Economists cannot agree on what ails the global economy

The leading industrialised nations are suffering from both supply and demand problems

Megan Greene

An employee scans toys at a Walmart Inc. store in Burbank, California, U.S., on Monday, Nov. 19, 2018. To get the jump on Black Friday selling, retailers are launching Black Friday-like promotions in the weeks prior to the event since competition and price transparency are forcing retailers to grab as much share of the consumers' wallet as they can. Photographer: Patrick T. Fallon/Bloomberg
Average hourly earnings growth remains below previous cycle peaks © Patrick T. Fallon/Bloomberg

A depressing consensus prevailed among economists at the recent American Economic Association annual meetings: the developed world is stuck with low growth, low inflation and low interest rates for years to come. Even worse, there is no consensus on why.

Supply and demand for goods and services are basic economic concepts. But when it comes to interpreting shocks to either in the real world, things get murky. Some economists blame prevailing conditions in the industrialised world on flagging supply, others on weak demand.

The supply siders argue that demand in the American economy is robust, propelled by a strong labour market. There is some evidence for this in the US, where unemployment has fallen to 3.5 per cent. The employment-to-population ratio, a measure comparing those employed to the total working-age population, is at its highest level since the dotcom era for those between 25 and 54 years old.

There are only two ways to boost potential growth: increase the number of workers, or improve workers’ capacity for production through technological advances. While unemployment is low, the labour force participation rate has been declining. The burden for boosting productivity and potential growth therefore falls mainly on technological innovation. Trend growth is weak, supply advocates say, because low productivity growth keeps companies from being able to supply enough goods and services.

Another group disagrees with this supply side analysis and blames the economic environment on weak demand. They subscribe to the theory of secular stagnation, resuscitated by former US Treasury secretary Lawrence Summers. Secular trends in industrialised countries — such as ageing populations and rising inequality — have caused desired savings to increase above the level of investment. This pushes down interest rates, giving central banks less room to cut rates to encourage consumption and investment.

Evidence of a savings glut and dearth of demand abounds. If the labour market were near full employment and supporting consumption, wage pressures should mount. Yet average hourly earnings growth remains below previous cycle peaks. If there were demand for new investment, we would not see savings flow into existing capital in the form of share buybacks and higher dividends.

So, do we have a supply problem or a demand one? The answer is probably both. A lack of demand could prompt companies to cut back on investment, which would undermine productivity and supply. One data point suggests that the demand-side effect may be stronger, however. When there is a negative supply-shock in the economy, inflation should accelerate. Instead, the industrialised world has witnessed feeble inflation since the financial crisis.

The good news is that both sides tend to agree on potential solutions. It starts with the view that central banks cannot carry the entire load, so fiscal stimulus should be deployed as well. On the supply side, governments could support research and development and improve education and skills training to boost productivity growth.

Public investment could also stimulate aggregate demand by addressing some of the structural drivers of secular stagnation. Stronger social insurance could reduce the propensity for people to hoard savings. Not all public investment need blow out the budget deficit. For example, a more progressive tax agenda could mitigate rising inequality.

The task now is for governments, whether they believe in the supply-side or demand-side arguments, to accept the role they must play. That, or accept the consensus that the current economy is as good as it gets, and the risk is on the downside.

The writer is a senior fellow at Harvard Kennedy School

Investors seek clarity from Fed on balance sheet expansion

Jay Powell set to address questions about market intervention at press conference

Brendan Greeley in Washington and Colby Smith in New York

Jay Powell and the Federal Reserve have managed to avoid fresh instability in the repo market © FT montage; Bloomberg

Investors are seeking more clarity from the US Federal Reserve this week on how much it may expand its balance sheet following the central bank’s efforts to restore order to short-term funding markets.

The Fed has been buying US Treasury bills at a rate of $60bn a month since a big jump in overnight borrowing costs last September and chairman Jay Powell is set to face sharp questions about how its actions are affecting markets on Wednesday.

Mr Powell will speak at a regular press conference after the Federal Open Market Committee’s two-day meeting, which is expected to result in a tweak to a key tool it uses to implement monetary policy with US interest rates close to the bottom of the Fed’s target range.

He is likely to have to address criticism from some market participants that the Fed’s actions have been pushing up asset prices.

“What the market really wants is to know what the medium-term game is,” said Mark Cabana, head of US rates strategy at Bank of America.

After September’s leap in the overnight “repo” rate, policymakers concluded that they had gone too far in withdrawing their post-crisis stimulus, allowing banks’ excess reserves held at the Fed to fall too low.

The Fed reversed course and began expanding its balance sheet again by buying short-dated Treasury bills, crediting banks with reserves and driving up the level of cash in the system. It said the bill buying would continue into the second quarter of 2020 but declined to offer a level of bank reserves it would consider sufficient.

The level had fallen as low as $1.4tn in September; it is now at $1.6tn.

Line chart of Bank reserves held at the Fed ($bn) showing Just don't call it QE

Since September, the Fed has also been intervening directly in the repo market. Originally it said those operations would continue until at least January, but Mr Powell and Richard Clarida, his vice-chairman, have more recently indicated they could continue until at least April.

“The Fed’s extremely aggressive response to the repo blowout in September, as well as their timidity in pulling back from that response . . . could be signalling to markets that this is a Fed with a very low tolerance for market fluctuations,” noted Blake Gwinn, head of front-end rates strategy for the Americas at NatWest Markets.

The turmoil in short-term funding markets reflects how the Fed, like other central banks, continues to wrestle with how to implement monetary policy in financial markets transformed by the financial crisis.

After almost two years of effort to keep the fed funds rate, its favoured policy interest rate, from bumping against the top of its target range, the Fed now finds it uncomfortably close to the bottom of the range — at 1.55 per cent, just 5 basis points above the low end.

Having previously cut the interest the Fed pays on banks’ excess reserves — something which acts as a magnet for other short-term rates such as the fed funds rate — the FOMC is expected to raise it on Wednesday by 5 basis points, according to analysts at multiple banks.

A graphic with no description

“The Fed is worried right now about losing control of fed funds, but to the downside,” said Mr Cabana at Bank of America.

Mr Powell has been at pains to say that none of its actions, in particular the decision to expand reserves held at the Fed, have added up to quantitative easing, the post-crisis stimulus programme in which the Fed expanded its balance sheet with longer-dated Treasuries.

But as the equity markets in the US continued to rise over the past few months, analysts have become sceptical that there is a difference.

“The market mythology has become the stock market can’t go down when the Fed is adding reserves,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

When it last met in December, the FOMC signalled that it did not intend to make any changes to interest rates in 2020. According to investor bets compiled by the CME Group, markets see a 90 per cent chance that the fed funds target range will be held at 1.5 to 1.75 per cent on Wednesday.

The Fed will not be publishing a new set of economic projections at this week’s meeting and analysts do not expect a change to the committee’s monetary policy statement.

Why Capex Can’t Catch a Break

December’s durable goods orders showed that capital spending remains anemic

By Justin Lahart

Boeing last month decided to suspend production of it 737 MAX, seen here at its Renton, Wash., facility on Jan. 10. Photo: lindsey wasson/Reuters 

One-off issues keep getting in the way of a capital spending revival. It is time to ask if those issues aren’t the real problem.

The Commerce Department on Tuesday reported that monthly orders for durable goods—long-lasting items ranging from sheet metal to motors—rose 2.4% in December. But that gain came about as a result of a 90% increase in orders for defense goods. Excluding that volatile category, orders fell 2.5%.

Nondefense aircraft and parts orders fell 75%, reflecting Boeing’scontinued travails with its 737 MAX. Nondefense capital goods orders excluding aircraft—a category that economists view as a good proxy for the forthcoming trend in capital spending—slipped 0.9%.

All of this suggests that the slump in business investment that began last year will likely continue into the opening months of 2020. Indeed, matters could get worse before they get better as a result of Boeing’s decision to halt production of the 737 MAX this month and worries that the coronavirus outbreak in China could dent the global economy.

It seems like capital spending just can’t catch a break. Boeing’s worsening woes, trade troubles, soft overseas growth and the General Motors ’ strike were among the hurdles it faced last year.

Now, just as easing trade tensions and forecasts of better global growth suggested there would be a break in the clouds, here come a fresh set of issues.

But just as with a basketball team blaming this or that coach or player for its dismal record, excuses for why capital spending isn’t picking up risk wearing a little thin. If companies were given an overwhelming reason to start spending more, they probably would.

Instead, they have been presented by a U.S. economy that, while steady, has been only growing at about a 2% annual rate. Moreover, rising labor costs have been pressuring profit margins.

The combination of tepid growth and an unemployment rate at a 50-year low clearly is unusual.

While it is true that over the longer run, increased capital spending would eventually help boost productivity and alleviate labor costs, companies tend not to step up capital spending when earnings growth is weak, as it has been for the past year. In an environment where growth is only moderate while unemployment is extremely low, companies’ default position is to play it safe.

Eventually, capital spending should still improve. The problem is that “eventually” could take a while to arrive.

The Economy Is Banks’ Best Friend

Low rates get a lot of attention, but solid economic performance and sentiment are proving more important for the biggest banks

By Telis Demos

Revenue from trading and advisory activity boosted overall revenue at Citigroup in the fourth quarter. Photo: justin lane/Shutterstock

Banks are doing their best to prove an old political adage: It’s the economy, stupid.

Yes, low rates continue to make life more complicated for lenders. But as long as the U.S. economy keeps ticking along, big banks seem equipped to fend off the many ill effects of rates. In the fourth quarter, receding trade-war tensions, tame repo rates and improving corporate sentiment bolstered trading desks and advisory activity. Revenue in those businesses in the quarter surged from the same period of 2018, powering sharp increases in overall revenues at JPMorgan Chaseand Citigroup.

And even when it comes to rates, one lesson from the latest quarter should be that it isn’t just where the Federal Reserve is setting rates but how steepthe yield curve—the difference between short-term and long-term rates—is that defines banks’ performance. The shape of the curve, usually a barometer of feelings about economic prospects, improved dramatically for banks in the quarter.

Banks mostly fund themselves at short-term rates and hold longer-term instruments, both as investments and in trading inventory. Usually, short-term yields are lower, but the yield curve inverted in March of last year in part because expectations for a recession grew. They resumed their normal shape starting in October as recession fears faded. U.S. 10-year benchmark yields were about 0.4 percentage point above three-month bill yields by the end of 2019.

The benefit of that steepening was visible in banks’ trading books, where they hold longer-term corporate and government bonds. Those books grew during a fourth quarter that registered solid client demand for trading services, thanks in part to the Federal Reserve’s successful actions to tamp down volatility in markets with its repo operations, and also to the market’s late-year improvement.

Debt held by JPMorgan’s trading desks was 26% higher on average in the quarter from the prior year and Citigroup’s overall trading inventory was up 18%. And those assets yielded more at Citigroup in the fourth quarter than in the third, powering an overall sequential rise in net interest margin for the bank.

Yield on debt held for trading purposes ticked a bit lower at JPMorgan, but less than on other assets. Overall, fixed-income trading revenue, including fees, surged 86% from the prior year at JPMorgan and 49% at Citigroup.

The two banks also blunted the impact of low rates by managing to grow their loan books—though JPMorgan gets an asterisk on this point because it also is in the process of reducing its holdings of home loans due to their high capital charges. Consumer loans grew sharply once again in the fourth quarter, notably in credit cards.

Corporate loan growth was more tepid, rising 2% globally at JPMorgan. Citigroup’s corporate lending picked up 4% in North America, but was down globally. Yet combined revenue at the two banks from advising companies on mergers and fundraising rose 5% as deal-making picked up late in the year.

“Trade certainly stabilized,” JPMorgan’s Chief Financial OfficerJennifer Piepszaktold analysts. “So we saw sentiment improve a little bit, which I think contributed to the overall success of the fourth quarter.”

Banks’ high valuations imply that they will not only be able to keep growing but also to improve their earning power. Indeed, both JPMorgan and Citigroup improved on their efficiency scores, with noninterest expenses at the two banks combined falling from 59% of revenue to 57%.

Wells Fargoremains a different story for now, facing higher costs in the quarter as a consequence of its long-running fake-account scandal.

The threat of a surge in credit costs still looms, but that only reinforces the point that the economy’s health, rather than rates, proves the best guide to banks’ performance.

Trump’s Near Miss with Iran

The drone strike that killed Qassem Suleimani not only brought the US and Iran to the brink of war; it exposed for all to see the disarray of US foreign policymaking under President Donald Trump. A majority of Americans think the episode has left the US less safe, and the incompetence displayed by Trump's team suggests they may be right.

Elizabeth Drew

drew50_SAUL LOEBAFP via Getty Images_trump

WASHINGTON, DC – The recent tense, dangerous exchanges between the United States and Iran have revealed a great deal about US President Donald Trump’s management of his foreign policy. The main conclusion is that he doesn’t have one.

Weighty decisions are made on the basis of gut reactions and often-contradictory impulses – for example, simultaneously seeking agreement and threatening the use of force. If there is any overarching vision or philosophy, it is that he wants to avoid another long, costly war. And yet he almost blundered into one anyway.

When he campaigned for president, Trump promised to bring US troops home. He has sometimes declined to respond to provocations, particularly by Iran-backed groups around the Middle East. This lulled the Iranians – and almost everyone else – into thinking that he would continue to turn the other cheek.

Eventually, some on the right wing of his Republican Party, and, most important, Fox News commentators, were calling him weak. This is a dangerous thing to say about Trump: his presidency shows why an insecure person should not be elected to that office.

Another characteristic of Trump’s conduct of foreign policy is that he is currently surrounded by a coterie of mediocrities. There is not a far-ranging mind, creative strategic thinker, or independent spirit among them. Trump is now on his fourth national security adviser in three years, his second secretary of defense, and second secretary of state; numerous other key foreign-policy jobs remain open.

The lesson for others is clear: the only way to last with Trump is not to challenge him. This expectation of blind deference is all the more problematic when the president knows little and lacks curiosity.

Mike Pompeo, the bumptious secretary of state, is widely viewed as the most accomplished sycophant among Trump’s top advisers. Pompeo, a former member of the US House of Representatives, is also a talkative alumnus of the Iran “regime change” caucus in Congress.

We learned after the fact that Pompeo had been pressing Trump for some time to order the assassination of Qassem Suleimani, the commander of Iran’s Quds Force, which the US has designated a foreign terrorist organization.

According to one report, when Trump finally did decide to order the killing of Iran’s second-most-important political leader on January 3, “The new team was cohesive and less inclined than its predecessors to push back against the president’s wishes.”

In the absence of a declaration of war against Iran, the killing of a foreign official – by a drone strike on Iraqi territory – was possibly illegal. But such niceties do not perturb Trump. The evidence is that Trump’s decision was taken without consideration of the possible consequences.

The national security system established under Dwight D. Eisenhower, designed to prevent such reckless measures, is broken to non-existent, with ever-greater power placed in the hands of the president. If that president is unstable, the entire world has a very serious problem.

In fact, all-out war with Iran was narrowly avoided because the Iranian leaders were shrewder than Trump. The greatest loss of life in this dangerous episode was caused by the tragic downing of a Ukrainian civilian flight that had just taken off from Tehran’s airport, killing all 176 people on board. The plane had been allowed by Iranian air authorities to depart about three hours after Iran had fired missiles at Iraqi military bases housing US troops.

This carefully targeted retaliation – no one was killed – for Suleimani’s death, plus back-channel messages carried by the Swiss, signaled that the Iranians wanted to stop the dangerous escalation.

They would lose a war with the US, but would almost certainly inflict serious damage on US assets, including through cyber attacks. A relieved Trump accepted the Iranians’ message and followed suit.

A rattled Congress demanded administration briefings on the rationale for killing Suleimani, and the lack of a clear one backfired on Trump and his national security officials. Conflicting and shifting rationales were offered, and the administration failed to persuade lawmakers that an “imminent” threat had forced the president’s hand.

That, coupled with the administration’s characteristic contempt for Congress and its members’ constitutional duty to hold the executive branch accountable and the legislature’s sole constitutional authority to declare war, led to a new congressional movement to curb the president’s war-making powers in the case of Iran.

But the House and the Senate (which is controlled by Trump’s Republican allies) are unlikely to agree on an approach, much less devise a measure that would survive a presidential veto.

Meanwhile, the relationship between the US and Iran is worse than ever, with the US having lost more since killing Suleimani. Iran announced that it would no longer observe limits on its nuclear program, lowering the estimated time it would take to develop a warhead from almost 15 years when Trump took office to just five months.

The US is coming under increasing pressure to withdraw its troops from Iraq – Suleimani’s longtime goal.

The US military’s training of Iraqi forces to fight the Islamic State – the reason the US was invited back into Iraq during Barack Obama’s presidency – is now on hold. Instead of withdrawing troops from the Middle East, as he promised, Trump has now committed thousands more to the region.

Meanwhile, inevitably, Trump and his acolytes are claiming victory and accusing critics of being sympathetic to Iran and even partial to the vicious Suleimani. Currently, there are signs that the public isn’t buying it.

A majority thinks the episode has left the US less safe, and they may be right: though the hostilities between the US and Iran – as well as its numerous proxies – have subsided, few believe the lull will last.

Elizabeth Drew is a Washington-based journalist and the author, most recently, of Washington Journal: Reporting Watergate and Richard Nixon's Downfall.

Evaluating the Importance of Recent Events

By: George Friedman

There are moments when the entire world seems to be coming apart, as if Armageddon itself were upon us. Public attention tends to be able to handle just one Armageddon at a time, and even though the end of the world would probably entail more than one calamity, newspapers have room for only one alarmed headline a day, and Twitter seems confined to one overwhelming rage attack at a time.

I am of course referring to the high-profile confrontation between the U.S. and Iran and the much lower profile Turkish deployment to Libya.

Catastrophic though they may seem, it is prudent to consider their current state, just a week or two after the panic, and to consider other panic-ridden global processes. What, after all, happened to China and Brexit?

The pattern of informational flow and emotional intensity does not derive from the underlying issue – the issues are still there. History grubs its way forward ineluctably, but we only sometimes notice it, usually when something happens that is both unexpected and noisy. Since humanity tends to expect tomorrow not to be any different than yesterday, and since its attention is drawn by noise, it assumes what was once unnoticed is now catastrophic.

Consider the unexpected and noisy events in Turkey and between the United States and Iran.

They are significant but the frantic noise drowns out their importance, which unfolds over years, decades and generations.

Iran's struggle to create a sphere of influence, the Shiite crescent as it is sometimes called, is challenged by its opponents. On one side are Iranian non-state proxies in Lebanon, Syria and Iraq. On the other side are Israel, Saudi Arabia and the United Arab Emirates.

The Iranians have tried to focus the struggle on Iraq, using substantial but far from overwhelming support among Iraqi Shiites. The United States has focused its efforts on Iran itself, using economic sanctions to undermine the regime and to block it in Iraq. Neither side has been successful.

The sanctions have created unhappiness, reflected in the university-based demonstrations over the downing of a Ukrainian plane. But student uprisings rarely bring about regime change. Others must join, and to this point, the regime is under pressure but not falling.

Turkey, meanwhile, made a significant move to exert its control over the Eastern Mediterranean and in Libya, the goal of which is strategic. The chaos of the Middle East increasingly impinges on Turkey, yet Turkey is, second to Israel, the major power in the region.

The assertion of power to the east changes the perception and reality and gives Ankara access to major oil supplies, which it needs to control for national security reasons. The expectation was that its move into Libya might create conflict with Russia.

The move into the Mediterranean might create tensions with Israel and Greece, both backed by the United States. Such tensions have not surfaced thus far, and indeed Turkey’s control of the Eastern Mediterranean is still in the concept development phase.

What is interesting is there seems to be something of an entente with Russia over Libya. Russia does not want to alienate Turkey, nor does Turkey want to alienate Russia. What happens later will happen. For now, a mistrustful bargain will do.

Both of these events were unexpected enough and noisy enough to capture the world’s attention. As a moment in a far longer drama, they were not trivial events.

Nor were they decisive enough to transform or endanger the world. It is interesting to look at two other events that just a few months ago seemed destined to endanger the world.

One was Brexit. Over three years ago, the British government called for a referendum on whether Britain should leave the EU. It was called because it was expected the British public would dismiss the idea as unworthy of the name. Instead, the British voted to leave. There followed a storm worthy of a Wagnerian opera.

If Britain left, it would collapse into nothingness. If it stayed, it would collapse into nothingness. The EU would punish Europe’s second-largest economy by isolating it. The Easter Rebellion in Ireland would be resurrected, and on and on.

Now, we are weeks away from the beginning of the divorce, and while it is still mentioned widely, Brexit has had the venom drawn from it. Europe needs Britain because it absorbs a vast number of exports.

The threats the EU made at the time weren’t credible, and the panic of the City died down as the finance world considered how it might make money out of Brexit without moving to Frankfurt.

The world will change in some way, but the fundamental reality on which Britain and its relationship to Europe rests will not change quickly. That relationship is a weighty thing, and moving it is like moving the Tower of London. It won’t happen quickly.

The other event was China. The Chinese did not welcome American exports, so the United States became unpleasant about Chinese exports. This was seen as a new Cold War, a struggle between two equal powers. The fact was that China was still staggering financially from 2008.

Its economy was a fraction of the size of the American economy (measured in something other than the mythical purchasing power parity). The Chinese economy was heavily dependent on exports, particularly to the United States. The U.S. is not heavily dependent on exports. Pig farmers and Apple execs were portrayed as being in agony. In fact, trade wars are common.

That was what the EU was threatening Britain with. And China was the weak hand. It could not allow its domestic market to be swamped by American goods, and it could not substitute for exports. It was a deadlock with intermittent threats and announcements of something or other.

We have now reached the point of intermittent statements and discussions on obscure websites like our own.

The point is that geopolitical analysis lays out the broad format and direction of events. It is easy to see noisy events outside the context of geopolitics and therefore to vastly overstate their significance.

The events between the U.S. and Iran last week are startling only if you fail to see the broad process underway, without which the important is overwhelmed by a mere set of events that flow from the important but are contained in the predictable emergence of Turkish power.

The events in the Mediterranean and North Africa are part of that. They did not occur out of nothing but out of geopolitical necessity. The same can be said about China and Brexit.

As time passes, the event is slowly forgotten, and the gradual evolution of history is something you get used to.