Rod Oram: Rogue US threat to Goldilocks economy
Rod Oram took a close look at the Treasury's fresh forecasts to find some reassuring scenarios. But he points overseas to the risks around Donald Trump and a frothy stock market as factors that could turn the Goldilocks view on its head.
Treasury’s forecasts in its half-year economic and fiscal update will be comforting to Government and business alike. While the economy is slightly weaker now than it forecast in May’s budget, it reckons we’ll make up the lost ground later.
Even Treasury’s alternative scenarios are reassuring. The downside one, “Softer but Stable Growth”, is particularly benign. If the recent falls in domestic business and consumer confidence persist, growth will plateau at current levels rather than peak in 2019. The new government could still fulfil its plans, with only a moderate tightening in its finances.
The upside scenario, “Stronger and More Cyclical World Growth”, is particularly bullish. Our trading partners would enjoy brisker growth, which will be great for our export volumes and prices. The response of central banks is the only slight fly-in-the ointment. They would reduce their stimulus so global growth would become more cyclical.
Treasury is in good company. Even some usually cautious analysts are resorting to the Goldilocks cliché to describe such apparently propitious and enduring global conditions of strengthening growth, low inflation and low interest rates. Heck, even Japan, that basket case of entrenched deflation and lethargic growth, is putting on a bit of a spurt, they note.
But what if that cliché is wrong? How should New Zealand - business, government and consumers - respond then?
This a very real risk because one character in the Goldilocks story has gone rogue. Under the presidency of Donald Trump, the US has turned into a big, burly, mad-as-hell alpha male blundering around global politics and economics.
Just this past week, Trump caused mayhem in the Middle East by recognising Jerusalem as Israel’s capital; the US Trade Representative Robert Lighthizer castigated sovereign members of the World Trade Organisation, thereby further undermining rules-based international trade; and Congress produced a tax bill that favours exporters, thereby breaking WTO rules and prompting a protest letter from the finance ministers of the five largest European economies.
On these and many other critical issues of international peace and prosperity the US is belligerent, irrational and isolated. No one can forecast where this will push the world. But it’s important to tune in now to save being blind-sided later.
One measure of the US’s economic and political bankruptcy is the travesty of a tax bill that Congress will send soon to the White House for Trump’s signature.
Republicans are railroading the bill through Congress in great haste and astonishingly without any hearings. It is so badly written, including handwritten additions scrawled in the margins, that it is creating myriad ways for taxpayers to game the system, according to experts’ analysis reported by New York magazine and others. They conclude there’s a real risk that tax revenue will fall and the government’s budget deficit rise more than forecast.
But that’s the least of the problems with the bill. Congressional Republicans and the Trump Administration say the tax cuts will be self-financing because they will trigger extra economic growth, and thus tax revenues.
However, the only “evidence” Steven Mnuchin, the Treasury Secretary, has offered is a one-page press release. Remarkably this “analysis” is based on the Administration’s forecast that the cuts will push US GDP growth to an average of 2.9 percent a year for the next decade. Treasury failed to test that economic assumption. It merely calculated the tax revenue implications.
In stark contrast, the vast majority of economists and institutions that have crunched the numbers, reckon the bill’s US$1.5 trillion of tax cuts over the next 10 years won’t do much for growth. Thus, the federal budget deficit will rise by US$1 trillion or so. Even almost all analysts ideologically aligned to the Republicans concur.
Five main reasons are cited for slower growth and bigger deficits:
- The tax cuts massively favour the rich, who will recycle little of the money into more consumption or productive investment.
- The middle class gain little, so their extra consumption will be minor; and that effect wears off over the next decade because their tax cuts are temporary.
- The corporate tax rate will fall from 35 percent to 21 percent. But the effective rate now, thanks to myriad write-offs, is only 18.6 percent, or 13.3 percent including the R&D tax credit, which is well below the OECD average. Thus, the effect of a lower headline rate will be minimal. It won’t trigger the higher wages and surge of investment that tax cut advocates claim would drive faster economic growth.
- Post-tax profits have nearly doubled their share of US GDP since 2000 without leading to any beneficial increase in investment. Instead the benefits flowed to shareholders not employees, as will the gains from these tax cuts. Likewise, the UK has cut its corporate tax rate from 30 percent to 19 percent since 2008 without any significant increase in investment.
- Trump is claiming growth will accelerate to a sustained 5 or 6 percent. But that simply isn’t possible in a mature economy with low unemployment and other constraints.
However, the tax bill will have a big negative impact politically. Opinion polls find only a third of the public support it. Instead, a large majority of voters realise some of their cherished tax deductions for the likes of mortgage interest and state and local taxes will be scaled back. Moreover, the bill’s 500 pages are crammed with favours for special interests, and hits on the general public, such as measures to weaken the affordable health insurance programmes.
And while the Republicans deny their tax bill will cause the budget deficit to escalate, they are planning to reduce government spending anyway. They say their next big legislative push will be sweeping cuts in social support programmes.
Quite simply, the US is tearing itself apart economically, politically, socially, culturally and racially. The more it damages itself, the more it will disrupt the rest of the world.
Moreover, the tensions afflicting the US are evident in other counties. As The Economist noted two weeks ago:
“In a recent survey of people in 28 countries, 62 per cent of respondents worried about globalisation; 55 percent thought an influx of foreigners was harming their economy and culture. These trends are marked in the United States. Two-thirds of Americans are concerned about immigration. Three-quarters think the government should protect local jobs and industry, even if that slows growth. Furthermore, trust in CEOs is dropping. In the survey just 38 percent thought they were very credible, down by five points from 2016. What was once standard business practice, whether minimising tax bills or investing abroad, exposes CEOs to suspicion and the intrusion of politics.”
Yet, a preternatural complacency is anesthetising asset markets around the world. The Vix, which measures stock market volatility, has only been this low twice in the past 23 years – in 1994 just before a massive global bond market sell-off, and in early 2007 before the first stages of the Global Financial Crisis.
Even more remarkably, the S&P 500 index in the US has just had its least volatile 12 months since the period that began a week after the assassination of President Kennedy, recent analysis by the Financial Times has shown.
Over the last half century, the index has moved by an average of 0.72 percent each day, more than double the volatility seen this year. It seems markets, now as then, are unable to process severe political shocks.
The Bank of International Settlements, the central banks’ bank, notes in its latest quarterly bulletin that “according to traditional valuation gauges that take a long-term view, some
stock markets did look frothy”, adding that “some froth was also present in corporate-credit markets”.
In a similar vein, Bank of America Merrill Lynch’s recent survey of fund managers found that a net 48 percent judged equities were overvalued, a record high. Yet, a net 49 percent of them had a higher than normal allocation to equities.
If global conditions turn fraught, they will prove Goldilocks was a fairy tale after all.
If we’re prepared for that, we can keep investing in more homes, infrastructure, health, education, innovation, productivity, technology, social programmes, environmental improvements and all tour other measures of progress. We have the strategies, policies, money and borrowing capacity to do so.
But if we don’t see the global turmoil coming, we’ll be stunned by it. Our confidence and ambition will take a nasty knock. We will neglect our opportunities and compound our problems.