The Italian Trigger

By John Mauldin


 
Train wrecks and their financial analogues are a worldwide phenomenon.

Europe, as I have written for several years, remains a giant accident waiting to happen—as Italy reminded us last week. You may have noticed the results when US trading resumed Tuesday.

A wider crash may not be imminent but is certainly possible and will have worldwide effects if/when it happens.


So now is a good time to review what’s already happened and what could be coming.
 
This letter is chapter 4 in my Train Crash series. If you’re just joining us, here are links to help you catch up.

Briefly, my thesis is that over the next decade, we will endure increasingly damaging debt crises that culminate in a coordinated global default—“The Great Reset,” as I call it. There are limits in how much leverage the world can handle, and I think we are already beyond them. And that is before we have a global recession. The only question now is how we will manage the collapse.
 
I previously quoted former BIS Chief Economist William White on how this will all unfold. Here’s his key point again.
 
… the trigger for a crisis could be anything if the system as a whole is unstable. Moreover, the size of the trigger event need not bear any relation to the systemic outcome. The lesson is that policymakers should be focused less on identifying potential triggers than on identifying signs of potential instability.
 
Bill says the financial system is so fragile that practically anything could trigger a crisis. Better to watch for signs of potential instability… and in Italy, instability isn’t just a potential. It is a probability at some point.
 
 
Italy had been without a government since its March 4 election, which yielded a hung parliament with no party or coalition holding a majority. The Five Star Movement and Lega Nord finally reached a deal, to most everyone’s surprise since those two parties, while both broadly populist, have some big differences. Nonetheless, they found enough common ground to propose a cabinet to President Sergio Mattarella.
 
Italian presidents are generally seen as rubberstamp figureheads. They really aren’t supposed to insert themselves into the process. Yet Mattarella unexpectedly rejected the coalition’s proposed finance minister, 81-year-old economist Paolo Savona, on the grounds Savona had previously opposed Italy’s eurozone membership. This enraged Five Star and Lega Nord, who then ended their plans to form a government and threatened to impeach Mattarella.
 
Such acrimony isn’t new in Italy. Politics there are messy, to say the least. Savona’s possible appointment set off alarm bells because it suggested the new government might try to take Italy out of the eurozone. Neither coalition party had raised that possibility in the campaign. The main promises were to reduce taxes and introduce a kind of universal income for poor and unemployed Italians.
 
In fact, the polls clearly demonstrate that Italians still want to stay in the eurozone. Not as much as the Germans or the French, but a clear majority.

At the beginning of the euro experiment back in 1999, 81% of Italians supported the euro and now only 59% do. (Some polls show as much as 66%.) Whatever the number, we can see a trend there.
 
On the flipside, only a small majority of Germans supported the euro at the beginning and now 80% do. France has seen a smaller rise in support, from 67% to 71%. And that pretty much tells you everything you need to know about which countries the euro helped. And in a few paragraphs, we will let those numbers instruct us as to the future direction of Europe.
 
The slowly disintegrating numbers in favor of the euro and Italy reflect the fact that the Germans and French are better off than the Italians compared to 17 years earlier. Germany, joined by the Dutch, Finns, and Austrians, runs a monster $1 trillion plus trade surplus with the rest of Europe and the eurozone. And that makes the workers in primarily Mediterranean countries increasingly less productive than the northern countries, which ultimately forces their wages down. So, the northern Italian business populist party (Lega Nord) feels Italian businesses are losing out because of the euro, and the southern Italian populist party (Five-Star), representing an area where wages are suppressed and unemployment high, have serious concerns about the euro.
 
My friend Louis Gave noted that Mattarella’s decision was “not a crime, it was worse—it was a mistake.” Even Mattarella has now acknowledged that. In a face-saving measure, the two populist political parties suggested a new finance minister, Giovanni Tria, who has some (let’s just say) interesting economic points of view, but at least he is in favor of the euro and thus allows Mattarella to correct his mistake. But then he approved Savona, whom just days earlier he had rejected as a potential finance minister due to past anti-euro views, to be the new Minister of European Affairs. If you are confused, remember this is Italy. Everything is confusing there, except the food.
 
 
Italy is not Europe’s only problem. The big Kahuna is Germany, which spent years offering generous vendor financing to the rest of the continent to entice the purchase of German goods. The result: a giant trade surplus for Germany and giant, unpayable debts for those who bought German goods. Greece, for instance.
 
But a lot of that debt is on the balance sheet of European banks. S&P just cut its rating for Deutsche Bank to BBB+. That is only a few notches above junk status.

And if there were Italian issues? A lot of German banks could see their ratings fall to below junk. Ugh. Will Germany let Deutsche Bank fail? Simple answer, no. But they may not feel the same love for Deutsche Bank shareholders.
 
Spain is not quite the basket case that Italy is, but its banks are certainly wobbly. Spanish lawmakers this week gave a no-confidence vote to Prime Minister Rajoy’s conservative government and installed a socialist prime minister. The Spanish economy is actually much improved; other issues are creating political instability.
 
The UK is still winding its way down the Brexit path, which doesn’t directly affect the euro but is disruptive nonetheless.
 
All in all, Europe is mostly stable but has problem spots like Italy. All it takes is one of them to bring the whole structure down. That’s why we see market moves like Italian two-year bond yields zooming from below zero to almost 3% within days and then falling below 0.8% the next few days.  

That’s some serious volatility. (h/t to Peter Boockvar for the chart.)
 
 
That’s not normal and doesn’t happen in a monetary union in which all the members share the same goals. And that’s kind of the problem: European governments have irreconcilable interests and thus don’t trust each other.

By accident of history and geography, the continent is fractured into dozens of competing economies, languages, and cultures. Unity has long been a dream, but only a dream. Simply avoiding war is hard enough.
 
The Euro currency union is fatally flawed because it leaves each member state to set its own fiscal policy. There are good reasons for that, but it is not sustainable indefinitely. The Eurozone must get either much more centralized or fall apart. All the Rube Goldberg contraptions the ECB and others invent are temporary fixes. They’ve worked so far. They won’t work forever. And that brings us to the latest strange proposal.
 
 
Italy’s situation could blow up the fragile trust that keeps Europe together, and the leading parties may even be planning for it. The discussions between Lega Nord and Five Star included an idea called the “mini-BOT” that would effectively serve as a parallel currency.
 
The BOT is Italy’s Treasury bill, and as in the US, it serves as a kind of cash equivalent in electronic trading. The mini-BOT would be a government debt instrument, in paper form, that pays zero interest and never matures. The government would use it to pay social benefits and accept it for tax payments. Private businesses would not be required to accept it, but they could.
 
Private businesses and individuals would also, in theory, buy the mini-BOT as a way to pay their taxes. But they would buy them at a discount. So, traders would immediately set up an arbitrage where the person getting the social benefits payment could sell them for euros for, call it, a 5% or 10% haircut. Former Prime Minister Silvio Berlusconi, who is still a force in Italy, insists this would be legal. The Northern League sees a way to ease the transition out of the euro and the Five-Star Movement sees a way to increase spending without having to take on euro debt. And since the new coalition government wants to increase the deficit an additional $180 billion euros or so through a combination of tax cuts and increased spending, this is being seriously proposed.
 
The mini-BOT probably could be a practical alternative to the euro for many transactions. From what I’ve read, the other eurozone countries would have difficulty stopping it because the euro would still be the only formal “currency.” And other Mediterranean countries would watch this experiment and begin moving in the same direction themselves.
 
You see where this goes. Italy might be able to use mini-BOTs (or let’s be honest and call them the new lira) to finance deficit spending without breaking eurozone rules. This could ultimately debase the euro and blow apart the eurozone. Germany would have to leave. From there, you can draw your own map.
 
Is this what the Italian populists want? Some of them, yes, but I suspect their leaders know not to go too far. More likely, they see it as a bargaining chip—a plausible threat they can use to extract concessions from the ECB and other eurozone leaders. The Greeks threatened something similar in 2015 and it didn’t work. I think Italy has a stronger hand.
 
But it gets scarier when you think about how this could happen. If Italy’s new government decides to launch a parallel currency, they will probably do it with no warning at all. Tipping their hand would spark capital flight and reduce the benefits. We could literally wake up one morning to learn the lira (or something like it) is back and Germany is leaving the Eurozone. Imagine how markets would react.
 
I think this scenario is unlikely, but it points to something else. As the coming debt crisis matures, national leaders and central bankers will find their choices narrowing. I’m constantly amazed at their creativity, but it has limits. They can’t kick the can down the road forever. At some point, the road ends and then they have to choose. When your only choices are “impossible” and “terrible,” then you pick the latter. We are going to see previously unthinkable ideas be seriously considered, and sometimes chosen, because all other options are even worse.
 
 
Here’s the problem that’s brewing. Germany and the other northern countries, but especially Germany, have prospered tremendously under the euro regime. If the eurozone were to break up, German GDP would simply fall out of bed. Half its economy is comprised of exports. Further, the new German currency would get stronger which would even put more pressure on German exports.
 
The Italians have no solution for their debt. Greece has been in a seven-year depression. And while some of the other countries are improving, unemployment rates in most of Europe are still lackluster to say the least.  

See the chart below and notice the high unemployment rates. And understand that the unemployment rates for young people (millennials) are probably double that. One in three Italian youth are unemployed.
 

Source: Statista
 
Let’s drill down on Italy’s employment data. Notice the further south you get, the higher the unemployment rate goes. That’s the Five-Star Movement’s base. The other part of the new majority is now called the League (formerly the Northern League) and is powerful in the low unemployment manufacturing regions of northern Italy. And for all the Italian problems we’re talking about, Italian manufacturing is a powerhouse. (Map h/t to Dennis Gartman.)
 
 
This is why you can’t entirely dismiss the notion of a parallel currency in Italy. The southern portion of the country wants to see more spending and the northern portion would like to ease out of the euro. Politics makes extraordinarily strange bedfellows in Italy. It’s not quite as outlandish as President Trump and Bernie Sanders forming a coalition government, but it was unthinkable just a year ago.
 
Germany and the rest of the export driven countries need to stay in the euro in order for their economies to grow and prosper. The southern countries need to figure out how to deal with their debt. Italy is around 135% of debt-to-GDP today.
 

I still think the most probable scenario is that Germany and the Netherlands reluctantly agree to let the European Central Bank mutualize all the sovereign debt, taking onto their balance sheet and issuing new ECB-backed debt for the entire zone. There would have to be serious constraints on running deficits after that point, but it would prevent a breakup, or at least delay it for another decade or so. Kind of the ultimate kicking the can down the road.
 
 
None of these dire possibilities appear to be in play right now. One way or another, Italy will slide through this. It could drag on a few months. But Tuesday’s market spasm ought to be a warning sign. Traders still know how to hit the “sell” button and will do it quickly if something surprises them. This time, it was manageable. At some point, it won’t be.
 

My friend Doug Kass, a brave soul who has been trading longer than most, actually turned bullish on banks following this week’s selloff, shedding his short positions.
 

After Doug wrote that, the Federal Reserve Board voted to loosen the Volcker Rule that had limited proprietary trading. Other agencies must agree, so it’s not a done deal yet. In theory, this should help banks and may also restore some of the bond market’s lost liquidity. I don’t think it will solve all our problems or prevent the larger crisis that I think is coming.
 

Charles Gave, who was also trading before today’s wizards were born, is questioning some of his assumptions. His longtime models say the time is nearing to sell US stocks and buy German stocks. But that model makes assumptions that are no longer true. For one, it assumes capital will flow to the place where it can be used most efficiently, and exchange rates will stay suitably flexible. Neither is necessarily true in an era of collapsing alliances and rising trade barriers.
 
Speaking of trade, with Trump once again getting ready to impose steel tariffs on the EU and lumber tariffs on Canada, things can get even more volatile. Since lumber is basically 20% of the cost of a house, a 20% increase in lumber prices (a gift to US lumber companies) would raise housing construction cost by 4%. Cars and aluminum cans would rise in costs. Not only are the countries that are paying the tariff being taxed, US consumers will be taxed with higher prices. This is not exactly the best way to stimulate an economy. Worse, it could all change again as negotiations continue, and businesses need policy certainty.
 
I haven’t written yet about the housing markets in Canada and Australia, both of which are in worse shape than the US was ten years ago. Especially Australia. You can just go around the world and find Bill White’s “pockets of instability” everywhere. One or two here and there is not an issue. The world typically just shrugs it off. But we are now beginning to see problems in a much larger geographical space. Argentina? Mexico electing a radical socialist? Where does it end?
 
 
I want to thank everyone who subscribed to our rejuvenated Over My Shoulder service. As I explained, it helps me keep Thoughts from the Frontline regular and free. But more important, you’re getting tons of valuable information to help you navigate through this economic minefield.
 
In the last month alone, Over My Shoulder subscribers received valuable research and analysis from Peter Boockvar, Steve Blumenthal, Woody Brock, Jesse Felder, Charles Gave, Louis Gave, Lacy Hunt, Doug Kass, David Kotok, and Grant Williams. Buying it separately would have cost thousands of dollars, but you got to see it for only $9.95. That counts as one of the world’s greatest bargains.
 
Better yet, you get the benefit of all that research without even having to read it. My co-editor Patrick Watson or I prepare brief summaries of each report that tell you the key points and bottom line. You can stop there or, if you have time, go on to read the full story. It’s your choice.
 
If you enjoy my letters and haven’t tried Over My Shoulder, you are missing out. Click here to learn more and give it a try.
 
I am trying not to schedule yet another plane trip until August, but I know a few quick trips will probably intrude on my summer schedule. I will let you know if maybe I’ll be in a town near you. You have a great week and here’s hoping the market rally continues.
 
Lastly, three cheers for the jobs report. Even with all the world’s instability, the US economy keeps churning along. We have a more volatile trading environment, but nothing to signal a recession in 2018. So, let’s enjoy the summer.
 
Your running as fast as his puppy-dog legs can take him analyst

John Mauldin
Chairman, Mauldin Economics


The euro must be made more robust to rival the dollar

US sanctions expose the mistakes made by the founders of the single currency

Wolfgang Münchau
,



Many years ago, I used to attend an annual seminar in pleasant surroundings, in which the participants discussed the politics and economics of two European countries. There were usually two groups. One would talk about foreign policy — mostly transatlantic relations. The other discussed economics and especially the euro. At the end the two listened to each others’ conclusions with polite boredom. The EU would today be in a better place if the foreign policy folk inside and outside that room had made the euro their own project.

The dollar, by contrast, has been an integral part of US foreign policy for many years. Its role as the global anchor currency allows the US to cut off an entire country from access to international commerce and finance, as in the case of Iran. Or a group of individuals as in the case of Russia.

The euro was not designed as a geopolitical instrument. I recall the debate in Germany in the 1990s. The Bundesbank deliberately rejected the idea of a strong international role for the euro, fearing it might conflict with the objective of price stability.

I also recall the debates among international economists about whether the euro could challenge the dollar as a global reserve currency. The opportunity was there. Serious academic papers were written. The fact that it did not happen was the result of a conscious political choice.

That choice is in part responsible for the EU’s difficulty in finding an effective response to Donald Trump today. The biggest problem with the US president’s decision to pull out of the Iran nuclear deal is the extraterritorial effect. European companies that defy the US sanctions would be cut off from US financial and product markets. So would the banks that fund those companies. Multinational companies or banks cannot afford that. Mr Trump can behave in this way because the US is ultimately in control of all dollar-based financial flows, including those that originate outside the US.

The EU cannot impose extraterritorial sanctions on US companies that defy European policy. The euro is not as critical to them as the dollar is to Europeans. After the euro was introduced in 1999, it quickly became the world’s second most important currency but still lags behind the dollar on most metrics. Its share of foreign exchange reserves was under 20 per cent at the end of 2016, compared with 64 per cent for the dollar, according to the European Central Bank. The gap was of similar magnitude in the categories of international debt and loans. The dollar leads the euro in foreign exchange turnover by a factor of three to one. The only category where the euro has almost caught up is that of a global payment currency. In the past decade the gap narrowed but it has widened again since the financial crisis.

In response to Mr Trump’s decision to cancel the Iran deal, the European Commission only managed to dig up the old blocking statute — a ban on European companies complying with the sanctions. The problem is that the EU has no financial instruments to protect European companies. How, for example, would you compensate a European bank for no longer being able to transact in dollars?

The failure to develop the euro into a rival to the dollar also makes the EU more vulnerable to trade tariffs. This is mostly due to the trade surplus. This, in turn, is the result of the eurozone decisions as to how to tackle the debt crisis: by forcing crisis countries to run positive current account balances. One consequence of this policy has been a populist backlash of the kind we see in Italy right now. US protectionism is another.

Before the financial crisis the eurozone ran a small current account surplus. By last year, it reached 3.5 per cent of economic output. The larger the surpluses became, the more dependent the eurozone had become on the rest of the world.

Instead of hyperventilating about Mr Trump, Europeans might want to reflect on what got them into this mess. The EU would be more resilient today if it had not handled the eurozone crisis the way it did, and if its founders had made the euro more robust from the outset. Technically, it would still be possible for the EU to fix the problem, but that would require a degree of political union that goes far beyond even what Emmanuel Macron, the French president, has proposed. It requires at its core a mutualised debt instrument, a euro bond, as a financial instrument to underpin a large sovereign debt market. It would also require a broader mandate for the European Central Bank.

I am, of course, aware that there is no political support for this in northern Europe. But just wait until Mr Trump imposes tariffs on BMW, Mercedes and other European companies.

Events are starting to intrude.


Trump “Victories” on Trade are Anything But

By: Peter Schiff


Earlier this year when President Trump began beating the drums loudly, causing fear of a trade war (and assuring us that such a conflict could be easily won), I cautioned that he had no idea the trouble he was courting. Based on his spectacular misunderstanding of the power dynamic built in to international trade, he was also in danger of bringing a knife to a gunfight.

As the year has progressed, the underbrush has gotten thornier, Trump’s progress on trade has slowed, and now it has likely stopped altogether. Despite that, in true Trumpian fashion, the President has declared resounding victory. But a quick look back reveals the opposite to be true.

The first shot in Trump’s trade offensive was his decision, shortly after he was sworn in as President, to withdraw the U.S. from the 20-nation Trans-Pacific Partnership (TPP). (1/2017 press release, Office of U.S. Trade Representative) As that agreement, which had sought to create a free trade zone uniting the Americas and Asia, was still being negotiated, the move was relatively easy and painless; a quick headline to suggest that Trump intended to keep campaign promises. Since that time, analysts agree that China has taken advantage of America’s absence by picking up the stalled negotiations and recasting them in a China-centric framework.

But the first real move against a living target came with the President’s bid to rewrite, or even fully scrap, the North American Free Trade Agreement (NAFTA), the Bill Clinton-era deal with Canada and Mexico that has greatly transformed business on this Continent. On the campaign trail, and in the White House, Trump repeatedly labeled NAFTA as one of the worst deals in history, a catastrophe for the American economy, and perhaps the single greatest cause of our current economic malaise. As a result, Trump’s trade negotiators began knocking on doors north and south of the border very early in his Presidency. But those negotiations never went anywhere.

Trump representatives quickly ran into the stone wall of economic reality and came to understand that although Mexico and Canada are much smaller than the U.S., they can push back strongly on commercial and political fronts. After threats and counter threats (including Trump’s attempt to have Mexico “pay” for the border wall through NAFTA concessions), it now appears that the current round of talks will expire with no substantive changes in the NAFTA framework.

But the main event in Trump’s trade war was supposed to emerge with China, the number two economy in the world and America’s chief economic rival in all things commercial. China’s gargantuan $375 billion annual trade surplus with the U.S., according to U.S. Census Bureau figures for 2017, is responsible for nearly half of America’s total trade deficit and is by far the largest such bi-lateral figure in the world. Clearly, any successful campaign to improve America’s trade position had to go through Beijing.

But Trump’s first salvo missed that mark widely. In March, he announced his plan to slap hefty tariffs on imported steel and aluminum. In making these announcements he specifically singled out China as the reason that such measures were needed. The problem is that China is a very small player in those markets, accounting for just 3.35% of our metals imports based on 2017 U.S. Commerce Department data. The tariffs had much more impact on our closest geo-political allies, including Canada, Mexico and the European Union. Uncertainty and confusion over these tariffs caused global stock markets to fall and opposition on both sides of the Atlantic intensified. Negotiations that followed resulted in significant delays, carve-outs, and reductions to the proposed tariffs. Even now, no one can be sure what will eventually occur.

But with the metals gambit appearing to be a spectacular misfire, the Trump administration got down to more serious business of direct confrontation with China. Earlier this month, they proposed duties of up to $150 billion on Chinese goods if China did not cooperate to reduce our bilateral trade deficit. Trump even offered a target number of $200 billion in bilateral reductions. In addition, the U.S. followed through with threats to lock out Chinese phone company ZTE from purchasing U.S. technological components as the company had been caught repeatedly selling such technology to North Korea and Iran.

But then the hard part started. The Chinese struck back with threats to target U.S. agricultural imports, specifically those that would impact districts in the Midwest and plains states that are vital to Republican electoral fortunes. The pushback from Congress was immediate. A U.S. delegation flew to China to extract concessions from China. They didn’t get any. In fact, the only real concessions came from us, not them. In a fortuitous coincidence for China, the trade talks are occurring at the same time that Trump is preparing for his nuclear summit with North Korea. It is clear that Kim Jong Un will not agree to anything without consent from the Chinese. Given Trump’s seeming hunger for a Nobel Peace Prize moment, Beijing was handed an enormous amount of leverage, which it clearly used. This pressure may have played a major part in Trump’s sudden concern for the loss of jobs in China. Despite ZTE’s clear violations of U.S. law, for which it had been previously sanctioned, Trump is determined to make China Great Again. But with the Korea negotiations now officially dead, it appears as if Trump got nothing for his efforts.

After another round of negotiations in Washington this week, it was finally announced that the U.S. and China had come to an agreement, which was regarded as a nothing burger. In it, China has agreed to buy “significantly more” goods and services from the U.S. But no specific quantities were announced (certainly nothing approaching the $200 billion Trump was seeking) and no new policies were mandated that could bring about such a change. If anything, China may simply buy more stuff that it had intended to buy anyway. And even if they do buy more oil from us (one of our principal exports to China), this may simply mean we sell less elsewhere. In other words, it changes nothing. Apparently, the art of the deal is to pretend one exists when it doesn’t. But the President’s frustration with the lack of progress may have prompted him to open even another front in the trade war this week when the Administration announced that it would seek to use obscure national security provisions in existing trade law to slap tariffs of up to 25% on imported cars, trucks, and auto parts. Given the amount of cars currently manufactured in the U.S. by foreign owned companies, and the degree to which U.S. cars use foreign-made parts, Trump could not have chosen a more perilous battlefield.

In truth, Trump dodged a bullet that he didn’t even know existed. To actually reduce America’s trade deficit would require that we import less and export more. This would mean that there would be fewer cheap things to buy at Walmart, and that more of our agricultural and resource production would be sold overseas. A reduction in the supply of goods would translate into higher prices for average Americans. If tariffs were added into the mix, then prices would rise even further. Given that interest rates and oil prices are currently both at multi-year highs, and likely going higher, a surge in consumer prices is precisely the wrong development for Americans already struggling with a rising cost of living.

The silver bullet for reducing the trade deficit is thought to be currency valuations. People like to point at China for making its currency too weak, thereby giving them a trade advantage. But China runs a trade deficit with Germany, based on 2017 data from OECD. Apparently, the advantages of a weak currency only matter for America. But the real problem is that the U.S. dollar is too strong based on our persistently enormous trade and budget deficits, political dysfunction, and our low economic growth relative to the fast-growing Asian economies. But the dollar continues to benefit from its status as the world’s reserve currency. Until that peg is removed, we will continue to run trade deficits no matter how loudly Trump shouts from the bully pulpit.

But the trade deficit is not the only deficit that the Administration is ill-prepared and unwilling to confront. America’s other deficit, the one resulting from the government’s inability to spend only what it raises in taxes, is also increasing unchecked. This year that deficit is expected to approach $1 Trillion. In 2020, it’s supposed to surpass that level, according to the Congressional Budget Office, and that’s if the economy doesn’t slow despite the current spike in interest rates and rise of oil prices. If the economy does slow, the deficits may be much higher than currently predicted. If we experience a recession, (remember those) deficits could increase into the multi-trillion dollar range. As retiring Republican Senator Bob Corker recently expressed, there is precisely zero enthusiasm in Washington to address this impending fiscal catastrophe.

Ironically, it will be America's surging budget deficits that hold the key to solving the trade deficit problem. If the Fed is finally forced to return to quantitative easing in order to monetize exploding budget deficits, prop up sagging asset markets, and "stimulate" a weakening economy, the dollar could fall sharply. While the initial decline can exacerbate the trade imbalance by raising the cost of imports, as it gives way to collapse, the trade deficit may then collapse as well, as foreign-made products become far too expensive for Americans to afford. But few will herald the elimination of the trade deficit as a victory, as the high price of dollar depreciation will be a significant reduction in living standards.

But yet, optimism in Washington and on Wall Street has never been higher. That adds up about as well as our trade figures.

The Jobs Recovery: A Longer View


With the monthly job-creation streak continuing to set records, the data shed light both on the rebound from the recession and on what’s left to be desired.
 
 
Friday’s jobs report was a blockbuster: Job growth rebounded after a recent dip, and the unemployment rate fell to a nearly two-decade low. But it’s worth taking a step back and putting the latest numbers in some longer-run context.
 
The United States lost nearly 8.7 million jobs in the Great Recession and its aftermath. It has gained 18.9 million since then — a powerful rebound that belied fears of another “jobless recovery.” (Net growth was needed just to keep pace with the working-age population, which has increased by about 10 million during the same period.)

Politicians, investors and, yes, journalists love to obsess over the month-to-month swings in the job numbers. But the true story of the recovery is one of remarkable consistency. American employers have added jobs for 92 straight months — far and away the longest streak on record — and apart from a few blips, the gains have been steady.

 


The trend in job growth is easier to see by focusing on the year-over-year growth at any point, rather than the more volatile monthly figures. Looked at this way, hiring accelerated early in the recovery, peaking in early 2015 at a pace of more than three million jobs per year. Growth gradually tapered after that, which isn’t surprising — most economists expected the rate of job creation to keep falling as companies recovered from the downturn and the pool of available workers dried up.


More recently, though, job growth has experienced an unexpected uptick. Employers have added an average of 207,000 jobs per month so far in 2018, up from 172,000 in the same five months a year ago. It’s too soon to say whether that acceleration is the start of a new trend or just a blip. But many economists expect the faster pace of growth to continue because of the tax cuts passed in December and the extra government spending approved by Congress in January.

All that hiring has gone a long way toward putting Americans back to work. The unemployment rate, now 3.8 percent, is the lowest since 2000. The progress is increasingly reaching groups that often face discrimination or other disadvantages in the job market: The unemployment rate for African-Americans hit its lowest level on record in May. The jobless rates for Hispanics, teenagers and those with less than a high school education are likewise at or near multidecade lows.


The unemployment rate doesn’t tell the full story, however. Government statistics count people as unemployed only if they are looking for work, a definition that excludes people who are voluntarily or involuntarily out of the labor force entirely. During the recession and recovery, that distinction was crucial: The official unemployment rate ignored millions of people who had abandoned their job searches as hopeless. Eight years of job growth, however, have shrunk the pool of “discouraged” workers, and broader definitions of unemployment all show strong progress.


But while the labor market today is healthy, there are signs it still isn’t booming the way it was in 1999 and 2000. The employment rate — the share of adults who have jobs, a measure that avoids tricky questions about who should count as unemployed — still hasn’t returned to its prerecession level. That’s largely because of the retirement of the baby boom generation. But even adjusted for the aging work force, the employment rate is below its peak in 2000.


 
Then there is the mystery that has loomed over the job market in recent years: lackluster wage growth. With unemployment low, companies are increasingly complaining about a shortage of qualified labor. Yet that hasn’t translated into fat raises for workers.
 


 
It’s important to note that wages are rising. Average hourly earnings were up 2.7 percent in May from a year earlier, faster than inflation. And while noisy and sometimes conflicting data make it hard to discern a clear trend, there are signs that the pace of growth is accelerating, especially for lower earners.
 
Still, many economists think wages should be rising faster given the tight labor market. Economists are divided over what explains the disconnect, with some seeing evidence of a long-term, structural shift in the economy, and others arguing that the slow wage growth suggests there is still room for the economy to improve.
 
 
Ben Casselman writes about economics, with a particular focus on stories involving data. He previously reported for FiveThirtyEight and The Wall Street Journal.


Why Aren’t Companies Spending More?

The tax cut gave companies ample means to significantly increase capital spending, but so far they don’t seem to be

By Justin Lahart

An employee assembles an engine on the production line at the Hyundai Motor Manufacturing Alabama facility in Montgomery, Ala. Photo: Luke Sharrett/Bloomberg News 


The renaissance in capital spending the tax cut was supposed to bring about isn’t showing up in the economic data.

The Commerce Department on Friday reported that orders for durable goods—long-lasting equipment like tractors and machinery—dropped 1.7% in April from a month earlier. That decline was driven by a drop in aircraft orders, however. Orders for nondefense capital goods excluding aircraft, which economists follow closely to gauge where capital spending is going, increased by 1% to a seasonally adjusted $67.3 billion after falling 1.2% in March. 
These orders have been hovering around the same level for the past half year, though. Given how much money the corporate tax cut is providing companies, and how much money is being repatriated from overseas as a result of the tax law’s provisions, this is something of a surprise.
It also seems at odds with what companies are saying. U.S. chief financial officers surveyed in the first quarter by Duke University’s Fuqua School of Business said they expected capital spending at their companies would be up an average of 11% over the next 12 months from the previous year. Capital spending at S&P 500 companies was up smartly in the first quarter, according to a Credit Suisse analysis.






So what is going on?


CAPITAL IDEA


Chief financial officers' expected change in capital spending over the next 12 months

Source: Duke University



For starters, it is important to remember that orders precede shipments. The gains in capital spending companies registered in the first quarter in many cases reflected plans put in place last year—before they had any clear sense about whether the tax cut would pass. Multinationals also don’t limit their capital spending to the U.S. Finally, there are areas of capital spending, such as software, not included in the durable-goods report.

It also could be that investors prefer the extra money from the corporate tax cut be returned to shareholders through dividends and buybacks. Some expansion-minded chief executives might prefer making acquisitions, which are immediately accretive to earnings, rather than embarking on costly projects that can take years to pay off. So far this year there have been $1.5 trillion in merger and acquisition deals worth $1 billion or more globally, according to a recent CreditSights analysis. That compares to $759 billion over the same period last year.

Even given those conditions, though, it seems like companies ought to be increasing capital spending by more. A tight labor market is giving them a good reason to try to boost their existing workers’ productivity and the tax cut has given them even more means to do it.

Their hesitation is unsettling.


Millennials Are Waiting For A $30T Inheritance That Might Not Come

By Fred Dunkley

Cash

There was a time when there was no question that your parents’ generation would pass on their millions in an inheritance. Keep it in the family and make sure your kids are sitting pretty for their own future.

With that in mind, there has perhaps never been a more lucrative time to be on the cusp of an inheritance. Baby boomers are said to be the wealthiest generation in history, worth an estimated $30 trillion. But will their Millennial children actually get their hands on this wealth?

Increasingly, surveys say ‘no’.

Over the 30 to 40 years, this $30 trillion in financial and non-financial assets is expected—under traditional circumstances—to pass from baby boomers to their Millennial heirs. To put this into perspective, baby boomers controls at least 70 percent of all disposable income in the U.S. So for the more than 75 million millennials born between 1981 and 1997 it would be a windfall inheritance.

Or will it?

New research suggests that baby boomers aren’t necessarily willing to part with their wealth and might instead take this opportunity to pay themselves back for all their years of supporting their children: tuition, starter homes, cars—you name it. Millennials might have to leave the nest empty-handed and make wealth on their own.

Not only are baby boomers not winding down their spending as they near retirement, they are actually increasing spending. Writing for CNBC, Gabriel Garcia, managing director at BNY Mellon’s Pershing Advisor Solutions, says baby boomers are spending up to $400 billion annually on consumer goods. They’ve become shopaholics, and they love to travel. They’ve also become more charitable. All of this is diminishing the Millennial inheritance.

According to a recent Gransnet survey of grandparents aged 50–70, one in six plans to spend all their money before they die.

Meanwhile, a Hearts and Wallets study of participants in their 50s and 60s found that only 40 percent planned to leave inheritances, while 30 percent specifically expected to spend all their money.

And the ‘great wealth transfer’ of wealth is further convoluted by questions of who is actually going to conduct it because the Millennial generation is highly skeptical of wealth management advisors favored by the Baby Boomers.

Only 6 percent of households use the estate planning services of their primary wealth advisor mostly because of their different attitudes about investing and advisors. While boomers feel comfortable with the advisor-led model, millennials, guided by social media, often demand greater transparency and control.

"The bottom line is that millennials do not trust conventional financial advisors," says Christopher Ma, director of the George Investments Institute at Stetson University in DeLand, Florida. "They were all raised in the tech age. They believe everything can be self-taught without human contact."

A recent Facebook study painted a similar story, noting that only 8 percent of Millennials trust financial institutions, 45 percent would switch financial firms for any better option, and millennials are 2 1/2 times likelier than Gen Xers or baby boomers to use robo-advisers to manage their wealth.