-found petrodollar wealth. And…Nixon made clear there was simply no coming back empty-handed. Failure would not only jeopardize America’s financial health but could also give the Soviet Union an opening to make further inroads into the Arab world.”

To complicate the task further, the United States wasn’t the only country seeking special favors from the Saudis: “Many of America’s allies, including the U.K. and Japan, were also deeply dependent on Saudi oil and quietly vying to get the kingdom to reinvest money back into their own economies. “

Yet the delegation, headed by Secretary William E. Simon, succeeded. The Saudis resumed supplying the United States with oil and plowed most of their proceeds back into U.S. Treasury debt, which enabled America to keep living beyond its means. (I know – this is a dubious benefit at best.) In return, the United States greatly stepped up sales of arms and military equipment to the Saudis, agreed to keep the scale of their Treasury holdings secret, and even gave the kingdom special access to the Treasury market. Moreover, Washington agreed (until this month) to the key condition that the Saudi Treasury holdings not be made public when the Department issued its monthly reports on foreign owners of U.S. government debt.

So it seems like the oil-rich Saudis said “Jump” and an oil-addicted America answered “How high?”, right? Not so fast. For example, Wong’s account shows that Simon didn’t enter the negotiations convinced he had a fatally weak hand. In fact, the former Goldman Sachs bond whiz “understood the appeal of U.S. government debt and how to sell the Saudis on the idea that America was the safest place to park their petrodollar.”

The arms sales angle also worked in Simon’s favor – in two ways. First, American weapons generally speaking were the world’s best. Second, the Saudis didn’t have a serious option of turning to the former Soviet Union, the closest competitor to the United States in military technology. Dealing with the atheistic Soviets could have stabilized the fundamentalist Saudi theocracy as much as disclosure that its financial support for the U.S. economy was in theory indirectly helping America pay for its own arms sales to Israel – the fear behind the Saudis’ insistence on keeping their Treasury purchases secret.

In addition, as poorly as the U.S. economy was performing in the mid-1970s, in part because it still supplied much of its own demand for oil, it was in far better shape than the Europeans and Japanese. They were far more dependent on Middle East producers, and therefore were paying much higher relative oil import bills. The real lesson here: The United States all along possessed the potential to prevent the Saudis and other foreign oil producers from even appearing to gain a stranglehold over the American economy. Its real and perceived vulnerability stemmed from neglectful policies, not geological realities.

Fast forward to today, and the energy and Middle East pictures have changed dramatically. Most important, America’s reliance on the region’s oil supplies has been greatly reduced by its own domestic energy production revolution, and influential Saudis have been revealed as not only staunch Cold War allies, but as major supporters and enablers of the the kind of Islamic terrorism that resulted in the September 11 attacks and that continues roiling the Middle East – and claiming American lives – today.

As a result, even though the Saudis remain important holders of American debt and assets, and therefore remain as significant props for U.S. economic activity, their leverage over the United States has clearly diminished since the height of their petro-power. At the same time, other forms of American economic dependency have reached worrisome levels – notably for many advanced manufactures, including those used in military systems. And these dependencies, too, result from neglectful policies, not industrial realities.

In this third decade of the post-Cold War era, with the subpar U.S. economy continuing to outperform most major competitors, it seems inconceivable that a future president would send his or her Treasury Secretary abroad to stave off the prospect of blackmail. But a few years before Simon actually left to meet with the Saudis, I strongly doubt that he or President Nixon could have imagined undertaking and ordering this mission, either.