The Economy As We Know It: November 2016

By Brian Gongol

The economy as we know it

There is a lot of money that has been "saved", but it's still not being put to especially good use as "investment"

Even after small increases this year, prevailing interest rates remain at the lowest levels in more than half a century.

Conventional wisdom has it that bonds are the "safe" category for investment, but they aren't earning any significant return, nor are any other savings-like investments. In the words of Warren Buffett, "savers have just been killed" by low interest rates.

Corporations are borrowing more money than ever, and they are adding to their borrowings at an increasing rate.

Those exceptionally low interest rates are among the factors chasing money into the welcoming arms of a stock market that is still well above its condition 5 years ago. American stocks aren't cheap by normal measures -- and that worried Federal Reserve chair Janet Yellen well over a year ago.

American non-financial companies have a total net worth of about $22.5 trillion, up by almost $1.5 trillion from a year ago.

There's lots of "saving" going on, but there's not a lot of real investment in things that will make the economy grow quickly in the long term. That's a problem.

Orders for durable goods, for instance, are only at their levels from just before the 2008/2009 financial panic, even though the trajectory for the economy at large has been upward since then. The amount of durable-goods spending has been mostly flat for almost five years.

President-elect Donald Trump's threats of new trade restrictions (including tariffs and "renegotiated" trade agreements) could force American companies to spend on unproductive investments instead of using efficient global supply chains. If domestic production had been efficient, it would have been preferred over outsourcing. Government intervention to force companies to "re-shore" their production will force some of them to invest in plant and equipment that do not have competitive advantages in the global market.

There is very good reason to worry about inflation

The velocity of money has never been lower in modern times, and it keeps trending downward. In other words, we need some spending to go around. Too much money is just sitting around without doing any good.

When that velocity speeds up, inflation will become a serious risk unless the Federal Reserve can pull the very large amount of money pumped into the economy off the table and raise interest rates.

A big money supply doesn't cause inflation if the velocity of money is low (the equation MV=PQ explains this: the amount of money [M] times the speed it's spent, or velocity [V], equals the total amount or quantity [Q] of economic activity times the price level [P]). But the minute that velocity picks up -- and it has to, eventually -- the risk of inflation becomes very high if the quantity of money stays high.

Donald Trump creates a big, new political risk that has a magnified effect on inflation: He has openly threatened to use inflation to devalue the Federal debt.

By running on an anti-importation platform, Trump has positioned himself on the side of a weak dollar (which is generally good for exporters and bad for importers).

Additionally, Trump's campaign promises advocating borrowing for hundreds of billions of dollars in infrastructure spending could involve lots of spending not backed by tax collection or other government revenues. This would increase the need for Federal borrowing, which could force the government to pay higher interest rates on new debt.

Higher interest rates paid by the Federal government would compound the already giant problem of interest as a portion of the Federal budget. Extraordinarily low interest rates have masked the scale of the problem: Any return to higher interest rates will cause it to enter a negative feedback loop, causing it to become an accelerating problem.

Big issues surround demographic and generational issues. Unusual circumstances have only postponed them a bit.

If interest rates rise, investors (particularly older ones) may worry about those high stock valuations, sell shares ("taking gains"), and put that money into the higher perceived safety of bonds.

Baby Boomers are probably becoming net sellers of stocks, not net buyers.

Many millennials and other young workers are unhealthily skeptical of the stock market. This probably has some effect that depresses stock prices.

Demand from foreign investors is expected to create some demand on the opposite side of the exchange for American companies and assets (and shares of stock).

The effects on real estate could be interesting; low interest rates have certainly subsidized a lot of real-estate purchases and construction, which can be seen in both the spike and subsequent hangover in farmland prices in places like Iowa (also spurred on, of course, by the ethanol boom), as well as anecdotally -- as in the boom in construction of some pretty outlandish new high-rises in New York City.

Farm prices keep slipping as commodity prices drop.

The Manhattan commercial real estate market is overheated, and residential real estate prices have been on a steady rise that outstrips inflation. Both indicate that more investment is going into real estate than would normally be economically efficient.

The rest of the world looks financially ugly, making the United States look prettier than we deserve.

The US dollar has strong buying power overseas, which is probably aggravating our already enormous trade deficits by disproportionately incentivizing imports.

Those trade deficits mean that America's net investment position is severely negative -- that is, foreign owners have taken a great deal of cash earned through exports to the United States and reinvested it in purchases of American assets.

Global political and legal uncertainty makes the United States artificially more attractive to the rest of the world's investors than it would otherwise be, leading to sustained net capital inflows to the United States.

The energy boom being experienced right now is artificially cushioning our economy, and we don't know how long the energy-related stealth stimulus will last

Low energy prices will serve to destabilize politics in Iran, Venezuela, Russia, and other countries, leading to unintended and unforeseen consequences

We should have serious concern about the future because we're not investing enough in the things that will make us more productive in the long term

There are no signs of increased investment in occupational education and training (the BLS appears to have collected no data on this topic for 20 years).

There are no signs of increased investment in capital equipment/durable goods.

We are seeing strong and growing evidence of the departure of Baby Boomers from the workforce.

Perhaps most worryingly, the threat of trade restrictions (and retaliations) and economic nationalism brought on by the incoming Trump administration could very easily cause the economy to become substantially less efficient.

These factors combined suggest that we're starving the economy of the things that would lead to higher productivity, which we will need more than ever as the population curve shifts in favor of more retirees. The fewer adults who are working, the more output we need to get from the workers who remain.

Moreover, the departure of experienced workers, if not carefully addressed with plans to capture and retain institutional memory, leads to skills gaps and shortages.

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