GDP Growth at 2.1% in Fourth Quarter

The preliminary estimate of real gross domestic product (GDP) growth for the fourth quarter of 2019 on the surface shows a continuation of solid continuation of the economic expansion, but the underlying data contains several areas of concern. GDP rose by an annual rate of 2.1 percent in the fourth quarter of 2019, according to “advance” GDP estimate released by the Bureau of Economic Analysis on Thursday, which was in line with expectations. In the third quarter, real GDP increased 2.1 percent.

Quarterly GDP growth, 2015-2019

The good news

On the positive side, residential fixed investment continued its strong rebound from the third quarter, rising by 5.8 percent. The probably was due to a combination of a shortage in housing inventory and support from the Federal Reserve’s interest rate cuts. An 8.7 percent drop in imports, largely due to international trade tensions, helped to boost the net exports (exports minus imports) component of GDP growth.

Quarterly residential fixed investment growth, 2015-2019

The bad news

On the negative side, non-residential fixed investment fell for the third straight quarter in row, dropping by 1.5 percent. This category of spending will need to return to positive growth soon for the economy to continue to grow at more than 2 percent.

Quarterly nonresidential fixed investment growth, 2015-2019

Mixed indicators

Although personal consumption spending growth remained relatively strong at 1.8 percent, it has weakened in the last two quarters. Results from the next two quarters should show if this the result of consumers taking a breath from the more rapid increases of the second and third quarters or the beginning of a longer trend of consumption growth below 2 percent.

Quarterly personal consumption growth, 2015-2019

I would also place the 3.6 percent increase in federal consumption and investment spending in the mixed category. Over the short term, this spending rise does give a boost the GDP growth. Over the long term, however, government spending cannot continue to rise faster the supporting economy without squeezing out private-sector investment and consumption.

Quarterly federal government consumption and investment growth, 2015-2019

Looking forward

Residential construction is likely to remain strong until the current shortage in the housing inventory is reduced, which should support economic growth over the next several quarters. The declining non-residential investment remains worrisome and could drag the economy into more sluggish growth if it is not reversed soon. It is unclear which side of the trade ledger, imports or exports, will gain the most from the recent easing of trade tensions with China. The impact of the Wuhan coronavirus on US-Chinese trade and global economy is also a wild card at this point.

CBO Report Points to Runaway Spending Increasing the Risk of a Fiscal Crisis

The latest budget and economic outlook from the non-partisan Congressional Budget Office (CBO), released on Tuesday, projects the federal budget deficit will rise from 4.6 percent of GDP in 2020 to 5.4 percent in 2030. These large deficits in turn will push the federal debt held by the public from 81 percent of GDP this year to 98 percent in 2030, and to 180 percent of GDP in 2050.

  • The CBO warns that a high and rising federal debt would reduce national saving and income, boost the government’s interest payments, limit the ability of policymakers to respond to unforeseen events, and increase the likelihood of a fiscal crisis.

Congress’s failure to rein in spending is the main culprit in the increase in the size of the deficit in the next 10 years. Specifically, the CBO projections point to the ever increasing costs of mandatory spending programs, particularly for Social Security and federal health care programs.

  • The CBO projects that by 2030 total outlays for Social Security and federal health care programs will rise to 13.0 percent of GDP from 10.3 percent this year, or 2.7 percentage points higher than this year and 5.4 percentage points higher than in 1995.
  • In the CBO outlook, defense and non-defense discretionary spending will fall to 5.6 percent of GDP in 2030 from 6.4 percent this year. Any new federal programs not already established in law would make the deficit even worse.

Whoever wins the presidential election this year will face the daunting task of addressing this mismatch of revenues and spending. President Trump’s preferred path, so far, of attempting to close the deficit by spurring economic growth will not work if the growth of mandatory spending continues to outpace economic growth.

  • Even the most optimistic growth projections produced by the Trump administration fall short of the 5 percent annual growth in mandatory spending estimated by the CBO during the next 10 years.
  • President Trump has promised new health care reforms to curb the growth in federal health care spending but he has not released any details.

The proposals of the various Democratic presidential candidates to vastly increase taxes to close the fiscal gap are even worse. The CBO outlook estimates that federal revenues will return to 18 percent of GDP by 2027 from 16.4 percent this year. As I mentioned last week, the historical data strongly suggests that there is a practical federal revenue ceiling of about 18 percent of GDP.

  • Any attempts to increase the taxes above this level would almost certainly fail as tax payers and corporations move to shelter more of their incomes or pull back from economic activities whose reduced after-tax profits are need seen to be worth the risk.
  • The economic consequences would be an economic slowdown, or even a recession, that would simultaneously reduce revenues below planned levels and increase demands for more social spending, thus widening rather than reducing the deficit.

The only long-term solution is to cut the growth in mandatory spending. The only question is whether the leadership in Washington will have the courage to take this action early enough to do it in an orderly manner or if they will wait until a fiscal crisis imposes a solution upon them. History will not look kindly on them if they choose the later path.

Defense Orders Drive Durable Goods Growth in December

New orders for manufactured durable goods in December increased by $5.7 billion or 2.4 percent to $245.5 billion, the US Census Bureau announced today. A shape rise in defense orders, which were up by 102 percent from November, drove the increase. Transportation equipment orders, driven by a 168 percent increase for defense aircraft, were up by 7.6 percent.

  • Excluding defense, new orders decreased by 2.5 percent.
  • Excluding transportation, new orders decreased by 0.1 percent.
  • Non-defense aircraft and parts declined by 69.1 percent as the grounding of Boeing’s 737 MAX airliner continues to hit the aircraft industry.

Although the preliminary results for December were significantly better than the consensus expectation of a fall of 0.3 percent, the heavy concentration of the growth in defense goods underlines potential weakness going forward.

IMF Sees Global Growth to Rebound

The IMF is forecasting global growth will rise from an estimated 2.9 percent in 2019 to 3.3 percent in 2020 and 3.4 percent in 2021, according to its World Economic Outlook Update released today. Although there are few visible signs of turning points yet in the global macroeconomic data, it supports its forecast with the following points:

  • Market sentiment has been boosted by tentatives signs that manufacturing activity and global trade are bottoming out.
  • A broad-based shift toward accommodative monetary policy.
  • Intermittent favorable news on US-China trade negotiations.
  • Diminished fears of a no-deal Brexit.

For the US economy, the Fund is expecting growth to moderate from 2.3 percent in 2019 to 2 percent in 2020 and declining further to 1.7 percent in 2021. It bases its view on the fading fiscal support from the 2017 tax overhaul and waning support of any further loosening of monetary policy.

Rising Spending Driving Budget Deficit Increase

Rising spending pushed the US Federal Deficit in $1.02 billion in 2019, or 4.7 percent of GDP, according to data released last week by the US Treasury. Rising health care and defense spending were the main drivers pushing total federal outlays by 7.5 percent to $4.5 trillion last year, outpacing the 5 percent increase in federal revenues. The analysis in this report will focus the trend of federal receipts and outlays as a share of GDP, as this gives a better measure of their burden on the economy than does annual dollar amounts.

Federal spending has been increasing relentlessly for the last 20 years, rising from about 18 percent of GDP at the end of the Clinton administration to 21 percent today. The trend is for it to continue to rise in the future. According to the Congressional Budget Office projections, federal outlays will reach 23 percent of GDP in 2030 and 26 percent of GDP in 2040. Most this increase is due to rising Social Security and Medicare payments. Increased defense spending related to the global war on terrorism has played a secondary role since 2011, but this burden is unlikely to increase in the future as a share of GDP.

Federal revenues are now at 16.2 percent of GDP and have averaged 17.3 percent of GDP over the past 40 years. With the exception of unexpected windfall in tax revenues during the boom of late 1990s, they have never risen above 18 percent of GDP, which appears to be a practical ceiling minus an unforeseen economic boom.

This mismatch between spending and revenues has created a structural deficit that neither party, so far, has any coherent plan to address. Federal spending, as a share of GDP, would need to be slashed by 14 percent to bring it down to the apparent revenue ceiling of 18 percent of GDP. The Trump administration has promised new health care reforms to curb the growth in federal health care spending, but so far has not released any detailed plans. Congressional leadership of both parties also have shown little willingness to reverse the growth in spending.

Conversely, federal revenues would need to rise by a draconian 31 percent to fully fund just the current level of spending. To fully meet 2040 federal spending obligations, revenues would need to increase by 63 percent. If history is any indicator, any attempts to raise tax rates to meet these goals would almost certainly fail. Increasing revenues above 18 percent of GDP would cause an economic slowdown, and possibly a recession, which would more likely increase the deficit over the long run rather than shrink it.

Of the two potential solutions to the rising deficit, cutting spending appears to be more doable than does raising taxes, but this will only succeed if lawmakers develop the courage to address the problem. With enough foresight, a plan could be implemented that would minimize the impact of spending cuts. More likely, economic realities will force a more painful solution through a fiscal crisis.

Low Unemployment, Rising Wages Benefiting Underprivileged

Historically low unemployment and rising wages indicate that the benefits of the current economic expansion are widespread, which likely will increase President Trump’s reelection chances. Data released by the Bureau of Labor Statistics on Friday shows the labor force remains tight, with the unemployment rate at historic lows and an increase in the labor force participation rate.

  • The headline unemployment rate in December remained at 3.5 percent, matching the lowest rate since May 1969. Broader measures of unemployment are all at the series low.
  • 74.2 percent of workers entering employment in the fourth quarter came from out of the labor force rather than from unemployment, which is the highest share since the series began in 1990. 
  • The labor force participation rate for prime-age adults (ages 25-54) up to 82.9 percent in December—1.6 percentage points above the rate in November 2016.

Historically disadvantaged workers–who are increasingly becoming swing voters–are seeing the most benefits as employers raise wages to attract and retain workers. December marks the 17th consecutive month that average hourly earnings growth for production non-supervisory workers has been at or above 3 percent. 

  • Wages for workers are growing faster than for managers
  • Wages for those without a bachelor’s degree are growing faster than for those with a bachelor’s degree or higher.
  • Wages for individuals at the bottom of the income scale are growing faster than for those at the top.
  • Wages for African Americans are growing faster than for white Americans.