Friday, March 23, 2018

The Fed, trade wars and recession

 by Michael Roberts

World stock markets took another tumble on the news that the US Federal Reserve under its new chair, Jerome Powell, had raised its policy interest rate and that President Trump had upped the stakes on an international trade war by adding to the already announced tariffs on imported steel and aluminium, a new range of tariffs on imported Chinese goods.  With China likely to retaliate, the risks are rising of a new recession triggered by rising borrowing costs on debt and falling exports globally.
The Trump administration announced plans on Thursday to impose tariffs on up to $60bn in annual imports from China, raising fears of a trade war between the world’s two largest economies and sending US stocks sharply lower.

The Fed’s ‘policy’ interest rate sets the floor for all borrowing costs in the US and even internationally in many countries.  It is now at 1.75%, a level not seen since 2005.  And the Fed’s policy committee (FOMC) signalled that it intended to raise its rate at least twice more this year and even more in 2019 and 2020, to double the rate to 3.5%.  Powell commented that “the economy was healthier than it had been in ten years” (i.e. at the beginning of the Great Recession in 2008).

The long depression, characterised by weak economic growth (the slowest recovery from a slump in the post-war period), low investment rates and profitability in the capitalist sector, appeared to be over.  And this justified further interest rate hikes to “normalise” the economy.  In addition, the recent corporate tax cuts and other measures by President Trump would lead to a sharp boost to consumer and investment demand “for at least, say, the next three years”.  The US economy was now primed to grow at 3% a year at minimum, suggested Powell.

In previous posts, I have argued that if the cost of borrowing rose while profits and profitability in the corporate sector turned down, then the Fed could provoke a new recession, as happened in 1937 during the Great Depression of the 1930s, when the US monetary authority thought the depression was over.  But profitability then had not made a recovery and increased borrowing costs only squeezed earnings for investment and so pushed the economy back again.  The risk is that this could happen again now.

The Fed does not look at profitability as an indicator of the health of the US capital; instead its mandate is employment and inflation.  On these indicators, employment continues to rise, with the official unemployment rate right down to pre-crisis levels; and inflation remains relatively subdued.  So all appears well.  And if the Fed did look at profitability, it might still argue that things are ok there too.  But that is not entirely correct.  As I argued in previous posts, the overall trend in US corporate profits has been down for over two years. And this is particularly the case for non-financial profits, the key sector for driving productive investment.

Indeed, although the first three months of 2018 are not yet over, various economic indicators forecast that US economic growth, far from accelerating towards 3% a year, has slowed to under 2% from 2.5% at the end of 2017.

Sure, that could just be a first quarter downward slip, as has happened in previous years.  After all, the Fed has raised its forecast for the whole of 2018 to 2.7% and 2.4% for 2019 – not 3%, but a bit better than previous years since 2008.

Actually, despite Trump’s boasts and Powell’s expectations, the US economy is stubbornly stuck in the 2% range of economic expansion.  And the Fed economists have been notoriously wrong in their forecasts of economic growth, inflation and employment.  The real pick-up since trough in the Kitchin short-term growth cycle of 2015-6 has been outside the US; in Europe and to some extent Japan and Asia.  Real GDP growth in Europe is currently higher than in the US.

Most significant has been a profit recovery. JP Morgan economists recently looked at global corporate profits, which in past posts I have measured as making a mild recovery.  Measuring profits as earnings from the top quoted companies in various stock exchanges (by no means a perfect measure as JPM admits), the JPM economists recorded a significant jump in profits across most areas of the capitalist world after a recession-like contraction through mid-2016”.

And where does this jump in profits come from? Mainly the energy sector, as oil prices recovered from the deep lows of the 2015-6; and from the financial sector, as stock and bond markets boomed.  In contrast, healthcare, IT and telecoms profits slowed.  And it came regionally in the advanced economies, while the emerging economies made only modest moves up. Within the advanced capitalist economies, it was profits in Europe and Japan that shot up – areas where the corporate sector had been in the doldrums or worse until recently.

None of this may last.  ‘High frequency’ indicators of economic activity, called the purchasing managers indexes (PMIs), have been at very high levels.  Anything over 50 implies that an economy is expanding and anything over 60 means very strong growth of up to 4% a year rate.  The US ‘composite’ PMI stands at 54 – not bad, but hardly exciting.  The Eurozone’s is higher at 55 but coming down.  Japan is around 52 and China is 53.

Indeed, figures for retail sales (consumer spending), employment and GDP growth suggest a ‘topping out’ of the recent acceleration since 2016.  And now the major capitalist economies face a double whammy of rising borrowing costs and the prospect of an international trade war – just as trade was picking up from the doldrums of the long depression.

A key measure of US borrowing costs, the spread between the US three-month Libor rate and the Overnight Index Swap rate, has reached its highest level since 2009.  And we already know that corporate debt in the US, Japan and Europe, is at record highs relative to GDP.

The hoped-for end to the long depression may be wishful thinking.

No comments: