Many of the indicators are flashing: economies across the world, especially the US, are booming, stock markets flirting with new record highs. But what next?
Booming, but will the US economy soon be drooping?
US consumer confidence, according to the closely watched Conference Board index, recently hit a new 17-year high. The latest purchasing managers indexes (PMIs) tracking the US economy were almost as good – the PMI tracking US manufacturing and produced by ISM rose to a 14-year high, hitting 61.3. It’s sister index, tracking US non-manufacturing was up too, this time to 58.5 – impressive, but not quite in the rarefied air that the manufacturing index is now occupying. Together, the two indexes point to annualised growth in excess of five per cent.
The US labour market is booming too, with a 201,000 rise in non-farm payrolls in August, and with unemployment now at just 3.9 per cent.
US Consumer Confidence from December 2003
Source: Conference Board
All this is reflected in the markets: The S&P 500 hit a new all-time high on August 29th – 2,914 – and is currently around 37 points off that record.
Brent crude oil passed $80 a barrel back in July, its highest level in around three years, and is now just a few cents short of $80.
President Trump predicted that he would get the US economy growing at five per cent plus; it seems that is close to happening.
Indeed, in Q2 of this year, the US economy grew by 4.1 per cent, annualised.
Amazingly, the US economy is in the midst of the second longest run of uninterrupted economic growth since the end of World War II.
The US president says that the US economy has never been stronger. In a way that is true. US GDP, after allowing for inflation, has never been higher. But then, except during a recession, or its immediate aftermath, the US economy is always bigger than ever before.
It is worth bearing in mind that US GDP grew at a similar pace to the rate seen in Q2 during the latter period of the Obama presidency.
There is a good reason for the rapid growth in the US economy. History tells us that economies often see exceptionally rapid growth during a period when they have fully recovered from a recession. The recession that began ten years or so ago meant that the US economy was producing well below full capacity – it’s is now making up for all that ground that was lost during the recovery period from the 2008 crash.
The US economy should be booming, and it was predicted here, on several occasions, that it would.
The question is, is the recovery sustainable?
The big doubts are simple enough to articulate.
The markets are looking a bit frothy. The bigger fear, though, is that the US economy could be overheating.
US inflation was at 2.9 per cent in both June and July – we should get the figures for August in a few days. More worrying still, US core inflation, that’s without food and energy, was 2.4 per cent in July, a decade high.
According to the latest US jobs report, average hourly earnings rose 0.4 per cent in August, which lifted the annual rate of wage rises to a nine-year high.
There is nothing surprising in these figures. The US economy is close to full employment, but it is still growing rapidly – higher inflation, and thus higher interest rates are what you would expect. We have been going through a period of abnormal economic conditions; it seems that things may be returning to a more predictable path.
Except, that is for the Trump effect – this has added an unpredictable element. I have two fears:
Firstly, protectionism. It is not just the US imposing tariffs, and the rhetoric coming from the US on international trade, the US is also undermining global institutions, set up during the aftermath of World War II in an attempt to create a more stable world. Among the victims of Trump’s wrath is the WTO – World Trade Organisation, in which the hard Brexit camp in the UK has invested so much hope. One of the key reasons, maybe the key reason, why interest rates have been so low for the last 20 years has been globalisation. If this goes into reverse, we may see real interest rates start to trend much higher, with private sector debts at record levels, I don’t think that the economy can cope with higher real interest rates are sustainable.
Secondly: fiscal stimulus at a time of near full employment. President Trump is boosting the US economy with tax cuts at a time when it is close to full employment. The last time either a UK or US government tried that approach was in the early 1970s and it ended in tears – a surge in inflation and much higher interest rates.
The only way the Trump stimulus will not lead to higher inflation and interest rates is if, since the tax cuts are typically targeted at the rich, we merely see a rise in savings, distributing debt from the private sector to the public sector, with a neutral effect on the economy, or if the so called fourth industrial revolution leads to a sharp rise in productivity.
Talking about productivity, US non-farm productivity recently rose at an annualised rate of 2.9 per cent – that is good, although not enough to make the recent economic growth look sustainable. More to the point, the last 12 months has seen US non-farm productivity rise by a trivial 1.3 per cent.
Capital economics has recently predicted that rising protectionism will push down on equities between now and the end of next year, that US economic growth will slow sharply next year, as boom turns to bust. In turn, it expects US interest rates to be cut next year, the oil price to fall but industrial metal prices to rise.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees