Around the world investors, businesses and central bankers are grappling with a startling fact: at the end of July Ameri
Posted: Sun Jul 03, 2022 4:27 pm
Around the world investors, businesses and central bankersare grappling with a startling fact: at the end of July America’seconomy will have been growing for 121 months, the longest runsince records began in 1854, according to the Rber, a researchbody. History suggests there will be a recession soon. And plentyof people are gloomy. Bond markets have been sounding the alarm, aslong-term interest rates sink below short-term ones, often aharbinger of a downturn. Manufacturing firms are wary; indices ofbusiness confidence are tumbling. Yet equity investors are stillbuoyant. The stock market is going gangbusters, rising by 19% sofar this year. And in June America’s economy created a whopping224,000 new jobs, more than twice as many as needed to keep up withthe growth of the workforce. The result is a puzzle that matters agreat deal. America’s economy accounts for a quarter of globaloutput, so if it stumbles the world will, too. But if it provesable to extend the cycle a lot longer, it may be time to rewritethe rules for how all rich economies behave.
The conflicting signals reflect an unusually sluggish andstretched expansion. Some of that is to be expected after the worstfinancial crisis in 80 years, but as our briefing explains, it isalso owing to deeper changes in America’s $21 trillion economy.Growth is slow but more stable as activity has shifted to servicesand intangible assets. Thanks to new regulations and the recentmemory of the bust, there are few signs of wild mortgage lending,over-investment or reckless financial firms. Inflation isremarkably subdued. These forces mean that a placid expansion cancontinue well beyond historical norms, but also suggest that theway it will eventually end will be different. Recessions used to betriggered by housing bubbles, price surges or industrial busts. Nowyou should worry about globally interconnected firms, a financialsystem addicted to cheap money and a political system that istoying with extreme policies because living standards are notrising fast enough.
Average GDP growth during this expansion has been amere 2.3%, much lower than the 3.6% that was seen in America’sthree previous expansions. That reflects some deep malaises. Theworkforce is ageing. Big firms hoard profits and invest less.Productivity growth has been slow. Robert Gordon, an economist,worries that America’s genius for innovation is flagging. Emojisand bitcoins are no substitute for breakthroughs such as jetengines or the internet.
That is the bad news. The good news is that the economy may beless volatile. A third of America’s 20th-century recessions werecaused by industrial slumps or oil-price shocks, according toGoldman Sachs. Today manufacturing is just 11% of GDP andeach dollar of output requires a quarter less energy than in 1999.Services have become even more vital, at 70% of output. Instead offickle factories and Florida condos, investment has shifted tointellectual property, which now accounts for more than a quarterof the total. After the searing experience of 2008, the value ofthe housing stock is 143% of GDP, well below the peak of 188%.Banks are rammed full of capital.
Most remarkable of all is very low inflation, which has averaged1.6% over the course of the expansion. In many past downturns, thejobs market overheated, causing inflation and leading the FederalReserve to hit the brakes. Today the dynamics are different. Theunemployment rate has fallen to 3.7%, close to the lowest in half acentury, but wage growth is only a tepid 3%. Workers have lessbargaining power in a globalised economy. The Fed’s credibilityhelps, too—most people believe that it can keep long-run inflationat about 2%. Given that racing prices are less of a worry and thatit lacks the ammunition to deal with a serious downturn, the Fed isbeing more active at signalling that it will ease policy whengrowth dips. This week the Fed signalled it would soon nudge ratesdown from today’s 2.25-2.5%, to keep growth going.
All this supports the idea that the familiar triggers forrecession are still absent and that the moderately good times canroll on for years yet. The trouble with this logic is that, just asthe economy has changed, so have the risks. Inevitably it is hardto identify exactly what might go wrong, but three new kinds ofproblems loom large.
First, America’s glossy corporate champions have unfamiliarvulnerabilities. Although fewer make physical goods, most rely onglobal production chains that are being shaken by the trade war(see article (Links to an external site.)). This isdepressing investment and could yet produce a shock—imagine ifApple was cut off from its factories in China. Tech firms,meanwhile, now account for a third of all investment by listedfirms, including intellectual property. Other businesses outsourcetheir need for services to a few giants. One of them,Alphabet, spent $45bn in the past year, five times more than Ford.But 85% of its sales come from advertising, which has been cyclicalin the past. It and other tech firms also face a regulatorystorm.
The second risk is financial. Although house prices and thebanks have been tamed, total private debts remain high byhistorical standards, at 250% of gdp. An edifice of assetprices and borrowing rests on the assumption of permanently low andstable interest rates, making it more fragile than it looks. Ifrates rise there will be distress among some firms, and trouble indebt markets—there was a sell-off in late 2018. If, by contrast,the Fed has to cut rates to near zero for a prolonged period tosustain growth, it could weaken the banks, as Europe has found.
A recession made in Washington?
The last danger is politics. As the economy has trodden a narrowpath, the boundaries of economic policy have been blown wide apart,partly out of frustration at a decade of sluggish wages. PresidentDonald Trump has tried to gin up growth, by cutting taxes andattacking the Fed. Most Democrats are keen to let rip on governmentspending. More extreme policies hover in the wings. On the left,modern monetary theory (a kind of money printing) and massive stateintervention are popular. One of Mr Trump’s new nominees to the Fedboard supports a gold standard. The greatest threat to America’slong and placid expansion is that a new era of wild policy may bejust beginning.
The conflicting signals reflect an unusually sluggish andstretched expansion. Some of that is to be expected after the worstfinancial crisis in 80 years, but as our briefing explains, it isalso owing to deeper changes in America’s $21 trillion economy.Growth is slow but more stable as activity has shifted to servicesand intangible assets. Thanks to new regulations and the recentmemory of the bust, there are few signs of wild mortgage lending,over-investment or reckless financial firms. Inflation isremarkably subdued. These forces mean that a placid expansion cancontinue well beyond historical norms, but also suggest that theway it will eventually end will be different. Recessions used to betriggered by housing bubbles, price surges or industrial busts. Nowyou should worry about globally interconnected firms, a financialsystem addicted to cheap money and a political system that istoying with extreme policies because living standards are notrising fast enough.
Average GDP growth during this expansion has been amere 2.3%, much lower than the 3.6% that was seen in America’sthree previous expansions. That reflects some deep malaises. Theworkforce is ageing. Big firms hoard profits and invest less.Productivity growth has been slow. Robert Gordon, an economist,worries that America’s genius for innovation is flagging. Emojisand bitcoins are no substitute for breakthroughs such as jetengines or the internet.
That is the bad news. The good news is that the economy may beless volatile. A third of America’s 20th-century recessions werecaused by industrial slumps or oil-price shocks, according toGoldman Sachs. Today manufacturing is just 11% of GDP andeach dollar of output requires a quarter less energy than in 1999.Services have become even more vital, at 70% of output. Instead offickle factories and Florida condos, investment has shifted tointellectual property, which now accounts for more than a quarterof the total. After the searing experience of 2008, the value ofthe housing stock is 143% of GDP, well below the peak of 188%.Banks are rammed full of capital.
Most remarkable of all is very low inflation, which has averaged1.6% over the course of the expansion. In many past downturns, thejobs market overheated, causing inflation and leading the FederalReserve to hit the brakes. Today the dynamics are different. Theunemployment rate has fallen to 3.7%, close to the lowest in half acentury, but wage growth is only a tepid 3%. Workers have lessbargaining power in a globalised economy. The Fed’s credibilityhelps, too—most people believe that it can keep long-run inflationat about 2%. Given that racing prices are less of a worry and thatit lacks the ammunition to deal with a serious downturn, the Fed isbeing more active at signalling that it will ease policy whengrowth dips. This week the Fed signalled it would soon nudge ratesdown from today’s 2.25-2.5%, to keep growth going.
All this supports the idea that the familiar triggers forrecession are still absent and that the moderately good times canroll on for years yet. The trouble with this logic is that, just asthe economy has changed, so have the risks. Inevitably it is hardto identify exactly what might go wrong, but three new kinds ofproblems loom large.
First, America’s glossy corporate champions have unfamiliarvulnerabilities. Although fewer make physical goods, most rely onglobal production chains that are being shaken by the trade war(see article (Links to an external site.)). This isdepressing investment and could yet produce a shock—imagine ifApple was cut off from its factories in China. Tech firms,meanwhile, now account for a third of all investment by listedfirms, including intellectual property. Other businesses outsourcetheir need for services to a few giants. One of them,Alphabet, spent $45bn in the past year, five times more than Ford.But 85% of its sales come from advertising, which has been cyclicalin the past. It and other tech firms also face a regulatorystorm.
The second risk is financial. Although house prices and thebanks have been tamed, total private debts remain high byhistorical standards, at 250% of gdp. An edifice of assetprices and borrowing rests on the assumption of permanently low andstable interest rates, making it more fragile than it looks. Ifrates rise there will be distress among some firms, and trouble indebt markets—there was a sell-off in late 2018. If, by contrast,the Fed has to cut rates to near zero for a prolonged period tosustain growth, it could weaken the banks, as Europe has found.
A recession made in Washington?
The last danger is politics. As the economy has trodden a narrowpath, the boundaries of economic policy have been blown wide apart,partly out of frustration at a decade of sluggish wages. PresidentDonald Trump has tried to gin up growth, by cutting taxes andattacking the Fed. Most Democrats are keen to let rip on governmentspending. More extreme policies hover in the wings. On the left,modern monetary theory (a kind of money printing) and massive stateintervention are popular. One of Mr Trump’s new nominees to the Fedboard supports a gold standard. The greatest threat to America’slong and placid expansion is that a new era of wild policy may bejust beginning.