Tuesday, February 21, 2017

Economic Projections

Wanted to touch briefly today on some things that are happening economically today.

First of all, there are plenty of troubling signs of a bubble in the markets, with stock valuations greatly outstripping earnings expectations.  ZeroHedge has some nice charts and very little text.  100% passes the "TL;DR" test!  Go check them out.  Here's my "favorite" of the lot of them:

HMMMMM.  That's not good.  I'm reading about Enron currently.  When you see stock valuations wildly outpacing earnings, you know you are looking at a potential big problem.

I would be lying if I told you that I knew for sure that we are currently in another bubble.  Maybe we aren't!  I certainly hope we aren't.  But the ZeroHedge article makes for short, "uh-oh"-inspiring reading, so read it.

Just like the S&P, it seems that the Trump administration may be engaged in some economic wishful thinking as well.  This WSJ article which you probably can't read because of the WSJ's obnoxious paywall breaks down the Trump team's rosy forecast for the economic future.  Let me parse it for you chunk by chunk.  Emphases added mine, as always.

Right off the bat:

The Trump administration has drafted preliminary economic growth forecasts in its federal budget planning that rely on assumptions that are far rosier than projections made by independent agencies and most private forecasters, according to several people familiar with the discussions.


The forecasts, which were initiated before President Donald Trump took office, project gross domestic product—a broad measure of national output of goods and services—growing between 3% and 3.5% a year over the coming decade, with inflation-adjusted annual growth ultimately settling at around 3.2% during the later years of the 10-year forecast.

The economy has grown around 2% on average over the past decade. Many economists believe sustained growth at more than 3% will be difficult to achieve without a sharp rebound in productivity growth and a reversal in the slowing expansion of the U.S. labor force, developments few are projecting. Worker productivity growth has slowed to 0.7% a year since 2010, a sharp slowdown from rates exceeding 3% in the late 1990s and early 2000s.

Where do we get this 3% growth?  From tax cuts?  As Paul Krugman reminds us, the best GDP growth of the last forty years (during the Clinton administration) took place when taxes were going up.  Yes, the Reagan years, years of max tax cutting, were the second best in terms of GDP growth.  But third best were the dread "socialist" Obama years - years that blew away the GDP growth of tax-cutter Dubya.

There's the traditional rosy GOP tax-cutting projections coming out of the Trump camp:

The higher annual growth estimates in the initial internal Trump forecasts would result in the U.S. economy becoming 17% larger after a decade relative to recent projections from the CBO, which produces forecasts that assume no changes to current tax and spending policies.

The higher growth assumption in the Trump forecast would show sharply lower deficits as a share of gross domestic product, especially in the back half of the 10-year forecast window.

Tax cuts leading to growth which in turn lead to decreased deficits is the premise of the famed "Laffer Curve," a curve that didn't even work during Morning Again in America.

Krugman points out that both Reagan and Obama (and to a certain extent Clinton) inherited economies where there was a lot of "slack," i.e., there were a ton of people just sitting around ready to re-enter the labor force.  Look at the pretty chart!:

Furthermore, while Trump did not, in fact, inherit a mess, both Reagan and Clinton did — in the narrow sense that both came into office amid depressed economies, with unemployment above 7 percent:

This meant a substantial amount of slack to be taken up when the economy returned to full employment. Rough calculation: 2 points of excess unemployment means 4 percent output gap under Okun’s Law, which means 0.5 percentage points of extra growth over an 8-year period.

I'm not sure that low growth is 100% set in stone, however.  As Dean Baker points out, where there's slack demand, there's going to be potentially employment people - men and women - sitting at home, not actively looking for jobs:

The fact that women's employment rates have fallen as well is important because it indicates that, contrary to what Brooks tells us, the problem is not a gender specific moral failing. The problem is most likely a good old-fashioned shortfall in demand in the economy.

This matters a great deal because we actually do know how to create more demand. It's called "spending money." This means that if the government spent more money on things like education, health care, and infrastructure, we could get more of these prime-age men and women employed. There are other ways to create demand. For example, if we got our trade deficit down by reducing the value of the dollar it would also generate more demand and employment.

So maybe the Trump administration will be able to get us 3% inflation.  I'd personally love it if we could hit this inflation target and I wish the President and his economic mandarins all the best getting there.

That said, the process by which the Trump administration has come to its economic projections strikes me as very similar to the way at which Enron put its stock valuation above all other concerns, especially cash flow, in a way that caused the company to collapse:

What’s unusual about the administration’s forecasts isn’t just their relative optimism but also the process by which they were derived. Normally, the executive branch starts with a baseline forecast prepared by career staff of the CEA [Council of Economic Advisors].

Officials then calculate how their policy changes add or subtract to that forecast. Those exercises are managed by the so-called troika—top political appointees at the CEA, the Treasury Department and the White House budget office. The heads of each department make final signoffs.

Discussions for the Trump administration unfolded differently, with transition officials telling the CEA staff the growth targets that their budget would produce and asking them to backfill other estimates off those figures.

Sounds a little Five-Year Plan-y to me.   

Let's hope I'm wrong, though, and let's hope "Tyler Durden" at ZeroHedge is wrong about a potential bubble.

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