America’s Economy Is No. 1. That Means Trouble. Solid growth, big deficits and a strong dollar stir memories of past crises

(…) it’s worth studying the reasons the U.S. is outperforming. In a nutshell, there’s an encouraging reason and a worrisome one.

The encouraging reason is that structurally, the U.S. continues to innovate and reap the rewards, judging by big-tech stocks and artificial intelligence adoption. The U.S. has done better at boosting productivity (output per worker).

It has also benefited from what economists call its terms of trade: The price of what it exports, notably natural gas, has risen more than the price of what it imports. In Europe, the opposite has happened.

The second, more worrisome, reason for stronger U.S. growth is government borrowing—including former President Donald Trump’s 2018 tax cut, bipartisan Covid-19 relief in 2020 and President Biden’s 2021 stimulus.

In fact, Washington continues to inject stimulus, albeit not with that label: hundreds of billions of dollars for veterans’ benefits, infrastructure, semiconductor manufacturing and renewable energy.

U.S. deficits have run roughly 2% of GDP higher than the IMF expected back in late 2022. They will be the highest, by far, among major advanced economies for the foreseeable future.

In the long run, deficits inflate future interest bills and crowd out private investment. But they might be leading to dangerous imbalances right now.

Deficits were justified when unemployment was high, private demand moribund and inflation and interest rates low. None of that is true now.

Instead, Biden and Congress continue to stoke demand in an economy that already has plenty. Through February, Biden had canceled $138 billion in student debt—and he has just unveiled plans to erase billions more—which directly boosts debtors’ purchasing power. Of the $95 billion in aid to Ukraine, Taiwan and Israel just approved by Congress, $57 billion will flow back to U.S. producers in the form of more weapons purchases.

It’s one reason inflation, though down from a year ago, has stalled above the Federal Reserve’s 2% target. The IMF thinks core inflation (which excludes food and energy) is a half percentage point higher than otherwise would be because of fiscal policy.

This, in turn, is keeping the Fed from cutting short-term interest rates. That, along with the flood of Treasury debt to finance the deficit, is pushing up long-term bond yields.

Textbooks predict that a combination of tight monetary and loose fiscal policy will suck in capital from overseas and drive up the dollar. That has often precipitated financial crises in emerging markets as exchange rates are devalued, governments default and banks fail.

The dollar has, indeed, risen this year. It hasn’t undermined emerging markets, which are generally in better shape than in previous crisis eras, though the risk bears watching. It might, however, destabilize the international economy another way: through protectionism.

In 1971, high U.S. inflation and government deficits led to an overvalued dollar and trade deficits. After the Nixon administration imposed a 10% surcharge on imports, West Germany and Japan agreed to revalue their currencies against the dollar.

In 1985, the script repeated: Higher U.S. interest rates and budget deficits had driven up the dollar and trade deficit. At New York’s Plaza Hotel that September, the Reagan administration persuaded Japanese and European officials to boost their currencies against the dollar. It followed with trade actions against Japan, in particular on autos and semiconductors.

The dollar hasn’t risen nearly as much now as it did in 1985, yet similar frictions are emerging. The Biden administration badly wants to boost American manufacturing, in particular of electric vehicles, and is watching with dismay as China, aided by a weaker yuan, floods the world with cheap exports. The U.S. trade deficit, after shrinking through most of last year, is growing again.

The macroeconomic solution would be for the U.S. to stimulate its economy less and China to stimulate its economy more. Neither seems likely. And unlike in 1971 and 1985, when West Germany and Japan felt compelled to raise their currencies to mollify the U.S.—their ally and protector—China feels no such obligation.

The result will almost certainly be more protectionist pressure. Biden is already planning higher tariffs on China. If Trump returns to the White House, expect no action on the deficit and, if his first term is a harbinger, more tariffs and a push to weaken the dollar.

The U.S. economy might still be king, but the reign will not be harmonious.

Greg Ip touches on some of the points I raised in American Exceptionalism: Don’t Extrapolate (Feb. 21, 2024).

This chart shows that higher borrowings and interest rates have doubled the Federal government interest payments in 3 years which now account for 15.3% of total expenditures from 10.9% in Q1’20. Meanwhile, expenditures ex-interest payments jumped 28%.

U.S Department of Treasury, U.S Department of Commerce and Wells Fargo Economics

About one third of Treasurys will be maturing during the next 12 months, very likely with a steep markup on renewals, taking even more budget space, crowding out more discretionary spending. And the Fed is not rushing to cut interest rates, is it?

Last February, I wrote:

Looking ahead, many important changes are likely:

• Consumer spending will normalize, with increased volatility. Since 1959, the personal savings rate has only been lower than the current 3.7% during the 2005-08 period when Americans splurged on housing, and briefly in 2022, in total only 7% of the time. Before the pandemic, the savings rate ranged between 5.0% and 8.5%.
• Construction spending will also normalize. Since 2010, total construction spending grew 50% faster than GDP, carrying a high economic multiplier.
• Government spending ex-interest expense will measurably slow down.
• The unemployment rate is at a historical low. Employment growth will slow.
• American politics are getting increasingly toxic and inefficient.

Bank of America’s data confirm my contention that March retail demand was not as strong as generally thought after March’s release (Roaring Lion???). It also looks like services were also on the weak side in March.

In fact, on a seasonally adjusted (SA) basis, total card spending per household fell 0.7% month-over-month (MoM) in March, following the 0.4% rise in February.

Spending on services fell 1.1% MoM SA in March, with weakness in both lodging and restaurant spending, while retail spending (excluding restaurants) decreased by 0.3% MoM.

Tuesday’s flash PMI raised the first yellow flag in quite a while:

• Slower increases in activity were recorded across both the manufacturing and services sectors, with rates of growth easing to three- and five-month lows respectively.
• April saw inflows of new business fall for the first time in six months and firms’ future output expectations slipped to a five-month low amid heightened concern about the outlook.
• Employment decreased for the first time since June 2020. The overall reduction in workforce numbers was centered on services, where employment decreased solidly and to the largest extent since mid-2020. In fact, excluding the opening wave of the COVID-19 pandemic, the decline in services staffing levels in April was the most pronounced since the end of 2009.

Indeed job postings, available through April 19, confirm the recent slowdown. Postings have declined 4% since the last BLS job openings data for February:

Canada Retail Sales Slip 0.1% in February, Seen Flat in March Data supports outlook for central bank rate cut as soon as June

An advance estimate of retail receipts indicates sales were unchanged in March, Statistics Canada said Wednesday.

That comes after sales in February edged down 0.1% to a seasonally adjusted C$66.73 billion, the equivalent of about $48.8 billion, the data agency said.

The monthly dip was softer than the modest 0.1% advance forecast by Statistics Canada and by economists, and follows a 0.3% pullback in January sales in a further sign of the strain on Canadian household budgets from high interest rates. February’s decline, led by a drop in trade at gas stations and fuel vendors, would have been even sharper if sales at motor vehicle and parts dealers hadn’t recovered from weakness the month before when vehicle production was disrupted by retooling at some production plants. (…)

Core sales—which strip out gas stations, fuel vendors and vehicle and parts dealers, were flat in February.

In volume terms, price-adjusted sales fell 0.3% from January, with a sharp fall in gasoline and fuel volumes. That suggests a modest headwind to industry-level gross domestic product, which Statistics Canada had previously projected grew for a second month running with a 0.4% increase in February. (…)

Canada’s per capita output drops 7% below trend, new Statscan report says

(…) Canada’s moribund economic performance on a per person basis has become a flashpoint of discussion over the past couple of years. In a speech last month, Bank of Canada senior deputy governor Carolyn Rogers said the country is facing an “emergency” of weak labour productivity and tepid levels of business investment.

The recent numbers paint a grim picture. Real GDP per capita has fallen to levels seen in 2017. Workers in places with higher per capita output tend to earn higher wages and live longer, making this a popular – if imperfect – measure of a country’s living standards. (…)

Productivity is the bedrock of per capita growth. Over the four decades leading up to the pandemic, increases in productivity accounted for 93 per cent of the improvement in real GDP per capita, Wednesday’s report said. (Economies can also boost per capita output via higher employment rates and the average employee working longer hours, although these have played a small role in Canada’s long-term gains.)

The trouble for Canada is that labour productivity has faltered of late: While it nudged higher over the final three months of 2023, that followed six consecutive quarters of decline. (…)

In its recent budget, the federal government pushed back on some of the pessimism regarding the decline in per capita output. Because newcomers typically earn less than the average Canadian, the government said that the recent influx of people is weighing on average income and productivity. “This should not be misinterpreted to imply that those already in the country are becoming worse off,” the budget read. (…)

In its latest projections, the Bank of Canada said it expects GDP per capita to decline in the first half of 2024, before picking up in the second half of the year and into early 2025. The central bank said the improvement would be driven by easing financial conditions – the bank is widely expected to lower its policy interest rate around the middle of the year – and rising confidence among consumers and businesses.

Since 1981, real GDP per capita has risen by an average annual rate of 1.1 per cent, the Statscan report said. To return to the long-term trend by 2033, Canada will need to experience a decade of above-average growth. (…)

The Statscan authors said it’s an open question of whether emerging technologies will usher in a new era of stronger productivity.

“The ability of Canadian companies to harness the benefits of new competitive technologies related to artificial intelligence, robotics and digitalization will be critical to the link between investment and productivity in the coming years and potentially important contributors to changes in living standards,” they wrote.

Chinese Tourists Are Again Embracing International Travel

More than a year since China reopened its borders, some 63% of its residents say they’re ready to return to exploring the world, according to a survey published on Wednesday, which Bloomberg previewed. They plan to venture farther afield than previously, with just 10% spurning international travel altogether—a significant shift from a year ago, when more than half of China’s consumers said they had no plans to go abroad and 31% said they weren’t even interested.

The return of China’s travelers has long been awaited in the travel industry, which is expected to surpass pre-pandemic levels this year by contributing $11.1 trillion to the global economy. The March 6–19 survey by marketing solutions firm Dragon Trail International queried 1,015 mainland Chinese leisure travelers located in 127 places, including first-, second- and third-tier cities. (…)

As of early April, outbound trip bookings for China’s weeklong May holiday lagged 2019 levels by only 13%, according to Dragon Trail, and included such places as Egypt and United Arab Emirates. The China Tourism Academy predicted that global Chinese tourist numbers will reach 130 million in 2024—84% of levels before Covid-19 struck. In 2019, some 155 million outbound Chinese travelers spent $253 billion abroad. (…)

Amid delays in visa issuance, first-quarter flights between the US and China remained 78.8% below those in the same period in 2019, according to data provided by aviation analytics firm Cirium. This contrasts with a near rebound for flights between the US and the rest of Asia, just 4% below pre-pandemic levels.

Still, Chinese travelers’ poor perception of the US has changed significantly since the pandemic. In 2021, 87% said they considered the US an unsafe tourist destination. In March, only 36% voiced that perception.

Meta’s Costs Rise Rapidly as Zuckerberg Vows to Keep Spending on AI Arms Race Meta reported record first-quarter sales, but investors soured on forecasts of rising costs related to AI. Shares fell about 15% after hours.

(…) Costs have mounted for many of the world’s biggest technology companies. AI models require sizable computing power to function, pushing companies to invest in servers and new generations of AI chips.

Wednesday’s stock hit for Meta shows the extent of unease, as the social-media company is the first of the world’s largest tech companies to report earnings. Google and Microsoft report earnings Thursday, and investors are likely to look closely at their AI-related spending. Amazon.com and Apple will provide January-to-March updates next week. (…)

Meta on Wednesday announced that it had increased its capital expenditures projections for 2024 to between $35 billion and $40 billion, up from between $30 billion and $37 billion. The company attributed the increase to its investments in its AI strategy. Meta said it expects its capital expenditures to increase in 2025 as well.

Meta also said it expects its revenue for the April-to-June period to be in the range of $36.5 billion to $39 billion. That was lower than the $38.3 billion that analysts surveyed by FactSet were expecting. (…)

Overall, Meta posted a net profit of $12.4 billion for the first quarter. That’s more than double the net profit that the company posted for the same period in 2023. (…)

• Apple’s troubles in China worsened. Even the Lunar New Year celebrations didn’t bring it much cheer with iPhone sales plunging 19% last quarter, the worst performance in four years, according to Counterpoint. (Bloomberg)

TRAVEL NOTES

• 45 days in Asia and SE Asia, impressions:
• Hong Kong: smoggy, smoggy.
• Ha Long Bay: foggy, foggy.
• Ho Chi Minh City (Saigon): one day of complete chaos is enough.
• Bangkok: worth much more than 2 days.
• Singapore: The “city in a garden” likely the best run large city in the world. Spectacular, loveable.
• Tokyo: 3rd time and still a great stay. 2nd best run large city in the world? Love Tokyo. Yen @ 155!!!

Note: I am travelling in Asia until April 24. Limited equipment and different time zones will limit the frequency and depth of my postings.

FLASH PMIs

USA: Output growth slows amid signs of demand weakness

The headline S&P Global Flash US PMI Composite Output Index dropped to 50.9 in April from 52.1 in March. Although continuing to signal an increase in business activity during the month, the latest data indicated only a slight expansion and one that was the softest since December. (…)

Slower increases in activity were recorded across both the manufacturing and services sectors, with rates of growth easing to three- and five-month lows respectively.

Output growth cooled in line with demand weakness as new orders decreased for the first time in six months, albeit dropping only modestly. Falling new business was signalled among manufacturers and service providers alike.

Some service providers suggested that elevated interest rates and high prices had restricted demand during the month. Meanwhile, manufacturers often linked lower new orders to inflationary pressures, weak demand and sufficient stock holdings at customers.

International demand held up slightly better than domestic sales, with new export orders remaining unchanged for the second month running.

Concerns about their ability to secure new orders dampened firms’ confidence in the year-ahead outlook for business activity in April. Business sentiment dipped to a five-month low, down in both manufacturing and services, but remained positive overall amid hopes that market conditions will pick up.

Signs of demand weakness impacted hiring plans at companies in the US at the start of the second quarter. A number of survey respondents indicated that they had held off on backfilling positions following the departure of staff. As a result, employment decreased for the first time since June 2020.

The overall reduction in workforce numbers was centered on services, where employment decreased solidly and to the largest extent since mid-2020. In fact, excluding the opening wave of the COVID-19 pandemic, the decline in services staffing levels in April was the most pronounced since the end of 2009. In contrast, manufacturing employment continued to increase modestly.

The drop in staffing levels partly reflected signs that current capacity was sufficient to handle workloads, with backlogs of work decreasing for the third month running and to a larger degree than in March.

Input prices continued to rise sharply in April, although the pace of inflation eased from the six-month high seen in March. This was in spite of the fastest increase in manufacturing input costs for a year amid rising raw material prices. Service providers often noted higher staff and shipping costs, though reported the second-lowest overall cost increase for three-and-a-half years.

In line with the picture for input costs, output prices increased at a solid but slower rate during April, the pace of inflation cooling again having accelerated to a ten-month high in March. Prices charged inflation was in line with the series long-run average, though still elevated by pre-pandemic standards. Slower charge inflation was seen across both the manufacturing and services sectors.

The S&P Global Flash US Manufacturing PMI posted 49.9 in April to signal broadly unchanged business conditions over the course of the month. The index was down from 51.9 in March and ended a three-month sequence of improving operating conditions.

US manufacturers drew down their stocks of purchases for the second consecutive month in April, and to a solid degree that was the most marked since August last year. Firms made some efforts to limit the pace of depletion, however, raising their purchasing activity slightly following a fall in the previous survey period.

There remained signs of spare capacity in supply chains amid relatively muted demand for inputs. Suppliers’ delivery times shortened for the third month running. Although modest, the latest improvement in vendor performance was more pronounced than that seen in March.

Finally, stocks of finished goods ticked higher following a fall in the previous month. According to respondents, the slight rise in post-production inventories reflected a slowdown in demand which left firms holding unsold goods.

Commenting on the data, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence said:

“The US economic upturn lost momentum at the start of the second quarter, with the flash PMI survey respondents reporting below-trend business activity growth in April. Further pace may be lost in the coming months, as April saw inflows of new business fall for the first time in six months and firms’ future output expectations slipped to a five-month low amid heightened concern about the outlook.

“The more challenging business environment prompted companies to cut payroll numbers at a rate not seen since the global financial crisis if the early pandemic lockdown months are excluded.

“The deterioration of demand and cooling of the labor market fed through to lower price pressures, as April saw a welcome easing in rates of increase for selling prices for both goods and services.

“Notably, the drivers of inflation have changed. Manufacturing has now registered the steeper rate of price increases in three of the past four months, with factory cost pressures intensifying in April amid higher raw material and fuel prices, contrasting with the wage-related services-led price pressures seen throughout much of 2023.”

Eurozone recovery gains momentum in April, but price pressures also revived

The seasonally adjusted HCOB Flash Eurozone Composite PMI Output Index, based on approximately 85% of usual survey responses and compiled by S&P Global, rose from 50.3 in March to 51.4 in April. The latest reading signals a second successive month of rising output after a continual decline over the nine months to February. The April expansion was the strongest since May of last year, though was only modest and well below the pace seen this time last year.

Although service sector output grew for a third successive month, with the rate of increase having gained momentum to register the fastest rise for 11 months, manufacturing output fell across the eurozone for a thirteenth straight month in April to act as a drag on the overall economy. The rate of decline in factory output eased, however, to the weakest for 12 months.

Sector variations were driven by underlying demand conditions. New orders for services rose in April at the fastest pace since May of last year, up for a second straight month, but new orders for manufactured goods fell at an increased rate. The latter have now fallen continually for two years.

By country, Germany notably edged back into growth territory for the first time in ten months as resurgent growth in the service sector was accompanied by a cooling of the manufacturing downturn. France meanwhile reported only a marginal contraction of output, the weakest recorded over the past 11 months, as the first rise in service sector activity since last May helped offset a persistent manufacturing decline. It was the rest of the region which collectively saw the best performance, however, despite growth slowing slightly, as output rose for a fourth consecutive month in April in response to robust growth in the service sector and near-stable manufacturing output.

Employment increased across the eurozone for a fourth month in a row in April after two months of marginal declines at the end of 2023. The rate of net job creation accelerated to the highest since last June. A ten-month high rate of employment growth in the service sector drove the increase, though the pace of headcount reduction in the manufacturing sector also eased to the slowest in seven months. Jobs growth was recorded in France, with the rate of increase reaching a nine-month high, alongside a marginal return to growth in Germany and sustained solid hiring in the rest of the region.

Having briefly lengthened at the start of the year in response to disruptions to Red Sea shipping, manufacturing supplier delivery times shortened for a third successive month in April, improving to the greatest degree since last August. In addition to fewer shipping delays, pressure was taken off supply chains from a further steep reduction in the purchasing of inputs by eurozone manufacturers.

Price pressures intensified slightly in April, remaining elevated by pre-pandemic standards, with higher rates of inflation seen for both input costs and average selling prices.

Average input costs across the goods and service sectors re-accelerated in April after having cooled in March, recording the joint-fastest increase seen over the past year. Although manufacturing input prices continued to fall, helped by improved supply conditions, the decline was the smallest recorded over the past 14 months. The rate of service sector cost inflation meanwhile edged up, albeit remaining below the recent highs seen at the start of the year, with companies often reporting higher wage rates as a key inflation driver alongside greater energy and fuel costs. Especially strong cost growth was seen in the German service sector.

Selling price inflation likewise accelerated in April, reviving from March’s four-month low to run well-above the pre-pandemic long-run average and hint at stubborn inflation pressures. While rates charged by manufacturers fell for a twelfth month in a row, prices levied by service providers rose at an increased rate, continuing to climb at a strong pace by historical standards. Selling price inflation picked up in Germany, France and across the rest of the region, with the latter registering the steepest rate of increase.

Looking ahead, business expectations about the coming 12 months cooled slightly compared to March but was the second-highest recorded over the past 14 months. A pull-back in service sector confidence, to a three-month low, contrasted with improved optimism in the manufacturing sector, where output expectations rose their highest since February of last year. While sentiment nevertheless remained relatively more upbeat in the service sector compared to manufacturing, the gap is now the narrowest for just over two years.

Recent months have seen business confidence improve in response to the expectation of lower interest rates, a moderating cost of living squeeze and signs of recovering household and corporate demand. Manufacturing has also been buoyed by signs of the global inventory cycle starting to become more supportive to demand. However, geopolitical uncertainty and financial market volatility subdued optimism about the year ahead outlook at some firms in April.