2-Year U.S. Downward Growth Mode Won't Turn On A Dime
- Two-year-long U.S. downward cyclical growth mode won’t turn on a dime.
- U.S. economy is not in a recessionary window of vulnerability.
- Major fiscal push by Trump can add to inflation, cause Fed rate hike.
Lakshman Achuthan is co-founder and chief operations officer of the Economic Cycle Research Institute.
Harlan Levy: What's your outlook on the U.S. economy and its potential for growth or retraction, especially in light of the Trump election?
Lakshman Achuthan: For almost two years, as we had predicted, U.S. economic growth has been in a cyclical slowdown mode, what ECRI calls a growth rate cycle downturn. As a result, year-over-year payroll job growth is down to a 32-month low; real personal income growth has fallen to a 33-month low; and GDP growth, excluding the onetime Q3 pop in soybean exports, is at a 3¼-year low. That downward cyclical growth vector won't turn on a dime.
H.L.: Is a recession in the U.S. a very real risk?
L.A.: Trump's election is a shock to the establishment. It has to remind everyone of the surprise Brexit vote that had the establishment consensus expecting an immediate U.K. recession as a result.
Both before and right after the Brexit vote, based on our U.K. leading indexes, we were alone in saying that a U.K. recession wasn't imminent, no matter what. It then took a couple of months for that reality to dawn on the consensus, and they still don't quite understand why they got it wrong.
This week, as Trump's victory became clear, economist Paul Krugman rushed to make a global recession forecast. We totally disagreed.
At the start of this year, when U.S. recession fears ran rampant, we said there was no recession risk, and we've maintained that view all year, and again going into the U.S. election this week. So, to be crystal clear, based on ECRI's leading indexes, no major economy is about to plunge into recession, and certainly not the U.S.
Here's why conventional economists like Krugman get it wrong. They think recessions are all about shocks. They're not. Recessions occur if an economy is in a recessionary window of vulnerability, and is then hit by a shock.
But when an economy is not in a window of vulnerability, like now, even a major shock doesn't result in recession. ECRI's array of leading indexes is designed specifically to tell us when that window of vulnerability will open up.
H.L.: What seems to be the path ahead for the Federal Reserve under a Trump regime, and what are the likely effects?
L.A.: Even as we kept predicting a growth slowdown, ECRI's U.S. Future Inflation Gauge continued to rise. So, early this year we made a "stagflation lite" call, meaning slowing growth with inflation simultaneously firming. That's exactly what has transpired.
On the eve of Trump's election, the USFIG climbed to a 101-month high, so inflation was slated to rise further anyway. But if the new administration makes a major fiscal push, that could add to inflation pressures possibly bolstering the Fed's inclination to hike rates in the coming months.
H.L.: How is the U.S. economy doing in coordinating with the other global economies and central banks, and how are they coordinating among each other, and what does the current situation portend?
L.A.: Most major economies have left deflation behind for the time being, Japan being a possible exception, and inflation is creeping up, consistent with our global reflation call back in the summer, that was based on ECRI's international future inflation gauges. Given the similar upward cyclical direction of inflation pressures, this makes it easier to coordinate monetary policy: especially with no major economy about to fall into recession, there's less of a need for swimming against the tide with fresh monetary accommodation.
H.L.: What do you see happening with China's economy in what may be a new world order?
L.A.: Thanks in part to more debt-fueled fixed asset investment, Chinese growth will stay stable in the near term. In the longer term, it's hard to see how they can keep meeting their growth target without a further buildup of their mountain of debt, which gets more precarious with every passing year. Still, the message from ECRI's leading indexes of the Chinese economy about the next few months is clear: so far, so good.
H.L.: The U.S. has been struggling to deal with a structural problem affecting the economy for more than a decade, mainly, it seems, via the Fed's monetary policy. How do you define this structural problem and how should it be solved. Also, how likely will a real solution happen.
L.A.: As students of the business cycle, we have a distinctive cyclical perspective at ECRI. In fact, our focus on cycles lets us discern what's cyclical and, by elimination, what's not. So, in the summer of 2008, before the Lehman collapse, we were able to first identify a structural problem -- a long-term pattern of weaker and weaker growth during successive U.S. expansions, stretching back to the 1970s -- that was reported in The New York Times but otherwise went unnoticed. It was more than five years later that this reality began to dawn on more people when Larry Summers started promoting the notion of "secular stagnation."
So, this is just simple math. In essence, growth in labor productivity, or output per hour, and potential labor-force growth add up to potential GDP growth. The Congressional Budget Office pegs potential labor force growth at 0.4 percent a year for the 2016-20 timeframe -- an uncontroversial estimate, given that the demographics are pretty much set in stone.
Separately, U.S. productivity growth, which has been falling for years has averaged about 0.7% a year for the last five years and 0.3% for the last two years and is just under zero for the past one year. As to where productivity growth is headed from here, some would like to believe that it'll approach its average of 2% per year from 1970 to the eve of the Great Recession, or even its average between World War II and the Great-Recession eve, of about 2¼% per year. But, as Fed Vice Chairman Stanley Fischer has said, "Productivity is extremely difficult to predict." So it's prudent to avoid heroic assumptions, and even if productivity growth does revert to the mean, it isn't clear why the relevant mean should be the one for the post-World War II period or the 1970-2008 time span, considering that the next few years are unlikely to resemble those earlier periods.
Rather, our default assumption is the simplest one. Productivity growth over the next five years will average what it did for the last few years. So, if things stay around where they are, simple math says potential real GDP growth will be zero-to-0.7% productivity growth, plus 0.4% potential labor force growth, i.e., around 1% per year through the beginning of the 2020s.
Demographics is destiny, and a sustainable boost to productivity growth is realistically possible only in the long run. Until one or both change, U.S. GDP growth will likely converge to around 1% a year. Given the simple math we've outlined, any proposed solution should be subject to a litmus test. Ultimately, only policies that genuinely address the challenges of demographics, productivity, or both, have a chance to succeed.
In the short term, job growth has been slowing since the beginning of 2015. Until we see a reacceleration in overall economic growth - which is not yet on the radar screen - a sustainable upturn in job growth is not tenable. But if job growth keeps slowing for many more months, there's only so far it can decline before it starts flirting with the zero line, meaning recession. So it's important that job growth should turn around in the coming months.
H.L.: Are wages still essentially dead in the water, or are they rising in any significant way?
L.A.: Actually, year-over-year average hourly earnings growth has climbed to its highest reading since the recession ended in 2009, so that's the good news. But half of that is due to inflation, mainly housing and health care. So wage growth is still in decline in real, meaning inflation-adjusted, terms, as is personal income growth.
H.L.: What are the weak sectors in the U.S. economy, and what are the strong ones, going forward?
L.A.: The major sectors have been slowing more or less in sync, though manufacturing sector growth prospects look a bit better.
H.L.: What are the major head winds and tail winds in the U.S. economy, and which side appears to be winning in the short-term and long-term?
L.A.: At this time, in addition to the cyclical headwind responsible for the nearly-two-year-old slowdown in economic growth, we've been dealing with a decades-long structural decline in economic growth. While the cyclical headwinds are being offset in part by a global industrial growth upturn, the longer-term structural headwinds won't abate until demographics improve, and that's not likely for many years, or productivity growth increases in a sustainable way, which can be possible only with policies that genuinely boost the economy's productive capacity, not just borrowing growth from the future, which is what most monetary and fiscal policy ends up doing.
H.L.: Are you at all hopeful, or do you think the world is mired in intractable problems that will gradually drag us all down into chaos or something short of chaos?
L.A.: I'm always hopeful. Technology, for instance, promises incredible advances in productivity over the very long term, but it's important to wisely navigate the path from here to there, so that too many people without the requisite skills don't get left behind. Without the proper navigation of the road ahead, we face plenty of pitfalls, and smaller problems can cascade into much bigger, intractable ones, and even chaos. So I hope our leaders will have the wisdom to make the right choices.