Editor’s note: Today, we’re sharing an essay from our friends at Agora Financial. In it, Jim Rickards shares what’s really going on with the U.S. economy today…
The Trump administration’s initiatives on the U.S. economy are notable and mostly positive.
Regulations have been cut. Taxes have been cut. Trump is aggressively seeking better trade deals. The stock market is back to all-time highs and consumer sentiment is off the charts.
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Second-quarter U.S. GDP growth was over 4 percent and projections for the third quarter are also strong.
What’s not to like?
The problem is we’ve seen all this before. Obama had several quarters of 4 percent or greater growth during the long recovery from 2009-2016. Stocks may be higher but not much higher than they were last January. Consumer sentiment doesn’t tell us much because it’s highly correlated to the stock market.
So Trump is having a good stretch, but it’s too early to say that the U.S. economy has broken out of its weak recovery performance or that sustainable above-trend growth has been achieved.
In fact, there’s good reason to believe the Trump economy is no different than the Obama economy, which is to say weak growth with occasional spikes and occasional dips down to zero.
The U.S. trade deficit spiked in July, according to the latest data. That’s a drag on third-quarter GDP growth. It’s also a reflection of the impact of a strong dollar (due to Fed rate hikes) and the trade war that is ongoing.
Strong growth in the second and perhaps third quarters could follow a pattern seen in the past nine years of short-term spikes followed by a return to subpar growth.
We may not be in a recession, not yet anyway, but there’s no reason to believe we are seeing a genuine boom.
The Fed is raising interest rates 1 percent per year in four separate 0.25 percent hikes each March, June, September and December. The Fed is also slashing its balance sheet about US$600 billion per year at its current tempo.
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The equivalent rate hike impact of this balance sheet reduction is uncertain because this kind of shrinkage has never been done before in the 105-year history of the Fed. However, the best estimates are that the impact is roughly equivalent to another 1 percent rate hike per year.
Combining the actual rate hikes with the implied rate hikes of balance sheet reduction means the Fed is raising nominal rates about 2 percent per year starting from a zero-rate level in late 2015. Actual inflation has risen slightly, but not more than about 0.50 percent per year over the past six months.
The bottom line is that real rates (net of inflation) are going up about 1.5 percent per year under current policy.
From a zero-base line, that’s a huge increase.
Those rate hikes would be fine if the economy were fundamentally strong, but it’s not. Real growth in Q2 2018 was 4.1 percent, but over 4.7 percent of that real growth was consumption, fixed investment (mostly commercial) and higher exports (getting ahead of tariffs).
Q2 growth looks temporary and artificially bunched in a single quarter. Lower growth and a leveling out seem likely in the quarters ahead.
The Fed seems oblivious to these possibilities. The Fed has extended its growth forecasts to yield 2.27 percent for Q3 and Q4, and expects 2.71 percent for 2018 as a whole. That’s a significant boost from the 2.19 percent average real growth since the end of the last recession in June 2009.
By itself, that forecast offers no opening for a pause in planned Fed rate hikes or balance sheet reduction. The Fed is on track for more rate hikes, a reduced balance sheet and no turning away from its current plans.
But the Fed’s assumptions may be wishful thinking.
Real annualised U.S. GDP growth exceeded 4 percent four times in the past nine years only to head for near-zero or even negative real growth in the months that followed. There’s no compelling reason to conclude that Q2 2018 will be any different. Data indicating performance close to recession levels will likely emerge in the next few months.
With Fed tightening and a weak economy on a collision course, the result might well be a recession.
Toward the end of this quarter, the full extent of a global slowdown will be apparent even to the Fed. In that case, get ready for a Fed “pause” on rate hikes in December, a weaker dollar, a stock market correction and increased tension in the trade wars.
Below, I show you why the Fed will be clueless when the next recession strikes. As you’ll see, the problem is the Fed’s models. What models should the Fed adopt instead? Read on.
for The Daily Reckoning
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