It’s the Strong Economy, Stupid: The US Keeps on Truckin’
If you are looking to explain the confounding ongoing strength of the US economy, it’s best to ignore the opinions of economists, Wall Street analysts and even Federal Reserve Governors, who have collectively spent the past two to three years predicting the imminent demise of the longest continuous economic expansion in American history.
Better to look instead to the 17th century scientist and natural philosopher Sir Isaac Newton, who put forth in his third law of motion: “For every action, there is an equal and opposite reaction.”
In this context, the stubbornly strong US economy over the past decade should not be shocking given the force of the decline during the “Great Recession” of 2008-2009 that immediately preceded it.
As Newton noted, when the pendulum swings too far in one direction it generally rebounds just as far in the opposite direction, absent exogenous forces.
When it comes to such outside forces on the economy, central bank interest rate policy ranks far and away as the most important.
While acts of war such as the recent Iranian missile strike on US bases in Iraq or even full-fledged wars can cause short-term sputtering, it is the level of interest rates that has the most significant influence on longer-term economic growth.
And despite its ongoing monthly prognostications, the US Federal Reserve has essentially maintained a “hands-off” policy when it comes to interest rates during the recovery, following the market rather than leading it one way or the other.
During the 11-year period beginning in December 2008, the Fed has moved the all-important Fed Funds interest rate exactly 1.5% higher, an average of 0.13% per annum – barely more than 1/10 of one percent per year. No wonder nobody’s noticed!
This “wait-and-see” approach has been a panacea for the “cut-and-run” mentality that took hold after the crash, which to a large extent creates a huge psychological overhang even today.
Both consumers and companies are now quick to pull back their spending and just as quick to resume it, creating choppy but consistent overall economic growth.
In this context, any overreaction by the Fed in one direction or the other could have a meaningful impact on the expansion, and in fact the Fed seemed to realize as much when it cut rates three times in 2019 after raising them nine times over the prior decade.
Currently ranging between 1.5 and 1.75%, the Fed Funds rate remains slightly below the inflation rate of approximately 2%, so it continues to follow the economy rather than lead it.
Assuming the US keeps chugging along at a slow but steady rate, January 2020 will mark the 128th consecutive month of economic growth.
Though a manufacturing rebound helped lift the country out of recession in the early 2010s, more recently the service sector has been largely responsible for economic growth.
Last November marked the 5th consecutive month of contraction in the US manufacturing sector, as the Institute of Supply Management (ISM) Index fell to 47.2, its lowest level since 46.3 in June 2009 at the end of the Great Recession. Meanwhile the ISM Services Index has grown steadily for almost a decade and now accounts for 80% of the economy by some measures.
The gap between the two sectors is now the largest in more than three years and the third largest since the beginning of the recovery.
Given that the trend is supposed to be your friend, it would appear we may soon see a decade-high divergence in this important ratio.
However, that may not end up being the case. Manufacturing in particular should get a boost from the phase-one trade agreement between the U.S. and China. This could lead to both sectors firing in unison again by the middle of this year, which would almost assure another year of economic expansion in 2020.
Risks to the economy include the failure of subsequent trade talks, the upcoming Presidential Election and the shortage of qualified workers to meet the job requirements of the 21st century.
The latter is partly due to a skills gap and partly due to the current administration’s immigration policies. The US currently has around a million more jobs available than people looking for work.
Many are in the STEM fields, but the majority are actually low-skilled retail, hotel and restaurant jobs that immigrants have historically filled. While this may not be enough to disrupt the current economic momentum, it may well put on the brakes beyond the near-term horizon.
Of course, businesses generally plan beyond the next few quarters and thus are likely to be cautious until the economy clearly shows its stripes later in 2010. A recent survey conducted by Duke University’s Fuqua School of Business showed that 56% of US CFOs are currently preparing for a recession.
But as noted earlier, companies are nimbler than ever before at turning the spigot on and off when it comes to spending, thanks largely to advances in technology and the growing “gig” economy, where freelance or part-time workers can be used at least temporarily to fill gaps in the labor force.
And despite the prevailing caution, CFOs surveyed by Deloitte still predict that capital spending will grow by 3.6% over the next 12 months, much of it devoted to technology.
If they are right, it seems likely that 2020 will be another year of “the same and more of the same” for the slow-but-steady US economy.
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