17 November 2016

A Stimulus, a Boom and White Men Dancing: an economic forecast to the end of the decade

The economy is going to sing for at least the next couple of years. After that, its performance will depend on the extent to which Donald was lying during his campaign.

The following is what I would write if a completely normal, centrist president were coming into office.

First of all, the economy is primed for take-off. Debt servicing as a percentage of household income is at the lowest on record. Initial unemployment claims are too (if measured as a percentage of the labor force). P/E ratios are high but not unreasonably so given how low interest rates are. Unemployment rate is under 5% and last year wages grew more rapidly than any year on record. This economy has been and is doing all the right things. And it will just get better.

The long-term prospect for the economy is even more impressive. The millennials and younger are entering the work force now at a rate faster than baby boomers are leaving it and this new generation of workers is the best educated ever. Also, when the economy has been healthy for five years or more, good things start to happen. Wages grow. Wealth is created. Entrepreneurs become bolder. And speaking of that, entrepreneurship education and awareness continues to rise and a record number of millennials want to become entrepreneurs.

Perhaps the biggest threat is in China where the economy is now going to force government liberalization or the government is going to stifle economic disruption. It's not clear which way that will go but it can make a big difference in global economic growth. Africa and India have the potential to compensate for China's woes but depending on which way it goes, this could still make a noticeable difference.

The next four years will be great and it's perfectly plausible that unemployment will drop below 4% within two to three years. We might even see the uninterrupted run of positive job creation run out another four years, as absurd as that sounds.

Now here is how I would adjust that for Trump. 

Short term, Trump changes this for the positive. Why? Congress will cooperate with him and he'll probably double the deficit from last year. This stimulus in the form of infrastructure spending and tax cuts will be a boost to the economy and could bump GDP growth up another half point or even full point. It is the expectation of this bump that is likely driving stock prices higher right now. The GOP knows that increasing the deficit will stimulate the economy and that is exactly why they wouldn't approve of it while Obama was in office. They don't actually care about deficits but do holler about them whenever they think that a Democrat might get the benefit of one.

Is this stimulus bad? No, but it's not great. The economy can handle the debt and will benefit from the boost. The capacity for debt is huge with interest rates so low and so much capital in search of either returns or a safe home. The problem is, the stimulus doesn't do nearly as much for the economy when unemployment is already under 5%. Party politics aside, it would have been so much better to have given the economy this bump about 3 to 6 years ago. This stimulus will be like white men dancing: the timing is off and it'll be awkward to watch in spite of the joy on the faces of the people doing it.

The stimulus won't be great though because it'll come in the form of tax cuts that mostly go to the rich. If you give a man making $20,000 an extra $1,000, he'll spend it. If you give a man making $2,000,000 an extra $1,000 he's unlikely to change his behavior at all; very little of the extra money is likely to increase spending. It's a stimulus that will do as much to promote income and wealth inequality as it does GDP. And a stimulus does less with the low unemployment we now have than it does with the kind of high unemployment we did have. If the the stimulus went to the poor instead of the rich or went into government programs, it would raise GDP by probably 1%; as it is, it might just bump it by half a percent.

As with George W. Bush, Trump will be running a big deficit with full employment. This is exciting initially but tough on an economy long term. It leaves it vulnerable because if the economy dips a little, there's not much you can do. At that point it's like Scotty calling up from the engine room of the Starship Enterprise saying, "I'm giving her all I've got, captain." And eventually, every boom busts and when it does, the bust is always worse when you've already been running a big deficit.

Meanwhile, Trump may be waving his hands or he may be acting on his campaign promises. If we're lucky he'll just be waving his hands pretending to act and he was lying about what he would do with trade,  with American companies who subcontract work abroad and with illegal immigrants. If he's not, the little boom will become an ugly bust.

It will take at least a year - probably two or three - before Trump can re-negotiate trade deals, begin to deport illegal aliens, and to change laws so that it is harder for American companies to find subcontractors outside of the US. If he's lucky - and it seems that he always is - the negatives of this won't hit until close to or even after re-election time and most people won't believe that he's setting the economy up for trade wars, a loss of 3% of the population and GDP, and an exodus of American companies to other countries. (It would be ironic if American companies re-located to Mexico, a place with low taxes and newly deported people who are great workers, and laws that make it easy to subcontract work to other places - even the US.)

But 3 to 5 years is a long time and when the Trump recession hits, none of his supporters will blame him because things were so good in 2017 and 2018.

The good news is that the next couple of years at least will be great. The bad news is that people will think this is proof that Trump's bad ideas were good rather than realize that an economy's momentum is such that today's realities are almost always a function of policies and actions taken at least a year - and often a decade - earlier. (And I'm not just talking about government policies. They're also the product of corporate policies that define next generation products, factories, and R&D initiatives years earlier.)

If Trump does what he promised, he'll blow up the economy. Even that will take at least 3 years. If he waffles on his promises, the economy could do pretty well in both the short term and long.

I don't say this because I am a fan of Trump. Putting aside the morality of it, deporting 11 million aliens alone is enough to set off a recession; that's nearly 4% of the population and that kind of exodus will disrupt home prices, sales, and entire industries. If he starts trade wars or attempts to control multinational corporations ability to buy and sell in other countries, he'll knock employment and GDP growth for a loop yet again. Longer term, his stance on immigrants is going to make the next Sergey Brin - the co-founder of Google - think twice about coming to the US for education and stay for a startup. Further, his rejection of climate change as a real issue won't just set us back on addressing what is the most important issue of our time but it'll set us back on the industries that will become to the 21st century what oil was to the 20th century. And of course his rejection of the first amendment in the form of a ban on Muslims will have all sorts of negative consequences. Sadly, these issues play out on a time scale that almost no one evaluates when making decisions about who to vote for and may not be fully evident in four years.

The central problem with the above forecast, of course, is that no candidate has entered office surrounded by more uncertainty. 80% of what he said while campaigning was somewhere between a half-truth and a pants-on-fire lie, so it's almost impossible to know what he'll do after the tax cuts are put in place. We can hope that he's limited by practical concerns; of course if he is, it'll be a first for him and the people around him but it'll be great for an economy so ready for a long boom.

There are a few added layers of uncertainty in the above forecast. The first is the unpredictability of what Trump will do. The second is what Ryan and Congress will let him do. The third is the general reaction of global markets to his Twitinomics, or policy by late night tweets.

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