*This post has been published in the blog NGDPAdvisers.
Justin Irving | Bloomberg’s Noah Smith, while rarely worth reading, is usually among the least-bad writers at what once was a serious financial news outlet. However, his post on Bloomberg last week: “Why the US economy is having a boom” is wrong enough to call for a response. In this post, Smith makes the case that the US economy is having a boom, and then goes on to detail what lies behind this boom. Before going through his case, let’s start by asking the question: “Is the US economy in a boom?”
The word “boom” evokes some temporary period of above-average economic growth. The Roaring 20s, the plentiful 50s and 60s and the Dot Com era. Because booms are characterized by unexpected levels of economic growth, asset prices, which had not priced in the growth, rise sharply. Is this what is going on today? Not quite.
While it is true growth is better today than anyone would have guessed in 2015, it is hardly unusual for the US economy.
The chart below shows the OECD’s “activity rate” (labor force participation) for US males aged 25-54. Looking at only relatively young males, it controls for changes in fertility and the propensity of women to stay home with their children.
The chart shows that male labor force activity is near an all-time low, at about 89%. Since the 1960s, male labor force activity has historically fallen after recessions and then flatlined at the new lower level, before falling again in the next recession. This seems to be the case with the current expansion. Some may respond that declining male activity is a long-term trend, due to complex sociological factors. Fair enough, though this still begs many questions and puts the notion of a “boom” into doubt right away.
Let us take the Manufacturing component of the Industrial Production index, next. Oil production is currently boosting the headline IP index, but this important component is still well off the pre-recession peak. Activity has recovered from the Fed-induced 2014-2016 growth slump, but the US in aggregate is making fewer widgets and gizmos in 2018 than it was in 2007, despite having about 10% more people. As Trump might say: “sad”.
The chart below shows the Kansas City Fed’s labor market index. Here things look better, as the index is back to the level of 2007, though below the level of 2000, the last time the US was widely considered to be in a boom.
A quintessential feature of the prosperous US economy was, historically, homeownership. Let us see how new home sales are doing…not so hot as the chart below shows. Again, despite a bit less than 1% population growth per year, and the short shelf life of much of the 1990s and 00s “McMansion” housing stock, Americans are buying fewer new houses today than they were in 1994.
Instead, the millennial generation, laden with student debt, largely unmarried, broadly underemployed and often drug-addled, are opting for the Khrushchyovka experience. Is it typical for booming economies to feature a young adult cohort living with roommates in cramped rental units?
The economy is certainly stronger than it has been since late 2008, no doubt about it. Powell was a good pick for Fed chair and the markets got a strong ‘supply side’ signal in November 2016, but this is not a boom, not yet at least. Instead, the US is bouncing back toward where it should have been, following a long, incomplete recovery from the great recession. The economy was permanently injured by that long period of inadequate activity, and we are just now getting a little bit of belated ‘physical therapy’. When you have been sick for a long while, just being normal feels like a superpower, but today’s economy is not anything special, not by a long shot.
Back to Smith. His case for calling it a boom:
“A broader measure, the prime-age employment-to-population ratio, is back to 2006 levels. Meanwhile, real gross domestic product growth for the second quarter was just revised up to 4.2 percent. Corporate profits are rising strongly. And investment as a percentage of the economy is at about the level of the mid-2000s boom”
He points to prime-age employment-to-population ratios, which are well below the late 90s boom, and he does not control for gender. Yes, this series is climbing and will presumably reach pre-recession levels in the next year, but reflects record low fertility among millennial women, offsetting the decline in male participation, a problem that will haunt the US economy in coming decades. He also oddly points to the investment share of GDP. Yes, this series is toward the high end of its post-recession range but is still below the 2015 peak, which was hardly a boom time. Both nominal and real GDP are growing, but let’s book a few years of 3%+ RGDP growth before crowning this a “boom”.
Smith goes on:
“Wages are still lagging. But all other indicators show the U.S. economy performing as strongly as at any time since the mid-2000s — and possibly even since the late 1990s.”
We have already shown this is not true. Despite population growth, manufacturing production and home sales are below pre-recession levels; broad labor market conditions are “solid”, but not “great”. He should have pointed to auto sales, which are at least strong.
“Which raises an interesting question: Why is this boom happening?
That is an almost impossible question to answer. Fundamentally, economists do not know why booms happen. It is possible that there is not even such a thing as a “boom” at all — that this is just how the economy works under normal circumstances when there is not a recession or crisis to throw it off its game. But it is possible to identify some factors that might — with the emphasis on “might” — be contributing to the strength of this economic expansion.”
There is no mystery here, and economists, at least some of them, have more or less figured out the modern market economy. Garett Jones taught us that potential growth is largely set by the relative proportion of a workforce that is composed of high ability people. The More Jeff Bezos or just plain old smart, reliable workers you have, the better you will do long term.
Milton Friedman (and Ben Bernanke, though not intentionally) taught us that, regardless of potential, monetary policy causes recessions and can work to keep an economy depressed for years. Donald Trump, or at least the business coalition that has his ear, finally, taught us that policy priorities at the top also matter.
One last bit from Smith:
“The first is low interest rates. The Federal Reserve kept short-term rates at or near zero for almost a decade after the financial crisis, suppressing long-term rates in the process. That, in turn, lowered borrowing rates for corporations and mortgage borrowers, which tends to juice investment.”
Statements like this are almost enough to make a Market Monetarist consider substance abuse. Anyone who has read the Market Monetarist space in the last decade knows that interest rates are just not that important an indicator.
As Friedman said, rates are typically low when the economy is depressed! Low rates did not do a damn thing for the better part of a decade. Then, when we got a business-focused administration and a Fed boss who knew better than to throw too much cold water on hopeful markets, things took off. Businesses do not invest unless they think there will be customers for their investments, regardless of how low rates are. Moreover, housing has been, and continues to be, a big disappointment.
Noah goes on to make more insensible statements, but let us not dwell on this farce.
The potential proto-boom we are seeing is mediated by monetary policy, there is no mystery. Yes, Trump’s tax cut and his red-tape-cutting approach have probably helped keep inflation lower than it might have otherwise been, possibly allowing for a bit more growth, but at the end of the day, it is about monetary policy. We know this because NGDP is rising faster, and NGDP only goes where the Fed lets it.
Money has to change hands for transactions to take place and that is captured in nominal GDP, our key indicator. The Fed controls the creation of money in the US, and through that awesome privilege, steers markets, investment and hiring.
Powell’s approach has been less to do things, but rather to not do bad things; to not throw cold water on an excited market. The market has gradually had its early enthusiasm vindicated and it now looks like 4.5% to 5% NGDP growth is something the Fed will tolerate. This is not a boom, this is normal, only we had forgotten what normal felt like.