Just once, we’d like to post that the economy is growing like pumpkins in September, that personal income is soaring (or at least not falling), that jobs are being created, businesses are being started and capital is being invested.
Would that it were true.
Readers of this blog may thing we’re pessimistic by nature. We’re not. It’s just that the economy has been a disaster for as long as we’ve written this blog.
Now, finally, the unemployment rate has fallen to 5% – just under 10% if you’re counting people who have given up looking for work or who are working part-time because they can’t find full-time work. In addition, the U.S. Bureau of Labor Statistics reported that personal income grew 2.5% between October 2014 and October 2015.
The economy is cyclical and it could signal that the job market is finally improving. However, the labor force participation rate remains at its lowest level in 38 years, so we’ll leave the cheery propaganda to mainstream media. We feel an obligation to tell the truth and the truth is that the economy is still in dismal shape. We’re not in a recession – at least not according to the traditional definition of one – but defining the current period of economic non-growth as a “recovery” is a stretch.
Consider what the current recovery hath wrought:
- Gallup reported that, since the beginning of the Obama Administration, the number of businesses that have closed exceeds the number of businesses that have been formed by 70,000.
- Gross domestic product grew at a measly 1.5% during the third quarter, as we reported last week, and more than 100 million Americans are not working.
- Employment may have peaked (see chart). Newedge strategist Brad Wishak points out “for the last 20 years at least, a 285k 5-month Mov. Avg in the MoM Change in nonfarm payrolls has signaled the top in job creation for that cycle.”
- Real economic output rose by just 2.3% in the third quarter – its lowest increase since Q1 2014. Real economic output combines productivity, hours worked and compensation, with a deflator adjustment.
- Productivity, which is key to raising wages and living standards, increased less than 0.5% a year from 2011 through 2014, which is the weakest four-year period outside of a recession since World War II.
Most distressing – and the reason for all of the above – is that, “Business investment in the real economy is weak,” as Nobel laureate Michael Spence and former Fed governor Kevin Warsh noted in a recent commentary in The Wall Street Journal. “While U.S. gross domestic product rose 8.7% from late 2007 through 2014, gross private investment was a mere 4.3% higher.”
Nowhere to Invest?
Now on his book tour, former Federal Reserve Chairman Ben Bernanke is claiming that capital spending is low because there are no longer any good investments for corporate America to make.
Right. Suddenly, after nearly two-and-a-half centuries, businesses no longer need the latest and greatest. They don’t need the latest information technology, robotics, nanotechnology or faster-more efficient-greener-lower cost upgrade. We’re reached the limit.
With interest rates near zero and innovations such as the cloud and big data taking place, you might think there would be plenty of capital investment in recent years.
Not so. Instead, with the Federal Reserve Board jacking up stock prices, businesses have been putting their money into share buybacks.
During the past five years, Spence and Warsh pointed out, the S&P 500 has grown by about 6.9% annually, while corporate profits have been underwhelming. In addition, they noted that “only about half of the profit improvement in the current period is from business operations; the balance of earnings-per-share gains arose from record levels of share buybacks. So the quality of earnings is as deficient as its quantity.”
In other words, business leaders have joined the Fed in artificially jacking up stock prices.
Looking Ahead
So whose fault is it that corporations are buying stock instead of new technology? The Fed’s, of course. By seeking to stimulate the economy, the Fed has instead dampened future growth, according to Spence and Warsh.
Capital investment is driven by perceived future demand, but by artificially jacking up stock prices, quantitative easing (QE) “has redirected capital from the real domestic economy to financial assets at home and abroad,” they wrote. “In this environment, it is hard to criticize companies that choose ‘shareholder friendly’ share buybacks over investment in a new factory.”
Spence and Warsh cite several reasons who the Fed’s monetary policy has resulted in record share buybacks instead of economic growth:
- Unwinding of the Fed’s easy money policy is creating uncertainty. Corporate decision makers are avoiding risk by focusing on short-term commitments.
- Financial assets are liquid; real assets are not. Company stock can be sold for cash at any time. Liquidating a factory building or heavy machinery would take far more time and effort.
- QE reduced volatility in financial markets, but not in the real economy. By purchasing long-term securities, the Fed removes significant market volatility from stocks and bonds, and made the purchase of real assets more speculative.
- QE’s efficacy in bolstering asset prices may arise less from the policy’s actual operations than its signaling effect. Studies in the U.S., Europe and Japan show that financial-asset prices move higher when QE programs are announced and implemented, and suffer when QE is thought to be ending.
“Efforts by the Fed to fill near-term shortfalls in demand through QE and so-called forward guidance have shown limited and diminishing signs of success,” Spence and Warsh wrote. “And policy makers refuse to tackle structural, supply-side impediments to investment growth, including fundamental tax reform.”
America has the highest corporate tax rate in the free world at 39.1%, compared with an average of 24.1% for all countries in the Organization for Economic Co-operation and Development.
America is also virtually the only developed country that taxes corporations when they return foreign earnings to the United States. This is double taxation, as corporations also pay taxes in the countries where they locate operations. The result has been that a growing number of American companies are moving their headquarters to other countries.
If you were a business owner, which would be the better incentive for you to invest in capital improvements – the purchase of trillions of dollars’ worth of bonds by the Fed or a lower tax rate?