What's Next in US Macro? Q4 GDP Breakdown with Citi's Steven Wieting
What's your take on the US GDP numbers released this morning?
Steven Wieting: I think the details are slightly disappointing beneath the surface. It's poising us for a sub-2% growth rate for first-quarter 2012, pretty much as we expected. There are lots of non-repeaters in this report. We had a very large positive contribution from inventories, which isn't the way you want to grow. In the first quarter, inventories should rise less and thus provide a drag on growth.
Aside from the anomalies, what are the biggest signs of weakness and of strength in this report?
Steven Wieting: Well, there's no big shock here. You see an increase in housing investment above 10%, maybe that's a bit of a surprise. But the apartment sector has been quite good fundamentally. There was a decline in business structures, but that's kind of erratic.
The trade sector was weaker. It already in the fourth quarter subtracted 10% from US growth. We're quite concerned about the external environment. This is the big picture question out there, in terms of how Europe will affect trading partners directly or indirectly. Export growth is slowing sharply and it looks vulnerable, and that's a concern.
The whole financial setting and positioning of the US economy is not robust, but [it is] dramatically better than where we were a few years ago. Within private sector components of GDP there is not a single private sector GDP component that is now contracting. Single family housing starts in the United States have fallen to a level barely above where we were in 1923, where we had a 25% unemployment rate. We have basically eliminated that as a growth driver with these massive declines behind us already.
People worry about inventories of unsold, foreclosed homes -- 52% of them are in five states. It's not like it's a barrel of oil or a bushel or corn that you can move from place to place. These sorts of things suggest that we've got some friction to the downside and it doesn't shock us too much to see an outright improvement in residential investment in this report.
The bad part of all this is that with the housing industry so much smaller it's not going to contribute much to growth, even in a recovery. Financial conditions, whether it's the wealth of households, or the ability of small businesses to borrow, have not improved enough to get growth back to a rapid clip. None of this will get the unemployment rate down very sharply or quickly. You have to look at this in the context of a very severe decline in the economy behind us, and nothing is going to repair that very quickly.
You have written about the economic surprise index in the past. Do you see a top in that index in the future -- a reversion to the mean?
Steven Wieting: Absolutely. It will be very difficult for the surprise index to keep getting higher; the surprises have to get stronger in that event. But you're moving from perhaps slower growth to stronger growth in some cases when the surprise index drops. In Europe, it's not as if we have absolute improvements in the economy, yet the surprise index has become positive because they have not been falling as much as expected.
How well does the surprise index serve as a proxy for how the market will react to data?
Steven Wieting: It's very useful, and there are some interesting anomalies here. The surprise index in the United States has been quite positive, yet you've seen long-term Treasury yields, for example, not move up. Arguably the Fed has something to do with that [through] maturity extension, Operation Twist. There are some idiosyncratic factors here in terms of the Euro as a reserve currency -- you can see divergences in the same region of Europe in certain sovereign bond yields where Euro membership seems to be the deciding factor.
This has probably held down US interest rates, and it's interesting that we've been getting a firmly underlying picture in the US economy and we still are enjoying, to some extent, this flight to quality. You can see that because the surprise index has picked up and, unusually, interest rates have not moved up with it.
We talk about getting back to normal economic growth. Why are we benchmarking current economic performance against the bubble period in the run up to the financial crisis?
Steven Wieting: When you look at headline economic growth in the US -- let's say the 2002-2007 expansion period -- it wasn't very impressive growth then. Even consumer spending.
You had some housing-related strength, but if you looked at the path of real consumer incomes and real consumption expenditures, the average year was different by a tenth of a percent in those two periods.
There was a massive balance sheet expansion, particularly in the financial sector, but in the household sector as well, in terms of both assets and liabilities rising very rapidly. Now, the liabilities are a lot sticker than the asset values, and that is a big problem.
If this were entirely a real economic event and everybody's expanded balance sheet of housing assets just immediately pushed up their consumption expenditures, consumer spending would have grown at peak rates that were double digits -- not 3 percent growth.
We just didn't have more than a housing bubble in an otherwise meager economy during that period. Think about the LBO boom. You had a lot of leveraging up, but nobody built factories or hired workers.
These balance sheet recessions are terrible and they are big, but we didn't blow up the real economy. We didn't have the consumption or hiring booms -- outside of some sectors -- that people have looked for.
Therefore, on the other side of this, there are drags on growth, but they aren't as big as the balance sheet adjustments.
What is your perspective on US fiscal policy risk?
Steven Wieting: This is a clear risk. It's kind of amazing that we don't focus on it until it's right in front of us. I guess that's the playbook we've had with all of the fiscal concerns.
No legislation involved, we simply didn't recognize the tax cuts of 2001 and 2003 or some of the things that happened in 2008 and 2009 as permanent revenue losses. Taxes rise for everyone in 2012 unless we can agree to do otherwise. There are also some very sharp spending cuts.
I think there has been greater political cohesion on pushing out fiscal pain. Republicans and Democrats usually come around to agreeing on that when it comes time to push out of tightening, but in a really partisan environment, they can say, "Well, I want this condition."
If they don't come to agreement, you don't have to write any legislation. You don't have a filibuster of any sort. You just automatically get this fiscal tightening. That is why I think we should be very aware and expect more from them.
It doesn't take dramatically higher tax rates. It does take the unemployment rate to be 7 or less for us to get to a sustainable-size budget deficit. If we do get a sustainable-size budget deficit cyclically, we won't maintain it if you have federal healthcare programs that are a blank check.
Japan has a falling, older population. The US has a young and growing population. The IMF estimates, though, that in the next 15 years, we will have incrementally more fiscal worsening than Japan because of aging.
That is because we are beginning with our healthcare costs more than double Japan's level and double the developed-country average. If you have such a high cost to begin with, even a slower growth rate in the demographic problem can really wreck our budget.
That is where we are headed if we don't do something.
What is your takeaway from this week's FOMC announcement?
Steven Wieting: The most important thing I think some people didn't get right away is that the level of the economy -- not just the growth rate -- matters. If you had an incredibly deep slump behind you -- you could have a rapid growth rate -- you still are at a level that really makes a difference here in terms of policy outlook going forward.
[The Federal Reserve] is going to argue that just because you get the first signs of growth, that doesn't mean you have to try to knock the economy down again. They have made it clear here that they want expansion to be deeper and more entrenched before they tighten.
There are possible mistakes in that that could be made. It just isn't inconsistent to have a more entrenched recovery before there is some effort to ease up on stimulus. I do think it's always going to be the case that it is going to be years from now before the Fed actively tries to knock the American economy down.
I hope that whoever we have in the Federal Reserve, if they have a reasonably clear case here that inflation is under control and the level of bank reserves is detached from the level of lending as it has been -- and it is partly because the third requirement, capital standards for banks, have been changed in this post-bubble period from the pre-bubble period.
You could simply never get this level of bank reserves to equally the same level of activity in the pre-bubble period. The bank capital requirement alone is 3.5x -- depending on the category -- the pre-bubble standard. You have to have a different monetary policy to be associated with that.
Is there an argument that higher rates would be better for bank lending?
Steven Wieting: My opinion is that higher rates have to be earned. It would be nice to have higher rates. We should look at it as a victory when the Fed can tighten and interest rates can go up.
I think interest rates are low and we've gotten a bit better treatment here in terms of overall US interest rates than in some respects we deserve, but just wanting a higher rate and saying we will benefit from that, when underlying income and activity has been subpar or worse, I don't think artificially boosting the rate would help at all -- even though there are costs associated with lower rates.
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