When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing – Former Citibank CEO Charles Prince (2007)
At Davos, Barclays CEO Jes Staley expressed something that’s been on my mind as of late: the world economy circa early 2018 sure looks a lot like the pre-subprime crisis / global financial crisis one. I’d even go one step further with this comparison: instead of looking like 2006, the world economy looks more like that closer to the eve of that cataclysmic event of a decade ago. Prior to the aforesaid event, there was some doubt as to whether a United States whose share of global economic activity is declining still mattered. After a localized problem in the US housing industry eventually led to problems in the broader world economy, this debate is a largely settled one: America still matters.
In this light, let us consider how the United States is doing at the current time and what its economic conditions mean for the rest of the world economy. From the exuberance exhibited by many market participants, things are going swimmingly and may do so for the next 11 years or so. Like Charles Prince in 2007, people are in full party mode in 2018. Dance, dance, dance. Have things improved significantly since then in its largest economy? And, have global economic imbalances righted themselves since then as to no longer pose a threat? The subtitle of this blog aside, I have strong doubts. Let us consider seven indications that matters haven’t really improved:
I. A High and Rising Budget Deficit
Before Trump’s election, forecasts for the United States’ fiscal situation were already looking dire due to foregoing health and pensions obligations of an aging society (the so-called “mandatory” spending). Although some debate surrounds whether or not Trump’s recently-passed tax cuts will boost economic growth–I have strong misgivings–the consensus is that it will only increase the United States’ debt pile.
Actually, the 2001 and 2003 Bush-era tax cuts were made at a time when the US fiscal outlook was not as dire. From 1998 to 2001, the Clinton-era budget surpluses suggested that the country could begin reducing its national debt going forward, but we know what’s happened since then. The difference with the Trump-era legislation is not so much its content–more of (unfunded) tax cuts absent tax reform–but its timing. Amid a worsening fiscal picture instead of an improved one largely inherited by George W. Bush, the Republican Party made a bad situation worse.
II. A High and Rising External Deficit
Dick Cheney famously said that “deficits don’t matter.” Despite alluding that these deficits do matter during his inaugural address, Trump has actually not done anything substantial to correct these deficits. (Starting trade wars doesn’t count.) With regard to America’s external deficit, it’s actually become worse under Trump. Even if he continually bemoans how little the US exports relative to what it imports, they’re, er, doing even more of the latter as of late.
In part, it’s due to Trump not having any grasp of basic international economics. By worsening the United States’ fiscal position, further government dissavings should, all else equal, result in a widening current account deficit. The most recent US trade deficit illustrates this phenomenon neatly. It’s been rising as of late, with the goods deficit reaching $70B in November 2017 and a towering $71.6B in December 2017. From 2005 to 2008, the United States ran trade deficits larger than $700B annually, including services. To be fair, the US is running larger services surpluses nowadays than in 2005-2008. Even if the overall trade deficit is smaller relative to GDP as a result, the overall trajectory is the same: onward and upwards.
III. A Plummeting Dollar
Can you believe that Bush 42 officials actually stuck to “strong dollar” policy shtick? The combination of high and rising budget and external deficits would have been consistent with a weaker dollar, and that’s what actually happened way back when the Euro reached higher than $1.50. Nowadays, of course, America’s finance guy doesn’t even bother with the pretense of having a “strong dollar” policy. Still, rhetoric matters less than actual policy, and the same dollar-toxic combination is very much in evidence.
Just as in 2008, the dollar is going where economic theory suggests it should–downwards. (Note that others also highlight increased global capital flows as a reason for dollar weakness. That the dollar strengthened in the wake of the global financial crisis is consistent with this interpretation.)
IV. A Rising Oil Price
Since oil is denominated in dollars, demand for its should increase as the currency depreciates and others can buy more of the stuff for less with their respective currencies. The average price of a barrel of oil averaged over $100 in 2008; this time frame is one of continually rising oil prices as well vis-a-vis a plummeting dollar. It’s not so much that high oil prices “caused” a global financial crisis, it’s that it fits in with the current pattern of the world economy circa early 2018. That is, commodity prices are being buoyed by a weak greenback.
V. A Soaring Stock Market
Many adopted a sanguine outlook on asset valuations–like equity shares–during a time when the United States had the aforementioned high and rising twin deficits as well as a weak dollar. The premise of this exuberance largely resembles that of a decade ago. In fact, the then-US Treasury secretary cited global conditions that were better than ever right before things headed south:
Just how red-hot is the current worldwide expansion? “This is far and away the strongest global economy I’ve seen in my business lifetime,” U.S. Treasury Secretary Hank Paulson declared on a recent visit to Fortune‘s offices [July 12, 2007; my emphases].
Maybe deficits don’t matter. Maybe economic fundamentals don’t matter, either. Just be mindful though of when folks were last saying the same sorts of things.
VI. A Movement Towards Financial Market Deregulation
Despite savaging bankers during his campaign, Trump has been as friendly to banks as you could possibly imagine, from cutting their taxes drastically to beginning to roll back crisis-era regulations meant to lower the possibility of another global financial crisis. With the pro-regulation Janet Yellen out of the way, the stage is set for further rollbacks on regulations set by the Federal Reserve.
VII. Dissavings-Fueled Household Consumption
In a truly “healthy” economy, additional household spending is funded by additional earnings. People spend more because they earn more. However, what if much of this spending is the result of dissavings? Obviously, there is an ultimate floor here since folks cannot deplete their savings forever to spend. In the run-up to the crisis, household savings were razor-thin, even becoming negative during some months. Is the story any different in 2018? I am afraid that it’s not. The savings rate Stateside has just fallen to its third-lowest on record:
Overall, economic growth climbed by 2.6 percent on a quarterly basis at the end of 2018, data released Friday showed. The expansion was driven in large part by personal consumption, which picked up substantially in the fourth quarter — a move that came as the savings rate slumped to 2.6 percent as a share of disposable income, its third-lowest on record.
Around 70% of American GDP is composed of consumer spending. If increases in consumer spending as of late have been driven by dissavings–other commentators note that the amount of increases in consumer spending has been approximately matched by falls in savings–then household consumption will inevitably fall back absent real income growth to continue elevated spending levels.
VII. Growing Household Indebtedness
The last piece of the puzzle is overall household indebtedness. To no one’s surprise, the United States’ total household debt has eclipsed its pre-financial-crisis era highs reached in the third quarter of 2008. To be sure, the form of debt is rather different this time around: instead of housing loans during the subprime mess, the worrisome components this time around are student loans, auto loans, and credit card debt to a lesser extent. The intuition, however, is the same: monies going towards servicing these debts reduces disposable income in a consumer-driven economy. So, as these debt levels rise even further, consumer spending would be expected to take a concomitant hit.
One saying is that something unsustainable has to, by definition, stop. Another saying goes the higher they rise, the more they have to fall. I have a bad feeling we’re about to reach the sudden stop, and that the higher people push things without justification, then the dislocations that will result from returning asset valuations and the rest back to more reasonable levels will be larger.
It’s hard to say that it’s *only* a US phenomena here insofar as (1) the rest of the world is still funding American profligacy and (2) the rest of the world still relies on the United States as the consumer of last resort. Colloquially speaking, what happens economically in America does not stay in America. In all these respects, the world economy today is similar to the pre-crisis one, and sensible sorts will at least take caution in its possible implications.