Summer 2024
The Beacon Outlook: United States
Welcome to The Beacon Outlook
This succinct, quarterly outlook delivers up-to-date analysis of leading indicators driving the national and state economies, including GDP growth, employment, housing and commercial real estate markets, taxable sales, international trade, and more.
HIGHLIGHTS
Ballooning National Deficit�
The national deficit has expanded to 8.7% of U.S. GDP, the largest ever seen in a full employment economy. With interest rates up, the cost of simply carrying this debt will cause the deficit to grow.
Consumer Spending Binge
Consumer spending in the United States has jumped to 70% of U.S. GDP, the highest level seen during the run up to the ‘Great Recession’. The spending spree is being driven by excessively high asset values, from home valuations to equity prices.�
Federal Reserve Policy
Over the past few years, Federal Reserve policy has left the U.S. economy with large imbalances and is largely responsible for the unruly turns the economy has taken.
The Real Consequences of Fed Policies Are Yet To Be Seen/Felt
The Godot Recession
Two years ago, the first recession calls for the U.S. economy began to hit the headlines, driven first by the surge in inflation and then the sharp increase in interest rates that quickly followed. By the beginning of 2023, it seemed as if the press and pundits simply assumed the downturn was a given and the only question was how long and how deep it would be. Of course—like Godot—no recession ever showed up, and the U.S. economy, to the chagrin of all those pessimistic forecasters, has continued to expand at a steady pace. The nation’s economy grew 2.9% in real terms from the 1st quarter of 2023 to the 1st quarter 2024, despite the 10-year treasury going from 1.5% to 4.5% between 2022 and 2024. Growth in the 2nd quarter is shaping up to come in at 2% and Beacon Economics’ forecast for the next year expects growth to continue in this steady 2% to 2.5% range. In short, the United States is settling into a steady expansion, albeit a slow-growth one due to the sluggish expansion of labor supply.
While there are still jitters about inflation, the pace of price increases has slowed sharply in the last year, decelerating from 7% to between 2% and 3% year-over-year according to the PCE deflator from the U.S. Bureau of Economic Analysis.[1] There is little to suggest it will move out of this range, in either direction, in the near term. While it isn’t enough to induce the Federal Reserve (Fed) to cut rates as was widely (and like the recession call, ridiculously) expected, it is a slow enough pace to assuage investors and consumers. The slowdown has led to a surge in confidence in both the University of Michigan’s consumer sentiment index and in the more important stock market indexes, some of which have climbed to record high levels in recent months.
Beacon Economics was one of the few forecasts in the nation that never bought into the recession hype, recognizing that inflation was not a true exogenous shock, but simply the consequence of excessive pandemic stimulus thrown at the economy by the Fed and Congress. Today, the forecasting community has grudgingly reduced its forecast probabilities from above a 60% average to below 35%. A recent Wall Street Journal article called the U.S. economy “the envy of the world.” How about that for a turnaround? All in all, there appears to be no sign of an ‘October economic surprise’ in the runup to this year’s contentious presidential election; whatever the outcome—don’t blame the economy.
Still, there is little doubt that the brakes the Fed applied in response to inflation created a very real negative shock to the U.S. economy in the form of higher interest rates—the collapse in real estate transactions, the number of failed banks, and the sharp decline in borrowing activity can attest to that. But higher interest rates clearly didn’t hit the U.S. consumer and that’s all that really matters for the nation’s economy—after all, consumer spending comprises over two-thirds of all U.S. economic activity and can carry the rest of the economy on its back. Growth in consumer spending has and will continue to drive the economy forward. Things are a bit slower than they were two years ago, but only because all the money that has been floating around the economy is declining as the Fed continues to mop up the excess cash through quantitative tightening (QT).
In terms of how the year will look, Beacon Economics expects durable goods sales to flatten somewhat given high consumer held inventories, but services spending will more than make up for that. Ongoing growth also implies that the U.S. unemployment rate will remain relatively low, although like consumer spending, the labor market is cooling modestly. Two years ago, there were two job openings for every person looking for a job, while today there are 1.4 openings. Still, this is higher than at any point pre-pandemic and suggests that real wages will continue to grow at a good pace.
Even the hard-hit real estate sector has shown surprising signs of stability despite the collapse in resales. The pace of housing starts is down from 2021, but better than prior to the pandemic. Indeed, real investment in structures has risen over the last year and is now at the same level it was pre-pandemic—despite all the problems with commercial real estate valuations. That’s good news for those worried about a recession, but bad news for those hoping for multiple Fed-driven interest rate cuts this year (just as this piece was being published, the Fed signaled that they expect to cut rates only once this year). For those of you who were hoping for both no recession and cuts in rates, stop being so greedy!
Behind all this economic strength lies a growing longer-term problem. Today’s ‘miserabilist’ screed is that inflation has reduced the buying power of American households, with tragic results. Not only does the data on real consumption contradict this notion, it also suggests that household expenditures are running excessively hot. Prior to the pandemic, consumer spending was 67% of U.S. GDP, while in the post-pandemic period it has been running at about 69%. Why are American households being so profligate? The reason boils down to a wealth effect that is being driven by overly hot asset market pricing and an increase in Federal deficit spending relative to pre-pandemic levels, one of the reasons for the sharp growth in the national debt.
Ultimately, when U.S. consumption increases relative to output, the nation is, by definition, borrowing from the rest of the world. This is clearly evident in the data. We have both a current account deficit that is twice (in nominal terms) what it was prior to the pandemic and a record level of external debt—both public and private. The U.S. net asset position today is in the worst deficit position in history. These are not sustainable trends. In any smaller economy the warning signs would already be flashing to global asset markets, but the United States is too big and too safe for the danger to be acknowledged… yet. We aren’t at a crisis point, but we may well be before the end of the decade. When we look back on this period, history will recognize that these issues began long before the pandemic struck, but actions by the Fed in response to the crisis made the situation significantly worse.
The Folly of the Fed
Gaslighting has always been a staple of politics, but it’s fair to say that it’s as much a part of our cherished policymaking institutions, including the Federal Reserve. One of the Fed’s most amazing feats has been its ability, along with its bevy of senior officials and unofficial macroeconomic advisors, to completely ignore this obvious truth: Recent inflation has resulted almost exclusively from the Fed’s decision to inject $5 trillion in new cash into the U.S. economy over an 18-month period through quantitative easing (QE), an action that expanded the nation’s money supply by 40%. It would be difficult to find an example of a nation that hadn’t seen a sharp increase in prices after such an aggressive expansion of the monetary base. And yet, the conversation among many pundits and in the media, has blamed inflation on supply chain disruptions, corporate greed, the Federal deficit, rising wages, and the other “usual suspects” as Captain Renault may have quipped.
There is no doubt that the Fed was responsible for the nation’s surge in inflation—albeit with willing assistance from the U.S. Congress (they provided the helicopters). And the Fed was not alone in its excessive response. Most developed nations indulged in the same excessive money supply growth, and they were all hit by inflation at some level. The height of said ‘gaslighting’ came in the form of a short paper recently authored by former Fed Chairman Ben Bernanke and MIT economist Olivier Blanchard entitled “An Analysis of Pandemic-Era Inflation in 11 Economies.” In the report, they claim to look for the “sources” of post-pandemic inflation using a number of sophisticated regression models. They resolve that growth in the money supply was not a cause of inflation but arrive at that conclusion primarily because they never bothered to include money supply as a possible causal factor. As a colleague joked, a more honest title for this study would have been “Eleven out of eleven central bankers want you to know that inflation was not their fault.”
To be fair, we must also acknowledge that the Fed has slowed inflation as well. Their efforts have included both a sharp increase in the Federal Funds rate, from 0% to over 5%, and far more significantly, they have engaged in QT to the tune of $90 billion per month.[2] To date, QT has reduced the Fed’s balance sheet by $1.5 trillion and is still going. Indeed, the Fed’s QT was so aggressive that it briefly caused the nation’s money supply to contract—something that hasn’t happened in the post-World War II era. Today, U.S. money supply is back in line with prices and the size of the economy, and inflation has largely run its course. But don’t expect long-run rates to come down, not with the money supply being as tight as it is; this would be true regardless of the Fed’s decision on the Federal Funds rate.
Today’s situation is a far cry from the 1970’s when, for years, the Fed failed to slow growth in U.S. money supply, causing a long-run spell of inflation that was significantly worse than what we’ve experienced in recent years. Consider that in the past five years consumer prices have increased 19%, less than half the pace they rose in the 1stquarter of 1979 when they jumped by 42% over the preceding 5-year period. More importantly, in today’s era, per capita incomes have also grown, by 26% over the past five years. All in all, today’s consumers have seen their real spending power rise despite inflation.
So, why gaslight? Why not just come clean and acknowledge that they overstepped in an abundance of caution, but still cleaned up the mess? (Ironically, the bump actually did the United States some good—the economy is growing better now than it was prior to the pandemic.) The ostensible reason is that no one ever takes the blame in Washington DC. But in this particular case, there may be good reason for the Fed to dodge. `
While real earnings have absolutely risen in the last five years, you would hardly know it from the ‘miserabilist’ narratives espoused in headlines and by our political leaders. In that world, most U.S. households are being crushed by rising prices and won’t feel relief until prices fall back to 2020 levels—in other words, never. And many voters are likely to believe these erroneous narratives. Beacon Economics recently wrote�about the psychological reasons why prices have such an outsized effect on consumer sentiment relative to other factors—in short, people really don’t like nominal price increases. If the Fed were to acknowledge their role in inflation and the rise in interest rates, the blowback would be similarly amplified and might be sufficient enough to cause Congress to exert more control over the Fed as an institution—which would be much worse than the current situation. Gaslight people, gaslight!
Jerome’s Real Legacy
While the Fed’s inflation problem is fading, there are other concerning long-term issues, and they have all been made worse, at least in part, by the Fed’s excessive expansion of U.S. money supply. Start with the simple fact that not only has real consumer spending been rising in recent years, but we’re also seeing signs that spending is too robust.
Consider that the household savings rate in the United States has drifted down into the mid-3’s, compared to the 5-to-6 ranges seen pre-pandemic. To put this in context, the savings rate in the years prior to the Great Recession was in the 2-to-3 range. Both then and now the decline in savings has been accompanied by an increase in asset prices to unusually high levels. But prior to the Great Recession, the excess spending was fueled by excessive private sector borrowing while this time it’s being fueled by excessive public sector borrowing.
This all circles back to why rising interest rates over the past few years haven’t slowed U.S. consumers much. The real danger period for consumer debt in the nation was back between 1998 and 2008, when households picked up twice as much debt as the Federal government. Since then, it has been government borrowing that has grown sharply, almost four times faster than household borrowing. The last surge in borrowing among U.S. households occurred between 2018 and 2023 and was mainly due to homeowners refinancing their mortgages to take advantage of ultra-low 30-year fixed rates. Hence, when rates went up, it didn’t matter much to consumers given their low levels of debt-to-income and low exposure to increases (as long as you don’t sell your house!).
All said, Americans have continued to spend, feeling wealthy from high asset prices and higher income. And it’s all because of all the “free” benefits we’re receiving courtesy of the Federal government’s growing debt burden—a debt burden that is becoming dramatically more expensive because it’s exposed to rising interest rates.
And signs of excess aren’t just showing up in terms of the Federal debt. The U.S. current account deficit is also dangerously wide, running at $200 billion per quarter—better than the $280 billion two years ago, but twice the level seen between 2010 and 2019. The nation’s net investment position is currently -72% of GDP, which is a technical way of saying that we owe the rest of the world an amount equivalent to 72% of one year’s U.S. output. A decade ago, this total was -32%, while 30 years ago it was -1%. The United States has been on a 30-year spending binge and the tab is becoming worrisomely large. Jerome Powell’s Fed didn’t create these problems, they really started in the late 1990s and were only partially cured post Great Recession, but it exacerbated them.
The other thing the Fed exacerbated by driving a surge in inflation is the ‘miserabilism’ afflicting the U.S. population. This relentless need to emphasize how bad things are, and to tie everything to decline and inequality, took off in the post-Great Recession period. Surveys of consumer sentiment regularly suggest that Americans feel worse off today than prior to the pandemic despite plentiful and direct data evidence showing the opposite. Recent articles by the American Enterprise Institute and the Fed itself provide clear-cut data points illustrating the disconnect. And what’s even more perverse, when people feel they are only slightly worse off than they were before, they believe the rest of the population is doing much worse, as is aptly shown in another recent Fed survey.
Inflation has only intensified these perceptions, which in turn has ratcheted up the populism in the platforms of both political parties during this election year. The position taken by most policymakers is that there’s no time to worry about little things like a massively expanding debt burden when you’re trying to save the nation from an economic crisis, albeit one that doesn’t actually exist.
None of this is sustainable. The United States is on an untenable spending binge. To be clear, this means that at some point it will no longer be sustained and the way in which the change will impact the U.S. economy could be dramatically ugly. In many ways it feels a bit like it did in 2003, when things were starting to move in such a way that suggested the nation was about to take a long walk down a pier of uncertain shortness. There are grave crises brewing that we should be worrying about, but instead, the nation is focused on problems that don’t really exist at the catastrophic level our politicians and pundits would have us believe. And, of course, each political party has their own distinct set of crises, fueling a level of political partisanship not seen for many decades in the United States. With all that said, the political drama this year will be playing out in the midst of an economic expansion that still has legs to it, no matter how shaky they may prove to be in the longer run.
U.S. FORECAST – OUTPUT
U.S. FORECAST – KEY INDICATORS
U.S. FORECAST – INFLATION
[1] The CPI price index tends to get more media attention because it comes in more quickly than the PCE. But the CPI is not chain linked and uses different weights, hence, it tends to overestimate price increases by a modest but still significant amount.
[2] Note, the increase in the FF rate is what inverted the yield curve and caused so many forecasters to assume a recession was nigh. After all, the previous seven U.S. recessions were preceded by an inverted yield curve. But social scientists should always be cognizant of the fact that correlation doesn’t equal causation. In past cycles, the Fed was responding to excessively strong trends in the economy, such as the pace of consumer borrowing in the run up to the Great Recession. Past recessions have correlated with an inverted yield curve only because the Fed did too little, too late to prevent the problem from becoming systemic. Not only is an inverted yield curve no sure-fire way to predict a recession, it is also evidence of the limited power the Fed actually has over the macroeconomy. View Beacon Economics’ post on this topic here
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