Dr. James West is chairman of the Department of Economics and Business at Moravian College in Bethlehem, Pa. He has provided his unique viewpoint on the U.S. and global economies for AIN’s special report on aircraft finance since 2007.
As we enter this election year, it’s a particularly important time to assess the progress of and the prospects for the U.S. economy. What is your view?
On the surface, the vital statistics of the economy look good. The U-3 unemployment rate registers at near full employment; the inflation rate [depending on the measure used] is near zero; interest rates are low; the dollar is strong; and the budget deficit at $435 billion is less than half of what it was in 2009. Meanwhile, the stock market is up again, after the downturn in August and September, although it is still below its high of 18,312 in May, and the Misery Index, the sum of unemployment and inflation, is near an all-time low, indicating that this is one of the best of times in the country’s macroeconomic history [now at five, the Misery Index is at its lowest point since the Eisenhower Administration; it reached its peak of 22 during the Carter years]. So, things look great, which makes economists nervous. We need to look deeperWhen we do, we find an air of uncertainty and anxiety lurking behind the good numbers. While the narrow U-3 measure of unemployment is good, the U-6 unemployment rate, which includes discouraged and part-time workers, is at 9.5 to 10 percent with a low worker-participation rate. Falling prices are a result of decreasing global demand. We are also experiencing an unprecedented and bubble-inspiring increase in the money supply; anemic industrial, housing and consumer spending; stagnant wages; sluggish exports; what many consider to be a stultifying tax and regulatory environment; and let’s face it, we do have a national debt of $18 trillion.
Nevertheless, the U.S. economy remains one of the bright spots on our economic planet. The economies of the BRICS countries (Brazil, Russia, India, China and South Africa), which were expanding just a year ago, have all hit snags, as has the EU. In face of a general global slowdown, the U.S. recovery, while painfully slow, continues to offer good opportunities for innovation and investment. This is a testament to the dynamic vitality of our still largely free-market and enterprise-driven economic system.
What is driving the decreasing prices of some products?
From the macro perspective, falling prices come from one of two sources: a rightward shifting (increasing) aggregate supply curve or a leftward shifting (declining) aggregate demand curve. The shifting supply curve, caused by falling energy costs, low interest rates and cost-saving innovation and technology, represents the good news in lower prices. The gap between the Consumer Price Index (CPI), which is near zero percent, and the core interest rate, at 1.5 percent, is almost entirely accounted for by the fall in the price of oil. However, there is bad news on the declining aggregate demand side, which is cause for concern.
Weak consumer, investment and foreign demand for U.S. exports reflects a fear of global deflation. This fear explains the Federal Reserve’s angst about raising interest rates by even a paltry quarter of a percent. This low demand, along with the low CPI, restrains wage increases, including a cost-of-living increase for those on Social Security. Another surprising impact of this low-growth/high-money-supply environment is the extremely rare appearance of negative interest rates, the European Central Bank being a case in point. [With a negative interest rate, customers end up paying the bank to hold and manage their money for them.] This modern times “liquidity trap,” reminiscent of Great Depression economics, causes a situation where monetary policy becomes ineffectual.
Haven’t we heard this song before?
It was John Maynard Keynes, the famed British economist, who introduced the idea of a liquidity trap that we may be in now. However, it was also Keynes who in 1930 wrote an article titled “The Economic Possibilities of our Grandchildren.” In that article Keynes proposed that the people are misguided to focus solely on the bad news of the day, which was not surprising at that time considering the tumult of World War I and the economic doldrums of the post-war years.
Instead, he urged people to broaden their vision and embrace the dynamics of change. Looking ahead 100 years to 2030, he predicted that 20th century and future generations would finally have solved the “economic problem” of deprivation and that mankind would find its true challenge no longer in the marketplace, but in greater arenas of life. Keynes imagined that the standard of living would be dramatically higher and that people, having their needs fulfilled, would work no more than 15 hours a week and devote most of their time to leisure and cultural activities. Had Keynes foreseen in 1930 the next 15 years of global depression and a second world war, he might have been more subdued in his optimism. Nevertheless, a fair observer looking at the economic and technological progress worldwide, especially since the end of the Cold War in the second half of the 20th century, cannot help but be impressed by Keynes’s prediction.
That said, the ideological debate about economic philosophy continues. Enemies and even sympathetic critics of a democratic, free enterprise system [i.e., capitalism] are raising the flag of socialist resurgence. French economist Thomas Piketty, author of the 2013 book Capitalism in the 21st Century, presidential candidate Senator Bernie Sanders [D-Ver.] and even Pope Francis have taken aim at the foundation doctrines of capitalism. In this philosophical arena it is imperative that defenders of free enterprise hone their arguments and marshal evidence of the success that it has accrued. While being frank in their criticism of the evils of “crony capitalism,” unethical behavior (Volkswagen, for a recent example) and excessive mal-distribution and poverty, the proponents of free enterprise must be assertive of the superiority of their ideas as they oppose a slide into socialism and statism, in which the state has centralized control over social and economic affairs.
In terms of the inequality debate, we must remember that the best income distributor is a job and that an economy that encourages entrepreneurship and education will far outperform an economy that resorts to state planning and micromanaging of business.
Many of the presidential candidates are promising changes to the federal income tax system if they are elected. Is this realistic?
Yes, but whenever changes to the tax system are proposed, they must have the goal of simplification and transparency. Under the current system too many people and organizations look for deals to protect their favorite deductions, which is a form of crony capitalism. When a tax code determines the direction of investment, the code becomes too complicated and is economically inefficient. The flip side of the tax question is government subsidy of personal and corporate welfare systems. These also misdirect efforts and investment, and need to be overhauled.
What should Joe the investor do now?
Our hypothetical friend Joe, the non-expert investor, is directed again to diversification. The liquidity splurge of the Fed might continue to bolster stock averages to new highs, but Joe should be aware of the possibility of another stock market bubble. Our recent past shows a series of eight-year cycles of financial crisis and by 2016 we might be in for another round. Falling interest rates, even negative rates, will end, and that will also impact bond prices. As Mark Twain and Will Rogers famously agreed, “Buy land; they ain’t making any more of it,” may be good advice, as financial risks make real assets like real estate more attractive. The commercial and housing inventories are set for recovery.
Perhaps the most important investment advice for Joe is to spend his vote wisely in the upcoming elections. There are big questions on the economic front that need to be decided. Joe should study the economic issues carefully, looking for substance over sound bites, and apply his intellect to maximizing his long-term rate of return. Good luck, Joe.
