posted on 07 October 2016
Written by Jim Welsh
Macro Factors and their impact on Monetary Policy, the Economy, and Financial Markets
Macro Tides Investment Outlook - October 7, 2016
More voters are disillusioned and dismayed than ever before with the candidates in this election. According to Time Magazine, 88% of would-be voters in the upcoming Presidential election describe themselves as angry, and not because they saw The Angry Birds Movie.
Most would probably agree we deserve better. But do we? In the last ten elections, less than 58% of registered voters bothered to vote, which means those newly elected Presidents had the support of less than one-third of the electorate.
Freedom is a privilege earned by assuming the responsibility to vote in every election. That responsibility extends to becoming knowledgeable and informed about the issues. Most people are born into a family that supports either the Democrat or Republican Party. Once someone identifies themselves as a democrat or a republican, they ‘know’ how to vote on each issue in every election. By the time they are old enough to vote, the political indoctrination they have received is fairly complete.
The concept of critical thinking, of challenging their political beliefs is never considered since they have been programmed on the issues from the time they were born. This is why Hillary Clinton and Donald Trump (and most politicians before them) get away with making promises they will never keep. The faithful of each party nod and wink and give their candidate a pass. It is more difficult this year for members of both parties to do this, which is why so many would-be voters are angry. Still, it’s far easier to give their party’s candidate a pass than to learn about issues like trade or how over-regulation impedes economic and job growth. Compared to fantasy sports leagues, reality T.V., and the number of likes our last Facebook posting received, all the stuff that will affect the quality of life most Americans will experience is just so boring! In life, we get what we pay for and deserve who we vote for, especially in this election.
Economics and the Election
The economy affects more Americans directly and indirectly than any other issue. It can either be the tide that lifts the standard of living of most Americans or an uphill slope that leaves too many working Americans running in place. Median income is still below the peak set in 2000, which has left many workers worse off despite 16 years of hard work.
In the October 28, 1980 debate between Ronald Reagan and Jimmy Carter, Reagan posed this question:
An updated version would ask whether you are better off than sixteen years ago. Since median income is also below the lower peak in 2007, many Americans would answer they aren’t better than nine years ago either. A late September poll found that among supporters of Hillary Clinton and Donald Trump, only 33% said they would be happy if their candidate won the election. Since 2000, the U.S. has had 8 years of a Republican in the White House and almost 8 years with a Democrat at the helm, but more than half of working Americans are worse off than they were in 2000 and 2007. It is no wonder so many voters are angry and frustrated. Most voters believe their choice will come down to which candidate is the lesser of two evils.
At last count, there were more than 322 million Americans. Most estimates suggest there are 11 million people living in the U.S. who entered the U.S. illegally, which is less than 4% of the population. According to the Centers for Disease Control (CDC) and Guttmacher Institute (GI), the number of abortions in the U.S. has declined from 1.6 million in 1990 to just over 1 million in 2015. At this rate, abortion affects about 0.6% of the population if the mother is also included. The number of transgender people in the U.S. is estimated to be .5% of the population, so the issue of transgender bathrooms is small.
I apologize if this statistical analysis has offended anyone. I respect that those directly involved with the burdens of immigration, abortion, or transgender identity feel strongly about these issues. My goal is not to minimize these issues but to compare them to how many people are affected by the economy.
When the economy does poorly the top 10% of wage earners are affected, just like everyone else. For them, though, a recession is more of a temporary setback since this group has savings and assets to ride out the storm. For the top 1%, a poor economy is more of an inconvenience than a hardship. For the remaining 90%, a weak economy poses real challenges and hard choices. For the bottom 50%, weak economic growth becomes sacrifices, anxiety, and suffering. In terms of priorities, the economy should be the most important issue since it materially affects more than 80% of the population. As Bill Clinton’s campaign strategist James Carville said in 1992:
If that’s the case, why do Hillary Clinton and Donald Trump spend so little time discussing the one issue that will affect the vast majority of Americans, rather than trading personal barbs that may incite the faithful but are a waste of time? That’s not to say that both candidates have not put forth plans that they claim will spur economic growth. Let’s evaluate one from each candidate and determine whether or not their proposal will have a positive effect on economic growth and Americans’ living standards.
Trade Lifts Economic Growth and Extends Consumers Purchasing Power
Between 1980 and 2007 global trade grew more than 6% annually. According to the World Trade Organization (WTO), over the long term world trade has usually grown 1.5 times as rapidly as total global growth. During the period of rapid globalization in the 1990’s, trade grew twice the rate of global GDP. Without a doubt, trade was a powerful positive force that lifted global GDP for more than 2 decades, and the standard of living for almost 1 billion workers around the world.
Consumers in the U.S. benefitted from the lower cost of goods manufactured overseas, imported into the U.S., and sold at Walmart to almost 100 million American shoppers every week. This helped stretch the paychecks of workers whose wages haven’t grown since 2000. Although this has been a significant benefit to the majority of American consumers, it isn’t visible to most shoppers and so goes unnoticed and underappreciated. In contrast, the loss of good paying manufacturing jobs garners headlines. For those who lost their job and livelihood, or forced to accept a job that pays 20% or more lower just to find employment, the growth in global trade was not a blessing.
The large increase in trade since 1980 was facilitated by numerous global trade agreements between countries around the world, including the U.S. If these trade agreements were so bad or unfair, why did trade and global growth increase so much? The obvious answer is trade agreements have not been unfair overall, despite job losses in the U.S. and other advanced economies. Clearly, more emphasis on job retraining programs in the U.S. and other advanced economies could have helped workers displaced by trade. The lack of political foresight over the past 30 years in addressing this problem does not overshadow the overall benefit of trade for the U.S. and global economy.
Since 2012 global trade has grown just over 3% per year, less than half of the average of the previous three decades. Trade has stopped being the engine of growth, which is one reason why global GDP growth has slowed. The WTO lowered its forecast for global trade in 2016 on September 27 to just 1.7% in 2016 and 1.8% in 2017. These estimates were down from the April WTO estimates of 2.8% and 3.6% respectively.The International Monetary Fund has concluded that ordinary economic weakness, including a “synchronized slowdown in economic activity" through much of the world and the lack of business investment, is responsible for as much as three-quarters of the decline in trade since the 2008 financial crisis. The IMF also said the lack of new trade agreements and shrinking supply chains had shaved 1.75% a year off global trade since 2012. The cumulative impact of these factors is that cumulative global trade volume is almost 8% lower than it otherwise would. Since 2008, trade in the largest 20 economies as a percent of GDP has fallen from 27.8% to 26.5% in 2015.
New IMF research shows an uptick in trade barriers in the last several years that may already be weighing on trade growth. (See next the chart second from the end of this article.) Statement from the IMF:
As the Great Depression was taking hold, the United States passed the Smoot-Hawley Tariff Act on June 17, 1930. The Act placed tariffs on 20,000 imported goods in an attempt to protect American jobs. Our trading partners were quick to respond with their own tariffs on American imports into their countries. Within three years, world trade plummeted 63.8%. Protectionism clearly made the Depression worse.
Since global trade plays a more significant role in the global economy today, any move toward protectionism could have a more profound impact now on the global economy than in the 1930’s.
The Trans-Pacific Partnership (TPP) was negotiated among a dozen Pacific Rim nations, including the U.S. and Japan. Hillary Clinton was in favor of TPP before she was against it, which appeased Bernie Sanders supporters. Donald Trump is also against TPP, but has made trade a centerpiece of his campaign. Trump has denounced trade in general and NAFTA in particular calling it the worst trade deal in history.
Trump has called for a tariff of 35% on imports from Mexico and 40% on goods imported from China. Donald Trump has called China a currency manipulator, accused China of “raping" the U.S., and has said China is responsible for “the greatest theft in the history of the world." Although the Chinese Yuan has declined -9.6% versus the dollar since February 2014, it has gained a net 15.0% versus the Dollar since 2007. The accusation that China is a currency manipulator is factually untrue.
The Japanese Yen is down roughly 25% against the Dollar since October 2012, more than double the Yuan’s -9.6% decline since February 2014, yet Mr. Trump has not discussed the Yen. Nor has Mr. Trump mentioned the 20% decline in the Euro versus the Dollar since May 2014.
China has run a huge trade deficit with the U.S. for years, despite the 15% appreciation in the Yuan since 2007. The bulk of America’s trade deficit with China is powered by demand for less expensive goods from American consumers. The savings U.S. consumers reaped from cheaper Chinese imports allowed consumers to spend their savings on other goods and services that contributed to U.S. growth.
Imposing tariffs on Chinese imports will succeed in raising consumer costs and not bring jobs back to the U.S. If Trump’s 40% tariffs were enacted, a product that cost $10.00 last week would cost $14.00 next week with the difference paid for by U.S. consumers. Some of these consumers are Trump supporters who don’t understand how Trump’s tariffs would adversely affect their pocketbook. In response to a 40% tariff, Chinese companies would shift production to Vietnam, Malaysia, or other low-cost producers. Job creation from the proposed tariffs in the U.S. would be minimal.
The non-partisan Peterson Institute was founded by Peter Peterson. He was Commerce Secretary under President Nixon, former Chairman of the New York Federal Reserve, and certainly no liberal loony. After analyzing Donald Trump’s trade proposals, the Peterson Institute made this assessment:
The Peterson Institute also criticized Hillary Clinton’s opposition to the Trans-Pacific Partnership. According to Adam Posen, President of the Peterson Institute:
Donald Trump is running for President and trade is a major part of his campaign, with an emphasis on using the threat of steep tariffs as a lever to renegotiate prior trade agreements. History has proven that tariffs and protectionism are poor economic policy. It fails to protect jobs but succeeds in slowing domestic and global economic growth. Mr. Trump must know this if he is as smart as he says. His supporters say he really doesn’t mean what he says. I grew up believing that a man is only as good as his word, which means saying what you mean and meaning what you say.
Economic Policy and Wage Growth
In the prior 10 post-World War II recoveries, average hourly earnings averaged an annual increase of 3.3%. In the recovery since June 2009, average hourly earnings have grown just 2.2% per year. In other words, average hourly earnings on average grew 50% faster in the prior recoveries compared to the current recovery.
As discussed previously, median income is below the peak in 2000 and the lower peak in 2007. While telling, the median income figure doesn’t reveal what has been going on. The chart below illustrates how real income (adjusted for inflation) has grown since 1968 for all wage earners, broken down by quintiles (each quintile is 20%) and the top 5 percent.
Earnings for those in the top 2 quintiles (top 40% of households) exceeded the prior peaks in 2000 and 2007 in 2015. Households in the bottom 3 quintiles are still below the 2000 peak-middle quintile -2.2% (40%-60% of households), 4th quintile -6.5% (20%-40% of households), bottom quintile -11.7% (0%-20% of households). It should be noted that those in the bottom 3 quintiles have benefitted the least from the current recovery. (Chart and table courtesy DShort.com)
This helps explain why the movement to increase the minimum wage has resonated and gained traction. On the surface, an increase in the minimum wage sounds fair and appropriate. A closer look raises a number of questions and suggests the negative unintended consequences may outweigh the benefits. According to the Bureau of Labor Statistics, 1.53 million hourly workers earned the Federal minimum wage of $7.25 in 2013.
Another 1.8 million workers earned less than the minimum wage because they earned tips, were full-time students, or disabled. The 3.3 million workers earning the minimum wage or less represented 4.3% of the 75.9 million hourly-paid workers and 2.6% of all workers in 2013.
More than half earning the minimum wage (50.4%) were between 16 and 24 years old. This means 2.15% of hourly-paid workers and 1.3% of all workers were over 24 years old in 2013. Although decent job growth has continued since 2013, the ratio of hourly workers wouldn’t be much different in 2016. This is another issue where media fanfare seems disproportionate to the small number of affected workers.
The increase in the minimum wage to $15.00 would not distinguish between teenage workers and those over 24. I doubt many employers will be willing to pay a 16 -18-year-old, with little or no experience, $15.00 an hour. Many teenage workers are likely to find it far more difficult to get a job and begin to learn the employment basics: showing up for work on time, learning to follow instructions, and experiencing the satisfaction of earning a paycheck. Employers will give their existing workers, who have already been trained, more working hours, rather than hiring an inexperienced worker at the same pay level. In 2014, the nonpartisan Congressional Budget Office (CBO) estimated that an increase in the minimum wage from $7.25 to $9.00 would result in the loss of 100,000 jobs. If it was raised to $10.10, the job losses would soar to 500,000, the CBO reported. The negative impact would be far worse it was increased to $15.00 an hour nationally. Why?
A Federal mandated minimum wage of $15.00 fails to address the large disparity in the cost of living in different parts of the country. A $15.00 minimum wage may be appropriate in New York, Chicago, and Los Angeles. But in many rural areas, that have a much lower cost of living, a $15.00 an hour minimum wage will only succeed in burdening small businesses in general, and putting a lot of small Mom and Pop small businesses out of business. A $15 minimum wage would increase labor costs and force businesses to increase their prices. The Fed might be happy with a bit more inflation, but consumers would find their paycheck wasn’t stretching as far. A smarter approach would be to index the minimum wage to a cost of living benchmark by county.
A worker who is older than 24 is far more likely to be supporting a family or paying for their education, than someone under 20 years old. This brings up an interesting question. Should minimum wage workers older than 24, supporting a dependent, or paying for college, qualify for a higher minimum wage than the base minimum wage, currently $7.25? I think so.
If workers attending college are paid a higher minimum wage, they might not have to depend as much on student loans, which is a good thing for them and the U.S. government, which has already guaranteed $1.3 trillion in student loans. The total in student loans significantly exceeds auto loans and credit card balances.
According to the New York Federal Reserve, as of April 2015, 17% of student loans are either in default (11%) or delinquent (6%). Only 37% of borrowers are current and paying down the amount of their loan. There is a high probability that the default rate will increase in coming years and cost the Federal government (taxpayers) several hundred billion dollars. A higher minimum wage for workers attending college might shift some of the coming student loan losses from taxpayers to employers who pay working students more.
There is no question that President Obama inherited an economy that was reeling when he took office in January 2009. A few economists and Democratic partisans have suggested the weak recovery can be explained by the lasting effects of the financial crisis. However, research of prior significant recessions and subsequent recoveries does not support this thesis. In fact, the research found that recoveries after a large decline in GDP were followed by better than average growth.
In their research paper entitled “Rare Events and Long Run Risks", Harvard Economics professor Robert Barro and Tao Jin examined macro-economic disasters in 42 countries since 1870, featuring 185 contractions in GDP per capita of 10% or more. What they found was that deep declines were followed by strong recoveries that grew twice as fast as the decline in the first two years of the recovery. Rather than per capita GDP growth of 1.5% in the first two years of the recovery from mid-2009 and mid-2011, growth should have been 3%. In their view the subpar growth was due to the government’s dependency on income transfer programs. Federal social benefits to persons as a percent of GDP grew from 8.7% in 2007 to 11.7% in 2010.
Increased income transfer payments do not promote productivity growth. No surprise then that productivity has averaged only .5% from 2010-2015, far below the 1.5% per year average from 1949 to 2009. The authors are not in favor of the increase in the minimum wage, believing it is inefficient regulation, since young and less experienced workers will be priced out of the labor market. The result - unintended job losses.
In a 2007 paper Federal Reserve economist Alison Felix used data from the Luxemborg Income Study, which tracks individual incomes across 30 countries. The analysis found that a 10% increase in corporate tax rates reduced wages by about 7%. In a 2009 paper Ms. Felix found that states in the U.S. with higher corporate tax rates had significantly lower wages, (ironically) especially for union workers.
The American Enterprise Institute gathered international tax rates and manufacturing wages in 72 countries over 22 years. Their analysis found that increases in corporate tax rates are for the most part paid for by workers receiving lower wages. In May, Canadian economists Kenneth McKenzie and Ergete Ferede found that when corporate tax revenue was increased by a dollar, wages dropped by more than a dollar.
Intense competition has been fostered by globalization which has made it difficult for companies to increase the price of their goods and services. This is one reason why inflation has remained low, despite extraordinary monetary accommodation by every major central bank. The level of corporate tax rates matters in a global economy, which is why a number of U.S. companies have moved their headquarters to other countries with far lower tax rates. Among 188 countries, the U.S. has the third highest corporate tax rate in the world at 35%, according to the Tax Foundation. While some companies are able to utilize the tax law to lower their tax burden, most can’t and none can compete with Ireland’s 12.5% tax rate, or other country’s low tax rates. In terms of global competitiveness, U.S. companies are at a substantial disadvantage, since taxes are a cost of doing business. Taxes are no different than labor and material costs, and help determine the price of every service or good sold. Of course, if a politician has never owned or managed a business, they probably don’t fully understand or appreciate this reality.
Empirical research covering many countries indicates that a reduction in corporate tax rates would result in an increase in wages. A reduction in U.S. corporate tax rates would reduce the incentive for multi-national corporations to move their headquarters overseas. If tax rates were lowered significantly, corporate inversions might be eliminated. A change in corporate tax policy would thus protect jobs and over time bring some jobs back to the U.S. An increase in the minimum wage to $15.00 an hour as discussed will help just 1.5% of the labor force, but will likely hurt an equivalent percentage of young workers in need of their first work experience and the small businesses that have traditionally employed them.
A review of the Democratic platform reminds me of an old saying. “Don’t let the existence of facts cloud my opinion." Here’s an excerpt from the platform statement:
Hillary Clinton is running as a modern-day Robin Hood, who will raise taxes on the rich, put the screws to corporate America in general and especially Wall Street and pharmaceutical firms, while raising the minimum wage, expanding social security, offering college for free, establish universal health care, and generate 50% of our energy from clean energy within 10 years! Mrs. Clinton’s pandering to just about every constituency is breathtaking and almost as problematic as Mr. Trump’s proposals for trade.
Analysis by the nonpartisan Congressional Budget Office found that an increase in the minimum wage to just $9.00 an hour would result in job losses, and hurt small businesses in rural areas particularly hard. If democrats were serious about stopping multi-national corporations from shipping jobs overseas, all they have to do is lower corporate tax rates. It would also help if they educated their constituents that lower tax rates would either result in higher wages for workers or lower prices for consumers since tax rates have a direct bearing on wages and product prices.
The Social Security Trustees, the agency overseeing the Social Security program, released their annual report on the health of the Social Security program in June 2016. The Trustees reported the unfunded liability had grown by about 6.5% in the prior twelve months, from $10.7 trillion to $11.4 trillion. The Trustees project the Social Security program will be insolvent in 2034, at which point benefits will need to be cut by 20%. The current payroll tax of 12.4% of earnings is split between the employee (6.2%) and the employer (6.2%).
To address the 75-year shortfall in the program, the payroll tax rate would have to be increased to almost 15% immediately. Any increase in the social security tax rate would subtract 1.3% of a worker’s pay (7.5%-6.2%=1.3%), which could prove problematic for those living paycheck to paycheck. Even eliminating the payroll tax ceiling from its current level of $117,500, would only fix 71% of the long-term funding shortfall. Expanding social security now would be like a driver whose car is heading for a cement pillar, deciding to step on the gas rather than breaking.
Making college free would boost enrollment and demand, which would cause the cost of a college education to continue to rise faster than incomes and inflation, as it has for the past 30 years. Most students can’t graduate in four years because they can’t get into the classes they need. Only 36% of students at four-year colleges graduate in four years, and most end up taking six years to get their bachelor's degree, according to Complete College America, a non-profit organization. Offering students a free college ride would drive up the total cost paid for a college education. The higher cost would be paid by taxpayers, or by increasing the amount of federal debt. It would also slow graduation rates to more than six years.
Of course, Mrs. Clinton was initially for free trade and the Trans-Pacific Partnership, until she realized she needed Bernie Sanders’ supporters in order to win.
Given the choice voters have in this year’s Presidential election, the only thought I have comes from the very good movie “Sully’. Brace for impact.
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