Steady as she goes might work for piloting a ship, but it’s a disappointing trend for the US economy. Economic growth of 2.0 percent per year has continued to leave resources—capital and labor—unused since the beginning of the recovery in the middle of 2009. That’s over four years of below-potential output. Imagine how much better off we would be if we had figured out how to make use of all those idle people and machines.
But the time is finally coming when US businesses will start to put those unused resources to work. As potential risks fade away, as Europe regains its footing, as China stabilizes, and as the US financial system finally puts the damage of the 2008 bust behind it and begins to operate at full throttle, US consumers and businesses will likely continue to do what they do best—spend and invest all of the resources available to them.
That’s why the Deloitte forecast shows the economy growing relatively quickly in the next few years. The exact timing is uncertain, of course. And we may see a short hit to economic activity from the temporary shutdown of the federal government. But past behavior of economic actors in the United States suggest that idle capital and labor won’t be left unused forever. The Deloitte forecast shows growth starting to accelerate in the middle of next year and enjoying two very good years in 2015 and 2016 as those idle resources are put back to work.
And while some people fret about the Fed’s loose monetary policy, the odds are profoundly against the US economy experiencing a bout of significant inflation in the next few years. High unemployment makes it impossible for inflationary mechanisms to take hold in the US economy. The Fed will likely continue to be more worried about low inflation than high inflation, and that’s just as it should be.
So the medium-term prospects for the US economy look good. Of course, there is always something to worry about. Here are a few things to keep you awake at night:
- The shutdown of the US government (just beginning as this is being written) could combine with the threat of a technical default to create a short but sharp hit on economic activity in the third quarter. The shutdown would have to last several weeks before the economic impact becomes significant—and the flood of payments after the shutdown would push up growth in the following quarter. There is a small but significant chance that a default (because of a failure by Congress to raise the debt ceiling) could create a systemic problem in financial markets.
- The Chinese economy can always make an economist nervous. Ever since the explosion of growth in the Asian tigers, China’s leaders have found themselves in an uncomfortable position. Having turned China’s capitalist spirit loose, it’s not clear how much control they have over events anymore.
- The Eurozone might fall back into recession—and the euro itself might come under pressure again. The direct impact of an implosion of the common European currency on the US economy would be modest. The more important question is whether one or more of the “systemically important” US financial institutions are exposed to risk from the Eurozone, given the events of the recent past.
- The Fed’s attempt to “taper” its purchases of long-term bonds might cause unexpected fireworks in financial markets. Hints of this have already created more excitement than most people would like. There are an awful lot of unknowns in too many markets—from mortgage rates to emerging market currencies—about what will happen as the Fed tries to unwind the extraordinary policy arrangements of the last five years.
Barring that type of drama, the US economy is set to pick up the pace in the next few years as recovery from the Great Recession really takes hold.
As potential risks fade away, as Europe regains its footing, as China stabilizes, and as the US financial system finally puts the damage of the 2008 bust behind it and begins to operate at full throttle, US consumers and businesses will likely continue to do what they do best—spend and invest all of the resources available to them.
What’s been happening?
The talk in financial markets has been all about the “taper” (when the Fed will start to reduce purchases of long-term bonds) and the potential impact on the economy.
Traders who tore themselves away from their screens would have discovered that the actual economy continued to grow at a moderate pace, without nearly as much drama as was evident in the day-to-day trading of stocks and bonds. Even though some of the data has been “soft” recently, it’s well within the bounds of variability that is to be expected at the current underlying trend of economic growth.
It’s hard to feel too bad looking at recent measures of the country’s basic economic health.
- Although job growth has slowed a bit, it is still at or above the level necessary to keep the unemployment rate from rising.
- Retail sales continue to grow, and auto sales went over 16 million units in August for the first time since 2007. US consumers continue doing what they do best.
- Despite the ups and downs of gasoline prices, overall inflation remained tame.
- The housing market continues to show signs of significant improvement. That’s important to both households, which are less likely to be underwater, and the financial system, which becomes stronger as higher house prices make repayment of mortgages more likely.
- Exports are almost 2 percent above their year-ago level.
Now, none of this is to say that current growth numbers are sufficient to push the economy back to its potential. The employment-to-population ratio remains depressingly low. But the fundamental story of moderate economic growth has been in place for the past year, and it is likely to continue, regardless of whatever specific words Fed officials happen to use in their next speech.
Ah, the US consumer—long-time supporter of the global economy, and still surprisingly resilient. Of course, consumers can’t spend money they don’t have, and their incomes are largely dependent on having jobs. As the US economy picks up its pace, and as jobs and incomes grow, consumer spending will respond. Just don’t expect US consumers to play Atlas and hold the global economy on their shoulders like they did in the aughts. The Deloitte forecast expects the US saving rate to remain between 4.75 and 5 percent, a good bit higher than in the previous decade.
US households actually face some pretty daunting obstacles in their pursuit of the good life. The biggest of these is growing inequality. For more about this, see the Deloitte Review article “Mind the gap” by Ira Kalish. Many US consumers spent the nineties and the aughts trying to keep up their spending when incomes were stagnant. After all, they kept being assured that technology was transforming the US economy and should be transforming their lives. But now they are wiser (and older, which is another problem as retirements loom without sufficient savings). As long as a large share of the gains from technology and other economic improvements flow to a relatively small number of households, overall US consumer spending is likely to remain restrained.
- Job growth has been decelerating, but not enough to create a rising unemployment rate. Even at the higher rate the economy experienced earlier this year, it would take a maddeningly long time to put active job seekers back to work—not to mention those who have simply left the labor market.
- Retail sales continued to grow.
- Auto sales went over the 16 million mark in August and have been above 15 million for all of this year. That’s a more “normal” rate than anything we’ve seen since the recession.
- Average hourly earnings are creeping up, although not much faster than inflation.
As long as a large share of the gains from technology and other economic improvements flow to a relatively small number of households, overall US consumer spending is likely to remain restrained.
It happens every year. Young people become old enough to leave home and start their own households. But it stopped happening during the recession. The number of households didn’t grow nearly enough to account for all the newly minted young adults. We’re sure that those young adults would prefer to live on their own and create new households; as the economy recovers, they will do exactly that.
This means the fundamentals are excellent for residential construction. We haven’t been building as many new housing units as the population would normally require for about five years, since 2008. In fact, housing construction was hit so hard that the oversupply then has turned into an undersupply now, so there’s a big hole that needs to be filled. We’re not returning to 2005, when housing construction powered the economy almost on its own, but this sector will likely be a big contributor to growth for awhile.
- House prices continued to rise—not surprising, since there hasn’t been much construction of new houses for half a decade.
- Housing permits and starts flattened out in the past few months. Housing construction is still quite a bit above year-ago levels. The large inventory of permits suggests that future construction will pick up again.
We’re not returning to 2005, when housing construction powered the economy almost on its own, but this sector will likely be a big contributor to growth for awhile.
There’s a lot of sad talk about the impact of uncertainty on business decisions. See, for example, the NFIB’s study of small business attitudes. The press release for the study makes the claim that “New study finds economic and political uncertainty top impediments to small-business growth” (although the actual study doesn’t seem to support this).1 So you might not realize that actual business spending in equipment and software has been the healthiest sector of the economy since the recovery started. It took longer for investments in structures to pick up, but that’s the usual story. For the past few quarters, investment in structures has been growing as well.
A lot of businesses are still waiting for assurance that they will have customers. Once those customers return, there will be even more reason to ramp up investment. Watch what businesses do, not what they say.
Business investment news
- Shipments of nondefense capital goods excluding aircraft have remained at a relatively high level, but they may be weakening. This is a key measure of business investment spending, and it bears watching.
- Interest rates rose, but financing investment is still a bargain. Or it would be, if there is a market for what the investment will produce.
The United States has long had a voracious appetite for foreign goods, and that’s not going to stop. Imports will grow at about twice the rate of GDP over the next few years, and they will accelerate along with GDP growth.
Exports look to prove a pleasant surprise, however. There are two reasons why US exporters will be happy:
- A variety of improvements ranging from the United States’ lead in technology to cheap natural gas will help to make US manufacturing more competitive with foreign goods.
- As risks abroad recede, investors are going to be looking outside the United States for higher returns. That’s not a bad thing for the United States since we, after all, account for a lot of those investors. To get higher returns in places like Europe and Asia, investors will be selling dollar assets. A lower dollar is just fine if it helps improve US competiveness and puts capital where it does the most good globally, so the possibility of a depreciating dollar is to be welcomed.
Foreign trade news
- Exports seem to be beginning to pick up after remaining flat since late last year. The slowdown was no surprise, given conditions in the two other drivers of the global economy. The clouds over Europe and China may be starting to clear a bit—giving US exports get a chance to grow.
- Imports have been stagnant or falling in recent months. But that’s largely because of the decline in petroleum imports due to tight oil and gas production in the United States. Nonpetroleum imports continue to grow in fits and starts. That’s only to be expected as the US economy grows at a moderate pace. Nonoil import growth will pick up as the US economy accelerates next year.
Government spending on goods and services has been stagnant, and the Deloitte forecast doesn’t see much change in the next few years. At the federal level, it is hard to see Congress and the president agreeing on much new spending over the next five years.
Figure 5. Government purchases of goods and services
Meanwhile, state and local governments are getting some good news from those rising house prices. Tax collections are up, and that might remove some of the pressure on their budgets. But those pesky pension liabilities continue to restrain state and local spending. The Congressional Budget Office estimates that there is a shortfall in state and local pension funding of $2–3 trillion.2
Look for government spending to grow more slowly than GDP for the next few years.
- Congress failed to pass funding for the new fiscal year. As of this writing, there are no indications about how long the situation will continue. About one-third of government spending (so-called “discretionary” spending) is affected by the shutdown. After the first week, all furloughed Defense Department employees were asked to return to work, so only about 400,000 people (of the total federal workforce of 4.1 million) remained furloughed. Congress also appears ready to pay the furloughed workers for this period, so they won’t lose much income (although their pay will be delayed). A short period of shutdown will have an imperceptible impact on the economy, but if the shutdown continues for a longer period, GDP growth will suffer. A simulation of the impact of a month-long shutdown suggests that GDP growth could be reduced by as much as 1 percent, with a bounce back in the next quarter when government spending is back up to speed.
- The federal budget situation continued to improve. So far, for the current fiscal year, the deficit is $400 billion below last year’s levels. Revenues are up, and spending is down as the economy recovers.
- State and local current finances are improving. The combined state and local budget deficit dipped below $200 billion at an annual rate for the first time since 2008.
- The City of Detroit’s bankruptcy may be an indicator of future trouble for other state and local governments. While Detroit may be on the front edge of advanced public sector financial distress, other local governments may take the same types of extraordinary measures to repair their balance sheets and stabilize their business models.
A US government default?
Any time the federal government does not pay its obligations, it has defaulted on those obligations. The US government currently borrows about one-third of the money it uses to pay its bills, so a failure by Congress to raise the debt ceiling means that—on some particular day in the near future—cash available (from tax payments and fees) will be too little to cover the bills that come due.
The Treasury secretary has said in the past that payments cannot by prioritized by type. This means that payments will be made as and when the Treasury has the cash to make them. Without a hike in the debt ceiling, some payments—interest payments, Social Security checks, and/or Medicare reimbursements, for example—will not be made.
As of early October, interest rates did not appear to reflect the possibility of a federal default. The closest the United States came to a default occurred in 2011. That summer, Congress passed an increase on the debt ceiling on the day the Treasury estimated it would run out of cash to make payments. As the date of expected default approached, only short-term Treasury rates were affected, and the market was careful to separate Treasuries with interest payments falling around the default deadline from those that did not have payments during that period.
This experience suggests that a default would not immediately lead to a general rise in US interest rates. Investors would watch carefully to determine the horizon over which the US government would be able to solve the problem.
With no obviously safe investment alternative to Treasuries, a default may not raise long-term interest rates substantially. It may even lower them, as the potential impact on the global economy causes investors to move toward safety, and as the supply of Treasuries becomes limited because the US government cannot issue more debt. Unlike Argentina and similar countries that have experienced sovereign default, there is no fundamental mismatch between the size of the debt of the United States and the government’s ability to tax to repay that debt.
A permanent solution to the political problem of the debt ceiling (for example, repeal of the law setting the ceiling) would almost instantly remove most of any risk premium that financial markets would place on US Treasury securities. Even in that case, however, a default is likely to cause financial markets to place a small but significant additional risk premium on US debt—raising the cost to the taxpayers of financing that debt.
With no obviously safe investment alternative to Treasuries, a default may not raise long-term interest rates substantially. It may even lower them, as the potential impact on the global economy causes investors to move toward safety, and as the supply of Treasuries becomes limited because the US government cannot issue more debt.
Contrary to what some people think, if the US economy is going to produce more goods and services, it will need more workers. As long as the labor market is out of balance, the current moderate wage growth will eventually encourage firms to increase capacity by hiring workers. However, employment growth is more likely to occur in industries such as health care and recreation services than in manufacturing. Accelerating production will carry with it an eventual acceleration in employment, and even a mild acceleration in wages.
However, a big question is lingering. A great many people have been out of work for a long time—long enough that their basic work skills may be eroded. When the labor market tightens up, will those people be employable? Once the employment-to-population ratio (rather than the unemployment rate) starts increasing and labor markets begin to tighten, the ultimate damage of the 2007–2009 recession will become measurable.
One unusual feature of the current recovery is the decline in the number of government workers. Government jobs were once thought of as recession-proof, but that’s not the case anymore. There isn’t a lot of desire for increased government spending. As a result, government employment is likely to grow slowly at best in the next few years, which may constrain job growth.
- Employment continues to grow faster than the long-run growth of the working-age population, although it has been slowing. The average job gain of 148,000 over the past three months is a deceleration from the 200,000 earlier in the year. The current pace of job growth is not enough to make up the large deficit in jobs that opened up during the recession.
- The employment-to-population ratio—a better measure of labor market slack than the unemployment rate—remains very high.
- Labor force growth had been picking up, but the deceleration in hiring seems to have pushed people out of the labor force again.
Contrary to what some people think, if the US economy is going to produce more goods and services, it will need more workers.
Interest rates are among the most difficult economic variables to forecast because movements depend on news. And if we knew it, it wouldn’t be news. The Deloitte interest rate forecast is designed to show a path for interest rates consistent with the forecast for the real economy. But the potential risk for different interest rate movements is higher here than in other parts of our forecast.
The Deloitte forecast sees interest rates headed up—maybe not this week, and maybe not this month. The forecast shows the economy regaining its health by late 2014, however, and a healthy economy will mean that lending will be once again become costly. The forecast moves interest rates back to “normal” interest rate levels as economic growth accelerates. That’s not a bad thing—unless returning to normal is bad.
Of course, some investors will be caught short. Those are the people who think that interest rates will remain low forever. Some of those will even be so-called sophisticated investors, so plenty of worried headlines will appear when interest rates go up. Don’t be fooled by what is just a welcome return to normal.
Investors practically went into a panic over reminders by a few Fed officials that Fed purchases of private-sector bonds won’t continue forever. Stock prices fell 5–6 percent before Fed Chairman Ben Bernanke reassured the markets that the Fed was not taking immediate action. Who knows what kind of panic will ensue when the time comes for the Fed to being to actually unwind policies that were always meant to be temporary? Look for too much excitement in financial markets.
The possibility of a US government default may also focus investors on the risk of lending to the US government, a risk they have hardly considered before. An actual default will have a more immediate impact on short-term rates than on long-term rates. That’s because, as we learned in 2011, investors really don’t expect a default to be a long-term problem. However, a failure by Congress to address the debt ceiling could lead to a permanently higher risk premium on US debt. It might also lead to systemic problems in financial markets, as some Treasury issues become technically in default (and therefore unusable as collateral). Please see the full discussion in the Government section.
Financial market news
- Stock prices have remained relatively high during the past few months, despite concerns over Fed policy and Syria.
- Interest rates remain above their lows. They still remain historically very low, however.
- There was little action in the principal foreign exchange markets. International money traders appear to be waiting to see how events in Europe and China proceed.
Remember those folks who were convinced that the Fed’s actions in 2009 would create runaway inflation? They might rather you didn’t. Prices have been the most boring part of forecasting for the past five years, and there is no reason to think that’s going to change.
Inflation is hard to come by when the labor market—which accounts for two-thirds of all costs in the US economy—is so slack. Workers don’t have leverage to obtain higher wages when prices go up, and businesses don’t have pricing power to cover higher costs. Instead, shocks from higher energy or food prices have just dissipated into the ether rather than being translated into sustained higher inflation.
That means that inflation will remain tame at least until the economy reaches full employment. With a labor surplus of 10–12 million people, that will take a while even in our forecast. So don’t hold your breath waiting for the return of the 1970s. Bell bottoms, disco, and high inflation are all safely in our past (for now).
- The overall consumer price index rose a rather hefty 0.5 percent in June. But that just made up for a 0.4 percent fall in April. The culprit is the price of gasoline.
- Underlying inflation, measured by the CPI less food and energy, remained tame and controlled. There is no sign that inflation is likely to pick up any time soon.
Remember those folks who were convinced that the Fed’s actions in 2009 would create runaway inflation? They might rather you didn’t.
Deloitte economic forecast
Percent change, year-over-year unless otherwise noted.
|Real consumer spending||−0.4||-1.6||2.0||2.6||2.2||2.0||2.3||3.1||3.1||2.9||2.7|
|Real consumer spending, durable goods||−5.1||−5.5||6.1||6.6||7.8||8.2||11.0||8.5||7.9||5.9||2.3|
|Real consumer spending, nondurable goods||−1.1||−1.8||2.2||1.9||1.4||1.7||0.9||2.2||2.3||2.4||2.8|
|Real consumer spending, service||0.8||−0.8||1.2||2.1||1.6||1.2||1.3||2.5||2.5||2.6||2.8|
|Real investment in private housing||−24.0||−21.2||−2.5||0.5||12.9||13.2||9.5||8.8||9.0||6.0||5.5|
|Real fixed business investment||−0.7||−15.6||2.5||7.6||7.3||2.2||5.2||8.9||9.7||7.4||5.7|
|Real inventory accumulation||−34||−148||58||34||58||49||50||68||75||69||56|
|Real exports of goods and services||5.7||−9.1||11.5||7.1||3.5||2.5||5.3||6.7||7.9||6.5||5.6|
|Real imports of goods and services||−2.6||−13.7||12.8||4.9||2.2||1.7||4.8||6.3||5.6||4.9||5.0|
|Real government consumption and investment||2.8||3.2||0.1||−3.2||−1.0||−2.2||0.2||0.9||1.1||1.3||1.3|
|Real federal government consumption and investment||6.8||5.7||4.4||−2.6||−1.4||−5.4||−2.5||0.1||1.1||1.7||1.7|
|Real state and local government consumption and investment||0.3||1.6||−2.7||−3.6||−0.7||−0.5||1.1||1.4||1.3||1.3||1.3|
|Housing starts (thousands)||900||554||586||612||783||949||1,200||1,506||1,768||1,808||1,810|
|Stock of owner occupied homes
|Interest rate on 30-year fixed rate mortgages (percent)||6.04||5.04||4.69||4.46||3.66||4.01||4.49||4.83||5.39||6.18||7.05|
|Current account balance, share of GDP (percent)||−4.6||−2.6||−3.0||−2.9||−2.7||−2.3||−2.0||−1.9||-1.6||-1.4||-1.1|
|Merchandise trade balance
|Relative unit labor costs (Index, 2008=100)||100.4||103.5||95.5||88.6||86.2||83.6||83.8||82.6||80.9||79.5||77.6|
|Federal budget balance, unified basis ($ billions, fiscal years)||−455||−1,416||−1,294||−1,297||−1,089||−637||−668||−599||−543||−553||−557|
|State and local budget balance ($ billions, NIPA basis)||−165||−272||−237||−213||−253||−207||−158||−120||−112||−124||−130|
|Average monthly change in employment||−232||−469||63||167||181||200||231||235||184||133||87|
|Income and wealth|
|Real disposable personal income||1.5||−0.5||1.1||2.4||2.0||0.5||2.3||3.0||3.7||3.7||2.8|
|Net household wealth
|Personal saving rate (percent of disposable income)||5.0||6.1||5.6||5.7||5.6||4.3||4.3||4.3||4.9||5.7||5.8|
|After tax corporate profits with corporate profits with inventory valuation and capital consumption adjustments||−16.0||8.4||25.0||7.9||7.0||2.1||1.2||6.9||7.0||3.1||4.0|
|Federal funds rate (percent)||0.51||0.12||0.19||0.07||0.16||0.13||0.13||0.25||0.74||2.18||4.05|
|Yield on 30−year treasury bond (percent)||3.73||4.31||4.14||3.04||2.86||4.12||4.33||4.78||5.46||6.16||6.47|
|Consumer price index||3.8||−0.3||1.6||3.1||2.1||1.6||2.2||2.2||2.2||2.2||2.0|
|Chained price index for personal consumption expenditures||3.1||−0.1||1.7||2.4||1.9||1.3||2.0||2.0||2.0||2.0||1.8|
|Employment cost index||3.0||1.7||1.9||2.0||1.9||1.9||1.8||2.5||3.6||3.7||3.1|
|CPI for energy products||13.7||−18.1||9.5||15.2||1.0||−0.2||3.0||2.7||4.8||4.5||1.4|
|Sources: Historical data: US government agencies and Oxford Economics. Forecast: Deloitte, using the Oxford Global Economic Model.|
- “Growth: External impediments,” NFIB National Small Business Poll, Volume 11, Issue 1, 2011.
- “The underfunding of state and local pension plans,” Congressional Budget Office, May 2011.