Grasping Reality on TypePad, by Brad DeLong

From: [email protected]
Subject: Your Squawk Box segment this Thursday, January 2: Please get to the studio at UC Berkley by 6:40am est
Body: The anchors will be Joe and Becky. You’ll share the segment with Shermichael Singleton, political consultant, contributor at The Hill. The discussion will be about "running against the Trump economy". Trump has had the best 3 year performance out of every president since Reagan, since being elected. How does one run against this? Who has the potential to compete? Can Trump keep it up, how? Please send thoughts and talking points.

• Jump in the S&P over the past eight years from 1300 to 2600 3200 [1]

  • A 1.5x 1.8x in the valuation ratio
  • A 1.16x due to inflation
  • A 1.15x due to an increase in the fundamental earning power underpinning each share of stock
    • All of that is due to buybacks. None of that is due to greater business earning power
    • Thus the optimism with respect to the valuation ratio—even given limited opportunities to earn money elsewhere—somewhat puzzles me
    • Plus there is the joker in the deck: will the wage share remain depressed indefinitely?
    • Usually I'm a "150% of your net worth in stocks" guy
    • Now we are moving money out, and I'm a "50% of your net worth in stocks" guy

• The talk I hear about the "strong Trump economy" makes no allowance for the difficulty of the dive he has faced relative to that that other presidents face...

  • Trump was handed very good cards
  • Taking account of the difficulty of the dive, I think you have to say that:
    • The Clinton economy turned out much better than expected (due to good policy)
    • The Obama economy turned out better than expected (due to good but inadequate policy)
    • The Trump economy has turned out as expected—but with extra damage done by the trade war, which has on net hurt manufacturing and agriculture, and with no investment boom
    • The Reagan economy turned out somewhat worse than expected—policy incoherence between the tax cutter, the defense spenders, and Paul Volcker really stomped the entire economy over 1981-3 and the Midwest over 1981-1987.
    • The George H.W. Bush economy turned out worse than expected—they took their eye off the ball on the S&L crisis
    • The George W. Bush administration really _ _ the pooch...

• It looks like we have dodged a recession...

  • We have had a manufacturing recession, but domestic manufacturing is no longer an important enough sector for a manufacturing recession to bring down the economy as a whole...
  • The Trump economy is very weak in productivity growth and the wage share, and those are very worrisome for long-term trends.

• The most striking aspect of the political situation is the strong divergence between Trump's good unemployment and inflation numbers and his lousy approval numbers

  • Yet perhaps what should surprise me the most is that his approval numbers are so high
  • Policy incoherence while you insult people on Twitter would not have seemed to me to be a governing strategy that many Americans would approve of...
  • It's not just not doing your job...
  • It's undignified
  • Yet he has his fans—and very few of them are beneficiaries of his tax cut, and there are no beneficiaries of his trade war or his foreign-born sliming...
    • Perhaps all his fans think they will benefit from his tax cut?
    • Recall John Steinbeck: "We didn’t have any self-admitted proletarians. Everyone was a temporarily embarrassed capitalist..."
    • A new paper out by Alberto Alesina and Stephanie Stantcheva on how Americans think there is much more and Europeans think there is substantially less upward mobility than in fact there is—and how in real life there is more in Europe than in America

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.