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THE DAILY EDGE: 25 April 2024

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%.

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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:

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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. (…)

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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!!!

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