Relevant and even prescient commentary on news, politics and the economy.

SAVINGS, INVESTMENT & THE DEFICITS

Over the past decade, thanks to fracking, the US has approached self-sufficiency in oil. Since 2008 the trade deficit in oil fell from over half of the overall trade deficit to under 10% in 2016.

TRAADE DEFICIT

 

 

 

 

 

 

 

 

 

Surprisingly, however, the massive decline in the oil deficit did not lead to a contraction of the overall trade deficit. Rather, the non-petroleum deficit expanded to offset the improvement in oil.  Actually, it should not be a surprise as this is a beautiful example of the standard economic analysis that the current account balance  (the trade deficit plus certain capital transactions) equals  the gap between domestic savings and investments.

When it first became obvious that the Reagan tax cuts were going to lead to a very large structural federal deficit, main stream economic forecasters started to talk about crowding out.  If you look at the US economy as a closed system, domestic investments must equal domestic savings and  interest rates are the price that changes to ensure that tat identity holds.

FED DEFICIT BY PRESIDENT

 

 

We clearly got a massive increase in the federal deficit as after the Reagan tax cuts the federal deficit exploded from -2% to – 6% of GDP.  Moreover, this occurred during the time of very strong economic growth that should have caused the deficit to contract.  But interest rates did not rise and the crowding out analysis was discredited.  Vice President Cheney even went so far to claim this demonstrated that deficit do not matter.

savings invest gap 2

 

 

 

 

 

 

 

 

 

 

But the view that savings must equal investments only holds in a closed economy. In those days virtually everyone looked at the US economy as a closed system and ignored the international aspects of the economy. In an open economy, however,  savings does not have to equal investments because foreign capital inflows can finance a gap between savings and investments.  In  a closed economy, interest rates adjust to ensure this identity.  But in an open economy both interest rates and the currency can move to ensure that economic identity prevails.

As the chart shows, the US has sustained a large gap between savings and investments since the 1980s.  Initially, the large federal deficit following the Reagan tax cut was accompanied by a massive 50% surge in the dollar.  This was generated by foreign investors bidding up the dollar as the demand for dollars exceed the supply.  But with a lag, the strong deficit lead to an increase in the current account deficit — the supply of dollars–and the supply and demand for dollars balanced without the dollar rising..  But this analysis brings up another identity that hold in an open economy; the domestic savings-investment gap must equal the current account balance.

savings-current account

 

 

 

 

 

 

 

 

 

 

As the chart shows, the identity that the savings-investment gap must equal the current account deficit has clearly held over the years.  We had crowding out after the Reagan tax cuts, it just worked through the dollar to hurt the economic sectors exposed to foreign competition  rather than interest rates to impact the interest sensitive sectors.  Moreover, as this analysis shows that the trade deficit is not a function of NAFTA or the other things that President Trump claims.  If you look at the US as an open economy it is obvious that the large  trade deficit and the loss of many manufacturing jobs has been caused by the Republican tax cuts that produced a structural federal deficit, a large domestic-savings gap and the large current account deficit.  Moreover, if Trump is able to implement another round of large tax cuts it will lead to a widening of the domestic-savings gap and  the current account –trade — deficits.  His tax policies will severely damage the American manufacturing worker that elected him in hopes that he could make America great again.

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Employment in coal mining

Trump is claiming he can restore coal mining to its former glory by reversing the new regulations that Obama enacted.

 

Obvious he has no idea what the history of employment in coal mining is.

Just note that it peaked in 1923.

 

Update: Today the NY Times had a very good article on coal and jobs: “Coal Mining Jobs Trump Would Bring Back No Longer Exist

COALMINING

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Trumponomics

Trump’s America First economic strategy looks a lot like the import substitution economic development strategy that was so popular several decades ago—notably in Latin America and South Asia..  But it only had limited success, especially compared to the export led growth strategy followed in East Asia.  Import substitution tended to produce fragmented, inefficient and low productivity industries protected from foreign competition by high tariffs and other trade barriers

Take autos, for example.  It does not take a lot more labor to build a $30,000 or $60,000 car than a $15,000 car.  But no one can profitably manufacture a $15,000 car using expensive American labor.  That is why most auto imports are economy or luxury cars.  But this is exactly what Trump is asking Detroit to do.  SEER suspects that the auto CEOs told Trump what he wanted to hear and went back home and did nothing. If for no other reason, the auto industry is operating at very high capacity utilization and does not have the idle capacity to dedicate to small car and truck production. If questioned, they can say it is more difficult than they thought and they are still working on it. That is probably preferable to  actually building some white elephant. Most manufactured imports are not profitable to make in the US at current prices.

 

The Border Adjustment Tax ( BAT) appears to be dead, but who knows.  SEER does not accept the idea being pushed that the dollar will automatically rise to offset the tariffs. It is an interesting theory, but SEER has not been able to find a single historic example of it ever actually happening.  The trade deficit is driven by the domestic savings-investment gap – including the federal deficit as negative savings.  BAT will be a major source of federal revenues and will dampen the savings- investment gap as well as the trade balance.  The impact of BAT on the dollar appears indeterminate as far as SEER can tell. But the bottom line is that the Republicans have long worked to shift taxes from income to consumption and BAT is just another example of that.

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Productivity and Capital Stock Per Employee

Last week Timothy  Taylor at Convertible Economist did a very good post on  gross vs net capital spending. Declining US Investment, Gross and Net

He showed that in recent years the more rapid growth of  high  tech  spending has had an unanticipated impact.  The new high tech equipment has a much shorter life span that more traditional equipment. Consequently, more and more of gross capital spending is just being used to replace old equipment ( depreciation).  Before the 1980s net investment was about 40% of gross investment but now it is only about 20% of gross investment. We are having to run faster and faster just to stay even. As he points out investment in capital is a major driver of productivity growth and is a major factor behind the stagnation in US economic growth.

I’ve taken his analysis one more step to show the relation between productivity growth and the change in real capital stock per employee.

productivity

 

 

As the chart shows, there is a very tight relationship between productivity growth and the growth of the real capital stock per employee.  I am convinced that this is a real and important factor behind the weak productivity and the stagnant economy in recent years. Real GDP growth  is essentially the growth of productivity plus the growth of the labor force. You should be able to tell that the trend growth of both economic series have a significant downward slope.

What I’m showing in this chart is not unusual and would fit in with most versions of mainstream economics.  But I’m going to take the analysis a step further and suggest that the underlying problem is cheap labor.  If labor is cheap, business has little or no incentive to make large scale investments to raise the productivity of labor.  Rather, the two dominant factor explaining much of business investment over the past few decades has been the shift of factories from the north to the south of the US and if this is not enough to shift production abroad.

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NAFTA and MANUFACTURING EMPLOYMENT

President Trump is not alone in blaming NAFTA for the decline in US manufacturing employment over the last several decades.  Many people on all sides of the political spectrum believe the same thing.  But as this chart demonstrates the economic data tells a very different story.nafta manuf

 

In the decade after NAFTA came into being, manufacturing output growth actually accelerated  to an average annual growth rate of 3.7% as compared to an average annual growth rate of 2.9%  in the decade before NAFTA was implemented. However, while manufacturing output growth actually  accelerated, the average annual growth rate of manufacturing employment weakened from -0.4% to -1.3%.  This was because the rate of growth in productivity or output per employment jumped about 50% from 3.3% to 5.0%.  The big jump in the growth of output per employee or productivity was the dominant factor in the drop in manufacturing employment.  Automation or  information technology accounted for  virtually all of the weakness in manufacturing employment after NAFTA.    NAFTA was a factor, but it was clearly a relatively minor factor.  The way NAFTA contributed was for low productivity industries like textiles and autos  to move abroad while high productivity industries like semiconductors grew rapidly so that the composition of US manufacturing changed drastically.   Because of this, Trumps policy of bring jobs back from overseas is almost certain to fail.

The important question is not why his policy will fail.  Rather, it is what will Trump do after it becomes obvious to everyone that it has failed.

If you want to blame the trade deficit for the drop in manufacturing employment, it obviously played a role.  But Mexico only accounts for some 5% to 10% of the US trade deficit,  so even on this basis, NAFTA played a very minor role in the drop in US manufacturing employment.

 

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Stock market performance by presidential administrations

It is leap year and Wall St. is having its usual discussion of which candidate will be better for the stock market. I do not know, but it is interesting to look at the historic record. Starting with Truman makes a good comparison as Republican and Democrats have served almost the same number of years and it covers all of the post WW II era. Moreover, each party has  an admiration with two presidents –JFK & LBJ and Nixon & Ford.  In addition, each has one president that only served for four years and lost their bid for a second term.

So this comparisons shows that the average annual stock market gain under Republican has been 7.3% while under Democrats it has been more than double that at 14.9%.

 

stocks by president
The primary reason for this were the two republican presidents where the S&P 500 actually was lower when they left office than when they took office. In modern times only three presidents suffered a falling market over their entire term–Hoover, Nixon and the second Bush. On the democratic side, they have the president with the largest average returns – -Clinton. Maybe the question should be, can Hillary repeat her husband’s record?

 

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Industrial Production as a share of real GDP

I regularly see people comment about the decline in the importance of industrial production but I never see any data on how much it has declined.  Finally, I saw a libertarian blogger talk about as a point in his argument but he also revealed that he   had not idea what had happened to industrial production relative to the economy.

The Federal Reserve actually publishes the value of industrial production as part of its monthly industrial production report, so it is quite easy to get the  raw data to construct a series of industrial production as a share of GDP.  It has fallen from 33% of real GDP in 1972 — as far back as the data goes — to 23% currently.  The trend is for the share to fall 2.4% annually.

ip
Manufacturing employment has had a similar fall, from 31% to 13.7% last quarter. The employment has seen a 2.4% annual decline.

 

For a while I agreed that there was an error in using this data to calculate industrial production as a share of GDP.   But after more consideration and checking with the Fed I have concluded that the original chart is correct.  There is no conceptional difference between the Fed data and the real GDP accounts.

 

 

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Federal Deficit by President

If you look at the federal deficit as a share of GDP by presidential administration an interesting pattern emerges.

Every Republican administration left office with a larger deficit than they inherited.

Every Democratic administration left office with a smaller deficit than they inherited.

fed deficits

Why should we pay any attention to anything any Republican says about the deficit.

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