The Global Economy In a Time of Transition
The 22nd annual Milken Institute Global Conference kicked off on April 29th in Los Angeles with an onstage conversation between Christine Lagarde, Managing Director and Chairwoman of the International Monetary Fund, and Gerald Baker, Editor-at-Large of the Wall Street Journal.
Baker started the discussion with the global economy. Lagarde commented: “it's a delicate moment, given the synchronized slowdown of the momentum for growth. We have about 70% of the globaleconomy which is slowing, but still growing. We are not expecting a recession.”
Regarding the U.S. she stated: “Even the ‘highest authorities’ were very surprised at the 3.2% GDP growth for the United States for the first quarter, expecting it to be low because of the shutdown of the administration, the weather, and the perineal bad first quarter.”
She noted one quarter of exceptional growth is not conclusive, but indicated the miscalculation will lead the IMF to “reassess our forecast for growth for the United States.”
Sustained Growth Potential
Asked if she thinks the United States seems to have moved into an elevated phase of growth, she responded that we need to analyze where the growth is coming from. About the first quarter, she saw an inventory jump, but not one with consumption or investment. The partial government shutdown also affected her analysis.
However, “given the investment in new technologies and capitalexpenditures (CapEx) we've seen in the last four quarters, we expect to see some improvement in productivity.” A productivity improvement would increase sustained growth potential, according to Lagarde.
A Supply-Side and Market Based Perspective
Lagarde may be over-emphasizing the importance of consumption, and the government shutdown. It would be prudent for her to evaluate the Gross Output (GO) model, which does not recognize consumption as a majority component of output, nor does it weigh government spending as much as is the case with the GDP measure. GO is a natural measure of the production sector.
Mark Skousen, a proponent of the GO model, and professor of Economics at Chapman University, maintains that Business and Investment spending are the true leading indicators of the economy and the stock market. If you want to know where the economy and the stock market are headed, forget about consumer spending and retail sales figures. “Look to manufacturing, capital expenditures, corporate profits, and productivity gains.”
GO for quarter four 2018 was subpar, Skousen observed in April, calling this only a cautionary sign, noting the important durable goods component was up a healthy amount.
Critically, the investment in new technologies and capital expenditures was inclusive for all of 2018, not for just quarter one, 2019. These cumulative CapEx investments strongly support expectations of an increase in long term growth potential.
The Bureau of Labor Statistics (BLS) announced on May 2nd Q12019 Nonfarm Business Sector productivity, which measures hourly output per worker, increased at a 3.6 percent annualized rate in the last quarter, the strongest pace since 2014.
What Do the Markets Tell Us?
Lagarde can improve her forecasts and understanding of market forces by checking market signals. David Ranson, Director of Research at HCWE Worldwide Economics, is a strong protagonist that the markets themselves give us reliable data of where the economy is headed. On Friday June 21st he noted that first-quarter US growth at 3.1 percent was elevated a bit by hesitation at the end of last year, due to turbulence in risky asset markets.
Data imply real GDP will run at about 2% for the next few quarters, based on credit spreads widening and gold prices which increased in June. However, Ranson maintains as long as business friendly policies toward taxation and regulation remain, that long term real GDP can still reach 3 percent, the goal set by the Trump administration.
Inflation and the Phillips Curve
Baker turned the focus of the discussion to inflation, stating despite low levels of unemployment and high growth in many countries, especially in the United States, “suppressed inflation” exists. He asked Lagarde to explain the “suppressed inflation.”
She replied: “It's a bit of a mystery. The famous Phillips Curve should lead inflation up given we have very low unemployment,” adding the U.S. is not the only case, stating “Germany, where unemployment is at rock bottom and participation is high, still sees inflation stubbornly in-between 1.2 and 1.7%.”
Actually, there really isn’t a mystery. The Phillips Curve no longer has statistical power. Former Fed Chair Paul Volcker views the Phillips Curve as unreliable and believes its use should be discontinued. Alan Greenspan shares this view. Nevertheless, Fed staffers still use it as do many members of the New York Fed and other policy makers.
The late economist Jack Treynor believes its continued use can potentially cause drastic consequences through bad policy decisions. Indeed, Treynor postulated the potentiality of the extreme. In 2007 he gave the presentation “Will the Phillips Curve cause World War III?” to the CFA Society of Los Angeles. As an example of bad policy decisions, Treynor cited Japan of the 1980’s. E.g. Japan’s central bankers “went with the Phillips Curve and expected inflation. By the time they could reverse their policy it was too late. The result was a classic liquidity trap, with negative inflation rates.”
Notably, current Fed Chairman, Jerome Powell, recently discounted the Phillips Curve. Lagarde should do the same.
Inflation Targeting
Central banks, particularly the Fed, were anticipating a tightening of policy late last year, but this year they postponed tightening due to weak inflation. Inflation has underperformed the Fed's expectations every year for about seven years. When asked “have the monetary policymakers got this wrong?,” Lagarde commented:
“I wouldn't say wrong. They have a mandate of price stability. The number set for decades is around 2% in order to have growth in the economy.” This mandate is called “Inflation Targeting,” and Lagarde rightfully questioned whether the mandate is justifiable.
Many experts argue the target rate should be increased to 4%, something Lagarde doesn’t see the logic of, especially since we can’t even get inflation to 2%.
Actually, there is ample evidence the mandate of inflation targeting is flawed. The Federal Reserve Board studied countries that adopted “Inflation Targeting” and indeed found that core price inflation dropped, including in the United Kingdom, New Zealand, and Canada. However, the definition of inflation can be too narrow. By ignoring inflation of the money supply and assets such as real estate, stocks, and commodities, asset bubbles can lead to a collapse in real estate or stocks (e.g. 2008-2009,) explained Mark Skousen in his text book “Economic Logic.”
In addition, the presumption of the need for any “built in inflation” – that is inflation targeting – is itself an issue. Zero inflationary growth is possible and desirable as was demonstrated in the 1980’s. Paul Craig Roberts, former Assistant of the U.S. Treasury under President Reagan, contends that the Reagan administration’s supply-side economic policies cured the malaise of rising inflation and unemployment and had theeconomy poised for long-run non-inflationary growth until the prospect was foiled by the rise of jobs offshoring.
Aging, Productivity, and Inflation
The onstage discussion ended with a rumination on how to define the way the economy works.
Global policy makers wonder if we're going to get back to “normal relationships,” [e.g. will the Phillips Curve regain its predictive qualities in the future] or has something fundamentally changed about the economy in the 20th century?
On this subject Lagarde responded: “Relationships are going to be different. I don't know whether it's a fundamental shift, but the aging phenomena is affecting almost the entire global economy,” with the exception of the African Sub-Saharan countries. An aging population causes labor to become increasingly scarce.
Regarding productivity, she wants the IMF to have the tools “to better measure and assess” the impact that new technologies are having on the level of productivity: “We might be measuring productivity in a funny skewed way, which is not applicable any longer to an economy where services dominate, where virtual economy is much stronger than real economy.”
The only constant, however, is change. If one relationship is no longer applicable or useful, it means many aren't. It's hard not to watch global economic authorities and wonder if they'll always be addressing yesterday's issues with models that no longer work.
