Talking Points and Snippets from Commonwealth Club January 25, 2019 Forecast Event
Forecasting: Because of the shutdown, we are flying much more blind than we would like to be. We are not getting the normal data flow. Thus there is more than the usual level of uncertainty. Given that:
- I believe there is something like an 80 percent probability that Europe is now in a small recession.
- The Chinese government continues to say that all is well.
- But somehow six percent fewer cars were bought in China in late 2018 than in late 2017.
- Over the past half century the reliable recession signal has been yield-curve inversion—since 1965 eight inversion signals: one false (1998), one near-recession (1966), and six recessions.
- There have been no recessions not signaled by a yield-curve inversion.
- The Federal Reserve currently plans are to invert the yield curve in June.
- Neither Steve Moore nor I understand why the Fed thinks that this is a good thing to do.
In the last yield-curve inversion, in 2006, they were worried about an inflationary spiral breaking out because of rising oil prices—they should not have been worrying about it, but they were. In the yield-curve inversion before that, in 2000, they were worried about the dot-com bubble. There is nothing like either of those going on now.
Some people think the Federal Reserve is about to back off. Some people think that this time really is different—that the bond market is spooking at shadows this time. Give each of these a 25% chance of being right, and you have to say that there is a 50% chance the U.S. will be in recession in a year and a half. We hope the recession, if it comes, will be a small one. We hope we will, somehow, dodge the bullet and not have a recession.
But, at least as I see it, that is the forecast: a 50% chance of 1.5%-2.5% growth over the next year and a half, and a 50% chance of negative growth.
If you want a more precise forecast, my advice is to consult your Magic-8 Ball.
The Shutdown: Let's review the bidding: Pelosi, Ryan, McCarthy, Schumer, McConnell, Trump reached a deal. Deal passes Senate unanimously. Trump watches "Fox and Friends". Trump announces he won't sign tghe deal. Paul Ryan—desperate not to embarrass Trump more—won't let the House vote on the deal. Ryan goes out and Pelosi gets in on January 4, and Pelosi passes the deal through the House. But because it is a new congressional session, the Senate's approval has expired. And McConnell—desperate not to embarrass Trump more—is now holding things up in the Senate.
From Pelosi and Schumer's standpoint, the big problem is this: they reach a new deal with Trump, Fox and Friends finds some reason to slag it, Trump backs out again.
The right, rational response to this situation is for Pelosi, McCarthy, Schumer, and McConnell to strike deals and then pass them with veto-proof majorities. But McCarthy and McConnell are too scared of Trump and not concerned enough about the well-being of the country to do that.
2.5 million people aren't getting their paychecks and 800,000 are getting very little work done. That's about a 0.5% hit to the economy. We won't see that because of oddities in the how the public sector is folded into official statistics, but it is there. Will there be a multiplier applied to it? In a year I will have the data so that then I will be able to look back and tell you. I cannot tell you now...
Reagan Revisionism: One thing that makes it very difficult to discuss things with Republicans is they see the Reagan administration through remarkably rose-colored glasses. Output per worker—GDP divided by the labor forcer—up by 4% under Bush I (one term), up by 20% under Clinton, up by 7% under Bush II, up by 14% under Obama, up by 16% under Reagan. The best performance is under Clinton: the 1990s. Reagan beats Obama—Obama, whom Republicans excoriate hourly for poor economic performance—by only a nose. It's Bush I and Bush II who bring up the rear. And all in all since 1980 you have an average of 5.4% growth during a Republican presidential term and 8.5% growth during a Democratic presidential term.
If you look at the American middle and working classes, the numbers look worse for Republicans. Excluding the top 10% of the distribution, growth in output per worker gives us Reagan at 10%, Bush I at 3% (one term), Clinton at 17%, Bush II at 3%, Obama at 13%. Why then do Republicans worship Reagan? One reason is that if you look at the top 1%, the income per worker figures are: Reagan 78%, Bush I 11% (one term), Clinton 35%, Bush II 20%, Obama 25%. For the top 1% the Reagan years were a wealth bonanza—but that was overwhelmingly redistribution from the non-rich upwards, rather than exceptionally rapid growth...
"Border Security": Steve, when you say "the American people will never let their politicians pursue a sensible immigration policy until they believe that the border is secure", you have a big problem—but not with what is going on on the border, with Fox News.
The border is secure. Terrorists do not cross our border from the south seeking to kill us all. There are no prayer rugs that have been discovered by the Border Patrol—that is not reality, but rather a plot point in "Sicario: Day of the Soldato". If you want to persuade more Americans that our border is secure, the sweet spot is not to spend money building a wall—which Mexico will not pay for—but rather to shift Fox News. Fox News has a profitable business model: scare the shit out of old people so their eyes stay glued to the screen so they can be sold fake diabetes cures and overpriced gold funds. If they weren't being falsely told that there are large caravans of illegal terrorists coming over the border to kill them in their beds, we would have a different situation—we3 would have a situation in which Marco Rubio would once again be happy leading a bipartisan immigration reform effort, and we could get something done on immigration that is not-stupid. The pressure point on the border as a political issue is not the border—it is Rupert, his sons Lachlan and James, and their rather peculiar business model.
All the real border security expenditures and polices in the world won't create a belief that the border is secure among those who vote for your political masters. Only Fox News changing its business model will create a belief that the border is secure among those who vote for your political masters...
Deficit: Back when interest rates were high, people like me convinced Democratic legislators to move heaven and earth to reduce the deficit. It required votes they saw as tough and unpopular, and those votes contributed to some of them losing their seats. Their appetite is gone. And the immediate need is gone too—you need to reduce the deficit when, as they were in the 1980s and 1990s, interest rates are high or when there is a good chance that interest rates are soon going to become high. That is not where we are. The deficit is a problem. It is not one of our twenty biggest problems. It will not become a big problem until interest rates become much higher than they are now. And when they do that will be the time to focus on the deficit...
Tax Reform of 2017?: Four times since 1980 Presidents have sold tax bills as things that will boost investment in America and generate a lot of supply-side economic growth. Reagan 1981, Clinton 1993, Bush 2001, and now Trump 2017. Adjusted for the effects of the short-run business cycle, investment in America fell after Reagan 1981 and Bush 2001 and rose sharply after Clinton 1993.
It looks like Trump 2017 is going to be a lot more like Reagan 1981 and Busch 2001. The jump in cycle-adjusted investment as a share of production is not jumping up. The people with models are not forecasting any jump—in fact, the people with models were never forecasting any jump. The boosters without models—the John Taylors, the Mike Boskins, the John Cochranes—who were forecasting a big jump a year ago are now all very, very quiet. The people who track financial flows are now saying that any boost to U.S. production is going to be outweighed by lower taxes collected on profits earned by foreigners who have invested in America.
If you and yours are making more than 500,000 dollar a year each and are going to keep on making that, you are winners. If not, you are losers...
Trade War?: Not yet hurting—unless you are a steel user or a soybean farmer here in the United States, or Microsoft (it looks like China's response has just been to ban its search engine Bing).
Is it hurting China? No. China appears to be reacting by snarfing up U.S. intellectual property to a much greater extent. They wanted to do this anyway, but were unwilling to start a fight to do it—but now that they are in a fight they are happy to proceed. Why is the Trump administration doing this? I think the answer is that Trump is not a wise man, that Navarro is a delusional man, and that Lighthizer is a corrupt man. I tell you, what the people who are wise, reality-based, and uncorrupt in the Trump administration really wish right now is that Trump had signed the TPP—then we would be negotiating with China over IP issues with 11 other countries backing us up and willing to impose penalties on China for misbehavior. As it is, we are going it alone.
Steve, you keep saying that Xi needs to deal because Trump is deadly serious on China and will not back down. Do remember that Trump declared victory on reforming NAFTA, "the worst trade deal in the history of the world", with small adjustments on auto parts rules-of-origin. Small adjustment on auto parts were enough to transform NAFTA, in Trump's mind, from the worst trade deal in the history of the world into something he is now very proud of. Xi has to to be thinking that he should deal with Trump the same way that Mexico did—hang tough, provide a few symbolic concessions only, and Trump will cave and go back to business-as-usual. What is there in the situation that would keep that from being the obvious strategy for Xi?...
China Trade and the Trans-Pacific Partnership: Steve, the Obama Administration was very interested in building leverage over China with respect to intellectual property. Look back at history, and you will see that this is something that always happens when you have rising industrializing superpower. Back in the nineteenth century e in the United States did not pay a cent to Britain for its intellectual property in textiles and steel. In the mid-twentieth century, when Japan was industrializing, they didn't pay an awful lot of attention to our intelleCtual property and were annoyed. And now China is doing the same thing. We did it to Britain. Japan did it to us. Now China is doing it to us. It is a source of annoyance. It's a thing to negotiate about. We push, we pull. But this source of friction and dispute doesn't change the fact that the international trade relationship between britain and the United States in the nineteenth century or Japan and America in the mid-twentieth century or the U.S. and China today is an enormous win-win. We are arguing about the division of this enormous surplus from the global division of labor.
Now the Obama Administration decided that it wanted to take a harder line with China on intellectual property, That was appropriate. And it set out to do this in a sensible way. It formed this organization called the Trans-Pacific Partnership to would present a united front for negotiations with China: get a lot of other countries that also trade with China on your side, and get a lot of leverage. And back then during the Obama Administration you supported this TPP policy—I remember an article from you, Kudlow and Laffer with the title "TPP Good for Both Sides of the Pacific". That TPP would have given us leverage to strike a deal with China on intellectual property.
Then, lo and behold, someone convinces Trump that the TPP is the second-worst trade deal in American history—indeed, that it is "almost as bad as NAFTA". And you want to work for Trump. So you start saying—to me, on Trish Regan's show—not "TPP is good for both sides of the Pacific" but instead that the agreement is not like NAFTA, is too long and is a bad thing.
Jared Kushner, somehow, finds the delusional Peter Navarro. And after Trump takes office there is a trade policy triumvirate of Trump, Navarro, and Lighthizer. Trump is... not a terribly wise person. Navarro seems to me to be simply delusional. Lighthizer—who was an effective trade-liberalization technocrat back in the Reagan and Bush administrations—is now adopting positions that I can only stand as the result of corruption. As I see it, only Trump, Navarro and Lighthizer in the White House actually like what they are doing with trade and China. The others are standing by, looking in in horror. Trump is insisting on bilateral balance with China. That ain't going to happen. As long as the United States remains a low-savings country, we are going to run trade deficits. And if we became a moderate-savings country and had balanced trade, we would still have a bilateral trade deficit with China: China would then have a trade deficit with the resource- and component-making countries that supplied it; and it would be those resource- and component-making countries that would have a trade deficit with us.
The day he gets into office, Trump blows up the TPP—second-worst trade deal in the history of the world, he says.
And so he throws away his leverage to negotiate with China on IP.
Instead of having a coalition of 12 confronting China with a common front, it is just us.
Xi right now is looking at Trump. Xi sees the Trump caved on NAFTA. Xi sees that Trump caved on "wall" negotiations with Mexico. Xi sees that Trump just caved on the shutdown. Xi sees that Trump is demanding something—bilateral balance—that makes no sense. Xi sees that Trump is not wise. Xi sees that Trump talks an awful lot of nonsense—NAFTA was not a horrible thing for the United States, not the worst trade deal in history.
Xi will conclude: it's hard to figure out how to even start to negotiate a deal with an administration where the decision makers consists of one guy who isn't wise, one guy who's delusional, one guy who looks to be corrupt, and a large group of others standing by watching the train wreck in horror. Xi has to think his beset option is to wait for Trump to come to him looking for a face-saving excuse to get out of the trap Trump has closed on himself.
Financial System Risks: I have a question for Professor Nancy Wallace. Let me channel the Treasury bureaucracy with respect to getting banks that we understand and that are insured back into the mortgage business to diminish risks.
Back in 2008, Hank Paulson took advantage of a momentary opportunity to nationalize Fannie and Freddie, which for 40 years had grown fat on discount financing obtained by claiming they had a Treasury guarantee while ignoring any attempts by the Treasury to direct their activities. Treasury announced that in a year or two there would be a completely different system of backstopping housing finance. In reaction, a lot of banks pulled out of the business. They did not want to incur this large regulatory risk on a mortgage portfolio with a more-than-20-years duration. They decided to wait and see what happened, and reenter the market when the new system was set up. And nothing happened. Paulson left office. It wasn't a Geithner priority. It wasn't a Lew priority. It isn't a Mnuchin priority.
And so non-bank banks that we do not understand now do the financing, creating risks known only to the mind of THE ONE WHO IS.
Should we all be on the phone to Steve Mnuchin this afternoon asking him to do something about this to get banks back in the game? And, if we should, what should we advise him to do to get banks back in the game?...
2017 Tax Cut: The tax cut has not produced the economy its boosters promised us it would fifteen months ago. Go back and read your Wall Street Journal from back then, and read the boosters—Robert Barro from harvard; the Stanford gang of John Taylor, Mike Boskin, George Shultz, John Cogan; a bunch of others. They were forecasting not 7% nominal investment growth but 30% nominal investment growth this year. It simply has not happened. There are a couple of reasons it did not happen. One is that such a big jump would have had to be financed by foreigners switching from buying our imports to financing investment and so generating an 800 billion dollar increase in the annual trade deficit—and that simply was never going to happen. Another is that the Republicans insisted on passing their bill through the Reconciliation process, which means the whole thing expires in a decade—and large chunks of it expire before then.
That means that the bill create a great deal of uncertainty about what the future of the tax code would be. And so, like the 2001 tax cut, it does not change business behavior much. Businesses get more cash, but with great uncertainty about what policy will be, the engage in an extraordinary orgy of stock buybacks rather than in boosting their investment.
Four times since 1980 presidents have sold tax bills as things that are gonna generate a lot of extra investment in America and boost long run growth: Reagan in 1981, Clinton in 1993, Bush in 2001, and now Trump in 2017. Adjusted for fluctuations up or down in unemployment, only one of these produced a sustained and significant boost to investment in America. Part of it was that Clinton was lucky. Most of it was that Clinton's policies were actually competent: designed to work.
The people who have models are now forecasting that there will be no jump in American national income as a result of the Trump tax bill. They are, in fact, forecasting a decline—production will be unchanged, but the amount of money foreigners collect from us is going up because they are getting 1/3 of the direct benefits from the tax cut.
Yield-Curve Inversion: Because of the shutdown we are now largely flying blind—we are not getting the dataflow that we would have normally gotten over the past month. There is an 80% probability that Europe is in a small recession. The Chinese government says China is not in recession but somehow 6% fewer cars were bought in China in late 2018 than in late 2017.
The reliable recession signal is yield-curve inversion signals in 1966, 1969, 1974, 1978, 1989, 1998, 2000, 2006—8 in the last half-century or so. 1966 was followed by a near-recession. 1998 was a false alarm. Otherwise—yield curve inversion calls it, 6 of 8, with no unforecast recessions.
The Federal Reserve's current plans are to invert the yield curve in June.
We do not understand why they are doing this—then they did this in 1989 and in 2006 they were worried about inflaiton, when they did this in 2000 they were worried about the stock price bubble, but nothing like that is relevant now.
There are people saying that the Fed will back off, and there are people saying that this time it really is different. Give each of those a 25% chance, and you got to say there is a 50% chance the U.S. will be in recession in a year. We hope it will be a small one. We hope that somehow we will dodge the bullet...
California Real Estate?: God, what a mess... After Howard Jarvis and Prop 13, the fact that property taxes were capped meant that local governments started looking at developments with fear: where are we going to find the money to provide services to all of these projects? The switch from local governments being boosters to local governments being NIMBYists has been the biggest governance disaster to afflict California in the past generation. If you own property, it's great. If you can easily get permits, it's great. Otherwise—we really need to fix this. It doesn't look like tax reform is going to have big effects, however...
Employment?: David Autor has a three-part classification of where the new jobs will come from, as "shop floor" jobs ebb away: frontier, wealth, and "last mile". Frontier jobs will, by and large, be good: people taking advantage of technology to do new things and to do things better. Wealth jobs—serving the wealthy—will be more important as people and as heirs and heiresses begin spending more out of the great wealth accumulations of the past generation in lots of ways (for example: tourism, housing, and personal enrichment—including funding things like the Commonwealth Club. So we like those). It's "last mile" jobs—the husks left behind because the real work has been automated and computerized and there is only a small, boring part left—that's the problem. The hope is that unemployment stays low enough that even those trapped in these "last mile" jobs have bargaining power. And that—keeping unemployment low—is, I think, the best way to deal with the employment problem...
California Jobs?: It's a race between tech employment generation and housing construction. If we can make housing construction win, it's a huge win for everyone. If not, we have bigger problems...
Federal Reserve Policy: Steve, you say Trump is focused on getting a really-tight labor market. Someone seeking to get a really-tight labor market would not have appointed Jay Powell to run the Federal Reserve. If Trump cared, he would have reappointed Janet Yellen, who was once described to me as "Ms. Dovey Dovey Labor Force Upgrading in a High Pressure Economy". To say that Trump is seeking to get a really-tight labor market is to impose coherence and knowledge on Trump and his administration that they do not at all possess.
And your attachment to a high-pressure economy is something new, no? Before Trump took office, you used to denounce Janet Yellen for her easy money policies twice a month, no? I cannot remember anybody being more strident than you in denouncing Bernanke's post-2009 policies as generating bubbles that would pop and crash...
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