Economic Analysis



Both P&G, Federal Reserve Have an Outdated Business Strategy

By Peter Morici, Ph.D.



Sept. 18, 2017-

Easy Money Isn’t Leading to a Stronger Economy. It’s Time to Try Something New

The Federal Reserve, like Procter & Gamble and a host of other icons on the decline, faces a tough new world but appears captive to a failed strategic doctrine and is at wits’ end about how to effectively navigate monetary policy.

Sadly, for all of us, the Fed has no real competition – unlike P&G PG, -0.30%  and other private-sector dinosaurs, it can’t lose market share to firms selling generics and boutique brands. If it makes bad policy, we are stuck with it.

At P&G, established management is engaged in a quarrelsome struggle with activist investors about how to cut costs and once again use slick ads to create hot new brands that enable it to put a few common chemicals and a seductive scent into a bottle and sell the concoction for huge multiples of actual production cost.

These days, folks that buy household and personal care products are better educated and more sophisticated than during the 1950s and 1960s. They have a greater intellectual immunity to pitches to pay more for “new and improved” when generic detergents or a Good News razor work as well as Tide or an expensive new shaving system.

Low inflation

Likewise, the Fed appears obsessed with pushing inflation to 2% as if anything less would not stimulate adequate growth. However, the temporary surge in gasoline prices from Harvey notwithstanding, inflation appears stuck below 2%. And with unemployment at pre-financial crisis levels, the Federal Reserve appears as out of touch as the folks that run P&G.

Inflation remains low because labor markets have changed – the decline of unions, rise of the contingent economy, more pervasive federal benefits that permit the semiskilled to work at very low wages, import and immigration policies that make international wage arbitrage pervasive, and breakthroughs in artificial intelligence and robotics that make easier substituting capital for labor.

And the shift from old-line manufacturing to technology products as the fundamental drivers of growth now permit businesses to create a lot more value with existing capacity and smaller investments in physical assets. That reduces the demand for and cost of capital and helps keep down the cost of making goods and services too.

With the industrialized economies growing in sync and at the best pace since before the financial crisis, it is apparent that low inflation is no barrier to economic expansion. And after nearly a decade of easy monetary policy, there is no theoretical or empirical evidence that cheap money can appreciably boost the U.S. growth rate above the 2% rate that was achieved during the Bush and Obama recoveries.

Obvious consequences

Moreover, very cheap money for long periods of time, as surely as too much inflation, begets speculation and skews reward structures for our brightest young people toward careers in finance away from engineering, with obvious consequences for long-term growth.

Putting the economy on the crutches of cheap credit enables politicians to put off structural measures – like health care and tax reform, streamlining financial regulations, and curbing entitlement abuse.

So why does the Fed cling to easy money?

Too often CEOs and boards – and Janet Yellen and the Fed governors are no exception – are so focused on the execution of established strategies and wedded to old doctrines that they don’t see the world and the imperatives for their success changing around them.

Fed meeting

When the Fed meets Tuesday and Wednesday, it should begin the process of unwinding its huge holdings of Treasuries and federal agency securities. That shouldn’t be as big a process as doves like Lael Brainard fear.

The Fed added some $4 billion in the wake of the crisis to boost its portfolio of securities to $4.5 billion. However, changes in Fed operations – such as offering interest-bearing deposits to money-market funds, asset managers and hedge funds – now require that it continue to hold at least $2.5 billion in assets, and Ben Bernanke estimates that figure will rise to $4 billion over the next decade.

It’s time to rethink the 2012 policy statement, which established the Fed’s 2% inflation target, and link interest rate policy to accomplishing 2% GDP growth and reasonable confidence that flight path for the economy can be sustained that over the next year or two.

 

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.


__________


The Deals President Trump Must Make

By Peter Morici, Ph.D.

 

Sept. 16, 2017-

Consensus of Moderate Leaning Conservative and Liberals Could Lead to Big Wins

 

By dealing with Democrats to raise the debt ceiling and fund the government through December, President Trump has opened a window for bargains on taxes and infrastructure that could be attractive to both the administration and minority party in Congress.

Mr. Trump is no conservative or even a real Republican. He ran in the Republican primaries to secure the legitimacy of a major party nomination, get on the ballot in all 50 states and borrow the Republican Party machinery for his general election campaign.

His supporters know it – 4 in 10 voted for him to shake up Washington but only 1 in 10 believed he would pursue traditional Republican policies. Unable to get much done through the GOP in Congress and facing a relentless criticism from the left-leaning media, he needs new, more politically correct friends.

Enter Senate Minority Leader Chuck Schumer.

Mr. Schumer is pressured by the same media and establishment left to preserve the Obama legacy and oppose everything Trump. He is limited to supporting projects essential to the national interest and making ordinary folks better off in ways the left prescribes.

Keeping the government from bankruptcy and open without submitting to conservative demands to cut entitlements surely qualifies.

Other issues

On other issues, Mr. Trump and Mr. Schumer appear opposed but perhaps not as much as left-leaning ideologies preach.

On taxes, the Trump administration wants to ease the burden on corporations, small businesses and the middle class. Mr. Schumer wants the latter but can’t stomach anything that lowers taxes for the wealthy – the left defines businesses of any kind, save food co-ops and the rich as one and the same.

Since 87 percent of income taxes is paid by the top 25 percent of earners, helping many large and most small businesses, which file through the personal income tax system, must entail lowering top income tax rates. Consequently, Treasury Secretary Steven Mnuchin must come up with another source of revenue that he can sell to Mr. Schumer as maintaining the burden on the wealthy to lower tax rates for everyone.

Doublespeak for sure but this is Washington.

Curbing the myriad of exemptions and special credits is hardly enough – the list of good targets, like mortgage interest deductions, contains too many sacred cows. However, resurrecting the House Republican leadership’s proposal to apply the corporate tax to imports and remit it on exports would generate $100 billion a year to support broad corporate and personal income tax cuts acceptable to both parties.

As those border taxes would be assessed directly on business – not consumers in the form of a sales tax – those could be justified as paying for lower corporate taxes and personal income tax rates.

Koch brothers

Such a move would outrage Republican supporters like the Koch brothers and retailers, most notably Wal-Mart, but the professional left and unions, whose favor Mr. Schumer must curry, hate those guys.

I see a deal in that. After all what does Mr. Trump need more in 2020 – the Koch Brothers and Wal-Mart or Mr. Schumer‘s embrace to delegitimize the mainstream media’s constant claim that his every breath is the work of Satan.

On infrastructure, the Trump administration has been pushing the idea of private-public partnerships to rebuild roads, bridges, airports and public utilities – engaging private companies and charging higher user fees was much supported by the Obama administration.

Sadly, such privatization of water and sewage, toll roads and emergency services often has gone badly – price gouging, bankruptcies and death-causing wait times for ambulances.

Mr. Schumer prefers public funding, but that would require a higher gas tax and special taxes and fees – trimming elsewhere in the federal budget, notably entitlements, would outrage his base, and increasing the deficit to spend appreciably more would be a nonstarter among most Republicans.

Some things can’t escape the necessity of publicly regulated utilities or just plain old government funding, and Mr. Trump’s embrace of a higher gas tax to pay for roads and bridges and similar measures would be tough for even The New York Times to condemn and an easy deal with Mr. Schumer.

Starting with these issues, Messrs. Trump with Schumer could forge a consensus of moderate-leaning liberal and conservatives in Congress for other issues, help the minority leader defend 25 Democratic seats up for reelection in 2018 and establish for Mr. Trump a record of accomplishment for 2020.

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

__________

 

Lessons from Hurricane Harvey

 

By Peter Morici, Ph.D.

 

Sept. 6, 2017-

Building Codes and Drainage Deficiencies Need Upgrade to Match Storm Threats

 

By the time all the measuring and calculating is done, Hurricane Harvey will prove an era-defining storm. Federal and state officials performed admirably to limit the suffering and loss of life, but the whole mess is far worse than it needed to be.

Federal and state agencies have become remarkably proficient at responding to emergencies but they continue to come up short on preventative measures to safeguard lives, property and the economy for the inevitable day the forces of nature strike.

Harvey as measured by the National Oceanic and Atmospheric Administration’s National Hurricane Center rated a 4 on a scale of 5. Wind damage to framed homes, for example, should not tally as high as for a Category 5 hurricane like Katrina in 2005. However, in terms of rainfall, Harvey tops them all – 50 inches is the largest accumulation recorded for the contiguous 48 states.

After the confused and disorganized response to Katrina, federal and state relief infrastructure was substantially improved and lines of responsibility more clearly defined. Governors are in charge of crisis management, whereas the federal government delivers resources the individual states cannot reasonably be expected to have on hand.

In this regard, Texas Gov. Greg Abbott and President Trump have been at the top of their games.

Property losses

Nevertheless, the property and incomes losses will prove devastating. Moody’s Analytics initially estimated property losses at $75 billion and lost business from shutdowns at $25 billion, but I expect those figures to ultimately be at least $110 and $50 billion – flood damage can appear deceptively limited at first glance and rebuilding will be slow.

Everyone is aware of rising gasoline prices, as oil shipments from the Texas Eagle Ford field and refineries operations in the Gulf region are curtailed. The Colonial Pipeline, which delivers gasoline, jet fuel and heating oil to the Northeast – including metropolitan New York – is particularly vulnerable to flooding. Overall, shortages, greater reliance on more expensive imports from Europe and generally higher prices will likely be with us through the end of the year.

We can’t change that geography – the location of Eagle Ford – but the refinery industry is unnecessarily concentrated along the western Gulf Coast and particularly vulnerable to tropical storms.

Environmental regulations have made difficult building and operating refineries in other parts of the country. Whereas 30 years ago the industry had 220 operating facilities, it now has only 141, and about one-quarter of its capacity is down thanks to the storm. Facilities in other parts of the country are already operating near full-tilt and are hard-pressed to make up the shortfall.

Unnecessarily vulnerable

Houston and the surrounding region are unnecessarily vulnerable to storms because building codes and zoning have not kept up with climate change. Flooding has increased as storms have become more severe – what was once a 250-year storm is now likely a 100-year storm, and the latter now a 25-year storm.

Whereas codes require building foundations to be 12 to 18 inches above the outdated 100-year standard, those should be upgraded, but haven’t. The spread of concrete and asphalt surfaces makes drainage impossible, and more emphasis on high-rise development coupled with green spaces would considerably aid water absorption during severe rains.

Regional drainage systems – the first line of defense – built around the turn of the 20th century can hardly handle a 10-year flood, but municipalities strained by other fiscal demands have been slow to upgrade those adequately.

Private flood insurance is very difficult to obtain, and federal insurance has coverage limits set 50 years ago and that doesn’t compensate businesses for lost commerce resulting from storm closures. More than half the homeowners and businesses hit by Harvey are outside of federally designated flood areas.

National Flood Insurance Program

All this will slow rebuilding and is simply unnecessary. Congress has been bickering over privatizing the National Flood Insurance Program, which has been losing money for years and has inadequate reserves to deal with Harvey and whatever comes next.

In recent years, so much attention at both the state and federal level has been focused on health care, mitigating income inequality and expanding entitlements that the essential functions of government – such as drainage pipe adequate to safeguard communities from the inevitable forces of nature – have been shortchanged.

The rescue vehicles arrive on time, but the damage is unnecessarily large and cleanup simply too slow and incomplete.

 

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

__________

Girding for a Showdown with China

 

By Peter Morici, Ph.D.

 

Sept. 3, 2017-

The Chinese Response to North Korea’s Noisy Threats becoming Ever More Crucial

 

North Korea’s nuclear and missile programs present the United States with no good options, but China’s posture is a foil for its wider strategic objectives.

Conventional military action appears not a viable option. Pyongyang’s artillery batteries could unleash devastation on Seoul before U.S. forces could destroy its nuclear capability.

China, as North Korea’s principle economic partner, holds the keys but has only taken limited steps. Its vote in favor of U.N. Security Council economic sanctions notwithstanding, it remains the regime’s major trading partner. It would prefer not to instigate an economic crisis that could cause millions of refugees to rush into China or reunification of the peninsula under a U.S.-aligned regime.

The United States has broader issues with Beijing – China’s territorial claims and militarization of artificial islands in neutral waters of the South China Sea, the defense of Japan, South Korea and Taiwan and the $300 billion bilateral trade deficit.

Skillfully, Beijing has suggested it might do more regarding North Korea if the United States scaled back joint military exercises with Japan and South Korea – i.e., Beijing will lean harder on the rogue state if America forsakes its allies.

Blackmail

The United States should not accede to such blackmail.

Former Defense Secretary Robert Gates proposes offering China two choices: the United States would recognize North Korea and forswear a regime change in return for hard, verifiable limits on North Korea’s nuclear weapons and missiles. Otherwise, the United States will “heavily populate Asia with missile defenses,” shoot down anything that “looks like a launch of an intercontinental ballistic missile” and commit to whatever means necessary to “contain this regime.”

The United States recognizing such a harshly repressive regime would smack of appeasement, and China won’t bite anyway. Beijing likes the peninsula organized as it is and although it screams U.S. defensive missiles could be used against it, Beijing has no reason to worry if it has no intention of launching an intercontinental ballistic attack. Moreover, the unending crisis distracts Washington’s attention from the other above-mentioned Sino-American issues.

A permanently beefed up military presence beyond antiballistic missiles could prove quite costly to the United States. It would stretch the Navy and Air Force – already overextended by years of war in the Middle East, troubles in Eastern Europe with Russia, and Obama-era defense spending cuts – to the point of limiting their ability to counter Chinese adventurism in the South China Sea and elsewhere.

China has been quite adroit in tying down U.S. presidents on narrow issues and stalling, while it undertakes other provocations. For example, persuading the Trump administration to negotiate on trade in a few highly focused areas such as beef, while it targets for whole capture the microprocessor, artificial intelligence and other high-tech industries.

Radical realignment

The United States needs a radical realignment of commercial and security relations with China.

We don’t need Beijing’s permission to deploy defensive missile systems in Asia or let North Korea become a bargaining chip on other problems. Rather, the United States should pursue a three-pronged strategy.

In the South China Sea, the Navy should more aggressively challenge Chinese occupation of the artificial islands, and the United States should demand China evacuate the islands.

On trade, the United States should demand that China manage down its bilateral trade surplus – according to a schedule of specified dollar targets – and open its markets to U.S. investment and intellectual property on the terms its companies enjoy in the West. Or the United States will impose a 40 percent tariff on Chinese exports and subject Chinese investment and intellectual property in the United States to policies that mirror the Chinese regime.

On North Korea, the United States should pursue Mr. Gates’ second option and deny access to the U.S. banking system any business in China doing business with North Korea – and their Chinese banks as well.

Overall, we should refuse to negotiate on any of these initiatives until China agrees to a new regime resolving all these disputes and takes tangible, complete actions that address our concerns.

Nothing would hit China harder than the economic and trade sanctions proposed – and they would hurt Americans too. However, U.S. strategic objectives should not be sold out for commercial gain – just as our commercial objectives should not be sacrificed to appease an emerging Asian power.

 

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

__________

 

Why Central Bankers Are So Confused by Low Prices

By Peter Morici, Ph.D.

Aug. 10, 2017 –

Yellen Doesn’t Understand Low Inflation Will Persist because of Changes in the Economy

 

Central bankers are captive to conventional economics – faced by low inflation and low unemployment they are flummoxed about pulling back on monetary stimulus. Their dilemma lies in an incorrect reading of statistics and taking modern macroeconomic theory too seriously.

Unemployment in the European Union is at its lowest level since 2009, yet inflation across the pond drags along at about 1.3%. U.S. unemployment is at a similar trough, while headline and core inflation remain well below the Fed’s 2% target.

According to the textbooks, unemployment and inflation are supposed to move in opposite directions, not in tandem as they have. As summarized by the Phillips curve, falling unemployment should coincide with tightening labor markets and rising wages and prices, and the inverse should be true as unemployment rises.

For one thing, headline unemployment rates are proving an increasingly poor measure of what is going on in many labor markets. In the United States and Europe, large numbers of adults are on the dole and opting out of work altogether, and on both continents many university graduates are underutilized in low-paying jobs – serving coffee at Starbucks, chaperoning tours of historic venues, and the like.

For another, macroeconomic models deal poorly with the fact that entitlement programs have created large pools of contingent workers – folks who may only again participate in the labor force if wages rise very sharply. More generally, those models paper over other demand- and supply-side structural changes that are holding down prices and subverting the historically expected inverse relationship between unemployment and inflation.

Central bankers point to low oil prices, instigated by the U.S. shale revolution, but those fell last year to about to $44 a barrel in 2016 and generally have been a bit higher in 2017.

Cell phone alibi

Janet Yellen is fond of pointing to falling cell-phone subscription rates – thanks to more intense competition among the four principal carriers. However, even after pulling cell-phone services out of the core deflator for personal consumption – the Fed’s preferred measure of inflation – price increases have been slowing through 2017 and were only 1.6% in June.

The cell-phone alibi looks even weaker after considering recent weakness in inflation for apartments, air fares, autos, and apparel. All are items that should exhibit more robust price increases this late in the business cycle but in varying measure, their prices have been dampened by swelling capacity and innovation that push down costs and retail prices.

Perhaps the most compelling phenomena have been the intersection of overbuilding in the retail sector – everything from grocery to department stores – and the revolution in supply-chain management and increased competition associated with the Amazon effect.

Internet aggregators are driving down supply-chain management costs and prices for many household items and business necessities. With their share of retail at only 8.5% but growing, that downward pressure on inflation is not likely to abate soon.

Wal-Mart and Amazon are in unique positions owing to the former’s mass and the latter’s unique access to consumers’ attention – most online product and price checks begin at the Amazon site these days – to drive down suppliers’ margins. In turn, suppliers push back on workers’ wages and producers of basic materials or in the case of manufacturers in China, they can rely on very generous credit conditions and subsidies that permit selling at or near a loss.

Shifts in consumer preferences

Similarly, shifts in consumer preferences are diminishing the pricing power of major consumer- product companies like Kraft Heinz, Procter and Gamble and colleges.

Consumers are getting smarter about the false monopoly premiums once demanded by many consumer brands and educational institutions.

These kinds of structural changes – all occurring with increasing perforce – simply shift the parameters of the Phillips curve in ways conventional macroeconomic models and the bubble think at central banks cannot accommodate.

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

__________

 

Why Republicans Won’t be Able to Pass a Big Tax Bill

 

By Peter Morici, Ph.D.

 

Aug. 7, 2017 –

If you think tax reform will be easy, I have a bridge I want to sell you

 

If anything should unite red-blooded Republicans, it’s tax cuts and reform. Sadly, the Trump administration and GOP congressional leaders are unwilling to face facts and make the tough choices necessary to get it done.

As evidence, I cite the Joint Statement on Tax Reform issued by the Big Six: Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Speaker Paul Ryan, Majority Leader Mitch McConnell, Senate Finance Chairman Orrin Hatch, and House Ways and Means Chairman Kevin Brady.

The document repeats campaign promises to lower taxes for working families and small businesses, boost investment, and encourage U.S. companies to bring back jobs from abroad. And to make tax reform permanent without imposing a broad-based consumption tax-read value-added, carbon- use or some other energy tax as advocated by the IMF.

That’s really great sounding stuff but hardly possible – at least not all together.

Democrats in the Senate are not likely to go along with a tax package that substantially reduces revenue and domestic spending together, and any tax package passing with less than 60 votes in the Senate, under reconciliation, must either not add to the deficit or sunset after 10 years.

Hence to make any tax changes permanent, 50 of the 52 Republican senators plus Vice President Mike Pence must agree to a package of tax and sustainable spending cuts.

Entitlements

Entitlements now consume more than 60% of the federal budget and along with interest payments, are likely to grow to 100% over the next decade.

The successful efforts of Sens. Shelley Moore Capito, Lisa Murkowski and Susan Collins of welfare-dependent West Virginia, Alaska and Maine – and others – to block Medicaid reform, as part of any plan to repeal or replace Obamacare, illustrate that the GOP talks a good game on entitlements reform but lacks the political courage to effect it.

Hence, offsetting spending reductions to finance tax cuts must come from discretionary spending.

That is made extraordinarily difficult by the fact that the overall budget package must also accommodate Republican promises to increase defense spending to rebuild the military, which has been stressed by years of war and prior cuts in appropriations for modernization of equipment and research imposed during the Obama years.

Defense spending increases must be counted in with revenue lost from tax cuts in calculating the necessary overall spending cuts to pass through reconciliation.

President Donald Trump has mused he is willing to raise taxes on upper-income Americans to provide tax relief for other Americans but the top 25% of income earners already pay 89% of the personal income tax, and most small businesses and many large ones are pass-through entities that pay taxes through the personal income tax code.

Coupled with provisions that phase out deductions and state and local taxes, many high-income individuals and limited-liability corporations are paying marginal tax rates of close to or exceeding 50%.

Small businesses

The number of small businesses has not recovered to pre-financial crisis levels, and it’s hard to see how Trump, pursuing a tax-the-rich policy to finance lower- and middle-class tax cuts, could do anything but further disadvantage small businesses, investment, and American competitiveness.

On the corporate side, revenue-neutral reform is not politically possible-eliminating deductions and credits to lower rates overall would raise taxes on at least as many companies as it would benefit. Chairman Brady proposed to lower corporate taxes overall by raising about $100 billion a year by applying corporate taxes on imports and rebating those on exports.

The latter instigated huge opposition from Wal-Mart, other retailers and manufacturers dependent on imported materials and components, even though the competitive effects would be minimal. All businesses would face the same taxes on imports and options to source more goods domestically.

Still the White House nixed border tax adjustments in the Joint Statement.

All this said, the Big Six have promised to come of up with a tax plan that simplifies the tax codes, cuts the tax burden overall, and pass it through Congress under “regular order” of legislative drafting, committee hearings, and voting procedures.

If you believe that one, well, I was born and raised in New York City and actually can sell you the Brooklyn Bridge. It’s a great piece of American history, with tolls a potentially enormous money maker, such a deal …..

 

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

__________

 

Seattle business consultant Terry Corbell provides high-performance management services and strategies.