Monday, November 11, 2013

What Kind of A Recovery Is This?

I've spent some time thinking through a typically informative presentation by my former colleague, Dr. Ward McCarthy and his partner Tom Simons, CFA of Jefferies, Inc, "U.S. Economy and Inflation: Economic Recovery in the Era of Conflicting Monetary and Fiscal Policy."

I want to pick out some points the authors make and then express a different set of questions and concerns.

  • "The U.S. economy entered the 5th consecutive year of growth in Q3 of 2013."
The authors note that the recovery and expansion phases of the current business cycle "have been slow to date."  Not only is this true, but the nature of the recovery and expansion has been singular among recent cycles in that it hasn't featured an early-cycle housing recovery.  Instead, it has featured a "late-cycle housing recovery," which along with a recent pickup in CAPEX spending are both "important for the continuation of the economic expansion."

The consumer sector has usually been one of the engines of recovery in prior business cycles, but not in this one.  How could it be otherwise?  The authors note,

  • "The unemployment rate has declined from 10% in October 2010 to as low as 7.2%, but remains high by historical standards."
  • "Real Personal Consumption Expenditures has been remarkably steady and sluggish for an extended period." 
What of the miraculous, unconventional monetary policy of the Bernanke Fed?  It appears to be the only thing propping up the stock market, because even the faintest whisper of a taper sends the market into atrial fibrillation. The authors note, "Consumer spending behavior provides evidence that the Fed's QE has not had a widespread impact on the consumer sector outside of housing activity."  

On a broad macroeconomic front, productivity growth in the U.S. economy has been one of the biggest contributors to economic growth and wealth creation for decades.  But, a secular shift in the composition of output may not bode well for this in the future. The authors put the problem in simple terms, "It takes 85% of the U.S. labor force to generate a monthly trade sector surplus of less than $20 bn."  

So, ironically in this recovery, "The decline in goods-producing activities has been fundamental to the sizable monthly trade deficits in goods that have been a drag on the economy and growth."  

In secular terms, this could change, were higher value-added manufacturing to be "right shored" to the U.S. The biggest barrier to this happening is our own fiscal, political and regulatory irresponsibility.  

During this recovery, the Federal government has run annual deficits of over one trillion dollars.  While an observer could point to a short-term decline in the ratio of the deficit to GDP ratio, the total stock of Federal debt stands at an astounding $16.7 trillion, according to the St. Louis Fed.  

The Congressional Budget Office forecasts of tax revenue, spending and deficits are inherently untrustworthy. The authors note that the most recent CBO forecast has discretionary spending "rising for the remaining 8 years in the forecast horizon" beyond FY14.  

This is before yesterday's announcement that Medicare spending shall treat mental health expenditures equally to medical expenditures. The impacts of the 39 million or so additional consumers coming into the plans before this expansion have been dramatically understated, but out politicians are looking no further than the 2014 election campaigns. 

Finally, our banking system is holding excess reserves of over $1.9 trillion, and the Fed's balance sheet may not normalize until 2019 or beyond.  Meanwhile, studies from the New York Fed show that unwinding the Fed's balance sheet will remove the patent medicine of Fed remittances to the Treasury which have been widely hailed as demonstrating the 'success' of the bailout and unconventional monetary policy.  We'll look at these issues in some later posts.

So we have a five year old recovery that is built on pretty sandy soils.  

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