Trump Plays with Fire on Trade

By: Peter Schiff



With his announcement last week of broad tariffs on imported steel and aluminum, President Trump launched what could be the first salvo of an all-out global trade war. Seemingly itching for a fight, he gleefully tweeted that “Trade wars are good, and easy to win.” It seems like Trump thinks the conflict will play out much like Ronald Reagan’s 1983 week-long invasion of Grenada rather than the more telling quagmires that unfolded in Vietnam, Afghanistan and Iraq. He’s wrong.

Apart from overestimating America's bargaining position, Trump and his supporters grossly misunderstand the nature of international trade and how Americans have benefited from a system that has allowed us to continually consume foreign goods on credit. While this “benefit” has also placed a cost on domestic industries, I don’t believe that Trump has any idea how a trade war can reduce current American living standards.

As justification for his surprise offensive, Trump likes to highlight how America’s gargantuan annual trade deficit (which has grown to more than $600 billion during his presidency) is simply the yardstick by which “stupid” American trade policies are subsidizing foreign economies. In his mind tariffs are just a means to take back what we have foolishly given away. As Trump explained via Twitter “ When we are down $100 billion with a certain country and they get cute, don’t trade anymore - we win big.” But does a country with a trade deficit really subsidize the country with the surplus? Or is it the other way around?

Let’s suppose you keep chickens at home, and your neighbor has a cow. Everyday you trade a half dozen eggs for a quart of milk. This is the nature of trade. You offer something that you have in abundance (that other people don’t) for something that someone else has in abundance (that you don’t). But let’s suppose you eat a few of your chickens and your egg production drops to four per day. You continue to get your quart of milk, but everyday your neighbor adds two eggs to the account that you owe. Theoretically, you will one day owe your neighbor a whole bunch of eggs. But, in the meantime, does that two-egg deficit represent a benefit to you or your neighbor? Remember your neighbor still has to deliver the same amount of milk for less of a current payoff. He MAY get that deferred compensation down the road, but he’s not getting it now. And with every egg you go into the hole, the greater the chances that your neighbor may ultimately get stiffed.

Who is likely to be worse off if this trade were to suddenly stop? Remember, you are not the only potential trading partner available to your neighbor. Maybe the house across the street will give him six eggs for his milk?

The eggs/milk deficit that you have with your neighbor allows you to consume more than your production capacity would typically allow. While this is a definite benefit to you now, it does dissuade you from making the sacrifices necessary to increase your egg production. Your own industry atrophies while your neighbor’s doesn’t. But so what? You still get all the milk you need.

The point of an economy is to maximize consumption. Since goods cannot be consumed that have not been produced, it goes without saying that production is a necessary precondition to consuming. But, if given the choice, most people would be happy to outsource the production to someone else and concentrate solely on the consumption. But in the real world such an arrangement is untenable over the long term.

Of course your milk/eggs trade arrangement will be a problem if your neighbor cuts off your credit and demands full payment. Then you are stuck with a big debt, reduced egg production, and no milk. But, for America, that day has yet to come. For now, our trading partners are happy to take our debt rather than our goods. But if Trump starts making more unreasonable demands, they may not be so willing.

It’s helpful to remember that a tariff is essentially a tax that will be paid by domestic consumers. It’s not like American producers will keep prices where they are and simply manufacture more steel to make up for the lost imports. Instead, prices will likely rise to almost the same level as the taxed imported products. Profits at American steel companies will increase, but production probably won’t.

The manufacturers will know that the artificial political barrier protecting them could be removed at any time. Will they take the risk in investing in plant and equipment capacity when they know that removal of the tariffs would instantly eliminate their advantages and expose them to losses? Given the thin support that such tariffs will have beyond the narrow steel industry, it’s safe to assume that current manufacturers will stand pat and use the extra profits to issue dividends and buy back shares. To a lesser extent, they may increase wages for the nation’s 140,000 steel workers. But this industry-specific benefit will come at a great cost to the overall economy.

Raising the cost of steel would also raise the cost of every American product manufactured with steel. Right now the discussion is focused on beer cans, with people arguing about how many cents per soup can the tariffs will add. But this is just the tip of the iceberg. The real impact will be seen for metal-intensive items that are manufactured both here and abroad.

While the Trump tariffs will directly raise the price of imported steel (and indirectly the price of domestic steel), it does nothing about the price of goods made FROM steel. So a domestic manufacturer of home appliances, such as Whirlpool, will have to pay more for steel used to make a refrigerator. But its foreign competitors will be able make refrigerators with untaxed steel and then ship the finished product to the U.S. without facing a tariff. This will give the foreign firm a competitive advantage over Whirlpool both at home and abroad. Whirlpool will shed profits and may shed workers. So whatever advantages are given to steel manufacturers will be paid for by companies and workers that use steel. The problem for Trump is that there are only 140,000 domestic workers in the steel-making industry, but more than six million workers in industries that make stuff FROM steel. (American Iron & Steel Institute)

Trump’s gambit is also politically ham-fisted. He likes to say that his tariffs are aimed at bad actors like China. But that country is far down the list of steel exporters to America. The move really hits our close allies first, particularly Canada, a country that accounts for 16% of our steel imports, according to a December 2017 report from the Dept. of Commerce. But 50% of U.S. steel exports GO to Canada. Total cross-border trade between the U.S. and Canada in 2016 came in at more than $600 billion annually, according to the Office of the U.S. Trade Representative. That’s a very big applecart to push over for a comparatively small gain.

Potentially even more dangerous is the way the tariffs will be implemented. By absurdly claiming that they are being done in the interest of “national security” rather than economic advantage, the Trump administration is inviting embarrassing losses at the World Trade Organization, which combined with a rapidly deteriorating diplomatic environment could further isolate the U.S economically.

The big problem is where it all ends. Already major voices in the European Union (particularly from Germany) have threatened retaliatory tariffs on politically and symbolically sensitive American exports like bourbon, blue jeans, and Harley-Davidson motorcycles. Trump has threatened to tax European cars, if the EU follows through on those threats. Given the personalities involved, and the national pride at stake, it’s not hard to see that this tit-for-tat could escalate quickly and lead to a full-blown trade war on multiple fronts.

But this is not a war we can win. A decline in imports will force us to rely on our own production to meet all of our consumption. But we no longer make large categories of products that we consume. Even if we were to be able to ramp up production quickly, American consumers would be looking at much higher prices. With plenty of indications that inflation is already starting to percolate, now is not a time to go out looking for more.

But most concerning is the likelihood that a large decline in trade translates into a diminished international appetite for U.S. dollars. With government borrowing about to surpass $1 trillion annually (even while the Federal Reserve itself is set to begin selling more than $600 billion annually in Treasury bonds) we will need to find lots of buyers for U.S. dollars for years to come. If a trade war discourages those buyers, the dollar will fall and interest rates will rise even faster. But it could get much worse than that. If a recession forces the Federal Reserve into another round of quantitative easing, we will desperately need foreigners to show up at our bond auctions. If they don’t we will lose the ability to export our inflation, and all the excess liquidity will remain at home, where it will push up prices on the limited domestic supply of goods and services. This means even higher prices for American consumers, many of which will also be unemployed. The combination of rising unemployment and inflation will be bad politics for Trump, as it will allow democrats to use the “misery index” to defeat him in 2020 much as Ronald Reagan used it to defeat one-term Democratic Jimmy Carter forty years earlier.

Let’s hope that Trump’s bluster on trade is just a negotiating tactic. Maybe he’s crazy like a fox, and his threats will produce a favorable outcome for the U.S. But given his international unpopularity, and how quickly world leaders have mobilized for war, I wouldn’t count on it. More likely his blunders on trade will simply move our day of economic reckoning that much closer.


The Housing Market’s Rebound Is Far From Over

By Lawrence C. Strauss  

    The Housing Market’s Rebound Is Far From Over  Photo: Barron’s 


The U.S. housing market’s thunderous crash a decade ago helped bring the global economy and financial system to their knees. But those dark days seem like a distant memory now, as For Sale signs sprout on suburban lawns—a sure sign of spring—and Open House events in many locales attract a crush of prospective buyers.  

Abetted by a robust job market, low interest rates, and beneficial demographics, the nation’s housing market has been enjoying a Goldilocks sort of recovery—neither too cold nor too hot (with the exception of several coastal markets), but just about right. Given strong demand, insufficient inventory, and modest annual price gains, many industry experts see the recovery continuing for several years—unless mortgage rates unexpectedly spike, spoiling what has been a tame but enjoyable party. 

“You have a lot of buyers chasing very few houses,” says John Kendig, a long-time associate broker in the Richmond, Va., area. He says his clients recently missed out on an 1,800-square-foot brick colonial near the city even though the couple offered about $25,000 over the list price of $425,000.

“Housing is in the third or fourth inning of a nine-inning game,” says Bill Smead, lead portfolio manager of the $1.3 billion Smead Value fund, which holds shares of two home builders, Lennar (ticker: LEN) and NVR (NVR), in a 28-stock portfolio. “This is a normally cyclical business in a secular growth trend.”

Housing stocks generally have sold off this year amid concerns that rising interest rates will crimp home-buying. The SPDR S&P Homebuilders exchange-traded fund (XHB), which tracks home builders, home-improvement retailers, and industry suppliers, is down 9.3% on the year, versus a 0.15% gain for the Standard & Poor’s 500 index. Shares of the four leading publicly traded home builders—Lennar, D.R. Horton (DHI), PulteGroup (PHM), and Toll Brothers (TOL)—are down about 12%, on average, after rallying nearly 70% in 2017.

The home builders recently traded for 10 times 2018 profit estimates, compared with the broad market’s price/earnings ratio of 17, even though the companies are expected to notch double-digit earnings growth this year and next. Bullish analysts and investors think that housing stocks could gain 10% to 15% in the next year. Shares of Lennar, NVR, and Meritage Homes (MTH) look particularly attractive, as does home-improvement retailer Lowe’s (LOW), whose stock lost 12% last week after badly missing its fourth-quarter earnings estimates.

BY EVERY MAJOR MEASURE, the housing market is on the mend, although sales remain well below the 2006 peak. Take single-family housing starts, recorded when construction on a new building begins. Monthly single-family starts hit a record 1.8 million in January 2006, plummeted to about 350,000 in March 2009, and came in at 877,000 in January of this year, up 3.7% month to month and 8% year to year.

New-home sales climbed 10% last year, to an annualized 615,000, and Matthew Pointon, property economist at Capital Economics, is eyeing another 10% gain in 2018. He notes that new construction has been hampered by labor and materials shortages, which are driving up builders’ costs. Pointon sees plenty of support for lasting housing demand, as rising wages and the new tax law boost household income. But the tax law takes as well as gives. Changes that limit the deduction on state and local taxes to $10,000 could make owning homes in high-tax states and municipalities more expensive, and less desirable.



To be sure, some recent housing data have disappointed. The National Association of Realtors reported last month that sales of existing homes slipped 3.2% in January from the prior month, and 4.8% from a year ago. And the U.S. Census Bureau said new-home sales fell 7.8% in January, following a 7.6% drop in December. Citing regional disparities, some economists have blamed the negative news on the weather. Lawrence Yun, chief economist at the NAR, cites “the utter lack of sufficient housing supply and its influence on higher home prices, [which] muted overall sales activity in much of the U.S.” in January. 

HOME PRICES HAVE appreciated at a mid-single digit rate for the past six years, including 6% last year, although price gains have been much greater in hot markets such as San Francisco, Seattle, Denver, and Las Vegas. Realtor.com (owned by Barron’s parent News Corp) sees price growth cooling to 3.2% this year, partly due to excess inventory at the higher end of the market. Affordability, in short, isn’t a widespread issue, which bodes well for the market’s health. 
Yet, low supply is producing bidding wars in some surprising places, including Richmond. Kendig, the associate broker, says the home his clients wanted had 27 viewings in its first day on the market. The sellers received 12 offers and considered three, including that of his clients, who lost to a higher bidder. “It is an attractive house in good condition, and there is extremely low inventory,” Kendig says.

In the aftermath of the housing bubble, he notes, many contractors who built homes went out of business, leaving a dearth of firms to deliver when demand rebounded. Meanwhile, Kendig’s clients, who have been house-hunting for six months, are still pounding the pavement. “We won’t give up because we can’t give up,” says Russell Lawson, the husband. “We need to move to a smaller house.”

Andrew and Annie Bolton encountered similar competition for houses in Maplewood, N.J., a New York suburb. In early February the couple, currently living with their young daughter in an apartment in Jersey City, N.J., bid $605,000 for a house listed at $550,000, and were told they were on the low end among multiple offers. The couple agreed to pay $650,000 for a four-bedroom colonial whose price had been slashed to that level from $700,000. Their offer was accepted within 24 hours, but a few days later, as the deal was under attorney review, another buyer emerged.

Andrew Bolton, who works for a technology start-up, had his bank write a letter in support of his application. He also wrote to the seller, raising his offer to $660,000 and granting the seller various concessions. Those moves worked. “It’s a very competitive market,” says Bolton. “It’s all about differentiating yourself through various contingencies and the terms you put in your offer.”

UNDERPINNING TODAY’S STRONG housing demand is the U.S. consumer. “The consumer’s health is about as good as it gets,” Mark Zandi, chief economist at Moody’s Analytics, told Barron’s in a recent interview.

“Unemployment is low and falling, there are lots of jobs, and wage growth is picking up,” said Zandi, a longtime student of the housing market. “Interest rates are still low, household debt service is near record lows, and confidence is near record highs. The recent correction in the stock market notwithstanding, wealth has increased greatly. There are lots of tailwinds behind the American consumer and the American household.”

Yet, even well-heeled consumers could struggle to find desired shelter. Zandi estimates that the supply of U.S. housing totals 1.3 million units, compared with 1.6 million needed. “That’s a gap of 300,000 units annually, on top of a market that, broadly speaking, is undersupplied,” he says. “The vacancy rates across the housing stock are about as low as they get.”

A national unemployment rate of 4.1% has helped spur housing demand, leading to wage inflation of 4.4% for people in the lowest three quintiles of median income, from about $13,000 to $59,000, notes Susan Maklari, a housing analyst at Credit Suisse. That’s a plus for starter homes, a market segment that has rebounded more slowly than others since the housing bust.

So, too, is an expected surge in home-buying by millennials, the generation born roughly from 1980 to 2000, which has been famously slow to “launch.” Household formation has trended a bit higher lately, to a four-quarter average of about 925,000, helped by millennials moving into the market. Vishwanath Tirupattur, a fixed-income strategist at Morgan Stanley, and his colleagues are forecasting annual household formation of 1.35 million over the next five years, based on current demographics.

Jamie Barnett, a single 30-year-old high school teacher, took the plunge about a year ago, purchasing a three-bedroom Cape-style house in Richmond. “I recognized that renting is just throwing my money way,” she says.

Barnett says she hasn’t seen a big wave of people her age buying homes, but there are some. Among her friends, she says, those who want to stay in Richmond are apt to buy because prices are “still pretty reasonable.” The median listing in Richmond was $289,975 in January, according to realtor.com

Barnett says she didn’t have any trouble securing a mortgage, and many of her peers might not, either. “Employment of 25- to 34-year-olds is at record highs, with employment growth for that group exceeding the national rate for the past five years,” Pointon of Capital Economics wrote recently.

THE DEMAND FOR entry-level homes could give a nice boost to Meritage Homes, a Scottsdale, Ariz.–based builder with a market capitalization of $1.7 billion that has targeted this market segment. The stock has fallen 16% year to date, to a recent $43. Maklari, the Credit Suisse analyst, rates Meritage Outperform, with a price target of $60.

On a conference call with analysts last month, the company’s CEO, Steven J. Hilton, cited the entry-level market as “a significant long-term opportunity…as millions of millennials will be purchasing their first homes over the next decade.”

Meritage aims to make entry-level homes the focus of 35% to 40% of its housing communities. The company operates in Arizona, Texas, Florida, Georgia, and the Carolinas, all of which have seen favorable housing demand. Hilton noted that job growth has been strong in Arizona, “particularly at the lower end of the wage spectrum, and those people are buying houses now.” Phoenix represents 20% of Meritage’s sales.

Meritage expects to grow its earnings at a double-digit pace in the next few years. Its shares are trading at an inexpensive 8.5 times the $5.02 a share analysts expect the company to earn in the current fiscal year. That’s up from $3.41 a share last year, on estimated sales growth of 11%, to $3.6 billion. The stock’s five-year average price/earnings multiple is 12.3, according to FactSet. Meritage also has a solid balance sheet, with a net debt-to-capital ratio of 41%. 



AMONG THE LARGE-CAP home builders, Lennar offers an attractive valuation and upside potential. Shares are trading at 10.7 times this fiscal year’s profit estimate of $5.30 a share, versus a five-year average P/E of nearly 15 times.

Sandy Sanders, senior portfolio manager of the John Hancock Fundamental Large Cap Core fund, expects total housing starts to rise to about 1.5 million a year, compared with 1.1 million to 1.2 million recently. Lennar, he says, is “very well positioned to capture that growth, but the stock is not capturing that.”

Lennar is based in Miami but operates across the country. It added significant scale when it closed last month on the $9 billion acquisition of CalAtlantic, a smaller home builder. Lennar has targeted $365 million of synergies, with $100 million coming in the current fiscal year, which ends in November.

The combined company will rank among the top three home builders in 24 of the 30 biggest U.S. housing markets, up from 16 previously, according to Michael Rehaut of JPMorgan. It will have the No. 1 position in 15 markets, including Phoenix, San Francisco, and Orlando, Fla. Sanders has a price target of $80 on the stock, based on a discounted cash-flow analysis. Lennar was changing hands on Friday at $57.

Unlike many other home builders, NVR, based in Reston, Va., doesn’t develop much land, which ties up a lot of capital. As a result, its return on equity averaged about 35% in the past two years. “NVR is the superior operator in the industry, by far,” says Smead, of Smead Value.

NVR shares trade for about 15 times this year’s profit estimate of nearly $190 a share, compared with a five-year average multiple of 17.8 times. Analysts expect earnings to compound at a rate of more than 20% this year and next. The company operates in 14 states, mainly in the East, with a concentration in the Washington, D.C., and Baltimore areas.

HOME-IMPROVEMENT RETAILERS offer another play on a housing-market rebound. Michael Liss, a co-manager at American Century Value fund, thinks Lowe’s has a good chance to improve its performance, spurred by an activist investor who has been prodding the company.

Lowe’s tumbled 12%, to $85, last week, after fiscal fourth-quarter earnings missed analysts’ expectations. The company earned 74 cents a share in the quarter, about 15% below consensus estimates, as profit margins shrank by more than half a percentage point. Lowe’s, based in Mooresville, N.C., projected this year’s earnings at a range of $5.40 to $5.50 a share. Wall Street had been expecting earnings of $5.58 in the year that ends next on Jan. 31.

Lowe’s now trades for 15.7 times earnings, using the midpoint of its indicated range, below rival Home Depot’s (HD) P/E of 19. The company’s profit margins have lagged Home Depot’s, as have returns on invested capital. The latter totaled 17.1% for Lowe’s in its latest fiscal year, compared with Home Depot’s 33%. Home Depot is regarded as having a stronger store base, with better locations and a bigger presence in higher-end markets.

D.E. Shaw, an activist hedge fund that recently won three board seats at Lowe’s, has been pressuring the company to improve its own home. Among the areas Lowe’s could address are its level of advertising spending, product selection and availability, store staffing models, and e-commerce operations.

THE BIGGEST RISK to the housing market’s health today is interest rates, which have been creeping higher. Peter Boockvar, editor of the Boock Report, maintains that the uptick in the average 30-year mortgage rate to 4.33% in January from 4.20% a month earlier had an immediate impact on contract signings.

The difference between a 4.2% and 4.3% rate on a fixed 30-year $300,000 mortgage would raise the monthly payment by only about $17, however, hardly a deal breaker for most borrowers. And a mortgage rate of 4.3% is well below the average 30-year fixed mortgage rate of just under 6% from 1997 through 2017, according to Maklari.

The prospect of higher rates also could motivate would-be buyers. That’s just what Saritte Harel, a Short Hills, N.J., real estate agent, has found. “In our New Jersey market right outside Manhattan, the towns along the direct train line…are still seeing a brisk market,” she says.

“With interest rates on the rise, many buyers are realizing it’s a good time to buy their first home.”


When the Fed Wishes for Inflation

Modest price increases but rising asset prices make the central bank’s job harder

By Justin Lahart

Shoppers flock to Herald Square in New York to look for bargains. Consumer prices rose 0.2% in February from a month earlier. Photo: Richard B. Levine/Zuma Press 


Inflation is dead, at least for now, and that is making life more difficult for the Federal Reserve.

By all rights inflation should be accelerating, driven by a tight jobs market strengthening further, a big stimulus hitting the economy and a weak dollar. But it isn’t. The Labor Department on Tuesday reported that consumer prices rose 0.2% in February from a month earlier, putting them 2.2% higher than a year ago. Prices excluding food and energy—the so-called core that better reflects inflation’s trend—rose 0.2%, leaving them up 1.8% on the year.

Friday’s strong jobs report makes the modest inflation numbers more vexing.

Inflation isn’t dead, of course. Economists point out that over the past six months core prices have risen at a 2.5% rate. Fed policy makers won’t hesitate to raise rates when they meet next week.


CORE READING
Six-month change in consumer prices,
excluding food and energy ítems, at an anual rate


But if inflation remains quiescent, and the fiscal stimulus propels asset prices higher instead, the Fed could face some tough decisions. The housing and credit bubbles that led to the financial crisis came about during a period of unexpectedly low inflation and good economic growth. The same goes for the dot-com bubble.

The Fed, and economists in general, now think asset-price excesses can cause real economic problems. But acknowledging this isn’t the same as knowing what to do. Economists still don’t agree on what makes a bubble a bubble, so it comes to a gut call. At the moment, the stock market seems pricey, but doesn’t seem like a bubble. But where would the line between the two be? And at what point would it be appropriate for the central bank to start leaning against the market, and how should it go about doing it?

If the economy and job market keep doing well, but inflation stays low, the Fed can, and probably will, raise rates four times this year. But even if it is worrying about asset prices, it could have a hard time justifying raising rates any more than that. As far as the central bank is concerned, a little more inflation might be a welcome thing.


Economists vs. Scientists on Long-Term Growth

Kenneth Rogoff

A truck cockpit being assembled


CAMBRIDGE – Most economic forecasters have largely shrugged off recent advances in artificial intelligence (for example, the quantum leap demonstrated by DeepMind’s self-learning chess program last December), seeing little impact on longer-term trend growth. Such pessimism is surely one of the reasons why real (inflation-adjusted) interest rates remain extremely low, even if the bellwether US ten-year bond rate has ticked up half a percentage point in the last few months. If supply-side pessimism is appropriate, the recent massive tax and spending packages in the United States will likely do much more to raise inflation than to boost investment.

There are plenty of reasons to object to recent US fiscal policy, even if lowering the corporate-tax rate made sense (albeit not by the amount enacted). Above all, we live in an era of rising inequality and falling income shares for labor relative to capital. Governments need to do more, not less, to redistribute income and wealth.

It is hard to know what US President Donald Trump is thinking when he boasts that his policies will deliver up to 6% growth (unless he is talking about prices, not output!). But if inflationary pressures do indeed materialize, current growth might last significantly longer than forecasters and markets believe.

In any case, the focus of economists’ pessimism is long-term growth. Their stance is underpinned by the belief that advanced economies cannot hope to repeat the dynamism that the US enjoyed from 1995-2005 (and other advanced economies a bit later), much less the salad days of the 1950s and 1960s.

But the doubters ought to consider the fact that many scientists, across many disciplines, see things differently. Young researchers, in particular, believe that advances in basic knowledge are coming as fast as ever, even if practical applications are taking a long time to develop.

Indeed, a small but influential cult touts the Hungarian-American mathematician John von Neumann’s “singularity” theory. Someday, thinking machines will become so sophisticated that they will be able to invent other machines without any human intervention, and suddenly technology will advance exponentially.

If so, perhaps we should be far more worried about the ethical and social implications of material growth that is faster than humans can spiritually absorb. The angst over AI mostly focuses on inequality and the future of work. But as science fiction writers have long warned us, the potential threats arising from the birth of silicon-based “life” forms are truly frightening.

It is hard to know who is right: neither economists nor scientists have a great track record when it comes to making long-term predictions. But right now, and leaving aside the possibility of an existential battle between man and machine, it seems quite plausible to expect a significant pickup in productivity growth over the next five years.

Consider that the main components of economic growth are increases in the labor force, increases in investment (both public and private), and “productivity,” namely the output than can be produced with a given amount of inputs, thanks to new ideas. Over the past 10-15 years, all three have been dismally low in the advanced economies.

Labor force growth has slowed sharply, owing to declining birth rates, with immigration failing to compensate even in pre-Trump America. The influx of women into the labor force played a major role in boosting growth in the latter part of the twentieth century. But now that has largely played out, although governments could do more to support female labor force participation and pay equity.

Similarly, global investment has collapsed since the 2008 financial crisis (though not in China), lowering potential growth. And measured productivity growth has declined everywhere, falling roughly by half in the US since the tech boom of the mid-1990s. No wonder global real interest rates are so low, with high post-crisis savings chasing a smaller supply of investment opportunities.

Still, the best bet is that AI and other new technologies will eventually come to have a much larger impact on growth than they have up to now. It is well known that it can take a very long time for businesses to reimagine productive processes to exploit new technologies: railroads and electricity are two leading examples. The pickup in global growth is likely to be a catalyst for change, creating incentives for firms to invest and introduce new technologies, some of which will substitute for labor, offsetting the slowdown in the growth of the workforce.

With the after-effects of the financial crisis fading, and AI perhaps starting to gain traction, trend US output growth can easily stay strong for the next several years (though, of course, a recession is also possible). The likely corresponding rise in real global interest rates will be tricky for central bankers to navigate. In the best case, they will be able to “ride the wave,” as Alan Greenspan famously did in the 1990s, though more inflation is likely this time.

The bottom line is that neither policymakers nor markets should be betting on the slow growth of the past decade carrying over to the next. But that might not be entirely welcome news. If the scientists are right, we may come to regret the growth we get.


Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Folly, his new book, The Curse of Cash, was released in August 2016.

 China Takes Dictatorship To The Next Level. History Says It Won’t Work

Every few decades a new “command and control” economy emerges, puts up awesome initial numbers, and convinces people prone to dictator-worship that they’ve seen the future and it works.

Between the 1920s and the 1970s, for instance, lots of influential people thought the Soviet Union would overtake the West, forcing the “free world” to embrace top-down economic planning.

Then in the 1970s and 80s Japan’s bureaucratically driven export machine convinced many that having a Ministry of Trade and Investment tell private conglomerates what to make and sell was far superior to letting markets decide such things.

Neither of those countries ended up taking over the world, for an obvious reason: A modern economy is more complex than a central planner’s brain, which makes dictatorships inflexible.

Diffuse, market-based systems are messy but tend to adapt more quickly and innovate more readily to a changing world, which is why Silicon Valley ended up in the US and not Moscow or Tokyo.

Which brings us to China, a quasi-dictatorship still run by something calling itself the communist party, in which the government exercises a strange mix of powers to direct investment while keeping markets and personal expression under tight control. Like Russia and Japan in their early days, it has put up some amazing numbers of late and is being hailed as the world’s next big thing.

And lately it’s been following the command-and-control script by taking off the velvet gloves and embracing its inner Stalin.

First, it removed the term limits which used to create the illusion of fluid leadership, enabling the guy currently in charge to rule for life.

‘Dictator for life’: Xi Jinping’s power grab condemned as step towards tyranny 
(Guardian) – The news broke at three minutes to four on a chilly winter’s afternoon in a two-sentence bulletin. 
“The Communist party of China central committee proposed to remove the expression that the president and vice-president of the People’s Republic of China‘shall serve no more than two consecutive terms’ from the country’s constitution,” Xinhua, China’s official news wire, reported. “The proposal was made public Sunday.”  
It was a typically dreary communique from the party-controlled propaganda agency.  
But to those who have spent their lives battling to decrypt the enigma that is elite Chinese politics, the text’s historic significance was unmissable. 
“A bombshell,” said Susan Shirk, one of the United States’ foremost China specialists.
“I wasn’t anticipating such an open declaration of the new regime … I thought maybe he would stop short of this.” 
“He” is China’s 64-year-old leader, Xi Jinping, a man who, after Sunday’s sensational and unexpected announcement, appears poised to lead the world’s second largest economy and one of its largest military forces well into next decade and quite possibly beyond.  
“It means that for a long time into the future, China will continue to move forwards according to Xi’s thoughts, his route, his guiding principles and his absolute leadership,” said Shi Yinhong, an international relations professor from Beijing’s Renmin University. 
Bill Bishop, the publisher of the Sinocism newsletter on Chinese politics, said the move confirmed Xi’s mutation into a species of “Putin-plus” – only Xi was “much more effective, much more powerful and, frankly, much more ambitious” than his Russian counterpart.  

Shirk, who was US deputy assistant secretary of state under Bill Clinton, said: “What is going on here is that Xi Jinping is setting himself up to rule China as a strongman, a personalistic leader – I have no problem calling it a dictator – for life.”

This is kind of old school, understandable to anyone with a memory that predates Facebook.

Dictators hate to give up power and refuse to do so whenever possible.

But China’s the next move is decidedly New Age authoritarian. Over the past couple of years it has taken the credit score concept that hypnotizes/tyrannizes Americans and raised it to a level that George Orwell would find completely plausible. Instead of just transactional information flowing into a database to form a picture of creditworthiness, in today’s China pretty much everything citizens do online – texting, buying and selling, charitable giving, political speech — is flowing into a database to produce a social ranking as defined by government preference.

“Good” citizens get perks while bad ones get…very little. They can’t borrow money, travel first class, or get into top schools. The following is from a much longer look at this subject from Wired Magazine. Read the rest of it here:
Inside China’s vast new experiment in social ranking 
In 2014 the Chinese government announced it was developing what it called a system of “social credit.” The State Council, China’s governing cabinet, publicly called for the establishment of a nationwide tracking system to rate the reputations of individuals, businesses, and even government officials. The aim is for every Chinese citizen to be trailed by a file compiling data from public and private sources by 2020, and for those files to be searchable by fingerprints and other biometric characteristics. The State Council calls it a “credit system that covers the whole society.” 
For the Chinese Communist Party, social credit is an attempt at a softer, more invisible authoritarianism. The goal is to nudge people toward behaviors ranging from energy conservation to obedience to the Party. Samantha Hoffman, a consultant with the International Institute for Strategic Studies in London who is researching social credit, says that the government wants to preempt instability that might threaten the Party.  
“That’s why social credit ideally requires both coercive aspects and nicer aspects, like providing social services and solving real problems. It’s all under the same Orwellian umbrella.” 
In 2015 Ant Financial was one of eight tech companies granted approval from the People’s Bank of China to develop their own private credit scoring platforms. The service tracks your behavior on the app to arrive at a score between 350 and 950, and offers perks and rewards to those with good scores. The algorithm considers not only whether you repay your bills but also what you buy, what degrees you hold, and the scores of your friends.  
The State Council has signaled that under the national social credit system people will be penalized for the crime of spreading online rumors, among other offenses, and that those deemed “seriously untrustworthy” can expect to receive substandard services.  
Ant Financial appears to be aiming for a society divided along moral lines as well. As Lucy Peng, the company’s chief executive, was quoted as saying in Ant Financial, Zhima Credit “will ensure that the bad people in society don’t have a place to go, while good people can move freely and without obstruction.”

Why is this a sign of weakness and harbinger of failure? Because innovation is inherently destructive.

There’s a reason why Silicon Valley’s holy grail is “disruptive” tech – replacing today’s methods with tomorrow’s is hugely profitable. But only for the disruptor. Those on the other side of the divide tend to focus on the “destruction” part of creative destruction and oppose it strenuously.

In a market-based system innovation is a continuous process. But in a system where “disruptive” might not be synonymous with “good” for the powers that be, the impulse to replace old and inefficient with something better might be stifled. So to the extent that the Chinese government gets to decide “social” winners and losers, its economy will be bypassed and/or disrupted by market forces from outside.

Assuming, of course, there are any market-based systems left to do the disrupting.

Sheila Bair Sees the Seeds of Another Financial Crisis

By Reshma Kapadia

     Sheila Bair Sees the Seeds of Another Financial Crisis Photo: Stephen Voss for Barron's 


Sheila Bair has demonstrated that she’s not afraid to be the lone person flagging potential problems.

The former head of the Federal Deposit Insurance Corp. is best known for her early warnings about the subprime mortgage market, and she’s still spotting problems in the financial system.

Bair has spent much of her career in Washington, D.C., beginning as a staff member for Sen. Robert Dole, and has long been comfortable going against the consensus. In 1992, as a commissioner on the Commodity Futures Trading Commission, Bair was the sole dissenting vote against loosening rules for energy trading companies, arguing that it set a “dangerous precedent.” Less than a decade later, Enron’s collapse proved her right. During the financial crisis, Bair, appointed to lead the FDIC by President George W. Bush in 2006, clashed with other officials, as she pushed for loan modifications and argued against bailing out the big banks.

After leaving the FDIC in 2011, Bair spent two years as president of Washington College, a small liberal-arts school in Maryland, where she focused on another growing problem—student debt. Bair also has served as an advisor to many institutions, including the China Bank Regulatory Commission and the Pew Charitable Trust, where she headed the Systemic Risk Council, a nonpartisan group that aims to improve financial stability. She also serves on several corporate boards, including the state-owned Industrial and Commercial Bank of China, and Paxos, a blockchain start-up that operates a bitcoin exchange.

It’s a portfolio that gives her a good vantage point on the market’s most pressing issues. We spoke with Bair to hear her views on China’s large debt, trouble spots she sees in the U.S. financial system and economy, and what regulators should do about bitcoin.

Barron’s: Investors have worried about whether China’s high debt is a risk to the global economy and financial stability. Is that a reasonable concern?

Bair: We look at their debt and wag our fingers and tsk, tsk. It is high. But they realize it is a threat to financial stability and are dealing with it. Last month, regulators took over privately held Anbang Insurance to keep it from collapsing. [Anbang is a conglomerate that had expanded aggressively overseas, acquiring hotels including the Waldorf Astoria in New York.] It is a sign they are continuing to crack down on reckless growth and excessive leverage.

What else is China doing to stabilize its financial system?

They need to reduce debt, increase transparency, and make sure banks stay on top of credit risk. The banks are very aware of credit quality and nonperforming loans. The words you hear are “prudence” and “sustainable growth,” and there is huge emphasis on risk management right now from bank leadership and regulators. They are also cracking down on wealth management products. That means more loans on bank balance sheets, because these products had previously been off balance sheets. But that’s a good thing because at least it’s transparent.

What questions do the Chinese most frequently ask you?

They are very focused on how Western investors look at them. There is confusion and trepidation about what the U.S. attitude is toward them, but they still want Western investor acceptance. That can work in favor of more transparency and market-driven decisions.

China just proposed abolishing its two-term limit for presidents, paving the way for Xi Jinping to stay in power indefinitely. What risk does that pose to investor acceptance?

It’s too soon to tell. More important will be how he uses his power, particularly in continuing to open markets and improve transparency. I’m struck by the difference in the tone of the political leadership—with Xi talking about deleveraging, constraining asset bubbles, and accepting short-term trade-offs to growth for long-term sustainability. Contrast that to the U.S., where we have a move toward deregulation and borrowing more. It saddens me that we are falling prey to short-termism.

What part of the deregulation push in the U.S. concerns you?

Many postcrisis financial reforms are still being finalized. Though the current administration was elected on an anti-big-bank kind of campaign, it has become very bank-friendly. I don’t have a problem with some deregulation, but I can’t believe we are moving to weaken capital rules for banks.

You are referring to a technical change in one provision of a bipartisan bill expected to hit the Senate floor this month.

Yes. It has a lot of good provisions, such as easing unnecessary supervisory infrastructure on regional and community banks that were caught up in the wider net after the crisis. The focus of postcrisis reforms should have been on the large, complex financial institutions that drove the problem. So that is all fine. But, of course, big banks are trying to ease the capital requirements [set after the financial crisis]. I’m hearing through the grapevine that the Office of the Comptroller of the Currency and the Federal Reserve are also moving on rules to loosen capital requirements.

Why is that problematic at this stage of the economic and credit cycle?

In these benign times, when banks have been profitable for many years and they just got a big tax cut, you want banks to keep building buffers. To loosen capital now is just crazy. When we get to a downturn, banks won’t have the cushion to absorb the losses. Without a cushion, we will have 2008 and 2009 again.

The idea we need to loosen up on banks so they can lend more to fuel growth—after a decade of highly accommodative monetary policy, a huge deficit-funded tax cut, and deregulation—is very shortsighted. And it’s not supported by data: Loan growth has exceeded gross-domestic-product growth. There is plenty of debt in the economy. The memories—and lessons—of what drove the crisis are completely being ignored. One outcome of bailing out the big banks was they emerged with a lot of political power.

What does that mean for the health of the financial system 10 years postcrisis?

There was not a lot of accountability imposed after the crisis. That was a mistake. I worry we still have the same system. Yes, it’s safer in that banks have more capital—so far—and more supervision, and the stress tests are helpful. But we didn’t fundamentally change the system.

Where, then, do you see potential problems that could trigger the next crisis?

I’d keep an eye on credit-card debt. Subprime auto has been a problem for a couple years, and valuations on loans used to finance leveraged buyouts are high. Any type of secured lending backed by an asset that is overvalued should be a concern. That is what happened with housing.

Corporate debt also has not gotten as much attention as it should. It is market-funded, rather than bank-funded, but the banks still have exposure. Then there’s cyber-risk. It took us so long to get around to the reforms postcrisis that we got a little behind on systemic cyber-risk, but regulators are very focused on it now.

That’s a lot to worry about. What does it mean for the economy?

With tax reform combined with deregulation, and the economy finally picking up steam, the economy could generate pretty good growth over the next year or two. But after that, if we keep throwing gas on flames with deficit spending, I worry about how severe the next downturn is going to be—and whether we will have any bullets left. Hopefully, in a couple of years, the Fed will have gotten interest rates up to the point it can ease on a short-term basis.

But on the fiscal side, there is very little breathing room. I worry about when the safe-haven status of Treasuries is questioned. As the Fed raises rates while we are deficit-spending, it will have a negative impact on stocks. These are things I’d like to get ahead of. I don’t think Congress has a clue that the reason they have been able to get away with this profligacy is because we are the best-looking horse in the glue factory. But we are in the glue factory. Our fiscal situation is not a good one.

You have also raised concerns about the $1.3 trillion outstanding student debt. Could that trigger a financial crisis?

That debt is all on the government’s balance sheet, so no, not a market crisis. But there are parallels to 2008: There are massive amounts of unaffordable loans being made to people who can’t pay them, and the easy availability of those loans is leading to asset inflation. In 2008, that was reflected in housing prices. Today, that’s tuition. It’s too easy to raise tuition because kids will borrow to pay for it. If the loan defaults, the primary beneficiaries—educational institutions—have no skin in the game, like in the mortgage crisis.

What is a possible solution?

Income-share agreements allow students to repay a loan based on a percentage of their income over a long period. It’s impossible for an undergrad to know what their earnings and repayment capacity will be when they graduate, yet student debt is fixed. We need high school math teachers just like we need hedge fund managers, but we have a one-size payment system, whether you are making $36,000 or $360,000.

Does anyone use such agreements?

Some, like Purdue University, are experimenting with it. It has to be structured so colleges fund $1 and the government funds $1, and they share the students’ payment. That way the college’s return on investment depends on whether a student graduates and gets a job, aligning institutional incentives with student success. Private investors are leading a lot of this, but that makes me uncomfortable.

Why?

Private investors look for big risk premiums. I fear they favor STEM [science, technology, engineering, and mathematics] majors who will have high paychecks. We need a program to support a wide array of disciplines. We need to get philanthropies, the government, and endowments into the mix. Instead of owning master limited partnerships, university endowments should be putting some money into their kids.

How does student debt affect inequality and the economy?

Student-loan stories always feature someone who borrowed $90,000 to go to grad school or med school. But those people generally get jobs and have earnings potential, and debt-forgiveness programs disproportionately help them. The distress and high default rates are among the kids borrowing $10,000 to go to a for-profit school and dropping out; $10,000 may not sound like a lot to you and me, but for a first-generation student or someone without a college degree, that’s a lot of money. Student debt also suppresses small-business formation. Kids who would have started a business in their parents’ garage can’t do that now because they owe $50,000. Beyond that, it’s just a terrible financial burden for our kids that didn’t exist 20 years ago.

We also didn’t have bitcoin 20 years ago. Some central bankers are concerned about the mania around cryptocurrencies. What is your view?

Don’t put any money into bitcoin that you can’t afford to lose. But I don’t think we should ban it—the green bills in your pocket don’t have an intrinsic value, either. The value is based on what others think is its value. That’s true of any currency. Regulation should be focused on good disclosure, education, warding off fraud, and making sure it is not used for illicit activities. Let the market figure out what it’s worth. That is what it is doing now.

Thanks, Sheila.