For more than a year the European economy has been in deflation territory. To reverse that trend the European Central Bank launched its Quantitative Easing program, aimed at flooding the euro zone with liquidity. According to crude monetary theory this will drive up prices in line with the so called quantity theory of money; few if any central bankers would admit that their take on money supply and inflation is this simple, but the only other explanation is so far-fetched that even the quantity theory of money makes sense.
The alternative theory says that the reason why businesses are not investing in Europe is that there is not enough cheap risk capital available in the economy. For this theory to work, though, the cost of borrowing that businesses face would have to have been exceptionally high during the recession. In fact, the exact opposite is true: since the Great Recession started the composite cost of borrowing for non-financial corporations in the euro zone has been in the 2-4 percent bracket. Right before the recession it topped out above ten percent.
In other words, the has been an abundance of liquidity available for anyone and everyone willing – and qualified – to borrow.
But if your business outlook says flat sales, at best, you are not going to take on new loans. And flat sales or worse has been the forecast story for European businesses for six years now.
What does this have to do with inflation? Well, low economic activity means low demand and low utilization of productive capacity. As a result, there is no upward pressure on prices and therefore no real-sector inflation in the economy. Whatever inflation may be looming in the near European future has a monetary origin.
Does this mean that the primitive quantity theory of money is correct? No, it does not. The quantity theory rests on a rigid structure of assumptions regarding the operation of a free market, both in terms of the flexibility of real-sector resources and of free-market prices. The most confounding part of the quantity theory of money is that the economy axiomatically always reverts back to full employment; then, and only then, can monetary inflation occur.
Europe is about to line up with several other countries proving that monetary inflation is just as possible – if not more possible – in a stagnant economy. In fact, when stagnation and low capacity utilization is combined with monetary inflation, there is a macroeconomic venom brewing. The worst response to this situation is one where key decision makers assume that the monetary inflation they see is actually real-sector inflation.
Somewhat surprisingly, that mistake is made by Ambrose Evans-Pritchard, who is without a doubt Europe’s best political commentator. But in his latest column in The Telegraph, Mr. Evans-Pritchard allows his otherwise astute analytical abilities to lead him astray:
Be thankful for small mercies. The world economy is no longer in a liquidity trap. The slide into deflation has, for now, run its course. The broad M3 money supply in the US has been soaring at an annual rate of 8.2pc over the past six months, harbinger of a reflationary boomlet by year’s end. Europe is catching up fast. A dynamic measure of eurozone M3 known as Divisia – tracked by the Bruegel Institute in Brussels – is back to growth levels last seen in 2007.
But GDP growth, business investments, employment and capacity utilization are far from 2007 levels. While inflation back then was a real-sector phenomenon, it is not founded in real-sector activity today.
And that should have us all worried. Evans-Pritchard included:
History may judge that the European Central Bank launched quantitative easing when the cycle was already turning, but Italy’s debt trajectory needs all the help it can get. The full force of monetary expansion – not to be confused with liquidity, which can move in the opposite direction – will kick in just as the one-off effects of cheap oil are washed out of the price data.
I know Mr. Evans-Pritchard is British, but that does not mean he has to entertain an erstwhile concept of liquidity. Just a small comment. Back to his column, where his discussion of inflation is taking a somewhat odd turn:
Inflation will soon be flirting with 2pc across the Atlantic world. Within a year, the global economic landscape will look entirely different, with an emphasis on the word “look”. In my view this will prove to be mini-cyclical in a world of “secular stagnation” and deficient demand, but mini-cycles can be powerful. Mr Stein said total loans in the US are now growing at a faster rate (six-month annualised) than during the five-year build-up to the Lehman crisis.
Again, all macroeconomic indicators point to a continuation of a ho-hum recovery here in the United States, the March GDP numbers notwithstanding. At the same time, practically nothing says that Europe will enjoy anything near a U.S. growth period any time soon. Therefore, it is wrong to compare the inflation rates in Europe and the United States as if they are apples and apples. They are not. Our inflation here in the United States is the result of a steady rise in economic activity, a tightening of available capacity in infrastructure and other capital stock and even a glimpse of labor shortage in some sectors.
In other words, traditional causes of inflation. Europe, on the other hand, still suffers from almost twice the unemployment rate, with GDP growth at half or less the rate of ours. To really drive home the point about Europe’s abundant, idling economic resources, let us once again repeat the point that the cost of borrowing for non-financial corporations is down to 2-4 percent (after topping 10 percent before the Great Recession).
There is in other words no demand-driven push on prices to rise in Europe. This means monetary inflation, and there is an abundance of evidence from the past century on just how destructive and unstable such inflation can be.
Mr. Evans-Pritchard does not see this. Instead, he is worried about monetary tightening in the United States and its possible global effects:
“The risk is that the Fed will have to raise rates much more quickly than the markets expect. This is what happened in 1994,” he said. That episode set off a bond rout. Yields on 10-year US Treasuries rose 260 basis points over 15 months, resetting the global price of money. It detonated Mexico’s Tequila crisis. Bonds are even more vulnerable to a reflation shock today. You need a very strong nerve to buy German 10-year Bunds at the current yield of 0.16pc, or French bonds at 0.43pc, at time when EMU money data no longer look remotely “Japanese”.
Just one second here… No longer remotely “Japanese”? GDP growth for 2014 in the euro zone (19 countries) was 0.89 percent, and 1.3 percent in the EU as a whole. How is that not “Japanese” data??
Yet on some points Mr. Evans-Pritchard does see the underlying real-sector dimension of the inflation issue:
[The U.S. labor market] is turning. The quit rate – a gauge of willingness to look for a better job – is nearing 2pc, the level when employers must build pay-moats to keep workers. It is true that the US economy gave a good imitation of hitting a brick wall in the first quarter. Retail sales have fallen for three months, the worst drop since 2009. The Atlanta Fed’s snap indicator – GDPNow – suggests that growth dropped to stall speed in March. The rise in non-farm payrolls slumped 126,000 in March, half expectations. Yet economies do not fall out of sky. The US has already survived the biggest fiscal squeeze since demobilisation after the Korean War without falling into recession.
And again, some sectors and states are already in tight labor supply. Try hire a Hooters waitress for less than $15/hr in North Dakota. Some trucking companies are pushing annual driver compensation north of $70,000.
But perhaps the problem, at the end of the day, is that analysts and commentators focus on too many variables at the same time. You can certainly look at the economy from an almost infinite number of angles and get different stories out of each one of them, but in reality some angles only show symptoms while others capture the causes. Mr. Evans-Pritchard stretches his analysis a bit thin, going into asset prices and a roster of secondary data, elevating those numbers to the same prominence as – actually higher prominence than – real-sector growth data.
In reality, asset prices depend on real-sector growth data; tainted by speculative expectations, they only give an imperfect image of where the economy is really heading.
When we look at the European and American economies from the angle of real-sector activity, we do again see the gaping difference between a growth, moderately healthy United States and a stagnant, industrially poor Europe. The former has a sound form of inflation on its way; the latter is experiencing the beginning of a dangerous episode of monetary inflation.
That said, I still recommend you all to keep reading Ambrose Evans-Pritchard. He is intelligent and thorough and he has no problem presenting unpopular views if he believes they are merited.
For the people who live in the European Union, daily life offers challenges in the form of zero growth, high unemployment, lack of opportunity and a gloomy outlook on the future. For a macroeconomist, however, the EU is a formidable experiment that must not be left undocumented. The union was constructed based on the European tradition of welfare statism, right when the welfare state as a socio-economic construct was beginning to show clear signs of macroeconomic ailment. For unknown reasons – though probably ideological preferences played a good part – the architects of the EU misinterpreted the symptoms of macroeconomic ailment such as persistent budget deficits. They saw them as expressions of irresponsible budget policies and therefore institutionalized budget-balancing guidelines for member-state fiscal policies. Those guidelines became the EU’s own constitutional balanced-budget requirement, also known as the Stability and Growth Pact.
The Stability and Growth Pact was created essentially to secure the fiscal sustainability of the European welfare state. The problem is that the welfare state in itself is not fiscally sustainable. A wealth of literature (which I am currently working my way through as part of my next book project) and a plethora of compelling data together convincingly show that the welfare state is in fact the fiscal venom that causes governments to go into structural deficits. So far, though, the political leaders of the European Union have not understood that their practice of the Stability and Growth Pact – known as statist austerity – has driven the European economy into a permanent recession. Their governments, consuming up to half of GDP, are subjected to spending cuts and in turn subject the private sector to higher taxes, which in turn causes the private sector to contract its activity or at the very least keep it constant.
As statist austerity causes GDP to stagnate, the welfare state’s budget problems are exacerbated. More people request assistance from its entitlement programs, while fewer people pay taxes. The budget problems that statist austerity was aimed at solving – again in order to make the welfare state look fiscally sustainable – actually cause a new round of budget problems. In response, austerity-minded governments tighten the fiscal belt yet another notch.
All in order to make the welfare state more affordable to a shrinking economy. In other words, saving the welfare state is the prime directive of European fiscal policy.
American fiscal policy has a different purpose. It aims to help the economy grow and lower unemployment. Granted, far from everything that comes out of U.S. fiscal policy is helpful in that respect, but at least the basic course of direction is right. Therefore, when representatives of the United States Treasury look at Europe and try to figure out what on Earth is going on over there, it is hardly surprising that some eyebrows go up and some foreheads are wrinkled.
The United States warned Europe on Thursday (9 April) against relying too much on exports for growth, and urged officials to make more use of fiscal policy, saying stronger demand was essential. In its semiannual report on foreign-exchanges policies to Congress, the US Treasury Department gave a preview of the positions it will press on foreign policymakers during next week’s International Monetary Fund meetings in Washington. The world cannot rely on the United States to be the “only engine of demand,” the report insisted. It urged nations to use all tools available to accelerate growth and not rely only on their central banks to boost recovery.
Before we get to the accolades, a technical comment. Exports is also “demand”, though from foreign buyers. The Treasury economists should know better and use the term “domestic demand”.
Now for the accolades. It is refreshing and reassuring to see that the Obama administration’s Treasury understands how the economy works. This is not a sarcastic comment – this is a genuine word of appreciation. Europe, by contrast, is filled to the brim with economists and other fiscal-policy decision makers whose actions and decisions prove that they have basically no comprehension of macroeconomics whatsoever. An economy is driven by its demand side: household spending and business investments from the private side, and government spending. Since consumer spending is 65-75 percent of a well-functioning economy, the confidence and prosperity of the general population is quintessential to the survival, growth and prosperity of any nation.
Furthermore, businesses invest because they ultimately will sell something to the general public. Therefore, confident households create confident businesses. A strong, forward-looking economy spends 15-20 percent of GDP on business investments.
Without growth in these two private-sector spending categories, there will be no growth in the economy as a whole. The economists of the U.S. Treasury know this, and they operate based on this basic, common-sense macroeconomic knowledge. Their criticism of Europe’s governments for not understanding the same thing is highly valid and echoes, in fact, what I have been saying on this blog for three years.
But there is one more aspect to this that the Treasury economists have not brought up – at least not as quoted by Euractiv. Let’s get back to their story:
The report singled out Europe’s biggest economy, saying “stronger demand growth in Germany is absolutely essential, as it has been persistently weak.” The US Treasury argues that policy makers in the euro area need to use fiscal policies to complement the monetary stimulus that the European Central Bank is providing. … While growth in Europe has shown some recent signs of picking up, the region remains the sick man of the global economy.
The problem for the Europeans is that they cannot do this. They cannot use fiscal policy to stimulate aggregate demand, because if they do they have to abandon statist austerity. Welfare states would again be allowed to go into deficits.
There are many reasons why the Europeans cannot let that happen. The first and most immediate reason is called “Greece”. The EU is in a very tense showdown with the socialist Greek government over repayments of loans – loans that in turn were given as part of EU-enforced statist austerity. If the EU now abandoned its austerity policies, the Greeks would rightly ask “what about us??” and the 25-percent drop in GDP that followed the harsh implementation of statist austerity in the country.
Another reason for the EU to stick to its austerity guns is the long-term concern for the welfare state’s fiscal sustainability. The Europeans are almost unanimously behind their welfare states and they are willing to sacrifice enormously for their ideologically driven big government. They have convinced themselves that the welfare state is not, has not been, and will not be the cause of their macroeconomic ailment. Therefore, they will try as best they can to defend the indefensible, namely the fiscal sustainability of the welfare state; that defense will take priority over any measures to help the private sector grow and thrive.
For these reasons, and others, there is no hope for a growth-oriented fiscal policy in Europe.
Apparently, the realization that something is structurally wrong is beginning to set in on some key policy makers. Euractiv again:
Speaking ahead of next week’s meetings, IMF managing director Christine Lagarde also warned that global recovery remained ‘moderate and uneven’ with too many parts of the world not doing enough to enact reforms even as risks to financial stability are rising. Mediocre economic growth could become the “new reality,” leaving millions stuck without jobs and increasing the risks to global financial stability, she insisted.
Ms. Lagarde and others interested in the systemic roots of this growth crisis are more than welcome to read my book Industrial Poverty about the structural problems in the European economy.
Again, it is encouraging to see American government officials notice and basically correctly analyze the differences between Europe and the United States. What is needed now is that those officials speak up about why the Europeans are ailing, and what the consequences will be for them and the world economy if they insist on protecting their welfare states at all cost.
Perhaps a President Rand Paul can take it up a notch…
I normally do not write about momentary events, such as the daily fluctuations on the international currency market. But today’s exchange rate between the dollar and the euro, which according to Bloomberg happens to be $1.06 per euro right now, is worth a broader analysis. The trend toward euro-dollar parity has gained a fair amount of attention in the media, and rightly so: when the euro was launched a decade and a half ago it was sold as a stellar currency, backed by some kind of European integrity, and certainty way above that flimsy greenback.
Reality turned out different. The euro and the dollar would have reached parity many years ago had it not been for the excessive money printing during Bernanke’s QE programs. But now that the Federal Reserve has cooled down its printing presses and the European Central Bank, on their end, have cranked up theirs, it is only logical that the two currencies are re-evaluated on the global currency market.
Immediately, one could question the case for parity based on the fact that the Federal Reserve Board of Governors meet tomorrow, Wednesday and likely will throw some cold water on the surge of the dollar. However, a postponed interest-rate hike will not make much of a difference over time: while only about three percent of all short-term rate changes are related to real-sector events, long-term trends are determined by the macroeconomic performance of the two economies. From this perspective, euro-dollar parity is a historic event. Its underlying cause is a long-term, widening gap between GDP growth, consumer spending, business investments and job creation in the United States and in Europe.
I have on several occasions analyzed the differences between the European and American economies. This is a good time for a quick recap. To begin with, the American economy is a much stronger job-producing machine than the European economy:
Our job creation record in this recovery is not exactly stellar, but our unemployment is nevertheless almost half of what it is in the euro zone. The EU as a whole is doing microscopically better than the euro zone, but that is almost entirely thanks to the comparatively positive trend in the British economy.
The American advantage in terms of job creation originates in a still-overall business friendly institutional framework. On the one hand, the Obama administration has a penchant for regulations; on the other hand this president has a comparatively modest spending record – far better than his predecessor – which has allowed Congress to combine largely unchanged taxes with an expansion of private-sector business opportunities. As a result, GDP growth is comparatively strong here:
It is important to understand the driving forces behind growth. If it is private consumption and business investments, it means that the private sector is doing well. In my recent blog series “State of the U.S. Economy” I pointed to these variables as being essential to the growth of our economy. What is particularly interesting is the visibly stronger confidence in business investments.
Therefore, we can safely conclude that we have a growth period in the U.S. economy that is well grounded and could last for a couple of more years.
The European economy, on the other hand, is not as lucky. Whatever growth they have appears to be driven by exports more than anything else. Private consumption is not playing a key role here:
The differences are striking in terms of private-consumption growth. Americans are now back at a level of consumption where they can maintain their standard of living and even start getting ahead a little bit. In Europe, by contrast, the standard of living has been declining consistently for over a decade: consumption growth has been below the Industrial Poverty threshold since the Millennium Recession.*
This points to a fundamental weakness in the European economy. While government has assumed more responsibilities for people’s lives in Europe than here – and as a result has a higher level of spending – it is important to understand that this does not compensate for lack of private-consumption growth. Government spending in Europe has been held back by welfare-statist austerity policies for a good six years now, which only pours more salt in the growth-stopping wounds on the European economy.
For all the macroeconomic reasons reported above, Europe will not return to growth any time soon. The American economy will continue to grow at moderate rates for another couple of years, during which we will see a reversal of the exchange rate between the euro and the dollar.
*) For an explanation of the two-percent growth threshold in private consumption, see my book Industrial Poverty, specifically the section about applying Okun’s Law to private consumption.
In the first three installments of this series we looked at the aggregate-demand side of the U.S. economy. The overall message is that the economy is in pretty good shape, given the circumstances: the private-sector share of the economy has grown over the past 15 years, consumers buy more durables (such as cars) while maintaing a steady overall level of indebtedness; business investments are increasingly stable at a high rate – and government consumption and investment spending has been declining for a couple of years.
There is no doubt that the economy could do better. In the past three years GDP has been growing at 2.1-2.4 percent per year, adjusted for inflation; a good growth rate this far out of a recession would be 3-3.5 percent. There are two reasons why we are not seeing more growth than we do:
- In the short run, the federal debt and the Obama administration’s affinity for regulations have put a damper on private-sector activity;
- In the long run, the U.S. economy is in the same early stages of industrial poverty that Europe experienced some 20-25 years ago.
Nevertheless, the economy is growing and so is the private sector. This fourth and last installment takes a closer look at the production side of the economy, asking the question: what industries produce the value that adds up to our Gross Domestic Product?
The first thing we note about the value-added analysis of GDP is that the American economy is remarkably stable from a structural viewpoint. The industries that were the backbone of the economy ten years ago remain its backbone today. In 2005,
- The financial industry produced 23.2 percent of the value added in the economy;
- Manufacturing came in second at 15.1 percent;
- Professional and business services contributed 12.7 percent.
Together, these three industries added $5.67 trillion to the economy (in current prices), or 44.2 percent of the entire GDP.
In 2014, the same three sectors, again topping the ranking in the same order, produced a total value of $7.83 trillion, representing almost exactly the same share of GDP.
This is a sign of structural stability, and it is worth noting that manufacturing – the death of which is so often declared – continues to grow. From 2005 (the earliest year with consistent value-added GDP data) through the third quarter of 2014, American manufacturing grew by an average of 2.4 percent per year (again in current prices). Admittedly, this is not exceptional; most other industries have seen stronger growth. But it is a higher growth rate than, e.g., manufacturing in Europe.
If we look at value-added per employee, manufacturing looks even better. For the same 2005-2014 period, per-employee value added grew by 4.2 percent per year:
- In 2005 the average manufacturing worker produced a total value of $119,800;
- In 2009, right in the middle of the Great Recession, he produced a total value of $145,900; and
- In 2014 (annual value based on the first three quarters) the value added per employee was $171,200.
The number of employees in manufacturing has gone down over the past ten years, from 14.2 million in 2005 to 12.2 million last year. On the upside, there are 700,000 more manufacturing workers in America today than there was in 2009 and 2010, the bottom of the Great Recession.
In other words, manufacturing is on the rebound in America.
The leading industry of our economy, the financial sector, is even healthier – at least judging from the value it produces. (Let us keep in mind that this is the market value of their services, not the investments they make.) Per employee, the financial sector produced a value of…
- $322,200 in 2005;
- $366,700 in 2009; and
- $440,200 in 2014.
During the same period of time, the financial industry has increased its value added to GDP by $1 trillion in current prices, from $2.5 trillion in 2005 to $3.5 trillion in 2014.
On the job-creation side, though, the financial industry seems to suffer from the same reluctance that is holding back manufacturing. In 2005 there were almost 8.2 million people working in the financial industry; in 2014 that same number was 147,000 people lower. That said, since its recession bottom of 7,678,000 employees the industry has regained 318,000 jobs.
There is one more sector that deserves a note. Of all the major industries, mining produces the highest per-employee value: $528,000 in 2014. Furthermore, with a value-added increase of more than ten percent per year and a job growth of 4.2 percent annually, mining strongly contributes to our economic recovery.
To sum up, there is growth almost in every corner of our economy. It is a ho-hum recovery, but it remains relatively steady and it has no doubt replaced the recession as the “norm” of the economy. This is good, but things can get better. While it is unrealistic to expect stellar growth rates for the United States when both China, Europe and Japan are in recession mode, at the very least we can squeeze another percent in annual growth out of the economy.
How could we that happen? Well, that is the question for another day. For now, relax and enjoy the ride.
This the third installment about the current state of the U.S. economy analyzes consumer spending and consumer credit. Since private consumption constitutes almost 70 percent of GDP, it is of fundamental importance to have an essential understanding of how households spend money – and how they finance that spending.
As I noted in the first part of this article series, consumption as a share of the U.S. GDP has risen in recent years, claiming an almost four percentage points larger share of the economy today than it did 15 years ago. In the second part I explained that…
as the sole engine pulling the industrialized world forward, the United States is doing a reasonably good job. More details from the GDP growth numbers reinforce this conclusion. There is, e.g., private consumption which over the past three years has averaged 2.1 percent in annual growth. For 2014, though, the preliminary growth rate was 2.5 percent, a good but not excellent number. Underneath it, though, is some good news: spending on durable goods – household appliances, automobiles etc – has averaged 6.5 percent per year since 2012. This means two things: American families are improving their credit scores again after taking a beating in the trough of the Great Recession; and they are more optimistic about the future.
One of the concerns with strong growth in durable-goods spending is that it will come at the price of rising household indebtedness. Fortunately, American families in general are not going down the debt lane; perhaps having learned from the mortgage circus before the Great Recession, they seem to be holding back on overall borrowing:
- In 2008 American households had a gross debt of $14.2 trillion, equal to 133.1 percent of their disposable income;
- In 2010 their debt was down to $13.9 trillion, pushing the debt-to-income ratio down to 124.3 percent;
- In 2012 those numbers were down to $13.6 trillion and 110.6 percent, respectively.
In 2013 household debt started increasing again, exceeding $14 trillion (by $61bn) in Q3 of 2014, the first time in almost five years. The debt-to-income ratio continued to slide, flattening out at 107.7 percent inQ2 and Q3 of 2014.
However, a more detailed look at household debt shows a relationship between debt and spending on durable goods. The small rise in household debt since 2013 is due to a rise in consumer credit, i.e., the kind of borrowing that is, e.g., often used to buy cars.
After the deep dip during the opening of the recession, U.S. consumers soon regained confidence and began spending on long-term items. Almost immediately the ratio of consumer credit to disposable income started rising again. After it bottomed out at 21.4 percent in 2010 the ratio has increased steadily since then. The latest numbers reported by the Federal Reserve is 24.8 percent for Q3 2014.
Since 2010 durable-goods spending has grown by, on average, 4.9 percent annually in current prices. The growth rate for disposable income is almost exactly the same. Theoretically, this means that consumers should not have to increase their indebtedness as they spend more on durables, but the explanation for that increase is not by any means illogical. While the consumer credit ratio has increased, the ratio of mortgages to disposable income has declined steadily:
- In 2008 the ratio was 97.3 percent;
- In 2010 it had fallen to 90.7 percent;
- In 2012 it was down to 77.6 percent.
By Q3 2014 it had declined yet more, to 71.8 percent. Compared to the mortgage-to-income ratio of 2008, U.S. households have $4.7 trillion less in mortgage loans today. This opens up for the opportunity to borrow for other purposes, such as car loans.
It is encouraging to see that American households are better off and feel more confident about their future. All is not well, of course, but the slowly improving debt situation combined with the confidence in spending on durables is yet another encouraging sign that our economy is slowly moving down the right track.
Yesterday I reported some data showing that the U.S. economy is in good shape from a structural viewpoint. Household spending and business investments – domestic private-sector activity – today absorb a larger share of output than they did under the Bush Jr. administration. Government consumption and investment spending has taken a step back, and the foreign trade balance is in better shape today than at the height of the Bush business cycle.
Today, let’s look at the same macroeconomic data from another perspective.
2. A strong growth pattern
In terms of inflation-adjusted growth, the U.S. economy is doing relatively well. GDP growht is not great – but these numbers from 2009-2014 are far better than what we can find anywhere in the developed world:
- 2009 -2.76 percent
- 2010 2.53 percent
- 2011 1.6 percent
- 2012 2.32 percent
- 2013 2.09 percent
- 2014 2.41 percent
When an economy grows faster than two percent per year it provides opportunities for people to achieve a standard of living higher than what previous generations have accomplished. Growth below causes stagnation or even a decline in the average standard of living.* From this perspective the American economy is just about keeping its nose above the water. It could do much better, but two factors are holding us back: the Obama administration’s affinity for heavy-handed regulations, and the combined global effects of a China in recession, a Europe in stagnation and a Russia in Ukraine.
In other words, as the sole engine pulling the industrialized world forward, the United States is doing a reasonably good job. More details from the GDP growth numbers reinforce this conclusion. There is, e.g., private consumption which over the past three years has averaged 2.1 percent in annual growth. For 2014, though, the preliminary growth rate was 2.5 percent, a good but not excellent number. Underneath it, though, is some good news: spending on durable goods – household appliances, automobiles etc – has averaged 6.5 percent per year since 2012. This means two things: American families are improving their credit scores again after taking a beating in the trough of the Great Recession; and they are more optimistic about the future.
This optimism is corroborated by encouraging employment, which we will get to in the fourth and last part of this series.
But there is even more good news in the GDP growth numbers. Gross fixed capital formation (GFCF or business investments) has averaged a growth rate of 5.7 percent per year over the past three years. Even better: the growth rate is stabilizing. In the figure above, investments fluctuate wildly:
- Down 26.4 percent in Q2 of 2009;
- Up 21.1 percent in Q3 od 2010;
- Growth plummets to 1.3 percent in Q3 2011;
- Next growth peak is 13.5 percentin Q1 2012.
From thereon the amplitude declines, forming a “confidence cone” where the annual rate stabilizes around 5.7 percent per year. A good number, the stability of which makes it even more impressive.
At the same time, no story of capital formation is complete without a detailed look at what kinds of investments businesses make. Here, again, there is an encouraging pattern of stability. Fixed investment falls into two categories, non-residential and residential, with the former constituting about 80 percent of total fixed investment. In this group spending is divided into structures, equipment and intellectual property products. Again the proportions between the different categories remain stable over time, with the equipment category representing 45-47 percent of non-residential investments.
While homes construction was weak in 2014 – growing by only 1.64 percent – it finished strongly in the fourth quarter at 2.6 percent over Q4 2013. But the residential investment numbers for 2012 and 2013 were downright impressive: 13.5 and 12 percent, respectively.
Finally, a word about government spending. Many people unfamiliar with national accounts make the mistake of looking at total government outlays as share of GDP, whereupon they understandably get outraged about how big government is. However, in order to understand the role of government properly one has to remove the financial transactions from government spending: GDP only consists of payments for work – by labor or capital – or for products. A financial transaction such as a cash entitlement does not pay for work or products, and therefore has no place in GDP.
The government spending included in GDP is payments for teachers in public school, police officers and tax collectors, as well as products such as tasty lunches for middle-school kids and gasoline for the presidential motorcade. It is also investments such as new highways and faster trucks for the postal service.
This kind of government spending has actually been shrinking in the past few years:
- 2011 -3.04 percent;
- 2012 -1.45 percent;
- 2013 -1.49 percent; and
- 2014 -0.18 percent.
All in all, then, the U.S. economy is in reasonably good shape. This does not mean that cash entitlements such as food stamps are not a problem. They are. But with this stable macroeconomic foundation the U.S. economy is well suited to handle reforms to entitlement programs.
Check back after the weekend for the two remaining installments in this series.
* The two-percent mark is arrived at through an adaptation of Okun’s Law. See:
Larson, Sven: Industrial Poverty – Yesterday Sweden, Today Europe, Tomorrow America; Gower Applied Research, London, UK 2014.
The U.S. economy stands as a contrast to the European misery. This is particularly interesting given the fact that the United States has a president that came into office with the most radical statist agenda since the FDR presidency. In fact, President Obama still gets a lot of criticism from libertarians and conservatives for his ideological stance. Some of that criticism is no doubt well deserved, but there are areas where the president has earned more accolades than he gets.
In fact, if you listen to the common conservative wisdom about Obama, we have an economy that is on the verge of being socialized. That may very well be correct when it comes to regulatory incursions and irresponsible environmental policies, including the legislative monstrosity known as the Affordable Care Act. But beyond regulations and the occasional run-amok entitlement program, Obama’s economy has been reasonably good.
Last summer I expressed my appreciation of how well the American economy was doing given the circumstances – see the first, second and third parts – with particular emphasis on the permanent nature of the nation’s economic performance. In the third part I explained:
If the spending growth that drove the GDP number were of a more transitional nature, then I would agree with [the skeptics]. But … the numbers indicate strengthening confidence among consumers and entrepreneurs. It is very likely, therefore that this is a sustainable recovery. Not a perfect recovery, but a sustainable one. We should be happy for it. After all, things could be much worse. We could be Europe.
The most recent GDP numbers, covering all of 2014, point in the same direction. Let us go through them in four parts.
1. The composition of GDP
A healthy economy is heavily dominated by private-sector economic activity. Europe’s welfare states are dominated by foreign trade and government spending. Consequently, unemployment is almost twice as high as here in the United States, GDP is barely growing and the general economic outlook is dystopic.
As shown in Figure 1, the U.S. economy is better structured today than it was 15 years ago. In the fourth quarter of 2014 private consumption constituted 68.1 percent of the U.S. GDP (measured in 2009 chained dollars). That is up from 64.2 percent in Q1 1999. Under the first six years of the Obama presidency private consumption has averaged 68.1 percent of GDP. Compare that number to the 66.9-percent average under Bush Jr.
Another piece of good news is that gross fixed capital formation – business investments in street lingo – have returned to a healthy level of 15+ percent of GDP. At 17.2 percent in Q4 of 2014, investments are far higher than the 12.5-percent share they commanded five years earlier.
On this front the Obama years have not been quite as good as the preceding eight years under Bush: business investments under Bush averaged 17.7 percent of the economy, compared to 15.2 percent under Obama. That said, by global comparison American corporations are fairly confident in the future.
There are two more components of GDP, in both of which the Obama years have been better for the economy than the Bush years:
- Net exports, the balance between exports and imports, averaged -4.8 percent per year under Bush. The Obama years have thus far shown a better foreign trade balance, with a net exports only -2.9 percent per year. A smaller foreign trade deficit, in other words.
- Government consumption and investment has been smaller under Obama. This may come as a surprise to many, but since Obama took office federal, state and local spending has been, on average, 19.6 percent of the economy. The Bush years saw relatively more government spending, at 20.2 percent.
It is important to understand that these government-spending figures do not include cash entitlements and other financial outlays. To qualify as a GDP expenditure, a dollar must be spent either on compensating someone for work or on making an investment that, in turn, pays people for work. If I buy a share in Coca Cola it does not count toward GDP, but if Coca Cola builds a new production line it does count toward GDP.
With this qualification in mind, we can again conclude that Obama’s first six years have not done too much damage to the economy. On the contrary, the private sector continues to grow, government is showing some restraint and our perennial balance-of-payments deficit is actually in better shape than it has been in 15 years.
There is a lot more to be said about the current state of the U.S. economy. This is the first installment in a four-part series.
How much time does the euro have left? That question was put on its edge last week when the Swiss National Bank decided it was no longer going to anchor the Swiss franc to the iceberg-bound euro ship. It was a wise decision for a number of reasons, the most compelling one being that the euro faces insurmountable challenges in the years ahead.
In fact, the Swiss decision was de facto a death spell for Europe’s currency union. More specifically, I noted that the euro…
survived the Greek depression of 2012 by a razor-thin margin. Now it faces three very serious threats to its own survival. The first is the upcoming Greek elections, where anti-austerity, anti-euro, pro-Hugo Chavez Syriza looks like winners. Should they emerge victorious they could very well initiate a Greek exit from the currency union. The euro would survive that, and the German government has a contingency plan in place to stabilize the euro. But then there is the Greek government debt… Syriza has openly declared that they want “debt forgiveness” for governments throughout Europe. If the drachma is reintroduced, it will very likely plummet vs. the euro, making it exceptionally difficult for Syriza to repay its loans to the EU and the ECB. A default is within the realm of the probable; remember the Greek “debt write down” three years ago.
If all the problems for the euro were tied to Greece, the currency would indeed have a future. But there are so many other challenges ahead for the common currency that nothing short of a miracle – or unprecedented political manipulation – can keep it alive through the next three years.
The biggest short-term problem – Greece aside – is the pending announcement by the ECB of its own Quantitative Easing program. Reuters reports:
The European Central Bank will announce a 600 billion euro sovereign bond buying program this week, money market traders polled by Reuters say, but they also believe this will not be enough to bring inflation up to target. In the past two months traders have consistently predicted that the ECB would undertake quantitative easing, considered the bank’s final weapon against deflation. Eighteen of 20 in Monday’s poll said the bank would announce QE on Thursday.
This highly anticipated European QE program must be viewed in its proper macroeconomic context. It is going to be very different from the American QE program. For starters, the balance between liquidity supply and liquidity demand was very different in the U.S. economy than it is in the euro zone today. After its initial plunge into the Great Recession the American economy slowly but relentlessly worked its way back to growth again. Since climbing back to growth in 2010 the U.S. GDP has grown at a rate slightly above two percent per year. This is not something to throw a party over, but it has allowed the economy to absorb much of the liquidity that the Federal Reserve has pumped into the economy.
By being able to absorb liquidity, the U.S. economy has avoided getting caught in the liquidity trap. Growth rates have been good enough to motivate businesses to increase investment-driven credit demand; households have gotten back to buying homes and automobiles (car and truck sales in 2014 were almost as good as in pre-recession 2006).
The European economy does not absorb liquidity. It is stagnant, and has been so for three years now. The ECB has pushed its bank deposit rate to -0.2 percent, in other words it is punishing banks for not lending enough money to its customers. Despite this ample supply of credit there are no signs of a recovery in the euro zone, with GDP growth having reached the one-percent rate once in three years.
In other words, the positive outlook on the future that motivates American entrepreneurs and households to absorb liquidity through credit is notably absent in the European economy. When the ECB now evidently plans to pump even more liquidity out in the economy, it appears to not understand how significant this difference is between the euro zone and the United States.
Or, to be fair, with all its highly educated economists onboard, the ECB most certainly understands what role liquidity demand plays in an economy. Its pending decision to launch a QE program appears instead to be based in open ignorance of the lack of liquidity demand.
Which leads us to ask why they would ignore it.
The answer to this question is in the declared purpose of the QE program. If it is aimed at buying treasury bonds, then the QE program clearly is not designed to re-ignite the economy, an argument otherwise used. If QE is supposed to monetize government deficits, then its purpose is really to secure the continued existence of the European welfare state. If that is the purpose, then the only safe prediction is that there will be no end to QE before the welfare state ends.
That, in turn, means the ECB would be stuck monetizing deficits for the rest of the life of the euro. Which, under such circumstances, would be a relatively short period of time…
More on this on Thursday, when the ECB is expected to announce its QE program. Stay tuned.
The production of macroeconomic data from the European Union for the last two quarters of 2014 is a bit slow. The main source, Eurostat, took until last week to release GDP data for the third quarter, though that was under ESA 2010 standards. We are still waiting for the “modernized” versions to be released.
According to the “older” series, which I reported on last week, economic stagnation continues to hold Europe in an unforgiving chokehold. A look at unemployment statistics – which is updated faster than national accounts data – confirms this picture:
Regardless of what configuration Europe is given – the EU as a whole or the euro zone – its unemployment rate is not where it should be. Before the Great Recession, U.S. unemployment was almost half of what it was in Europe; after a brief period of declining jobless rates, Europe experienced a long period of unrelenting increase. In fact, as Figure 1 shows, European unemployment has been creeping upward for five years, from mid-2008 to mid-2013.
It remains to be seen if 2013 actually was the peak, and if 2014 represents the beginning of a long-term decline. There is no underlying trend in GDP or any of its individual components to hint of a real recovery. Here, the European economy stands in stark contrast to the U.S. economy, where unemployment has been falling, albeit slowly, since 2010.
All is not dark as night in Europe, though. Some countries have seen a drastic decline in unemployment since the peak. Measured from the first quarter of 2013 through the third quarter of 2014, the unemployment rates in…
Hungary fell by more than a third;
Lithuania declined by almost one third;
Estonia, Poland and Portugal have plummeted by about one quarter;
Bulgaria, Czech Republic and the U.K. are down by just over one fifth.
Despite these reductions, rates are still disturbingly high in many countries. Here are the EU member states with an unemployment rate higher than the U.S. rate of 6.2 percent:
|Unemployment, EU States, Q3 2014|
While it is good to see that “only” a quarter of all Greeks were unemployed in Q3 2014, as opposed to 28 percent a year ago, it should also be noted that unemployment was lower in 2012 when their economy was plunging like the Titanic after she hit the iceberg. In Q3 2012 the Greek unemployment rate was 25 percent exactly.
Spain, with Europe’s second-highest unemployment rate, saw its peak in early 2013 at 26.9 percent. They are now back where they were in 2012, but the decline is very, very slow.
Cyprus is actually still in the phase where unemployment is increasing. It is unclear if the same is true for Croatia, where unemployment has been fluctuating between 14 and 18 percent – averaging 16.6 – over the past three years. What is clear, though, is that there is no downward trend in the Croatian unemployment rate.
Fifth on the list is Portugal, where unemployment topped at 17.8 percent in Q1 2013 and has been moving down very slowly since then. To their credit, the Portuguese have seen a slow improvement in GDP growth, from an annual, inflation-adjusted rate of -1.4 percent in Q2 2013 to one percent in Q3 2014. Greece and Spain have seen similar improvements:
The Spanish improvement is predominantly driven by exports. The same is ostensibly true for Greece and Portugal as well, in which case the case for a lasting improvement is basically non-existent. A more detailed examination of national accounts data will give us a more detailed picture (stay tuned).
The small decline in Europe’s notoriously high unemployment reported above is far too weak, far to little to indicate anything beyond a temporary easing of the social and economic pressure that comes with large segments of the labor force being unemployed for years.
Welcome back to The Liberty Bullhorn – the starting point of economic freedom on the internet!
While this year is promising for many, especially Americans who have a steadily improving job market to search for new opportunities, the outlook on the new year is hardly better in Europe today than it was a year ago. As far as Europe is concerned, 2014 went down in history as the year of squandered hopes for a recovery. I have lost track of all the forecasts that predicted “the” recovery take-off during last year, though it would be valuable for future reference to collect all the “squandered hopes” forecasts. There is a lot to be learned from the serial failures of econometrics-based forecasting during 2014.
The reason why Europe is nowhere near a recovery is that its political leadership is doing absolutely nothing to address the fundamental structural problem of their economy. The welfare state is still in place and its austerity policies have been driven by an urge to save the welfare state – make it slimmer and more affordable – so that it can fit inside a smaller economy with high unemployment and weak tax revenues. But it is precisely these efforts that have escalated the current crisis to a level where – as I explain in my book – it has now become a permanent state of economic affairs.
So long as Europe’s leaders refuse to acknowledge the nature of the economic crisis, they will continue to inject the patient with the medicine that perpetuates the illness.
There are some lights in the tunnel, for sure. The Greek economy has, of late, shown signs of transitioning from an almost unreal ratcheting down into an economic depression to a state that is at least a little bit promising. Its vital macroeconomic signs indicate stagnation rather than decline, which is hardly something to write home about, but good news for people who on average have lost 25 percent of their income, their jobs, and their standard of living since the beginning of the Great Recession.
Sadly, just as the Greeks were being given an opportunity to catch their breath, their elected officials went ahead and caused an early parliamentary election to be held in late January. If current opinion polls are correct, the next prime minister will be Mr. Tsirpas of the Syriza party – a radical socialist group that considers deceased Venezuelan president Hugo Chavez and his authoritarian government a good role model.
Greece does not need an economic model that has caused high unemployment, eradicated property rights and brought about 63 percent inflation. Greece needs major free-market reforms, thoughtfully executed and coupled with growth-generating tax cuts.
But Greece is not the only EU member state that is struggling. France is going nowhere, and going there fast. The socialists in charge in Paris stick to their tax-to-the-max policies, which is part of the reason why the country is going into 2015 with record-high unemployment. Economic forecasters, perhaps burned by last year’s irresponsibly positive predictions, now expect a 0.4-percent increase in real GDP for 2015. That is much more realistic.
Overall, when predicting Europe’s future, one should not ask “when is the economy going to recover?” but “what reasons do the European economy have to start growing again?”.
Again, there is not much positive to look forward to for our European friends. However, it is better to talk about things the way they are, and then find a solution to the problems thus identified, than to pretend that everything is really not what it really is.
Europe has a lot of potential. It could join us here in America and restore prosperity, hope and opportunity for the entire industrialized world. If Europe chooses to do so, we have a future to look forward to that is almost unimaginably positive.
If, on the other hand, Europe’s political leaders stick to their statist guns, their continent will continue on its current path to becoming the next Latin America. It will no longer be even close to comparison with the United States, whose economy will continue its ho-hum economic recovery through 2015 and 2016. Beyond that, it depends entirely on who is elected president next year. If it is a Republican friendly to Capitalism, like Rand Paul or Mitt Romney, we will know for certain that there will be good, growth-promoting tax and spending reforms. A more mainstream-oriented Jeb Bush or Chris Christie would also be good, but not only second-tier good.
Even a fiscally conservative Democrat would be preferable to the kind of leadership they have in Europe.
Hopefully, there can be some libertarian-inspired change for the better in Britain thanks to the seemingly unstoppable UKIP. Maybe – just maybe – that could inspire a surge of support for libertarian ideas elsewhere in Europe.