Michael Wilson hears a wailing and a gnashing of teeth. Is it all just in his own head?
Can you hear that funny noise? That high-pitched whining sound, like a gearbox that’s been pushed a bit too hard and needs to cool down for a bit? That faint, disturbing chatter of invisible teeth? That ominous grumbling from deep in the works that says that this really shouldn’t be happening, but somehow it is?
Yes, I thought so. It’s the unmistakeable sound of sour-faced newspaper pundits trying their very hardest to process the fact that President Donald Trump’s America has somehow failed to descend into chaos under the new management. And that, despite the worst efforts of an administration that’s still at war with itself, the US economy is genuinely growing at an annual rate of more than 3%. And that unemployment is down around its historical low, at just 4.1%. And that US businesses are in good heart.
And that, barring major political accidents, Donald Trump is heading into next November’s mid-term elections with an economic record that certainly looks impressive. Even though his 33% satisfaction ratios among the population at large are the lowest for any first-term president since records began.
Drat and double drat, as Dick Dastardly from the Wacky Races would undoubtedly have said (am I showing my age here?). Time to think again, Muttley. But which of us will be over the mountain and across the finish line first? Aaah, that’s still to be decided…..
Let’s start by being generous. Donald J Trump inherited an economy in which nobody had been doing much for the little man (or indeed the hard-working middle class) for more than twenty years. Real incomes for most had stagnated or fallen, while the share of the profits going to the top 1 per cent continued to increase. And his peculiarly distant Democrat predecessor, the heavily intellectual Barack Obama, had failed to communicate any real level of engagement with the growing concern.
Looking back, it was an open goal. Trump didn’t need to produce proof of his plans to reinvigorate the slower parts of the US economy when he approached the US electorate in November 2016; all he needed to do was promise to improve the lot of the working man, and the blue-collar states would fall into line to vote for him.
For a while, we cynics were able to sniff that the Trump plan would come to nothing as soon as the average American understood that there was no plan, apart from handing out tax breaks to the employers and borrowing private sector money with which to rebuild the country’s tattered, outdated transport infrastructure. At the same time, we said, the cost of imported consumer goods would soon rise, thanks to Trump’s import tariffs and the much weaker dollar which would be bound to ensue.
But then something awful happened. The dollar weakened by up to 15%, the import tariffs started to bite, and Trump’s tax reform was passed by Congress. And even though its benefits went straight to the 1 per cent rather than to the workers, nobody noticed. The party started, retail sales soared on a tide of cheap new credit, and American households’ savings ratio dropped from a ten year average of around 6% to just 2.4% in December 2017. That wasn’t as bad as Britain’s pathetic 1.7%, but we at least had the excuse that our economy was under pressure.
Smoke, mirrors and the dollar
And all the while, the stock market boomed, of course. President Trump hasn’t hesitated to claim personal credit for the 18% growth in the S&P 500 index in the 13 months since his inauguration, but he tends to forget that President Obama presided over a somewhat more impressive 176% growth during his 96 months in the White House, while Bill Clinton had made 211%. (An unlucky George W Bush had seen the index fall by 39.5% during his blighted reign.) Keep hold of those figures, folks, and we’ll see how they compare as the future unfolds.
One of the points that Americans forget is that their enthusiasm for Wall Street doesn’t always translate to foreign investors. The dollar slid by 14% against the pound during the 13 months to end-January, and by 15% against the euro. Which would have meant that few equity investors would have seen anything to match what they could have got by staying in their home markets. Hmmmmm.
Does Trump see the weak dollar as an unwelcome aberration? It seems not, if Treasury Secretary Steve Mnuchin’s boast to the January Davos conference is anything to go by. He is absolutely right to claim that a weak greenback is helping the trade balance by making American exports cheaper while imports get more expensive – but to portray it as a policy tool, as he did, is bound to sound a little unfortunate when it comes from a government that has railed so hard against both Germany and China for being “currency manipulators”.
Mind the gap
That accusation probably won’t trouble the White House too much. Apart from cars, where most foreign-owned US market models are built in America, the country has little enough to fear from foreign imports of consumer goods and services. It’s a great big country, and it’s hugely self-sufficient, especially now that it’s pumping its own oil. But what’s this?
As we were finalising this article, the news broke that the US trade deficit (including services) grew by 12.1% during 2017, reaching $566 billion – the biggest since 2008. And $375 billion of that was with China! So was that because of wicked Chinese currency manipulation? It seems unlikely, given that the renminbi had strengthened by 5.5% during 2017.
Is there a better explanation, then? US commentators are saying that America’s import surge ($2.9 trillion, against $2.3 trillion of exports) was the result of stronger consumer purchasing. And that’s where it gets interesting.
On the minus side, analysts are pointing out that the imbalance didn’t reflect the impact of Trump’s amended tax plan, because it hadn’t properly taken effect yet. And nor did it reflect any major changes in trade policy, because apart from a lot of huffing and puffing, the President had largely confined himself to threats which hadn’t been translated into policy. The inference that’s being made on all sides is that the retail party atmosphere is likely to grow bigger this year, and that the trade balance will worsen precipitately.
Is the Prez doing anything wrong?
I’ll come back to this theme in a minute, but bear with me while I look at the question of import tariffs and so forth. As we’ve said, there are almost none in force at the moment – give or take a recent tax on Chinese solar panels and washing machines. My guess is that Trump has no wish to deliver on his threats to impose 35% trade tariffs on China, Mexico or elsewhere, because that would force up consumer prices in a way that would hurt his prospects in the November elections. And it’s the poorest who buy the most cheap goods, obviously.
It wouldn’t be surprising if it all changed after November though. After all, protectionist trade practices are not entirely without president. (Sorry, precedent.) Ronald Reagan ran a very severe set of “voluntary” (ho ho) quotas against invading Japanese car and motorcycle manufacturers in the 1980s – indeed, new Hondas became so scarce in California that people were paying well over the odds for them.
But Reagan was trying to achieve something very specific – namely, to give the antiquated and lazy US auto industry a four-year designated break in which to get its act together and start producing competitive models. And when the protection period was over, he phased out the quotas. Does Trump have the self-discipline to do that?
Reagan was also a president who sought to enliven his country’s economy with a truly massive set of tax cuts and subsidies. After all, the Keynesian principle had worked well enough for America during the 1930s depression, so why not? But where the Gipper differed from Trump (and from George W Bush, for that matter) was that his largesse was intended only for a limited period – after which Reagan raised taxes again during his final term. If there are any clear signs that Mr Trump intends to pull back the $1.5 trillion on subsidies which he’s just handed out, then we’d be glad to hear of them. Until then, US businesses are surely running on an intravenous sugar drip?
Inflation: the bogeyman returns
And so we (or rather I) return to my point. The latest figures suggest that ordinary Americans are spending their substantial pay rises (up by an average 2.9% in January) on having a good time. This isn’t the place to debate whether the White House would have done better to spent its cash on health services instead – it’s simply where we are. But the big problem now is how the country will cope with the growing inflationary pressures. It’s all going to be a tough challenge for the new Federal Reserve chairman, Jerome Powell.
Mr Powell, who turned 65 the day before his inauguration on 5th February, has got a lot to do. On the one hand, he needs to rein in the Trump spending boom with a tighter bank rate policy, but without hurting the self-same Trump spending boom on which the November election may hinge.
If Mr Powell raises rates by a lot, he will put a huge damper on US businesses’ plans to develop and create new jobs. More importantly, though, he will boost the value of the dollar, which the boss doesn’t want – because it’ll make the trade deficit worse in a year when it’s already looking threatening. One way and another, it would be quite surprising if Powell’s career path runs any more smoothly than his predecessor Janet Yellen’s.
But here’s an interesting thought. Proper consumer-led inflation is something that the developed world has hardly seen in the last quarter of a century. Since the mid-1990s, all the talk has been about how to avert the threat from deflation. (Briefly, the worry is that if consumers think their new sofa will be cheaper next year, then they’ll defer the purchase and the sofa market will go through the floor, so to speak.) So are we ready for a new era? And do we even have the outdated skills in the financial cadres to know how an old-fashioned inflationary spiral works?
For enlightenment, I checked out the original prophet of the low-inflation world. Roger Bootle, who is now the executive chairman of Capital Economics, first shook up the world with his 1996 tome “The Death of Inflation – Surviving and Thriving in the Zero Era”, which was pretty much the set text on the subject until about three years ago, when he more or less declared the idea dead.
In a rather fine article for the Telegraph (https://tinyurl.com/y7arr4a2), the scholarly and careful Mr Bootle explains why he felt it was time to bury his idea. The rise of China, he says, has upset the traditional balance between the great economic powers by adding a new, powerful and “disruptive” force. (That’s my choice of word, not his.) As the severely rocking boat has grappled with its new occupant, it transpires that the new entrant is becoming rather rich, and suddenly it’s looking for places to invest its money, for a decent return please.
“That would be enough to raise the growth rate of aggregate demand quite decisively. Central banks would then shift away from nervously trying to boost demand to again seeing their job as restraining it. Once that shift has occurred, interest rates and bond yields will again be a few percentage points above inflation, thus giving a significant positive real interest rate.”
I doubt that Donald Trump would disagree. Although his views on “rapist” China buying up US Treasury bonds would presumably be unprintable.
Yet this is not the whole story either. All around the world – in America, in the UK, in the Eurozone – central banks are now preparing to wind back the quantitative easing programmes of the last decade. And the chances are that we’ve all long since forgotten just how big a contribution they’ve made to lowering interest rates and suppressing inflation. We are all going to have to reset the metrics of our expectations as this important new trend gets under way. And yes, it would be surprising if a few fringe operators didn’t come a cropper along the way. Will they be allowed to fail? You bet they will.
Calling the CAPE Crusader…
But let’s go back to the stock market, if we may. Donald Trump has declared, over and over and over, that the surge in US stock prices is the surest sign of his economic success. If he was ruffled by the deep setbacks that the Dow suffered in early February, then he managed not to show it. (Or maybe his minders just confiscated his Twitter account?)
But the fact that the sun is shining again doesn’t mean that all is necessarily well on Wall Street, or that Trump’s hubris is well-judged. The cyclically-adjusted Shiller CAPE index, the “affordability ratio” which tracks the inflation-adjusted price/earnings ratio of (usually American) stocks over a (usually) ten year period, is still squawking a red alert which nobody seems to be hearing at present.
At the time of writing in mid-February, the ten year Shiller figure for the S&P 500 was nudging 33, which was almost double its long-term mean of 16.8. It was also the index’s second highest level of all time – second only to 1999, when it had topped 44 before the 2000 panic had trashed the dotcom boom and put an end to the party.
It was as recently as January 2018 that the S&P CAPE figure overtook the 1929 pre-crash level. And it certainly looks doesn’t look good against London’s more modest figure of around 18, or rip-roaring Hong Kong’s 21. (Figures for end-2017 from Barclays’ international comparison site at https://tinyurl.com/yd7n7fbb.)
There’s plenty of room there for caution, it might seem. But hang on, say the bulls, that’s not entirely fair. The Shiller CAPE, like any other p/e ratio, can be distorted by periods of poor corporate earnings, which can make it a lagging indicator. And right now, the mid-2008 financial crisis is still in the ten year calculation. That ratio won’t look so stupid in the autumn when the panic has passed out of the calculations and vanished downstream.
Is there anything in this claim? One way to test it might be to calculate a nine year CAPE instead of a ten year one, and it’s already been tried. And it showed a figure of 28, which was still somewhat too high for comfort. So what’s a poor analyst to do?
Well, we could always try asking Professor Shiller himself. (Smacks forehead. Why didn’t I think of that earlier?) You can read Shiller’s January 2018 thoughts for yourself at https://tinyurl.com/ycanvlou. And what does he say?
Essentially, that the United States is an international anomaly, in that the historical pattern of past earnings growth, as reflected in his own CAPE calculations, doesn’t give any guide as to future profits. In fact, it’s the inverse – a poor earnings record implies that things will improve.
“That’s the opposite of momentum,” Shiller says. “It means that good news about earnings growth in the past decade is (slightly) bad news about earnings growth in the future” And vice versa! Oh, my aching head.
The way ahead?
But I started out by trying to be generous, and I’ll try to end in the same constructive way. Let’s assume that the US economy, which is operating at very nearly full capacity, doesn’t suffer the overheating problems which bedevilled the 1970s and 1980s, and that somehow it all works out for the best. There are two things which the world is waiting for.
The first is a commitment to better returns for employees, who have had a raw deal for many decades. That means, among other things, that company boards need to stop funnelling all their gains into their major shareholders’ pockets and start distributing the proceeds more fairly. It’s hard to see how that can be achieved without upsetting the pension funds and the institutional investors, but it’s got to happen eventually.
The second is that President Trump needs to come good on his much-hyped plan to rebuild the tatty infrastructure, and its antique industrial plants as well. From its broken-up highways to its steel mills and its heavily-lobbying oil refineries, the system is crying out for regeneration. Trump’s intravenous sugar-drip therapy may give the patient enough strength to achieve this without too much fuss. But it needs to be backed up by concerted, consistent and systematic leadership. Which is something we haven’t seen much of lately.
Michael Wilson is Editor-in-Chief at IFA Magazine