Most readers remember the pre-recession days of 4% GDP growth, interest rates at levels where savers had return choices worth pursuing (e.g., the 10 year T-Note at 4%), and workers could count on annual real wage growth. Today, many refer to this as “normal,” and there is a desire, if not a movement, to return the economy back to such a state.
You can see this in the political arena. It is called “Trumponomics” with its pledge to “make America great again” partly by returning the economy to a 3%+ economic growth rate. The movement is also apparent in the Federal Reserve’s desire to raise interest rates back to “more normal” levels and their meticulous preparation of the equity and debt markets for multiple rate hikes and the beginning of the unwinding of their bloated balance sheet.
Remember the “New Normal”
It seems obvious to ask, “What if ‘normal’ is no longer what we had pre-recession?” I no longer hear any discussion of what Pimco’s El Erian referred to as the “New Normal” way back in 2010 in a speech entitled “Navigating the New Normal in Industrial Countries.” What he said then about structural change still applies today. After all, we have had more than eight years of the weakest expansion in post-WWII history, and it took unprecedented bank reserve creation and unthinkable fiscal deficits to accomplish even that!
Today, it boggles my mind to think that our political leaders, our mainstream business economists, and those we have entrusted with setting appropriate monetary and fiscal policy now all think, and act, as if we are on the precipice of returning to that pre-recession set of economic normalcies.
Demographics, Productivity, Sharing, and Debt
To put it simply – we aren’t. The domestic economy, for structural reasons, can’t grow that fast. Here’s why:
• Demographics: According to the Wall Street Journal (5/16/17 “Can Trump Deliver 3% Growth…”, Timiraos and Tamgel), over the past decade the prime aged working population (25-54 years old) has grown at a 0.1% annual rate. When the U.S. had consistent 3%+ growth in the 80s, that population was growing at a 2.2% annual rate;
• Productivity: GDP growth over the long-term is a combination of labor force growth and productivity gains. With the economy apparently approaching full employment, the skill sets of those not already employed are lacking, making productivity growth difficult, if not impossible to achieve. The combination of a stagnant labor force and stagnant productivity is not at all conducive to organic economic growth;
• The Shared Economy: Enabled by technology, millennials prefer to share assets rather than own them. Uber, Airbnb, car sharing etc. are the resulting manifestations that assets can be efficiently shared, and, therefore, we don’t need as many of them;
• Debt: Some of the movement toward a shared economy is the result of the burden of student debt borne mainly by the millennials ($1.3 trillion and rising) which results in lower levels of home and auto purchases and the desire to live in the metro areas where there is close access to work, school, and shopping. In addition to student debt, auto debt and credit card debt have both risen to record levels, and the pent-up demand that is the result of every recession appears now to have been exhausted. Total U.S. consumer debt, approaching $13 trillion, has now surpassed its pre-recession peak. How much more can debt grow? The Fed’s latest Senior Loan Officer Survey shows falling Commercial and Industrial loans, falling Commercial RE loans, and weakening consumer lending in all categories.
All the above are structural issues and they have led us to live in a world where deflation is normal, not the inflation we were so used to pre-recession. Here are some recent examples of deflationary pressures:
• Auto prices: Pre-recession, do you remember such high consumer incentives, or dealer lots choked with inventories, or the prices of used cars rapidly falling?
• When did you last see Chinese ports with record levels of iron ore just sitting there? (demand for finished iron and steel products worldwide has clearly diminished);
• From the 1970s through to the latest recession, oil prices were on a long-term uptrend. Now, there appears to be a glut of oil with prices seemingly in a long-term downtrend;
• What about retail! Changing buying habits are playing havoc with retail space; and if you think warehouse employees are as well compensated as department store sales staff, you simply haven’t shopped at Macy’s, Nordstrom’s or other mall anchor tenants. On one trading day in mid-May, Macy’s stock was clocked for a -17% loss, and Nordstrom’s for -11%;
• The Fed’s hoped for 2% sustainable inflation rate is quickly fading. According to a recent David Rosenberg post, core inflation (ex food and energy) looks like this in 2017: January: 2.3%; February 2.2%; March 2.0%; April 1.9%. Core goods prices are falling, and they have been falling for more than a year (14 months in a row). Even services inflation is subdued. The cost of education is now rising at an annual rate of only 1.8%, down from 2.3% as of last December; and health care inflation was at a lowly annual rate of 3.1% in April, down from 5.1% as recently as last August.
We need to begin to redefine what we believe “normal” is, or, to recall El Elian’s insight way back in 2010, to think in terms of the “New Normal.” We seem to have forgotten the immense structural changes that our economy has undergone in the last nine years.
• The economy’s capacity for economic growth is much lower than it was a decade ago. Economists recognize this by ascribing 1.8% to the economy’s “potential” GDP growth. Yet, despite this recognition, many of those same economists somehow think that 3%-4% economic growth is about to return;
• Because of its slow growth characteristics, the economy will be much more susceptible to recessions than it has been in the past, either through an extraneous event or from a monetary or fiscal policy misstep;
• The policy misstep issue is especially true for an activist monetary authority, or a Congress too worried about debt totals and not allowing fiscal stimulus when it is obvious that is what is needed to spur growth.
Because of slower than “normal” growth and deflationary pressures, interest rates are going to remain “lower for longer.” But, by “longer,” I don’t mean a few quarters. I mean years; a very long time. And, given this more practical view of today’s “normal,” where growth will be slow and subject to hiccups, the equity market will eventually come to its senses.