Weekly Wrap: The Best Part of Trump’s Tax Reform? Agreement That Deficits Don’t Matter

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Welcome to the 12th edition of the Weekly Wrap, where our deficit of gratitude for your reading this is bottomless.

Tax Reform And Shifting Opinions

Tax reform got one step closer this week as the Senate voted 51-49 in favor of a 2018 budget. This will allow Republicans to pass a tax bill without 60 votes in the Senate. Of course, this means tax policy will be in place for a maximum of 10 years, but we’ll look past that for now.

This is great news on one particular point. Policymakers are finally realizing that deficits don’t matter. As White House Budget Director Mick Mulvaney noted (via Bloomberg),

“I’ve been very candid about this. We need to have new deficits because of that. We need to have the growth… If we simply look at this as being deficit-neutral, you’re never going to get the type of tax reform and tax reductions that you need to get to sustain 3 percent economic growth.”

The tax package “The tax measure could add as much as $1.5 trillion to budget deficits over a decade,” according to the New York Times. The massive tax cuts are being paid for (or at least somewhat offset) by eliminating or capping some popular items, like state and local taxes and retirement savings tax breaks. These mostly impact the wealthiest of taxpayers, though many middle income earners will still see tax hikes.

But getting back to debts and deficits. The United States can borrow effectively endlessly from the rest of the world. That’s why bond yields are still so low by historical standards, even though the national debt is at an all-time high and still growing. The U.S. government simply having the ability to tax the wealthiest population on earth is enough for U.S. Treasury bonds to be the ultimate safe haven. Thus, deficits and debts don’t matter.

What would be a big deal is threatening the world’s confidence in the U.S. Treasury and the dollar. Exorbitant privilege is the term economists use to describe the dollar as the world’s reserve currency (here’s former Federal Reserve Chair Ben Bernanke on Exorbitant Privilege).

Oil is denominated for in dollars across the globe. Foreign nations borrow in dollars because it adds an air of stability to investors. Borrowing in dollars forces budgetary discipline on those governments. After all, if they have to devalue their home currency, the debts in U.S. dollars become more unsustainable.

The dollar as the world’s reserve currency is an inherent subsidy by the rest of the world to citizens of the United States. If misguided foreign policy, trade policy, or simply upsetting the apple cart just to create chaos were to threaten the dollar’s global status, Americans would feel the pinch big time.

What We Wrote This Week

The Growing Chasm Between Barcelona and Madrid: Checking in on the Catalonia Independence Referendum

“If there’s an impasse, or Puigdemont demands a hard Catalonia exit, or there are more riots in the streets between Catalonian nationalists and integrated Spanish supporters, that yield could shoot right back up.”

What Do Trump Stock Market Tweets Mean for the Fed Chair Decision?

“Trump likes to tweet about stock market milestones. But Trump also has a decision to make about who will lead the Federal Reserve. A hawkish pick for the Fed chief could increase the chances of a stock market correction.”

Why a Brexit Deal Remains a Leap of Faith: Theresa May’s Big Week of Negotiations

“Theresa May is finding out that Brexit negotiations are producing no winners. She herself, with a tenuous grip on the Prime Ministership, is feeling the burn the most.”

Watch our videos from this week

Spot Exchanges Shorts: Will Catalonia Leave Spain?

Spot Exchanges Shorts: The Apprentice: Federal Reserve Edition

Econ Vlog: Is Global Political Risk Creeping Up on Investors?

 

Cover photo: Gage Skidmore (Flickr Commons)
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Econ Vlog: Is Global Political Risk Creeping Up on Investors?

Spot Exchanges Shorts: The Apprentice: Federal Reserve Edition

What Do Trump Stock Market Tweets Mean for the Fed Chair Decision?

Another stock market record, another @realDonaldTrump tweet basking in it.

Yesterday’s example: After the Dow Jones Industrial Average hit 23,000, the president tweeted “WOW!” with an animated stock chart. Trump is certainly soaking in the sunshine of an index that has gained 25% since election day.

But this enthusiasm is headed for a crossroads. Trump likes to tweet about stock market milestones. But Trump also has a decision to make about who will lead the Federal Reserve. A hawkish pick for the Fed chief could increase the chances of a stock market correction.

Who is in the lead for the next Chair of the Federal Reserve?

How we got to 23,000; or life before before Trump stock market tweets

For years, many have argued that the low interest rate policies of the Bernanke and Yellen Feds have led to high asset prices, including in stocks.

Real interest rates – measured by the 10-year Yield minus CPI – turned negative in September for the first time since February. Overall, real yields are still well below the historical norm. In the 1990s, real yields were between 3 and 5 percent. The post-crisis, historically low rate environment is one of the key components for our currently lofty market valuations.

But if Trump picks a hawk on monetary policy – someone like John Taylor or Kevin Warsh – the Fed’s baseline interest rate could be hiked faster and higher than it would under a Janet Yellen or Gary Cohn regime (Though real interest rates have actually fallen as the Fed has increased interest rates over the past two years. See: The Janet Yellen Paradox: When Raising Rates Doesn’t Equal Tighter Financial Conditions).

Could we have a hawkish Fed and continued market record highs?

History shows that markets have performed well after a rate hike cycle. According to a Charles Schwab analysis,

As shown in the chart below, the S&P 500 Index returned an average of 9.0% and 5.5% before and after, respectively, the start of a Fed rate hike campaign. In all 11 of these instances, the S&P 500 Index generated positive returns for the six months before a rate hike. Additionally, market volatility rose around the time of each initial rate increase. In spite of this volatility, the S&P 500 Index generally resumed its upward climb after the rate hikes, generating positive returns in 8 of 11 instances.

Stock prices grew slower after a rate hike, but market more often than not continued to trend upward. But let’s take this bull case with a cautiously optimistic bent. First, 11 is an incredibly small sample size, so we need to understand what happens when rates rise. Second, we have to consider what could derail the bull market.

Stock Market Correction Ingredients

First, higher interest rates mean higher discount rates.

• Higher interest rates put downward pressure on price. All future expected earnings are discounted by the prevailing interest rate (plus a risk premium), so as rates rise, price tends to fall. In textbook finance, this is as true for bonds as it is for the broader market.

Second, higher rates could hurt earnings growth.

• To support the current stock market levels, earnings would have to grow even faster to offset that increase in interest rates. The question is whether or not the market can support faster earnings growth.

• Higher interest rates impact earnings in two ways. It increases the cost of capital for companies, so borrowing in the capital markets becomes more expensive. Higher rates also decrease the incentive to invest in new projects, because the return from sitting on cash is higher.

A standard market valuation is the Price-to-Earnings ratio. Higher expected earnings growth tends to lead to higher prices. Analysts are predicting double-digit earnings growth throughout 2018, according to a recent analysis by Factset. These expectations have led to the lofty market valuations – the S&P 500 Forward 12-month Price-to-Earnings ratio hit 18x earnings for the first time in 15 years.

If earnings growth falters on the back of higher rates, however, that could cause market valuations – and market prices – to tumble.

Which will win out, Twitter or Monetary Policy?

Since Trump likes Twitter, and likes to talk about how his administration’s policies are increasing stock market levels, would he really want to risk that by picking a hawk to lead the Fed?

The Fed is said to be the one who takes away the punchbowl after economic growth leads to inflation. So who does Trump choose? It is difficult to imagine that Trump would take away his own Twitter punchbowl with a hawkish choice to head the central bank.

Trump may say he loves John Taylor, but this could simply be a baseless statement to appease Republicans who distrusts the current Fed leadership. Trump is a “low-interest rate” guy who likes lofty valuations. The choice for the next chair of the Fed will probably reflect this.

Economics Book Review: Edward Luce’s The Retreat of Western Liberalism

The Retreat of Western Liberalism
Edward Luce
Atlantic Monthly Press
2017
234 pp

The United States became a superpower not only by living open markets and democratic principles, but by promoting those values abroad. The U.S. was imperfect in this mission, but it was a solid foundation for the post-World War II order. And it worked well.

But now, those values might be slipping away, and the alternative isn’t pretty. The future is looking increasingly dim for liberal democracy. The Financial Times commentator Edward Luce writes a short, but impactful overview of why the small-l liberal values have eroded in recent years.

A Post-Mortem of a Generation of Politics and Policies

There have been plenty of post-mortems from the 2016 election, but this book is different. Luce wants us to consider that the election of Donald Trump was 40 years in the making.

Luce argues that the Clinton campaign played right into the hands of identity politics. That strategy was doomed from the start. Writing off half of the voting electorate as “deplorable” was bad. But the death knell of the campaign rang decades before Clinton’s campaign even began. Technocratic-minded liberals have ignored depressed economic and cultural state of white working class Americans for the entire post-industrial period.

But Luce argues that this isn’t as much the fault of Clinton as the general capital-L Liberal position of the past generation. Gone are the days of representing the working class. In is the idea of the rainbow coalition. By embracing technocracy – led by the “Berkeley-Harvard types” – the wants and needs of the white working class were ignored. And this has been going on for decades, and was embodied by the Bill Clinton/Tony Blair “Third Way.” As Luce notes, “The Third Way has remade politics. Lip service was still paid to the blue-collar worker. But the new left’s chosen politics was a form of anti-politics in which ‘whatever works’ had apparently replaced ideology. Beneath them was the void.”

The growing thread of racial resentment is gross. But it’s simply one symptom of letting that void simmer for decades. With a bit of hindsight bias, a populist reaction was almost certain in both the U.S. and the U.K. And that’s exactly what we got.

Luce mentions the Yogi Berra quote, “Predictions are hard, especially about the future.” Some of Luce’s own predictions are hard to square, just a few months after the book’s publishing. Because of this, it’s hard to take Luce’s hypotheticals at face value.

But that justifies Luce’s argument on the dangers of the Trump presidency, as well. Trump himself is so mercurial, it’s hard to know what will happen. This is a break from seven consecutive decades of America the stalwart. It’s hard to find upside in this volatility.

So what’s next for liberals?

The government of the United States was designed to tamp down populist movements. But now that Trump has risen to the top seat, Luce argues that the mechanisms that countervail populist uprisings don’t really have a response. There aren’t too many steps to turn our representative democratic system inward and make it a truly authoritarian body. As Luce notes, “Imagine how things would look with a competent and sophisticated white nationalist in the White House.”

But Trump himself isn’t the end-all to American democracy. Rather, Luce is more afraid of what comes next. Will liberal democrats (lowercase l and d) rise to the occasion and restore what made modern America great? Or will we allow our most base instincts, in a time of declining relative wealth and power, get the best of us?

Luce argues that the prescriptions that Trump offers have nothing to do with solving the insecurities of working-class whites. Massive tax cuts, rollbacks of Wall Street regulations, and repealing Obamacare are more likely to hurt his voting base than to help it. That presents an opportunity for liberals.

But it could just as easily present the greatest challenge to American democracy. If Trump fails, what will the next demagogue say and do to win over these voters?

Things might mean revert to the way things were – when America was the global beacon of western liberal values. But the extrapolation of the populism that has consumed America could just as easily spell the death of the liberalism. Luce isn’t optimistic.

Weekly Wrap: 6 Days, 6 Stock Market All-Time Highs. What’s Going On?

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Welcome to the 10th edition of the Weekly Wrap, where we believe life can always be summed up with a quote from the 1983 classic Trading Places. 

Stock Market Investors: “Feeling Good, Louis!”

https://giphy.com/embed/5xtDarqlsEW6F7F14Fq

Stock investors are holding their heads up high these days. Strong economic fundamentals like GDP growth and manufacturing output have buoyed markets. Tax reform is in full discussion mode, which could cause stocks to further pop. Treasury yields have risen over the past week, signaling a complete risk-on environment.

A few key stats on the market’s remarkable run this past week

6: The number of consecutive S&P 500 market close record highs.

 

8: Number of sessions in a row the S&P 500 has been ended in positive territory.

0: Number of days ever that the VIX, Wall Street’s “Fear Index,” has closed lower than its Thursday level of 9.19.

0.87: Total index put/call ratio on the Chicago Board of Exchange, below the average of 1.03 over the past year.

 

If the put/call ratio is high, that means investors are buying insurance on a market drop. But traders have pared those hedges, signaling a faith that the market stays around the current levels.

Throwing caution to the market winds?

There is a lot of faith being placed in the ability of Congress to pass meaningful tax legislation. To measure how this is playing out in the market, the S&P 500 Buyback ETF (SPYB) is a good yardstick. If corporate tax reform passes, companies will presumably have more cash to throw around. Companies that have a penchant for buybacks would then have more money to repurchase shares, causing stocks to rise further.

Buyback stocks jumped ahead of the broader market after the election on anticipation of tax reform. But as the GOP agenda hit a few hurdles, these stocks fell behind the broader market. The reignition of tax reform discussions have caused the SPYB to rally over the past few weeks, however. Investors seem confident tax legislation will happen this time – or else those stocks could see a reversal of fortune.

The pattern of trading between the S&P 500 growth stocks versus value stocks has also shown that this run might be a bit overbought. Comparing iShares S&P 500 Growth ETF (IVW) and S&P 500 Value ETF (IVE), value stocks have been left in the dust since the spring. Growth stocks tend to do well when investors are bullish on the future.

The gap between growth and value isn’t as large as it was a few months ago, but its clear that pricey stocks like Netflix and Tesla have been the preferred investment over boring Coca-Cola and General Electric. But has that enthusiasm led to an overallocation to growth stocks? That gap in relative value could close quickly if things get choppy.

Fear index shows fearlessness

And finally, the VIX chart above shows a level of complacency that we’ve never seen in the markets.

• As mentioned in our Catalonia referendum discussion, the VIX has jumped to its highest levels over the past decade on European-originated crises. See: spikes in 2010, 2011, and 2015.

• If Catalonia actually does break from Spain, the fallout from that would certainly press on investors. If this emboldened other nationalist movements to follow suit – most notably in Italy – that would be downright disastrous for the European project. The Greek debt crisis would pale in comparison to a splintering of EU-member countries.

• This doesn’t even mention some of the other risks out there: North Korea, Iran, China, Brexit discussions, lack of free-trade agreement progress.

There is apparently a lot to love about the market these days, but political risk – both domestic and abroad – is still out there. Investors should tiptoe through the geopolitical minefield.

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What We Wrote This Week

The Janet Yellen Paradox: When Raising Rates Doesn’t Equal Tighter Fiscal Conditions

• “So one of two things is happening. Either the Fed’s policy has worked too well, and we are at a point where the central bank should be loosening policy. Or the market is out of sync with the Fed’s policy maneuvers.”

Catalonia Referendum Roundup: What Does The Secession Vote Mean for Investors?

• “But the referendum does create larger questions. Does it embolden other separatist movements across Europe? If these movements have legs, then look for a bigger selloff of sovereign debt for other potential break-up nations (Italy chief among them) and the euro.”

And finally: Our first vlog, discussing the Catalonia independence referendum

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Other Links and Notes

The dollars and cents cost of a recession might be really small compared to the psychological impact it has on people and communities. (Why Some Scars From the Recession May Never Vanish; Ben Casselman, New York Times)

• “There are a bunch of people who were knocked out by the recession who aren’t coming back even in the places where unemployment has fallen,” Mr. Summers said, although he said he believed there is room for further improvement in the labor market.”

Tyler Cowen argues that monetary policy is going to be less important than maintaining an independent Fed. (The Fed Needs a Savvy Politician as Its Chair; Tyler Cowen, Bloomberg View)

• “But the next time major economic volatility comes around, Fed decisions will be scrutinized and politicized like never before. This will happen in the mainstream media, on social media, and perhaps by our very own president in his tweets or offhand remarks. The key factor for any Fed leader will be the ability to maintain and project a coherent, unified voice at the Fed, so that the Fed remains an island of relative sanity in the polarized nation. This will be a problem of crisis management, but unlike Bernanke’s crisis management it will be fought first and foremost in the trenches of public opinion.”

Preaching to the choir. (I’m Fed Up With Football and Bullish on Baseball; Al Hunt, Bloomberg View)

• “I don’t know if pro football will go the way of boxing, but I’m confident that baseball is prospering as it did when Sandy Koufax and Henry Aaron stalked the diamond.”

Cover photo: Thomas Hawk (Flickr Commons)

Weekly Wrap: A 1 in 1,095 Day Event for Econ Nerds

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Welcome to the 9th edition of the Weekly Wrap, where we had a great week scrolling through 1,262 pages of chart-tastic econ data.

The Federal Reserve’s Survey of Consumer Finances. The Greatest.

The Fed’s triennial report on the state of American household finances was released this week. This is one of the greatest gifts to people who enjoy spending weekends building charts. Or people who made bar bets about how many renters vs. buyers own equities (Answer at the end).

It will take years to run through and properly comment on all of this data. But here are three charts that immediately caught our attention.

Median income for those without a high school diploma has surged in the past few years

This was a particularly interesting finding, especially considering the narratives in the 2016 election. Median income for those without a high school diploma jumped 14.7 percent since 2013. For comparison, the median income for those with a college degree rose just 2.1 percent over the same period.

But can we dispel the argument that working-class America is not being left behind, at least in terms of income? Most certainly not.

Since 1989, the median wage has grown the most for the college-educated folks, and stagnated – if not fallen – for other groups:

[table id=3 /]

Another interesting trend is in the median income for families that fall into the college-educated category. While real incomes are up 5 percent since 1989, it is down 8 percent since the 2004 peak. The college wage premium is alive and well, though it might not be as big as it once was.

Incomes in the South and Midwest are Surging

Another finding that runs contrary to the 2016 election zeitgeist, the median income for families is rising fastest in the South and Midwest.

Incomes are still highest for families in the Northeast, but that region saw the slowest growth between 2013 and 2016.  

Again, can we dispel the narratives that Trump ran on in 2016 based on this data? Yet again, the answer is no. Incomes (adjusted for inflation) have actually fallen in three of the four regions since 2004. Only in the south is the median family better off than they were 13 years ago.

[table id=4 /]

Incomes for Families in Cities are Rising Much Faster than for Rural Families

Finally, we have a data point that validates the Trump narrative. Families of rural America saw income growth that was just one-fifth of the growth in cities.

This is the continuation of a long-term trend as well. The real (inflation-adjusted) median income for a family in a metropolitan area is 10 percent higher than it was in 1989. For rural families, it’s just 2.7 percent.

One caveat, if we’re going to look at this through the intersection of politics and economics: many suburban counties voted overwhelmingly for Trump. These counties are considered within the range of metropolitan statistical areas. Suburban Cincinnati is a good example. Trump won just 42 percent of votes in Hamilton County. But once you cross the county line, that number jumps into the 60s.

Takeaway: There are some fascinating insights to this report, and we will surely be dissecting it until the next dataset comes out in 2020.

What We Wrote This Week

Loftium Won’t Cause Another Housing Crash, But It Stirs Bad Memories (September 25): “Of course, this one company will never cause a meltdown of the entire nation’s housing market and economy. But it should still be considered from a micro level. If memory serves correct, things didn’t seem to work out too well for either the borrowers or the lenders in Vegas and Phoenix.”

5 Charts That Explain the State of American Manufacturing (September 27): “Manufacturing is not declining, it’s evolving. Productivity in American manufacturing has been the key story of the past few decades. It simply takes fewer workers to produce more goods than it once did. And the goods that are produced are higher quality and of higher value than before.”

The Trump Trade Is Back. Kinda. (September 28): If an entire swath of companies are going to rise and fall based on the latest legislative proposals, then investing in small caps is a bet on Congress getting their act together and passing meaningful legislation. But if we take the past nine months as any kind of indicator, that has some long odds.”

Other Links and Notes

We’re all pass-through entities now. Go incorporate yourself immediately. “It is an important asterisk to one of the core elements of the plan: a desire to tax income of “pass-through” businesses such as partnerships at a rate of only 25 percent. Currently, such income is taxed at the owners’ individual income tax rate, which is as high as 39.6 percent (and would fall to 35 percent in the Republican plan). The Republicans want the pass-through businesses to have a tax rate more in line with that of big, C-class corporations (which they are proposing to tax at 20 percent).” (Tax Plan Punts on a Loophole for the Wealthy; Neil Irwin, New York Times The Upshot)

We wrote about Toronto housing recently; UBS confirms it is bubbly. “Toronto and London are among the cities most at risk of a housing bubble as economic optimism and low borrowing costs push up property values in urban areas worldwide, according to UBS Group AG. The Canadian city, which entered the index of 20 locations for the first time this year, has the most overvalued housing market, while London was the third-riskiest in Europe after Stockholm and Munich, the Swiss bank said in a report published on Thursday.” (Toronto, London Among Riskiest Housing Bubble Cities, UBS Says; Jack Sidders, Bloomberg)

It’s not the fees that will kill you, it’s that you’re a terrible investor. “Those who bought in 2009 and held on until today would be pretty happy, but I get the impression that very few people did that. They either bought too late, sold too early, panicked and puked at the worst possible time, or chased a hot new trend. The result is that they inevitably underperformed a 60/40 mix of stocks and bonds 1  , which would have provided about a 10.4 percent return since the start of 2009.” (Fees Are Not the Enemy of Investors; Jared Dillian, Bloomberg View)

*Survey of Consumer Finances Trivia Question

The answer: 64.6 percent of homeowners and 29.6 percent of renters.

Cover photo: Federal Reserve (Flickr Commons)

The Trump Trade Is Back. Kinda.

The markets loved the election of Donald Trump. After November 8th of last year, some segments of the market skyrocketed, on the idea that Trump would be a boon to small cap stocks, infrastructure stocks, companies that are highly-taxed. The yield curve was expected to steepen as growth expectations jumped.

After a few months, the Trump Trade was all but dead. While health care reform may be off the table for now, tax reform is be the new focus for markets.

Yesterday, the Trump administration released a framework for the most sweeping changes in the tax codes since the 1980s. Small cap stocks, which are broadly more heavily taxed than large caps, loved it. The SPDR S&P 600 Small Cap ETF (SLY) jumped 1.97% yesterday, compared to a 0.39% gain for the broader market.

As we wrote last month, small caps jumped way ahead of large caps after the election. But the rally fizzled after a difficult summer with few legislative wins from Capitol Hill. Since then, small caps have come roaring back, and are again beating large caps since election day.

The enthusiasm is seen in the bond markets as well. The spread between the 2-year and 10-year Treasuries jumped five basis points to 0.84 percent yesterday. That is the biggest change since early July.

Investing on Political Hunches: Never a Good Idea

From a markets perspective, there is a bit of a mismatch in expectations here. Clearly small caps seem to be driven by narratives, rather than fundamentals. If an entire swath of companies are going to rise and fall based on the latest legislative proposals, then investing in small caps is a bet on Congress getting their act together and passing meaningful legislation.

But if we take the past nine months as any kind of indicator, that has some long odds. In fact, the online betting market predictit.org has odds on it. Bettors are giving a corporate tax cut a 34 percent chance of passing and an individual tax cut a 30 percent chance by the end of 2017.

 

Cover photo: Kurtis Garbutt, Flickr Commons

5 Charts That Explain the State of American Manufacturing

It doesn’t take too deep of a dive into the archives of @realDonaldTrump to find some 140 character commentaries on the state of American manufacturing.

“@danlifting: @realDonaldTrump Get a life George Will. USA doesn’t make anything anymore. TRUMP will bring manufacturing Back to USA!”

— Donald J. Trump (@realDonaldTrump) October 18, 2015

//platform.twitter.com/widgets.js

“@AMuller65: @realDonaldTrump Do you ever see the USA once again becoming a Manufacturing power?Only with new & capable leadership.

— Donald J. Trump (@realDonaldTrump) July 28, 2013

//platform.twitter.com/widgets.js

But is this true? Does America not make anything anymore? Is the United States an industrial wasteland?

The answer is a resounding no. In fact, America is an industrial powerhouse compared to its global peers. But the story is a bit more nuanced than that.

Manufacturing is not declining, it’s evolving. Productivity in American manufacturing has been the key story of the past few decades. It simply takes fewer workers to produce more goods than it once did. And the goods that are produced are higher quality and of higher value than before.

What does that mean for manufacturing employment?

Simply put, it’s declining. In the postwar years, manufacturing made up about 30 percent of jobs in America. Today, that number is down to about 8 percent.

This causes a lot of friction in the economy and in society. One needs only to look at the voting patterns across the American Rust Belt to understand what kind of social dislocation declining manufacturing employment brings.

But looking at the chart above, it looks like share of manufacturing jobs has stabilized. That could mean that the American economy needs about 8 percent of all jobs to power the manufacturing sector. And because the economy itself has grown…

The number of manufacturing jobs is growing.

As of August 2017, there were about 12.5 million Americans employed in manufacturing. This well below the 1979 peak of about 20 million people employed in manufacturing, but we may have seen the bottom. Since the February 2010 low, the American economy has added about a million manufacturing jobs. If the 8 percent of all jobs in manufacturing number holds, the number of factory jobs should only continue to grow.

Employment in manufacturing might be down 40 percent over the last generation, but does that mean the U.S. is less globally competitive? No.

Of G7 countries, America has been the manufacturing leader. And it’s not particularly close.

Since 1980, American manufacturing output has doubled. The next closest peer is Germany, which has increased output by 67 percent over the same period.

And this is where the competitiveness argument goes awry. Comparing the U.S. to countries that have been developing for the past few decades isn’t accurate. The United States got rich by being the low-price workshop to the world a few generations ago. Today, American manufacturers are producing high-end goods, which are the result of decades of investment in both machines and people. Developing countries have taken on the role that America used to play – which is why U.S.’s share of manufacturing is declining.

But manufacturing is hardly dead. America is producing more than ever. Which comes back to productivity.

American manufacturers are more productive than the rest of the economy

Throughout the 1990s, American manufacturers were less productive than the rest of the private sector. But that has changed in recent years – since 2010, manufacturers are producing 20 percent more per hour of human input. This is directly related to global competitiveness – the U.S. can’t win on wages, but it does produce more valuable goods. Manufacturing Boeing jets creates more wealth and produces better manufacturing jobs than what existed 100 years ago.

If companies are producing more, why are manufacturing employees poorer?

Again, this harks back to the #MAGA narrative of the 2016 election. Workers, especially those in the manufacturing sector, are seeing slower wage growth than the overall economy. Those factory jobs are fewer and farther between, as well.

But why? If output per hour is increasing so much for manufacturing workers, why aren’t they seeing wage gains?

It’s not because there’s a giant glut of manufacturing workers – the unemployment rate for those in the manufacturing sector is below the national average. Instead, it could be the changing dynamic between capital and labor.

A recent report from Brookings suggests that declining rates of union membership could have to do with stagnant wage growth. Across the economy, the share of income to capital has been increasing. Shareholders and the owners of companies have taken a larger share of profits, while less has trickled down to the actual workers. Manufacturing, in particular, has a long history of organized labor. Union membership has declined across the entire economy, but it could be hurting most in industries like manufacturing.

What does this all mean for American manufacturing?

The irony is that solutions like tariffs and breaking up trade pacts could make American manufacturing less productive and will reduce global competitiveness. Just like any company or industry, productivity is at the core of long-term success. Enacting price controls or boxing in the American manufacturing industry from global competition will decrease productivity and reduce competitiveness.

As some might argue, we could force the American economy to produce more of the goods that we currently import. That would indeed create manufacturing jobs. But that would also make us all poorer. Financing for valuable companies and projects would be shifted to lower-return manufacturing. That decreases returns on capital.

And it’s not even a guarantee that many jobs would be created. American manufacturers have done a lot more with fewer human hands in the process. Why would that stop?

Free-marketer types would argue that the invisible hand should find the right balance of financial and human capital allocated to manufacturing in America. Messing with that balance would not only make American manufacturing less competitive, it would make the entire economy less dynamic.

 

Cover photo: Thomas, Flickr Commons

Weekly Wrap: Assessing the Trump Trade

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Welcome to the 7th edition of the Weekly Wrap, where we are happy to take the other side of politically-motivated trades.

Stock Market Report Card: Election Day + 10 months

A friend recently asked “Is there a legitimate correlation between the Trump administration and the stock market being at an all time high?”

The answer is sort of complicated. Since November 8th, the S&P 500 has jumped about 17%, so investors are clearly enthused by something. But is it the Trump administration?

After the election, there were a few Trump-related stories that were popular among investors. Apropos to the original question, the idea of the Trump Trade was discussed on Bloomberg’s What’d You Miss just yesterday. Their chart shows some of the top post-election trades:

Chart: Bloomberg’s What’d You Miss

• Domestic economy: American-focused companies were going to rediscover their global competitiveness, and U.S. households would reap the windfall of low taxes

• Corporate taxes: Taxes on companies would plummet, making the highest taxed companies attractive investments.

• Stock buybacks: With companies soon-to-be flush in cash, corporate treasuries would be able to spend more on buying back stocks. Companies with a history of buying back their shares, like IBM and AT&T, were thought to surge.

Since the spout of enthusiasm between election day and inauguration day, each of these trades have since faded. Since November 8th, the market is up 17 percent. AT&T is down 1.3 percent. IBM has fallen 6.5 percent.

Other Trump Trades ideas have fallen, as well: small-cap stocks and infrastructure companies, to name a few. Financials are one area where the enthusiasm has remained. The financial ETF XLF has outperformed the broader market since election day, gaining 24 percent

The verdict? The broader market has continued to rise, even as most of the Trump-agenda trade ideas have fizzled. But we could give the administration a shard of credit for creating the atmospherics that have benefitted the markets.

The real driver? This is just the continuation of a near 10-year trend.

What we wrote this week

A Stormy Snapshot of Flood Insurance (September 8): “The solutions are actually pretty simple: Governments should simply charge a fee to properties that are most susceptible to flooding. That would be used to offset the costs of damage. The broad, risk pooled hurricane insurance program should continue to exist. But by simply taxing those  highest risk households, we can reduce the cost of the externalities imposed on everyone else.”

8 Things To Know About the Labor Force Participation Rate (September 11 ): “Opioids and video games. Those are the two attention-grabbing keywords when it comes to the decline of America’s labor force participation rate. Narratives about pill mills in Appalachia or millennials playing video games in their parents basement are sticky. But the story about the falling rate of work in the U.S. is much more complex than pills and Playstations.”

Greek and German Bond Yields: A cautionary tale (September 12): “Today, Eurozone growth is OK but not spectacular. To reach the next level of growth, investment in nations that have seen perpetual under-investment for years could provide that boost. After all, how much better would the entire Eurozone economy look if Greek and Spanish unemployment were even 15 percent and 10 percent, instead of 21 percent and 17 percent?”

The UK Death Cross: Wage earners are feeling poorer thanks to inflation and Brexit uncertainty (September 13): “Uncertainty hurts. That’s the lesson for the economy of the United Kingdom since the Brexit decision last July. With Brexit negotiations still in process and a weaker pound sterling, Britons are feeling the pain of economic unknown unknowns.”

Other Links and Notes

How much does the strong dollar hurt exports? In the long-run, more than you might think. “Nevertheless I do worry that the fall in exports from a strong dollar is a bit stronger than the rise in exports from a weak dollar: I suspect because there is a hysteresis effect: Once a factory is shut down, it stays shut down—and if firms don’t continuously invest to stay at the cutting edge of technology, it can be hard for a high-wage advanced economy to stay globally competitive.” (A Few Words on the Dollar; Brad Sester, Council on Foreign Relations)

Are markets underweighting political risk? Probably. “Political risk is part of a new normal. It takes its toll slowly and at the margin as decisions to hire or invest are deferred, rethought or resized. But until the unthinkable happens, don’t expect it to tank the economy.” (Comfortably Numb: Why the U.S. Economy Shrugs Off Politics; Greg Ip, Wall Street Journal)

Amazon is picking a new headquarters; Boston mayor Marty Walsh doesn’t want to play the game. “It’s hard to imagine where the Boston region would find the room for a company that will ultimately want up to eight million square feet of office space (the Pentagon, for comparison, has 6.6 million). Mayor Marty Walsh also said on Thursday that Boston is “not going to get into a bidding war with another city over something like this.” And it’s pretty clear that a bidding war is what Amazon wants.“ (Dear Amazon, We Picked Your New Headquarters for You; Emily Badger, Quoctrung Bui, Claire Cain Miller, NYT/The Upshot)