Where Will We Get the Cash?

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Where Will We Get the Cash?
Boo!
The markets deliver a shock to complacent investors
Out of a clear blue economic sky, volatility returns and may linger
Donald Trump has been lucky with the US economy
He is taking credit for the continuation of a post-crisis recovery begun under Obama
Martin Wolf
So I think you have a brand new United States.” That was Donald Trump’s boast in his speech to the business elite gathered at the World Economic Forum in Davos. So how, if at all, is America “new”?
How might this belief of Mr Trump’s affect his global economic agenda? Why did Mr Trump, who shocked Davos, by stating at his inaugural that “Protection will lead to great prosperity and strength”, become only the second US president to visit the annual meeting in Switzerland, after Bill Clinton, in 2000?
Mr Trump’s main aim, it was clear, was to assert that “after years of stagnation, the United States is once again experiencing strong economic growth”. Moreover, it is “open for business”. These and similar claims on employment and consumer and business confidence ran through his speech. It is true that the US economy is strong; it is not true that this follows years of stagnation.
Between the second quarter of 2009 and the end of 2016, the US economy grew at a compound annual rate of 2.2 per cent. Over the past four quarters, it grew by 2.5 per cent. That is not a significant change. The big shift in growth — downwards, unfortunately — was after the financial crisis of 2008. The economy is 17 per cent smaller than it would have been if the 1968-2007 trend had continued. Since its recovery, in 2009, it has been on a far slower trend. This may change, but has not yet done so. The same is true for labour productivity, whose growth remains low. (See charts.)
The unemployment rate has indeed fallen under Mr Trump, from 4.7 per cent in December 2016 to 4.1 per cent in December 2017, a very low rate by historical standards. But this is a continuation of the downward trend since 2010. If anybody deserves the credit, it is the Federal Reserve, for policies too often condemned by the Republicans. Eighty-six per cent of men aged 25-54 had jobs in December 2017. This is a percentage point higher than a year earlier, but 5.6 percentage points higher than in January 2010. Unfortunately, it is still below the previous cyclical peaks of nearly 90 per cent in 1999 and 88 per cent in 2007. The proportion of prime-aged women with jobs is also below levels in 2000.
Mr Trump is particularly enthusiastic about stocks, claiming that the market is “smashing one record after another”. This is not wrong. In terms of Robert Shiller’s cyclically adjusted price/earnings ratio, valuations of the US market are as high as in 1929 and have been exceeded since then only by the exalted valuations of 1998, 1999 and 2000. The rise of the market in the last year is quite remarkable, given how high it already was. But this should be a worry, not a boast. Mr Trump may soon come to regret lauding a high stock market. It is at no president’s beck and call.
An argument for hoping that better times will soon be here is the huge tax cut for business. It is quite unlikely, however, that this will unleash a flood of investment and higher underlying economic growth. A more plausible view is that it will mainly increase stock prices, wealth inequality and the speed of the competitive race to the bottom on taxation of capital. British experience on this is sobering. The slashing of UK corporate tax rates to 19 per cent has done little for investment or median real wages. The hope that it proves any different in the US is likely to be disappointed.
Briefly, Mr Trump is taking credit for the continuation of a post-crisis recovery begun under his predecessor. This is no “brand new” economy. He has been lucky. Provided the stock market does not blow up, he may stay lucky. Yet the question is how a lucky Mr Trump will behave. Will a man who feels he is on a winning streak be more demanding or more accommodating?
A particular concern is trade policy. On this, Mr Trump has stated: “We support free trade, but it needs to be fair and it needs to be reciprocal. Because, in the end, unfair trade undermines us all.” This is not new rhetoric.
The optimistic view is that we are going to see more of the sort of measures announced last week on solar panels and washing machines. These are foolish, but standard. Even the renegotiation of the North American Free Trade Agreement might be a damp squib. Now that the other 11 participants in the Trans-Pacific Partnership have, to their credit, agreed to go ahead, Mr Trump even says that: “We would consider negotiating with the rest, either individually, or perhaps as a group.”
The pessimistic view is that the administration is hooked on fundamentally crazy doctrines: the US trade deficit is the result not of macroeconomic imbalances, but of cheating on trade policy; in addition, the way to eliminate this deficit is via new bilateral deals with all important trade partners. This approach would blow up the multilateral trading system. It is also incompatible with market economics. Only planned economies could attempt the bilateral balancing in which Robert Lighthizer, the US trade representative, and his master apparently believe. An aggrieved superpower armed with such a benighted doctrine could do immense damage to the global economy and international relations.
How then should we evaluate the confident and emollient Mr Trump we saw in Davos? His boasts may be empty, but he has indeed been lucky in inheriting an economy enjoying a strong post-crisis recovery. The economy should remain his friend, so long as he does not trust too much in the stock market.
That is good news for him. A strong US economy is good news for the world, too. A confident Mr Trump might not be. The question is how he reacts. Will he be more reasonable or more intransigent? His speech did not provide all the answers. Uncertainty still reigns.
How Did That Get Into My Bond Fund??
Debt deals set records from Tajikistan to East Rutherford, N.J., as investors keep hunting yield.
Last fall, a hydroelectric dam in Tajikistan, the government of Portugal and a cruise-ship operator all issued debt at unusually low interest rates. The seemingly unconnected deals are part of a proliferation of aggressive bond sales influenced by a decade of loose monetary policy and a demographic shift in global investing.
Historical limits on who can borrow, and at what cost, have broken down as fund managers agree to previously unpalatable terms.
Central bankers in the U.S., Europe and Japan helped shape the new breed of deals by simultaneously purchasing over $1 trillion in high-quality bonds since 2009 and lowering benchmark interest rates to jump-start their faltering economies. Modest economic growth came, but the strategy crowded private investors out of safe debt, prompting them to buy riskier bonds to boost returns.
Retiring baby boomers amplified the trend by moving their investments away from stocks into bonds, boosting assets in U.S. bond mutual funds to $4.6 trillion in November from $1.5 trillion a decade earlier, according to the Investment Company Institute, a trade group for investment firms.The article goes on to present some examples of bonds that might not exist in less bubbly times.
- Tajikistan borrowed $500 million to finish construction of a hydroelectric dam that was started under the Soviet Union. This is one of the world’s most corrupt countries – a fact noted in the offering prospectus — and the dam’s electricity will be sold to Afghanistan, which, as most Americans know, is in the middle of a civil war that the “good guys” might easily lose (also mentioned in the prospectus). The deal’s investment bank, Citigroup, initially marketed the bonds to yield 8% but received such a warm welcome that it cut the rate to 7.1%. Buyers included big U.S. firms like Fidelity, which bought $14 million of the bonds, presumably to boost the yield of funds sold to retirees.
- The American Dream Mall in East Rutherford, N.J. broke ground in 2003 but ran out of money to finish construction. In 2017 the mall’s current owner—its third—employed Goldman Sachs to sell $1.1 billion of 6.9% muni bonds, fully half of which were bought by the Nuveen fund family. “Unlike most malls, American Dream will derive most of its revenue from experiential attractions that can’t be replicated online, rather than depending on retailers,” said a Noveen executive.
- On Nov. 8, Portugal sold €1.25 billion ($1.55 billion) of 10-year bonds that yielded 1.94%—the lowest rate ever for the country. Portugal needed an international bailout in 2011 and still has a junk credit rating. It’s one of the most heavily indebted countries in Europe, but the auction set its borrowing cost below that of the U.S. government, which sold 10-year bonds in November to yield 2.31% [those bonds now yield 2.7%].
The Dollar Breakdown: A Sign of Inflation to Come?
By Mishka vom Dorp
Recently, we saw the dollar index (the DXY), which measures the USD against a basket of the world’s major currencies, break below its support of 91 for the first time since January of 2015 (Figure 1). This event may signal the most important trend of 2018: the breakdown of the dollar. ![]() Figure 1: Daily Dollar Index (DXY) Source: Thomson Reuters Eikon The recent drop of .96 percent was the second largest drop in over a year and caught many traders by surprise given the recent strong U.S. retail sales data which increased their expectations of a rate hike in March to 75 percent. Some of this selloff can be attributed to the strengthening Euro that came after the German Chancellor, Angela Merkel, announced an agreement to form a coalition government. This deal had been struck after months of negotiations while the weakening dollar has been a year-long trend. Shortly after President Trump was elected in November of 2016, we saw the dollar rally over 5.5 percent only to hit a peak of over 103 in December of that year. In December of 2016, I wrote that a strong dollar would be the biggest headwind against the Trump administration’s domestic economic policy agenda: “If Donald Trump plans on bringing manufacturing jobs back to the United States, the dollar will be his main enemy. Since Trump’s election victory, the central bank's dollar gauge has risen over 4 percent against a basket of major currencies (Figure 2): ![]() Figure 2: Broad Index of the Foreign Exchange Value of the Dollar Source: Bloomberg This should worry the President-elect since exports and manufacturing jobs will remain uncompetitive as long as the dollar continues to strengthen. Sure, he can place disruptions in the market such as tariffs to make foreign goods less competitive, but that would start an international trade war which would be a zero-sum game. Instead, the President-elect, once sworn in, can manufacture competitiveness through fiscal policy. With Trump’s planned tax cuts coupled with his planned infrastructure spending … the fiscal policy measures once implemented will be highly inflationary which should be good for gold [and bad for the dollar].” —Is it Time to Catch a Falling Knife? Dec. 15, 2016. Furthermore, a strong dollar would likely exacerbate the U.S. balance of trade deficit by making foreign goods cheaper. Both things Trump has stated multiple times he is looking to fix and he himself acknowledged the best way to do this is by having a weaker dollar. I also wrote about Fed Chairman Janet Yellen who, with her recent hawkish shift, is seen as the biggest roadblock for the Trump Administration and its wish to manufacture a week dollar if the Fed continued to raise rates: “Janet Yellen, the Chair of the Board of Governors of the Federal Reserve, has her term ending on February 3rd, 2018. The Fed’s main mandate is to keep inflation rates at 2 percent. With an inflationary fiscal policy regime implemented by Trump, Janet Yellen could be the only person to stand in Trump’s way. That is why Trump will most likely not reappoint Yellen, and instead appoint someone who would be more amenable to keeping rates low. Furthermore, there are two vacancies on the board and they will most likely be dovish replacements.“ —Is it Time to Catch a Falling Knife? Dec. 15, 2016. So it did not come as a surprise when Trump announced he would be replacing Yellen with Jerome Powell as his choice to lead the Fed in November of last year. With Powell set to take over in February, it is likely he will take an even less aggressive approach to raising rates than that of Yellen. Either way, the weaker dollar has helped sustain gold’s buoyancy despite the five rate hikes we have seen since 2015 (Figure 3). ![]() Figure 3: Gold (yellow) vs DXY (purple) Source: Thomson Reuters Eikon Looking back over the past year, one can see there is a strong inverse relationship between gold and the dollar which has only strengthened over the past month. I believe the recent slide below support levels opens the door to a rally that could be similar to what we saw in the early 2000s, when the DXY broke down from 120 and fell all the way to the low 70s in 2008 (Figure 4). ![]() Figure 4: Gold (yellow) vs DXY (purple) Source: Thomson Reuters Eikon So where does gold go from here? There are two major factors which I believe influence gold. The aforementioned dollar and real interest rates, which is the nominal rate set by the Fed minus inflation. A weaker dollar obviously means a stronger gold price in dollar terms but the real rate’s influence is a bit more convoluted. Since both Treasurys and gold are seen as safe-haven assets, investors who are worried about market risk have a choice to park their savings in a “risk free” asset that has a yield (Treasurys) or one that does not (gold). If real rates are positive, investors will likely favor Treasurys, since they provide a yield above that of inflation. However, when the inflation rate is greater than or equal to the nominal rate, investors prefer gold, since parking cash in Treasurys yields a negative return. However, despite the Fed's efforts to manufacture inflation through historically low interest rates and large-scale asset purchase programs, we still have yet to see the Consumer Price Index (CPI) rise significantly, hence real rates have remained in positive territory. The best way to view real rates is by looking at the yields of Treasury Inflation Protection Securities (TIPS), where the principal is adjusted up and down based on CPI data. Looking at the 10-Year TIP (Figure 5), one can see the inverse relationship of TIPS to gold. ![]() Figure 5: 10-Year TIPS (orange) vs US Gold Spot Price (yellow) Source: Thomson Reuters Eikon What arguably sparked the end of the 5-year bear market in gold was the fall of the TIPS yield from 0.7 percent in January 2016 to negative real interest rates by July 2016. Since then, the 10-Year TIPS yield has bounced off the bottom to .53 percent. With the recent decline in the dollar, from a U.S. consumer’s perspective, foreign goods and services will now cost more than they did a year ago considering the dollar has declined over 12 percent. With over 27 percent of the of the U.S. GDP made up of imported goods and services, the effects will be felt far and wide. Though inflation takes time, there is a very good chance we could see real interest rates begin to decline over the coming year. Though it is likely the Fed will attempt to counteract inflation by raising rates, it’s anticipated that President Trump will stack the deck with more dovish board members with the three current vacancies of seven total positions. From 1945 to 2001, the average economic expansion following a recession in the U.S. was just shy of five years. We are now into the ninth year of expansion and it is likely the Fed will have very little room to adjust rates down without going into negative territory once the next recession hits. For now, I believe we will continue to see a weaker dollar, more inflation and a less aggressive Fed. This combined should all be positive for gold and the miners that extract the yellow metal. The bull market which started in 2016 is now once again in full swing after a lackluster 2017. For those investors sitting on large cash positions, I believe now is the time to consider deploying funds into quality explorers, developers and producers. |
Trumponomics Is Failing on Growth
Simon Johnson
WASHINGTON, DC – US President Donald Trump and his Secretary of the Treasury, Steven Mnuchin, have promised an economic miracle. They argue that when the United States adopts their policies, it will consistently achieve annual economic growth above 3%, or even above 4%.
After a year of being in charge, pushing hard on deregulation, and getting what it wanted in terms of tax cuts, how is the Trump team doing?
We are still in the early days, but the results so far have been disappointing. And the US’s medium-term prospects for sustained growth could be endangered if Trump pursues the policies he claims to want.
Trump has repeatedly argued that America’s overall economic performance in 2017 should be seen as the direct result of his policies, and he has made a big deal out of the third-quarter growth rate, which was initially reported as 3.3%, then revised down to 3.2%. Yet, in the fourth quarter, growth was down to 2.6%, and initial estimates suggest that overall growth for the year will not surpass 2.3%. That is lower than what was achieved under former President Barack Obama in 2014 (2.6%) and 2015 (2.9%).
In fact, under Obama, the quarterly growth rate surpassed 3% seven times, and even reached 4.6% on two occasions. From the third quarter of 2009, growth was positive in every quarter, save two. But not only was headline growth sturdy under Obama; his administration also presided over considerable job growth – the economy added more than two million jobs annually in seven out of his eight years in office – as well as falling unemployment and higher labor-force participation.
Far from a miracle, Trump has failed to deliver any kind of improvement to economic growth. To understand why, it helps to remember that Trump has not actually done much in office. Notwithstanding his constant bragging about deregulation, the total economic impact of his regulatory repeals has been trivial relative to the size of the economy.
Moreover, the tax cuts that Trump signed into law at the end of 2017 will have very little positive impact on growth. The tax package is primarily about redistribution from middle-income households – particularly those in high-tax, Democratic-leaning states such as New York and California – to the richest Americans.
People who own capital that is already in place – such as large buildings in New York – will do well. But the law does not offer much of an incentive to invest in new capital, either by launching a new company, developing new products, or investing in new plants and equipment. Furthermore, as I pointed out at a recent Intelligence Squared US debate in New York, the law may actually have a negative effect on research and development, which is a key driver of long-term growth in the US.
Looking at the 2017 data, there is no sign that business investment ticked upward under Trump. Yes, this is a volatile data series, because it rises and falls with the usual course of events. But it is also another area where Obama set the bar high during his two terms.
The most positive thing that can be said about Trump’s first year of economic policymaking is that he did not deliver on his campaign promise to disrupt trade. The North American Free Trade Agreement (NAFTA) remains intact, as do trade relations with China and other major US partners. The administration did impose tariffs in January on solar panels and washing machines, but those are small relative to the size of the economy. As a result, Trump has not caused a massive, self-inflicted recession, and we should perhaps congratulate his team more often for avoiding that scenario.
Then again, we are entering a period of heightened Trump-related risk. Having terminated the Deferred Action for Childhood Arrivals (DACA) program last year, Trump has put 800,000 young people who were brought to the US illegally as children in danger of being thrown out of the country.
Given that these are highly productive people who contribute heavily to the US economy, Trump’s approach could have dire economic, not to mention human, consequences. Trump and his allies are also pursuing sharp reductions in legal immigration, which would reduce the US’s medium-term growth prospects, perhaps significantly.
Trump has not abandoned his threat to rip up NAFTA, either. If he does take any steps in this direction, it will not be helpful to the US economy. Ironically, it could also do great damage to the Mexican economy, likely resulting in increased undocumented migration to the US. Without any such disruption, however, demographic trends suggest that migration from Latin America to the US will continue to decline steadily.
The biggest danger that Trump poses concerns financial deregulation. Both the Trump administration and the Republican-led Congress are attempting to roll back protections against systemic risk that were put in place after the 2008 financial crisis. Unfortunately, these kinds of attempts to juice the economy typically end badly. When George W. Bush’s administration did the same thing, we were left with the Great Recession.
Simon Johnson, a former chief economist of the IMF, is a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-founder of a leading economics blog, The Baseline Scenario. He is the co-author, with James Kwak, of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.