The Global ExpansionJuly 2, 2015
From our point of view, the question is not when will the US economy take off, but rather how much longer can it hold on. We see the expansion as already well advanced, but given the slow trajectory it may continue far longer than a normal post-war cycle. Traditional late cycle limits, like rising wages, are barely visible. Moreover, the Federal Reserve is adopting the market view that rate increases will be quite moderate by historical comparison. Rather than a classic capital spending led boom late in the cycle, the oil-based correction is undermining investment. Continued expansion has been driven by hiring more consumers, while government spending rises as deficits become surpluses. Bottom line, we are growing via population growth rather than by productivity.
With few bottlenecks in the supply chain, there is little inflation. Meanwhile, weak growth outside the US has dampened exports (leaving more resources to satisfy domestic demand) and imported deflation as the strong dollar buys more abroad. The lack of bottlenecks and price pressure also limits the need for capital expansion. It is only the creative destruction from technology—another significantly deflationary force—that is driving investment. Above all, the economic expansion—like the stock markets bull run—appears to be widely unloved. Many more seem fearful of success (and the inflation it may bring) than risk taking. This cautiousness will likely stretch the expansion as rapid technological advances sustain deflation pressures and real economic growth.
A major factor extending the US and the global expansion is the lack of synchronization in economic policy for the world’s three largest trading blocs. The US is late in its cycle and about to start monetary tightening. Fiscal policy has been on a tighter setting since the Lehman crisis. Exchange rates also have been limiting US growth and regulation has become more burdensome as administrators gain experience. In Europe, they are still in the early phases of the QE we stopped a year ago. Their banking system still faces a crisis from Greece, regardless of what deal is work out in the short run. Fiscal policy is supposed to be tightening, but the effects so far have been limited. A weaker Euro has provided the bulk of their stimulus, as the greatest result of QE was a wave of money moving offshore due to rate spreads. Now European interest rates are rising, but spreads remain wide and the currency weak by historical standards. Finally, in China, authorities are using successively larger doses of fiscal and monetary stimulus to re-ignite growth. Interest rates and the reserve requirement were lowered again this weekend. Whether this was to prop up the equity market is merely a matter of semantics. They are also loosening regulatory restraints far faster than expected. The only stimulus lever that has not been pulled (perhaps yanked is a better term) is a weaker yuan, as China remains committed to a long run goal of becoming a reserve currency. Bottom line, while labor resources may be somewhat tighter in the US, there is plenty of spare capacity in the rest of the world that will compete for trade, limiting US inflation and investment.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.