1/6/14 – Economic Growth Is the New Consensus

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jan 6, 2014 12:05:55 PM

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As the new year begins, there’s definitely a change in the atmosphere. Not the 18 inches of snow that my snowblower very efficiently directed right into my face. Not the arctic air of the past couple of days, or even the 50-degree rainstorm of today. (If you live in New England and want the weather to change, wait 10 minutes.)

The change I’m referring to is a definite aura of hope for the economy. Carmen Reinhart and Ken Rogoff—the economists who wrote This Time Is Different, about how financial crises are never different—have come out with a study that suggests the U.S. economic recovery is actually doing pretty well, compared with the experiences of other countries emerging from similar crises.

Okay, as hope goes, this is pretty small beer. Shrinking the economy by 5 percent per person, as opposed to an average of 9 percent, and returning to the pre-crash peak in 6 years, rather than the average 6.7, doesn’t sound all that great. When you consider the alternatives, though—including France, Spain, and other countries that are still in trouble—it looks pretty good.

With Ben Bernanke leaving the Federal Reserve and Janet Yellen scheduled to be confirmed today, it’s worth taking a look at why the U.S. is doing better than expected, and better than many other countries.

Probably one of the biggest reasons is that we took the pain and cleared the system. The contrary exhibit would be Japan, which never actually recognized many of the losses from its binge in the late 1980s and has been paying for the past 20 years. In the U.S. housing market, for example, massive foreclosures, massive write-downs of real estate loans, and the complete decimation of the housing industry were incredibly painful, but they laid the groundwork for the current real estate recovery. Housing has come back substantially and is now well on its way to becoming—gasp—a normal market, with values and trends determined locally. It sounds weird, but this is success. By relocalizing the housing markets, we have removed housing as a systemic risk and made it a long-term source of growth again.

Another big reason is that Americans themselves didn’t take all the pain; the Fed and the federal government stepped in and spent to pick up the slack. You can (and I would) argue that this has gone on too long, but by preventing a deeper collapse, the Fed’s support enabled a quicker recovery and far less damage—both to the economy and to U.S. citizens. When you compare our results with, say, those of Ireland or Greece, you can see the risks of excessive austerity.

The final big reason, in my opinion, is the flexibility of our labor market. As much damage was done by the massive loss of jobs and high unemployment, we have, again, laid the groundwork to be more competitive as a country. Jobs have started to relocate here from abroad, drawn by cheaper productivity-adjusted wages. Make no mistake, our wages are still higher, but since our workers are more productive, they’re worth it. As jobs come back (and they are) and as unemployment declines (and it is), we will see greater wage growth, which will further help grow the economy in a virtuous cycle.

It’s far too soon to declare victory, and I am not. We still need to navigate the disengagement of the Federal Reserve from the economy, which will be very challenging. We still need to see whether Europe will continue to recover, or not. We still need to see whether the promise of employment and wage growth will continue.

The fact of the matter is, though, most people now expect it to happen rather than expect it not to, and, like anything in economics, expectations can become self-fulfilling. Expectations drive consumer spending, business hiring and investment, and pretty much everything else in the economy. Consumer confidence is coming back. Business investment plans are coming back. Hiring plans are coming back.

So far, we have successfully navigated between the Scylla of too little stimulus and Charybdis of too little pain. The “taper” debate that the Fed is now having is about how best to stay in the sweet spot, with the apparent consensus that there’s more danger in not winding down the stimulus than in continuing. Again, this is progress.

We are in a much better position than we were a year ago, and most of the risks now are in slower growth, rather than collapse. While I hope the downside does not come true, we’ll be in much better shape than we would have been last year if it does.

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