No Upturn In Slowing U.S. Growth: ECRI Co-Founder Lakshman Achuthan

Includes: DIA, IWM, QQQ, SPY
by: Harlan Levy


Financial market turmoil a concern for the decelerating U.S. economy.

Structural reform, not low rates, the only way to get U.S., global growth.

Central banks must face reality: Low Interest rates don’t increase productivity.

Higher healthcare, rent costs undercutting consumers and their gas price break.

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Lakshman Achuthan is co-founder of the Economic Cycle Research Institute and editor of ECRI's forecasting publications.

Harlan Levy: A basic question seems to be will the turmoil in the financial markets infect the U.S. ECRO co-economy and stop it from its slow growth pace?

Lakshman Achuthan: Just to be clear, the growth of the U.S. economy has been slowing for over a year - really since the beginning of last year. So the question of whether stock market volatility is going to impact U.S. growth is tricky, because growth is already slowing. Can it slow further? Everything that we're looking at in our leading indicators says more slowing ahead. We don't see any clear signs of an upturn in U.S. economic growth.

Having said that, the stock market is not the economy, and, while I'm almost positive that people would be concerned if equity prices fell more, there have been times that equities have fallen without a recession. It's not impossible for that to happen.

Also, in the current environment consumers have a little bit of a reprieve with lower gasoline prices.

Sometimes you might wonder why people aren't happier about that, because gas prices have fallen quiet sharply. Part of the reason may be the pretty sharp increases that we've seen in the expenditures by people who rent their homes. A lot more people rent homes today after the housing bust, and what you see is a pretty big increase in healthcare spending in recent years.

For about a quarter of a century healthcare inflation was hovering around 4.5 or 4.75 percent. Then it ran all the way over 6 percent in 2013 and remains pretty close to that high. That's a sharp increase for people who are renters.

Almost at the same time, rents themselves have really soared, and rental inflation was hovering around 20 percent or in the low 20s and then around 2012 and 2013 it ran up well over 25 percent.

So some of the positive impact of lower gas prices has been eaten up by higher rent and health care costs.

That fits with the idea of economic growth continuing to slow and consumption also slowing.

H.L.: Another major question is how disruptive, how threatening to the U.S. economy and global economies is the current lack of coordination among the global economies and central banks?

L.A.: That's a good point. Basically, the world has been participating in a grand experiment involving many of these large central banks. The grand experiment is simply too big to fail.

In the U.S. you have the Federal Reserve embarking on its zero interest rate policy in 2008. Then it unleashed quantitative easing to depress interest rates further. Now it's trying to start a rate-hike cycle, and it's unclear if it will succeed.

You take a look at Japan, another example of a grand experiment. "Abenomics," named after the prime minister, was launched three years ago, promising to leave its lost three decades behind it. However, that also is really struggling, and that's generous in saying that. Japan has already experienced its fourth recession since 2008 in 2014. It barely avoided a fifth one in 2015.

And Japan's GDP number was minus-1.4 percent for the fourth quarter.

There you have a grand experiment that doesn't seem to be working too well. And the Bank of Japan took interest rates negative a couple of weeks ago in order to stimulate the economy. However, the yen continues to remain relatively strong.

Then you turn to China, and their efforts to pull the right levers at the right time. However, they don't seem to have the confidence of the markets. The Chinese stock market crashed since the summer, and there's a lot of exchange rate volatility, and a sharp slowdown in economic growth.

In Europe, including the U.K., they were also being very accommodative, trying to combat declines in long-term trend growth. That's not really possible with monetary policy. It's really a structural issue, hot a short-term cyclical issue, for which monetary policy is better suited. If you lower interest rates or increase liquidity you're trying to pull demand forward from the near future and to get people to invest today. But when you've been doing that for seven years there's not much left of future demand.

That's where you get into the question is how are these central banks coordinating things today. In Japan, where the rates have gone negative, in part to make the yen weaker, it hasn't really happened, because of the U.S. dollar getting weaker, as people recognize that U.S. growth is falling.

You have a lot of central banks with different goals, with one bank wanting a weaker currency relative to another, which also wants a weaker currency, and it's unclear the central banks will coordinate their independent needs. If you all try to lower rates, and everybody lowers rate the same amount, on a relative basis not much has changed.

H.L.: So how disruptive is all this?

L.A.: How disruptive and threatening all of this is depends on where the economic cycle goes next. We could have the slowdown worsen to the point that a recession becomes a very real risk. That could be quite disruptive, to say the least. On the other hand you could have the slowdown in growth bottom out without going negative.

Which one of these scenarios has not been determined just yet. Which is why we monitor our leading indicators so closely.

My mentor Geoffrey H. Moore, the former head of the National Bureau of Economic Research and co-founder of ECRI, always cautioned me not to try to predict the predictors, so I'm going to heed his advice and just monitor the indicators. I can report the growth rates have continued to ease, but they are not yet pointing to a recession.

H.L.: So when might things change?

L.A.: That's a hard one. I can't really predict.

H.L.: Is the effect of the oil price situation being exaggerated, and what do you think is oil's real effect?

L.A.: There are positives and negatives. For certain investors who have exposure top different energy-related activity it can be a negative but a positive for discretionary spending, as part of the household budget, but a good piece of that is getting eaten up by higher rents and healthcare costs, as I just said.

H.L.: What's your view of the Federal Reserve's current actions?

L.A.: They're in a bit of a bind, because their plan to raise rates through 2016 has run into a cyclical downturn in economic growth, so that may be difficult to raise rates four times this year.

At the same time, if you look at their models and the unemployment rate at 4.9 percent, that would suggest that they have to raise rates now.

It makes it very difficult to say at the same time that we have full employment and the economy is fine and still not raise rates.

One of their key goals is to do no harm. I just think they're in a tough spot. The real issue goes back to the use of monetary policy to deal with a structural problem in existence for over a decade and not going away.

H.L.: How would you deal with this structural problem?

L.A.: The structural problem is the long-term growth has been stair-stepping down or decades. When you look at how you get real growth, it's dependent on demographics and how fast your working population is growing and also dependent on productivity growth.

Both are running at about half a percent a year, which adds up to 1 percent of real long-term trend growth. Most public and private budgets assume something closer to 3 percent growth, and it's unclear how monetary policy can impact demographics and productivity.

What should happen is that the policymakers of all stripes, when they talk of their prescriptions to help the overall economy it would be useful if they address the issue of productivity and workforce growth. Without that, I don't know why long-term growth would rise.

You'd have to imaging something that would increase population growth or productivity growth. When you look at productivity, you could say if we invest in education and infrastructure these may indeed help productivity growth, but at the moment there's a lot of excess capacity and not a lot of confidence, so it's unclear why you'll get a lot of investment in the private sector.

The public sector can do it, but I have no idea what Congress is going to do, but when it's polarized it's hard to get anything done.

H.L.: Do you see much job growth?

L.A.: Job growth is continuing, but the quality is not that great in the sense that most of the jobs are going to the less educated, so if you look at the employment population ratio, it shows a solid job market for people without a high school education. But when you look at the people with at least a high school diploma if not higher, job growth is pretty much flat and hasn't really recovered since the recession.

You also see a bit of a spike in multiple jobholders, which means they have to hold down multiple jobs to make ends meet. Multiple job-holders have been responsible for over 60 percent of net job gains since last spring.

H.L.: Are wages still essentially dead in the water, or are they rising in any significant way?

L.A.: We'll have a little bit of an increase the past few months in hours worked, but the number of hours worked hasn't improved that much,. So it isn't a lot to write home about.

In the context of a slowing economy, it's not likely6 to move up strongly. A lot really depends on where our forward-looking indicators go next. If they point to a soft landing, that's welcome news, or if they continue to ease up, which would steer you toward a recession track.

H.L.: How weak is manufacturing?

L.A.: Manufacturing has been weak for quite a while. In mid-2014 we pointed toward a downturn, and that continues. In 2015 we started to see the service sector also begin to slow. About the only sector that seems to be holding up is construction, but that's a smaller slice of the U.S. economy so it's unlikely to change the course of the overall economy.

H.L.: Are you at all hopeful, or are you full of despair?

L.A: I'm a hopeful guy. I think it may be a good thing that the central banks are starting to acknowledge the long-term growth decline and that they can't really address the structural issues.

It may be that they just double-down and try to do the same things but more so. On the other hand, they may also look to alternate policy approaches away from monetary policy, and that remains to be seen.

People need to face what's been going on, long-term trend growth going down for decades and that it's all about demographic and productivity growth, and unless you incorporate that into policies going forward, then we're not really dealing with reality.

I'm hopeful that policymakers do start to include that in their discussions.

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