Economic Monitor – Weekly Commentary
by Scott J. Brown, Ph.D.

Who wants pie?
May 2 – May 6, 2016

“We ought to make the pie higher.” – George W. Bush

Productivity growth is perhaps the single most important factor in the economy. Increased output per worker facilitates improvements in the standard of living over time. It’s how our children have a better future. It also helps support corporate profits. What to make then of the current situation, where productivity growth has slowed to a crawl in the U.S. and around the world? Will there be enough pie to go around?

As a statistic, productivity is quirky. Those who have studied the hard sciences know that when you start multiplying and dividing statistical estimates, the uncertainty can get unruly. Productivity is nominal output, divided by a price measure, then divided by a labor input measure – each is estimated. As a consequence, quarterly productivity figures are choppy and subject to large revisions. Given all that, the trend in recent years has been unusually weak. Figures are somewhat better for the nonfinancial corporate sector, but still slower.

Economists had long puzzled over the slowdown in productivity growth from the late 1970s to the early 1990s. Nobel Laureate Robert Solow said, during that time, that computers were everywhere in the economy except in the productivity figures. Scanners and inventory management software were just getting going in the early 1980s, but took some time to perfect (you’re welcome, Amazon and Walmart). In the late 1990s along came cell phones, networking equipment, and the Internet. Productivity surged, first in the production of these technologies, then in their application. Firms discovered they could do more with fewer workers and the early 2000s. It was not just a jobless recovery, but a “job loss” recovery. Productivity growth after the Great Recession has been anemic, likely because of weaker (productivity boosting) capital spending in the early part of the recovery.

The slowdown in productivity growth is a puzzle. No one seems to know the exact cause, but there are theories. As noted, weaker business fixed investment was a likely factor. Some have suggested that this is really a measurement issue. Real GDP is likely a lot stronger because it doesn’t properly account for the fact that I have dictionaries, encyclopedias, maps, restaurant and film reviews, and so on in the palm of my hand. Others argue that productivity is lower because people are watching cat videos instead of working.

If the issue is capital investment, that may take care of itself over time (as long as capital investment picks up). If it’s more permanent, then the longer-term outlook is more troublesome.

In the 1950s and 60s, real wage growth rose in line with productivity. Since the early 1970s, most (not all) of the growth in productivity has gone to profits. What will then happen if the slower trend of productivity growth is more permanent? Much will depend on the amount of slack in the labor force. If the job market tightens, labor could take a larger share of a smaller pie (actually a more slowly growing pie).

California and New York are now in the process of raising their minimum wages to $15 per hour (over five years in CA, steeper but strangely inconsistent across NY). Many will argue whether this is good or bad. Typically, minimum wage increases aren’t all that important (it’s usually very low to begin with and you rarely see much impact on employment, or poverty for that matter). Yet, California will be more of an experiment. Going from $10 to $15 is a large increase as far as minimum wages go.

Waitress, a new musical opened on Broadway last week. Before the play begins, someone actually bakes a pie, so the smell wafts through the theatre during the play. To enhance the aroma, the recipe is altered. The result smells great, but tastes “wrong.” Yet, that doesn’t stop the stage hands from eating it.


Budget deficit fears
April 25 – April 29, 2016

Just when you thought all the fear-mongering had subsided, the national debt has resurfaced as a topic in this year’s presidential race. Yes, the deficit is large. No, it is not a problem. However, there some concerns about the longer run.

The federal budget deficit hit $1.4 trillion in FY09, or about 10% of nominal GDP. That is enormous, but it simply reflected the magnitude of the Great Recession. Revenues fell. Recession-related spending (unemployment insurance, fiscal stimulus) rose. As the economy recovered, recession-related spending went away and tax receipts improved. The deficit is now down to 2.5% of GDP, which is sustainable.

Some politicians talk as if cutting the deficit were simply a matter of “trimming the fat.” However, if one excludes social Security, Medicare, interest payments, and defense outlays, there’s not a whole lot left to cut. If you cut nondefense discretionary spending to zero over the next 10 years, you would still be running a budget deficit.

While the deficit (as a percentage of GDP) is currently manageable, it is expected to rise in the years ahead as the baby-boom generation continues to move into retirement. The Congressional Budget Office projects that the deficit will approach 5% of GDP by FY26. So, something’s going to have to give at some point. We can reduce the deficit (or limit its growth) by scaling back entitlements or by raising revenues. Some now argue (I kid you not) that we have to cut entitlements now so that we don’t have to cut them later (which makes no sense if you think about it for more than a second). Raising revenues is tricky. Republicans aren’t going to go along with increases in tax rates (even if called “revenue enhancements,” as they were during the Reagan years). Broadening the tax base, as part of overall tax reform, could get bipartisan support, but that means giving up certain tax breaks that some will object to (that is, those benefiting from those tax breaks). It’s true that the U.S. has one of the highest corporate tax rates in the world, but the effective rate (what corporations actually pay) is among the lowest. If you started from scratch, you could certainly come up with a better, more efficient tax system, but the problem is you can’t start from scratch.

The national debt, the sum of past budget deficits, is now over 100% of GDP. However, marketable debt is about 76% of GDP (the difference is the money that the government owes itself, mostly the Social Security and Medicare trust funds). There is no magic level of debt that gets an economy in trouble. Research arguing that view has been discredited. The federal government currently has no problem borrowing, nor is there any evidence that it is crowding out private investment.

Here is something to worry about. The Great Recession has put potential GDP on a lower, slower track. This makes future budget strains more of a problem than if we had remained on the pre-recession trajectory. More unsettling, that assumes that the economy does not stumble into a recession along the way.


The Fed, the dollar, and trade activity
April 18 – April 22, 2016

Financial markets have some tendency to over-react to news and the increased globalization of financial markets means that things can now get out of hand a lot more quickly on a global scale. Minor shifts in the Fed policy outlook have had a large impact on exchange rates. The strengthening of the dollar has had an outsized impact on commodity prices. However, shifts in the financial markets can themselves have important effects on economic conditions. It’s enough to make your head spin.

As with most countries, the responsibility for the dollar falls to the Treasury, not the central bank. The Fed can influence exchange rates, to be sure, and react to the impact of exchange rate movements on the economy, but the exchange rate of the dollar is not its job. Talk of “currency wars” is way overdone. Central bank policy is driven by the outlook for the domestic economy. The strength in the dollar over the last two years has been due to a number of factors, but many would put tighter Fed policy at the top of the list (along with easier monetary policy abroad). Yet, the Fed has raised rates by only 25 basis points – and the expected path of rate increases is very gradual.

The dollar’s strengthening against the currencies of our major trading partners was especially pronounced. From the end of 2013, the U.S. dollar had appreciated 35% against the Canadian dollar and 45% against the Mexican peso. These are large moves and cannot be justified by monetary policy differentials.

In general, policymakers do not worry too much about the level of exchange rates. It’s the speed of adjustment that is worrisome. Rapid moves are destabilizing. The Treasury can intervene by buying or selling currency reserves, or use open-mouth operations to try to talk the exchange rate in one direction or the other – but when push comes to shove, intervention can be only a temporary fix. Currency flows are simply too large for the authority to do much about it.

Canada and Mexico account for more than a third of U.S. exports. Anecdotal reports from businesses exporting to these two countries were increasingly sour in the first couple of months of the year (and exporters to the rest of the world weren’t exactly cheery either). It’s well known that currency movements tend to overshoot. The currency market did begin to turn in early February, coinciding with economic data and market conditions that suggested a softer Fed rate outlook. Still, while the dollar’s softening has provided some relief, there’s a question of how much damage has been done.

Not surprisingly, the U.S. has imported more stuff from abroad. However, nominal imports (the amount we pay for imported goods and materials) have fallen year-over-year due to the drop in import prices (mostly petroleum). The U.S. ran a trade surplus with OPEC last year (and in the first two months of 2016). This is a huge problem for many of the countries in OPEC, which have tied government spending programs to oil revenues. Moreover, while the contraction in U.S. energy exploration has been sharp, energy extraction is still going strong (down, but still high by historical standards).

U.S. merchandise exports have fallen, but mostly due to lower prices, especially for agricultural products and raw materials. The exception is exports of capital equipment, which have declined in inflation adjusted terms, reflecting the slowdown in capital spending worldwide. That slowdown in business investment is troubling, but it’s unclear how long it will last.

We have an inherently unstable global financial system. That doesn’t mean that downside risks will materialize, but they may. Trade is important to the U.S. economy, but we’ve always been relatively self-contained and strength in the domestic economy should remain the driving force in the quarters and years ahead. For the financial markets, we’re likely to see forces of optimism and pessimism duking it out for some time.


The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.