This short document (2 pages) is a synthesis of my macroeconomic views. One page of explanation and one page of graphs – The 2 pages Macro – 15 March 2019
Tensions between China and the US are about technological leadership. The Chinese, whose technological catch-up has been rapid in recent decades, is now rather ahead of 5G and Artificial Intelligence. The US does not accept, rightly, this change of equilibrium.
The standoff will continue and I can not imagine a quick trade agreement because it would assume that one of the two countries accepts the leadership of the other. This seems totally illusory and that is why the global environment will remain volatile.
The US is pressuring its allies to limit Chinese influence. To be convinced, read this article of the Wall Street Journal published this afternoon (March 11). It indicates the pressure of the Americans on the Germans in the adoption of a Chinese 5G technology for the renewal of their mobile network.
The article “Drop Huawei or See Intelligence Sharing Pared Back, U.S. Tells Germany” is available here
Here is the first paragraph
“BERLIN—The Trump administration has told the German government it would limit the intelligence it shares with German security agencies if Berlin allows Huawei Technologies Co. to build Germany’s next-generation mobile-internet infrastructure.”….
US growth is expected at 2.9% on average in 2018. This corresponds to a growth rate of 0.7/0.8% in Q4 (non-annualized figures). This view is consensual, as is the consensual perceived robustness of the economy and the slowdown to an average growth of 2.5% in 2019.
Making all of these elements compatible is interesting.
If the 2.9% of 2018 is ok (with 0.8% in Q4), it is necessary to think about 2019.
The average quarterly growth rate needed to converge to 2.5% is 0.5% (non annualized) The slowdown in the US economy is strong from the very beginning of the year. This figure must be compared to 0.8% which is the average quarterly growth in 2018.
The assumption of maintaining robust growth in the first half of 2019 (0.8% per quarter) implies a rapid decline from the summer. Convergence to 2.5% implies a contraction of -0.2% per quarter from the summer.
If growth is robust at the beginning of 2019, then to be compatible with the consensus forecasts, it will take a break from the summer
The US external trade is weakening rapidly. Its deficit has never been so important (measured in real terms and ex oil trade). Imports have a strong momentum. It reflects the White House fiscal strategy and it is done at the expense of American citizens. Not the good strategy. This large imbalance is also a good reason for the Fed to maintain its tightening bias in order to limit the domestic demand momentum. Powell has spoken many times of the non sustainable fiscal policy of the White House. This trade imbalance is just an illustration of it.
Donald Trump hit out again recently at the Federal Reserve for its monetary policy management, taking it to task for hiking interest rates, which he claims would hamper US growth. But this is something of a bold statement given the White House’s fiscal policy.
The chart below depicts US unemployment and the government balance as a percentage of GDP, revealing that the two indicators have trended in a similar way over almost 60 years, each reflecting the US cycle. When economic activity is robust, jobless numbers decrease, while at the same time, tax income increases and spending to support the economy is lower, thereby improving the budget balance. This twofold trend has always worked well, even when Ronald Reagan embarked on economic stimulus at the start of the 1980s. Meanwhile, the budget surplus at the end of the 1990s is also an illustration of this trend, with Bill Clinton’s – fairly smart – moves to implement austerity policies to gain leeway in the event of a downturn in the cycle.
But the current period marks an exception. The cycle is robust, as reflected by the drop in unemployment to 3.7% in September 2018, hitting its lowest since 1969, yet the government balance is not improving, but rather it is deteriorating under the influence of Donald Trump’s policies. The public deficit stands at close to 5%, yet it should have fallen significantly on the back of the economic cycle. The government is driving economic stimulus at a time when the economy is running on full employment.
So it is reasonable for the Fed to take action to counter these excesses and avoid the emergence of persistent imbalances. We cannot rule out the possibility that fiscal policy will bolster domestic demand, triggering a significant surge in inflation and a larger external imbalance despite the White House’s protectionist measures (demand is rising sharply – due to tax cuts and increased spending – and supply does not have time to adjust, which leads to a swell in imports).
The Fed, as embodied by Chair Jay Powell, has clearly indicated that this policy is not sustainable in the medium term and that it must be offset, which is why the Fed is hiking interest rates – and it is right to do so – thereby setting the US economy on a more sustainable path for the medium term.
However, the risk lies in the event of a severe negative economic shock, as there would be no leeway for fiscal policy to adjust, and there would be no scope for raising the budget deficit or implementing a stimulus plan like Obama did in 2009, as the budget deficit is already extensive before a potential shock: the US economy would therefore be hampered over the long term. Trump’s policies will only help the better-off in society, who benefit from lower taxes, while the cost of this policy is spread out across the population via the ensuing increase in the public deficit. And this approach will create even more inequality in the longer term as some Republicans are alarmed at the extent of public debt and are arguing for a reduction in social spending to make this debt sustainable in the medium term. For now, America seems to have lost sight of the meaning of the words equality and fairness.
The ISM index for the manufacturing sector is, in August, at its highest since May 2004. It was then at 61.3 versus 61.4 in May 2004.
The reading of this index is puzzling for different reasons
1 – Since 2011, the average growth in the US is 2.2% but the trend was 2.7% between 2000 and 2007. But the ISM index was, on average, higher since 2011 than before the crisis. Its average was 54.1 from January 2011 to August 2018 but only 52.1 from January 2000 to December 2007. A higher ISM index doesn’t not reflect a stronger growth momentum. We can see that also when looking at the manufacturing production index. On the same periods, the annual growth rate was 1.8% from 2000 to 2007 but 1.15% from 2011 to July 2018.
In other words, the index is higher than in the past while growth is lower.
2 – There is a robust index calculated by the Federal Reserve of Chicago. The CFNAI (Chicago Fed National Activity Index) is the synthesis of 85 indicators (industrial production, employment, personal income,….). It’s reading is easy with an average at zero and a standard deviation of one.
The CFNAI is an accurate measure of the business cycle based on observed variables. Usually the two profiles are consistent as the graph shows.
Recent data show a persistent divergence between the two. The CFNAI is close to 0 while the ISM is at a high historical level. It is probably too high giving a wrong signal of the US growth strength.
In a recent opinion piece, the German foreign minister Heiko Maas discussed how Europe needs to reassess its partnership with the United States, stating that the two areas have been drifting apart, requiring them to reshape their relationship in light of recent changes, and calling for an assertion of Europe’s autonomy in diplomatic, military and financial terms.
German Chancellor Angela Merkel disputed this point of view, refuting this notion of drifting apart, which she believes would damage the very long-standing relationship between Germany and the US, which acted as the foundations for North Atlantic relations. It would also require greater political integration within Europe, which is not the direction Germany wants to take, opting instead for a sort of federal approach without a federal government, but with strict rules for each State. This sits in contrast with French president Emmanuel Macron’s aim and the idea of a substantial European budget to influence the pace of European construction.
Heiko Maas also raised the issue of dependence on the dollar Continue reading