Euro-Dollar Parity, Part 1

I normally do not write about momentary events, such as the daily fluctuations on the international currency market. But today’s exchange rate between the dollar and the euro, which according to Bloomberg happens to be $1.06 per euro right now, is worth a broader analysis. The trend toward euro-dollar parity has gained a fair amount of attention in the media, and rightly so: when the euro was launched a decade and a half ago it was sold as a stellar currency, backed by some kind of European integrity, and certainty way above that flimsy greenback.

Reality turned out different. The euro and the dollar would have reached parity many years ago had it not been for the excessive money printing during Bernanke’s QE programs. But now that the Federal Reserve has cooled down its printing presses and the European Central Bank, on their end, have cranked up theirs, it is only logical that the two currencies are re-evaluated on the global currency market.

Immediately, one could question the case for parity based on the fact that the Federal Reserve Board of Governors meet tomorrow, Wednesday and likely will throw some cold water on the surge of the dollar. However, a postponed interest-rate hike will not make much of a difference over time: while only about three percent of all short-term rate changes are related to real-sector events, long-term trends are determined by the macroeconomic performance of the two economies. From this perspective, euro-dollar parity is a historic event. Its underlying cause is a long-term, widening gap between GDP growth, consumer spending, business investments and job creation in the United States and in Europe.

I have on several occasions analyzed the differences between the European and American economies. This is a good time for a quick recap. To begin with, the American economy is a much stronger job-producing machine than the European economy:

EU_US_RFC_1.jpg

Our job creation record in this recovery is not exactly stellar, but our unemployment is nevertheless almost half of what it is in the euro zone. The EU as a whole is doing microscopically better than the euro zone, but that is almost entirely thanks to the comparatively positive trend in the British economy.

The American advantage in terms of job creation originates in a still-overall business friendly institutional framework. On the one hand, the Obama administration has a penchant for regulations; on the other hand this president has a comparatively modest spending record – far better than his predecessor – which has allowed Congress to combine largely unchanged taxes with an expansion of private-sector business opportunities. As a result, GDP growth is comparatively strong here:

EU_US_RFC_2.jpg

It is important to understand the driving forces behind growth. If it is private consumption and business investments, it means that the private sector is doing well. In my recent blog series “State of the U.S. Economy” I pointed to these variables as being essential to the growth of our economy. What is particularly interesting is the visibly stronger confidence in business investments.

Therefore, we can safely conclude that we have a growth period in the U.S. economy that is well grounded and could last for a couple of more years.

The European economy, on the other hand, is not as lucky. Whatever growth they have appears to be driven by exports more than anything else. Private consumption is not playing a key role here:

EU_US_RFC_3.jpg

The differences are striking in terms of private-consumption growth. Americans are now back at a level of consumption where they can maintain their standard of living and even start getting ahead a little bit. In Europe, by contrast, the standard of living has been declining consistently for over a decade: consumption growth has been below the Industrial Poverty threshold since the Millennium Recession.*

This points to a fundamental weakness in the European economy. While government has assumed more responsibilities for people’s lives in Europe than here – and as a result has a higher level of spending – it is important to understand that this does not compensate for lack of private-consumption growth. Government spending in Europe has been held back by welfare-statist austerity policies for a good six years now, which only pours more salt in the growth-stopping wounds on the European economy.

For all the macroeconomic reasons reported above, Europe will not return to growth any time soon. The American economy will continue to grow at moderate rates for another couple of years, during which we will see a reversal of the exchange rate between the euro and the dollar.

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*) For an explanation of the two-percent growth threshold in private consumption, see my book Industrial Poverty, specifically the section about applying Okun’s Law to private consumption.

Rethinking Libertarian Success

Yesterday I asked if libertarianism has failed as a political theory. The question is merited: in a world where government is involved in everything from health care and education to “saving” for your retirement, and where government involvement is increasing, one has to wonder why the libertarian movement has not been able to move the needle in the right direction.

Despite this pessimistic review of the lack of libertarian accomplishments, the answer to yesterday’s question is actually: No.

The libertarian movement has not failed. But its list of accomplishments is way too short. If all libertarians share the common goal of saving – and restoring – individual and economic freedom, then our combined efforts thus far have missed the target by a big margin. If we are going to reach the ultimate goal of a minimal state with a maximum of freedom, we need to reboot our operations and get back to work, but do so under two very important conditions.

Before we get to the two conditions, though, let us acknowledge what is actually on the list of libertarian accomplishments. Globally, the movement helped bring down the Soviet empire. It provided moral inspiration to liberty-minded people from Greifswald to the Black Sea. Economic literature on free-market Capitalism were studied behind the Iron Curtain long before the Wall fell in Berlin. Even Robert Nozick, who himself had Polish ancestry, influenced thinkers and inspired people to challenge the prevailing communist order.

Domestically, though, the accomplishments in Thatcher’s Britain and Reagan’s America were more of a temporary nature. They are in fact difficult to see today. The United States reaped the harvests of the Reagan tax cuts all the way through the 1990s, but unrelenting growth in government spending eventually neutralized and overwhelmed the positive effects of the tax cuts.

In retrospect, the Reagan era and its surge in the intellectual, political and economic pursuit of liberty looks less and less like a corner turned in modern American history. In the context of the decades before and after his presidency, Reagan appears to have inspired a temporary halt to, but not a termination of, a very long trend of welfare statism.

The first condition for future success is that libertarians revise their political methodology. the need for revision is well explained by the Niskanen Center, a newly founded libertarian think tank in Washington, DC. In their conspectus, declaring their raison d’etre, the Center explains:

Despite having invested tremendous time, energy, and resources in achieving political change, libertarians have produced little policy change. Of the 509 significant domestic legislative policy changes since World War II, more than half (265) expanded government while only four percent (20) contracted government. When policymakers act, they have, on balance, acted to expand state power.

 They also analyze the “mechanics” of policy change in Washington, DC and how libertarians, despite major investments, thus far have failed to correctly identify and successfully use those mechanics to turn libertarian ideas into legislative practice.

In addition to misunderstanding the legislative mechanics, libertarians have also failed to fully comprehend the nature of government spending. This brings us to the second condition for future success. The Reagan-era tax cuts were accompanied by 7+ percent annual federal spending increases; the George W Bush administration repeated the pattern, combining tax cuts with 6.7-percent annual spending increases. The libertarian movement has failed to fully comprehend the reasons behind, and the complexity of, those spending increases. Therefore, they have lost the debate over government spending to the welfare statists.

This is a general observation; there are bright exceptions to it who pursue actionable reforms to welfare-state entitlement programs. But they are just that – exceptions. Their voices are simply not strong enough to set the tone for the libertarian movement in general. Instead, libertarians tend to fragment their analysis and policy approach, and in too many cases they leave the entitlement sector of our society altogether. Those who do tend to end up fighting the battle of eclectic flea killing, a.k.a., legalization of recreational drugs.

While some libertarians turn on, tune in a and drop out of the fight for economic freedom, the welfare state eats its way deeper into the flesh of the free market. The time to change course is now – and it begins with:

a) following the advice of aforementioned Niskanen Center, i.e., revising the political methodology and learning to master legislative mechanics; and

b) studying and intellectually conquering the welfare state.

I cannot stress enough how important the second condition is. Libertarians in general – again, there are exceptions – dismiss the welfare state by saying either that “just cut spending darn it” and the welfare state will go away; or by refocusing on issues that are not as intellectually intimidating or hard to navigate in terms of policy and actionable reform legislation.

In other words, there is an enormous amount of work to be done. But all is not lost. On the contrary, looking at the young generation in this great country, there are glimmers of hope. A fledgling libertarian grassroots movement has risen as a result of the Tea Party reaction. It consists for the most part of regular Americans whose interest in politics and willingness to become activists are fueled by clearly visible government over-reach.

More specifically, the Obama presidency is actually a gift to the libertarian movement. After having promised “hope” and “change” and rallied millions of young voters and activists, the 44th president burdened job creators with massive regulations that made it very difficult for young workers and professionals to find jobs; he put health insurance out of reach for many of those who got jobs; and he vigorously defended government surveillance programs, invading the electronic integrity of a young generation who takes the privacy of their cell phones as seriously as the privacy of their own pockets.

Young voters turned away from Obama in his re-election bid. Thanks only to an unbelievably out-of-touch Romney campaign, Obama managed to prevail. But this has not made disappointment among the young go away – on the contrary. When today’s 20-somethings look at the career opportunities their parents had, and when they know that the government is intercepting and storing their text messages, their minds are open to arguments on government over-reach, individual freedom – and libertarianism.

The growing interest in individual liberty is a promising platform for a renewed effort to end America’s slow but steady transformation into a European welfare state. High school and college students are flocking in growing numbers to internships and educational offerings by liberty-promoting organizations. Dedicated donors provide financial support, and sharp minds at think tanks and advocacy groups can turn that money into intellectual firepower.

Only two pieces are missing. One of them is the right use of the legislative mechanics. Explains Niskanen Center president Jerry Taylor, whose operational credo “terrain dictates tactics” sets the prelude for his verdict:

The political terrain could not be clearer. Despite our best efforts, America is a center-left nation. Libertarians constitute no more than 5 percent of the public. And if a Republican manages to win the White House in 2016, the recent erosion in the public support for more government will almost certainly reverse.

Europe’s record is even more disappointing. Anyway, Taylor continues:

Until some political tectonic plate shift occurs, radical libertarian policy change is not in the cards. Repealing the Great Society, much less the New Deal, is unlikely. Business regulation of some sort is not going away. The EPA, FCC, SEC, etc. will not be abolished. Less radical improvements in public policy are possible. But to do that, we need to stop making “the better” the enemy of “the best” and cease complaining that the former commits the unpardonable sin of “compromising on principle.” By definition, advocating anything short of the night watchman state “compromises on principle,” and the night watchman state—for now anyway—is a fantasy.

While Taylor unintentionally overlooks the rekindled interest in libertarian ideas during the Obama years, he is correct in that the road from today’s welfare state to the night watchman state is long and littered with road bumps and uphill battles. But if libertarians can intellectually conquer the welfare state, and if they can learn to master the legislative mechanics that Taylor points to, then no road bump or uphill will stand in their way.

Has Libertarianism Failed?

In a four-part series I presented the current state of the U.S. economy. Overall, things look relatively good here: growth is moderately good, private consumption is moderately healthy, business investments are stabilizing at a good rate and government consumption and investment spending is under control.

Generally, the private sector of the U.S. economy is in fairly good shape. So what is there to complain about?

First of all, the growth rates that I refer to as “moderately good” are at least a full percentage point below what we should have at this stage of a recovery, even from a deep recession. There are reasons why we are not at higher growth, one of them being the kind of government spending that does not show up in GDP: entitlements. Another reason is the Obama administration’s affinity for regulations. Without big entitlements and invasive regulations we could easily be growing at 3.5-4 percent per year.

Secondly, the biggest strength of the U.S. economy is relative, not absolute. As I continuously report on this blog, Europe is in a perennial state of stagnation and industrial poverty. The Chinese economy is in what looks like a relatively serious recession; add to that a real estate bubble that they still don’t know how to handle and the growing trend of job migration from China to lower-cost countries like Vietnam. Japan is fledgling but not much more than that.

And third – well, there is always Obamacare… Fortunately it looks like that reform, well-intended as it was, is being reshaped into something more palatable and manageable. It takes time, though, and while the president understandably holds on to his trademark legislative achievement he, too, must come to the conclusion that not all is good in America’s most complicated piece of legislation ever. When that happens, another ball and chain around the ankle of the American economy will fall off and allow free-market Capitalism to grow even bigger.

Bottom line: the U.S. economy is not very impressive when compared to itself a couple of decades ago, but at least from an international perspective it is the best place to be for job seekers, families and businesses.

The big question is why we can’t do better. What is holding us back? As a libertarian my conclusion is “big government”. As an economist my conclusion is “it depends, but big government is a strong candidate”. But that does only begs another question: how is it that the United States, a constitutional republic born from the yearnings of freedom, has fallen for the temptation of the big welfare state?

This is a big question to answer. A good way to start is to ask what has happened to the most freedom-loving movement in recent American history – the libertarian movement – and why it has failed to turn the tide on big government. After all, modern libertarianism is now almost half-a-century old. The intellectual groundwork was laid in part by economists like Milton Friedman and Friedrich von Hayek (who, by the way, allegedly did not get along with one another…) and partly by the great moral philosopher Robert Nozick. In his Anarchy, State and Utopia, originally published in 1971, Nozick challenged the prevailing wisdom of redistributive justice and – by implication – the theoretical foundations of the welfare state. His vision of the minimal state was close in theory to the small government that would be necessary for Hayek’s and Friedman’s free-market Capitalism to work.

The Reagan presidency marked a surge for libertarianism in America. Similarly, the Thatcher era unleashed libertarian thinking and activism in Britain. While its success on continental Europe was more limited, the libertarian movement made its footprints, especially in Scandinavia and eastern Europe, where it helped inspire the liberation from the Soviet empire.

But what looked like a success story back then never translated into policy success. Why?

The question is highly relevant. In a world where government consumes 40 percent or more of GDP; when taxes can take away more than half of a man’s earnings; when government controls or wants to control the education of all children and the health care of all citizens; in that world, libertarianism seems to be little more than a topic for esoteric dinner conversations.

Where are the libertarian victories? Can libertarianism even be saved?

Yes, it can. But only under some very important conditions. For more on this, check in tomorrow.

State of the U.S. Economy, Part 4

In the first three installments of this series we looked at the aggregate-demand side of the U.S. economy. The overall message is that the economy is in pretty good shape, given the circumstances: the private-sector share of the economy has grown over the past 15 years, consumers buy more durables (such as cars) while maintaing a steady overall level of indebtedness; business investments are increasingly stable at a high rate – and government consumption and investment spending has been declining for a couple of years.

There is no doubt that the economy could do better. In the past three years GDP has been growing at 2.1-2.4 percent per year, adjusted for inflation; a good growth rate this far out of a recession would be 3-3.5 percent. There are two reasons why we are not seeing more growth than we do:

  • In the short run, the federal debt and the Obama administration’s affinity for regulations have put a damper on private-sector activity;
  • In the long run, the U.S. economy is in the same early stages of industrial poverty that Europe experienced some 20-25 years ago.

Nevertheless, the economy is growing and so is the private sector. This fourth and last installment takes a closer look at the production side of the economy, asking the question: what industries produce the value that adds up to our Gross Domestic Product?

The first thing we note about the value-added analysis of GDP is that the American economy is remarkably stable from a structural viewpoint. The industries that were the backbone of the economy ten years ago remain its backbone today. In 2005,

  • The financial industry produced 23.2 percent of the value added in the economy;
  • Manufacturing came in second at 15.1 percent;
  • Professional and business services contributed 12.7 percent.

Together, these three industries added $5.67 trillion to the economy (in current prices), or 44.2 percent of the entire GDP.

In 2014, the same three sectors, again topping the ranking in the same order, produced a total value of $7.83 trillion, representing almost exactly the same share of GDP.

This is a sign of structural stability, and it is worth noting that manufacturing – the death of which is so often declared – continues to grow. From 2005 (the earliest year with consistent value-added GDP data) through the third quarter of 2014, American manufacturing grew by an average of 2.4 percent per year (again in current prices). Admittedly, this is not exceptional; most other industries have seen stronger growth. But it is a higher growth rate than, e.g., manufacturing in Europe.

If we look at value-added per employee, manufacturing looks even better. For the same 2005-2014 period, per-employee value added grew by 4.2 percent per year:

  • In 2005 the average manufacturing worker produced a total value of $119,800;
  • In 2009, right in the middle of the Great Recession, he produced a total value of $145,900; and
  • In 2014 (annual value based on the first three quarters) the value added per employee was $171,200.

The number of employees in manufacturing has gone down over the past ten years, from 14.2 million in 2005 to 12.2 million last year. On the upside, there are 700,000 more manufacturing workers in America today than there was in 2009 and 2010, the bottom of the Great Recession.

In other words, manufacturing is on the rebound in America.

The leading industry of our economy, the financial sector, is even healthier – at least judging from the value it produces. (Let us keep in mind that this is the market value of their services, not the investments they make.) Per employee, the financial sector produced a value of…

  • $322,200 in 2005;
  • $366,700 in 2009; and
  • $440,200 in 2014.

During the same period of time, the financial industry has increased its value added to GDP by $1 trillion in current prices, from $2.5 trillion in 2005 to $3.5 trillion in 2014.

On the job-creation side, though, the financial industry seems to suffer from the same reluctance that is holding  back manufacturing. In 2005 there were almost 8.2 million people working in the financial industry; in 2014 that same number was 147,000 people lower. That said, since its recession bottom of 7,678,000 employees the industry has regained 318,000 jobs.

There is one more sector that deserves a note. Of all the major industries, mining produces the highest per-employee value: $528,000 in 2014. Furthermore, with a value-added increase of more than ten percent per year and a job growth of 4.2 percent annually, mining strongly contributes to our economic recovery.

To sum up, there is growth almost in every corner of our economy. It is a ho-hum recovery, but it remains relatively steady and it has no doubt replaced the recession as the “norm” of the economy. This is good, but things can get better. While it is unrealistic to expect stellar growth rates for the United States when both China, Europe and Japan are in recession mode, at the very least we can squeeze another percent in annual growth out of the economy.

How could we that happen? Well, that is the question for another day. For now, relax and enjoy the ride.

State of the U.S. Economy, Part 3

This the third installment about the current state of the U.S. economy analyzes consumer spending and consumer credit. Since private consumption constitutes almost 70 percent of GDP, it is of fundamental importance to have an essential understanding of how households spend money – and how they finance that spending.

As I noted in the first part of this article series, consumption as a share of the U.S. GDP has risen in recent years, claiming an almost four percentage points larger share of the economy today than it did 15 years ago. In the second part I explained that…

as the sole engine pulling the industrialized world forward, the United States is doing a reasonably good job. More details from the GDP growth numbers reinforce this conclusion. There is, e.g., private consumption which over the past three years has averaged 2.1 percent in annual growth. For 2014, though, the preliminary growth rate was 2.5 percent, a good but not excellent number. Underneath it, though, is some good news: spending on durable goods – household appliances, automobiles etc – has averaged 6.5 percent per year since 2012. This means two things: American families are improving their credit scores again after taking a beating in the trough of the Great Recession; and they are more optimistic about the future.

One of the concerns with strong growth in durable-goods spending is that it will come at the price of rising household indebtedness. Fortunately, American families in general are not going down the debt lane; perhaps having learned from the mortgage circus before the Great Recession, they seem to be holding back on overall borrowing:

  • In 2008 American households had a gross debt of $14.2 trillion, equal to 133.1 percent of their disposable income;
  • In 2010 their debt was down to $13.9 trillion, pushing the debt-to-income ratio down to 124.3 percent;
  • In 2012 those numbers were down to $13.6 trillion and 110.6 percent, respectively.

In 2013 household debt started increasing again, exceeding $14 trillion (by $61bn) in Q3 of 2014, the first time in almost five years. The debt-to-income ratio continued to slide, flattening out at 107.7 percent inQ2 and Q3 of 2014.

However, a more detailed look at household debt shows a relationship between debt and spending on durable goods. The small rise in household debt since 2013 is due to a rise in consumer credit, i.e., the kind of borrowing that is, e.g., often used to buy cars.

Cdg Conscred

After the deep dip during the opening of the recession, U.S. consumers soon regained confidence and began spending on long-term items. Almost immediately the ratio of consumer credit to disposable income started rising again. After it bottomed out at 21.4 percent in 2010 the ratio has increased steadily since then. The latest numbers reported by the Federal Reserve is 24.8 percent for Q3 2014.

Since 2010 durable-goods spending has grown by, on average, 4.9 percent annually in current prices. The growth rate for disposable income is almost exactly the same. Theoretically, this means that consumers should not have to increase their indebtedness as they spend more on durables, but the explanation for that increase is not by any means illogical. While the consumer credit ratio has increased, the ratio of mortgages to disposable income has declined steadily:

  • In 2008 the ratio was 97.3 percent;
  • In 2010 it had fallen to 90.7 percent;
  • In 2012 it was down to 77.6 percent.

By Q3 2014 it had declined yet more, to 71.8 percent. Compared to the mortgage-to-income ratio of 2008, U.S. households have $4.7 trillion less in mortgage loans today. This opens up for the opportunity to borrow for other purposes, such as car loans.

It is encouraging to see that American households are better off and feel more confident about their future. All is not well, of course, but the slowly improving debt situation combined with the confidence in spending on durables is yet another encouraging sign that our economy is slowly moving down the right track.

The Euro and the Deficit Crisis

The fiscal stress on the euro-zone continues. Last week the EU non-solved the Greek problem:

Eurozone finance ministers on Tuesday (24 February) approved a list of reforms submitted by Athens and cleared the path for national parliaments to endorse a four-month extension of the Greek bailout, which otherwise would have run out on 28 February. “We call on the Greek authorities to further develop and broaden the list of reform measures, based on the current arrangement, in close coordination with the institutions,” the Eurogroup of finance ministers said in a press statement.

Don’t expect that to happen. Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.

The question is what those circumstances will look like. The EU Observer article provides a hint:

[The] IMF, while saying it can support the conclusion that the reforms plan is “sufficiently comprehensive”, criticised the plan for lacking details particularly in key areas. “We note in particular that there are neither clear commitments to design and implement the envisaged comprehensive pension and VAT policy reforms, nor unequivocal undertakings to continue already-agreed policies for opening up closed sectors, for administrative reforms, for privatisation, and for labour market reforms,” IMF chief Christine Lagarde wrote in a letter to Eurogroup chief Jeroen Dijsselbloem.

These are reforms that the new socialist government in Athens would not want to carry out. It is a good guess that they will be punting on the reforms to provoke the IMF into making an ultimatum. At that point Tsipras can tell the Greek people that he will not subject them to any more IMF-imposed austerity, and the only way he can protect them is to re-introduce the drakhma.

Will this happen in four months? It remains to be seen. But there is no way that Tsipras is going to tow the line dictated by the IMF, the ECB and the EU. His very rise to political stardom is driven by unrelenting opposition to such fiscal subordination.

In other words, the Greek crisis is far from over and will continue to be a sore spot on the euro-zone map. If it were the only one, the euro zone and the entire EU political project might still have a future. That is not the case, however:

The European Commission on Wednesday (25 February) gave France another two years to bring its budget within EU rules – the third extension in a row – saying that sanctions represent a “failure”. France has until 2017, having already missed a 2015 deadline, to reduce its budget from the projected 4.1 percent of GDP this year to below 3 percent. “Sanctions are always a failure,” said economic affairs commissioner Pierre Moscovici adding that “if we can convince and encourage, it is better”.

This is a non-solution similar to the Greek one, though for somewhat different reasons. In the Greek case the EU does not want to provoke an imminent Greek currency secession; in France they do not want to give anti-EU politicians more gasoline to pour on the European crisis fire.

What the European leadership does not seem to realize, or at least will not admit, is that the euro will lose either way. By pushing Greece too hard the EU Commission will give Tsipras his excuse to reintroduce the drakhma; by treating France with silk gloves the Commission hollows out the enforcement backbone of the currency union. Known as the Stability and Growth Pact – the balanced-budget requirement built into the EU constitution – it was supposed to hold sanctions as a sword over member states to minimize budget deficits. Now the EU Commission has effectively neutered the Pact and created an ad-hoc environment where austerity is forced upon some countries but not others.

With no sanctions there are no incentives for the states to comply. On the contrary: compliance means austerity, which comes with a big political price tag for the member states; non-compliance, on the other hand, comes with no price tag whatsoever.

To be blunt, the silk-glove treatment of France has put the final nail in the coffin of the Stability and Growth Pact. Aside from its consequences for the inherent strength of the euro, this silk glove stands in sharp contrast to the iron fist that the Commission presented Greece with already in 2010. The EU Observer again:

Valdis Dombrovskis, a commission vice-president dealing with euro issues, admitted that France is the “most complicated” case discussed on Wednesday. Paris is in theory in line for a fine for persistent breaching of the euro rules. However the politics of outright punishing a founding member of the EU, a large member state, and a country where the economically populist far-right is riding high in the polls, has always made it unlikely that the commission would go down this route.

This is of course a major mistake. The only mitigating circumstance is that France is not yet in a situation where it requires loans from the EU-ECB-IMF troika to pay its bills. But if the socialist government generally continues with its current entitlement-friendly, tax-to-the-max policies it will not see its budget problems go away.

Down the road there is at least a theoretical possibility that France could be sucked into the bailout hole. More likely, though, is that Marine Le Pen will be elected president in 2017 and pull France out of the euro. That will, so to speak, solve the problem for both parties.

I have said this before and I will maintain it ad nauseam: so long as Europe’s political leaders persist in their fervent defense of the welfare state, they will continue to drive their continent deeper and deeper into the macroeconomic quagmire called industrial poverty.

State of the U.S. Economy, Part 2

Yesterday I reported some data showing that the U.S. economy is in good shape from a structural viewpoint. Household spending and business investments – domestic private-sector activity – today absorb a larger share of output than they did under the Bush Jr. administration. Government consumption and investment spending has taken a step back, and the foreign trade balance is in better shape today than at the height of the Bush business cycle.

Today, let’s look at the same macroeconomic data from another perspective.

2. A strong growth pattern

Untitled

In terms of inflation-adjusted growth, the U.S. economy is doing relatively well. GDP growht is not great – but these numbers from 2009-2014 are far better than what we can find anywhere in the developed world:

  • 2009 -2.76 percent
  • 2010 2.53 percent
  • 2011 1.6 percent
  • 2012 2.32 percent
  • 2013 2.09 percent
  • 2014 2.41 percent

When an economy grows faster than two percent per year it provides opportunities for people to achieve a standard of living higher than what previous generations have accomplished. Growth below causes stagnation or even a decline in the average standard of living.* From this perspective the American economy is just about keeping its nose above the water. It could do much better, but two factors are holding us back: the Obama administration’s affinity for heavy-handed regulations, and the combined global effects of a China in recession, a Europe in stagnation and a Russia in Ukraine.

In other words, as the sole engine pulling the industrialized world forward, the United States is doing a reasonably good job. More details from the GDP growth numbers reinforce this conclusion. There is, e.g., private consumption which over the past three years has averaged 2.1 percent in annual growth. For 2014, though, the preliminary growth rate was 2.5 percent, a good but not excellent number. Underneath it, though, is some good news: spending on durable goods – household appliances, automobiles etc – has averaged 6.5 percent per year since 2012. This means two things: American families are improving their credit scores again after taking a beating in the trough of the Great Recession; and they are more optimistic about the future.

This optimism is corroborated by encouraging employment, which we will get to in the fourth and last part of this series.

But there is even more good news in the GDP growth numbers. Gross fixed capital formation (GFCF or business investments) has averaged a growth rate of 5.7 percent per year over the past three years. Even better: the growth rate is stabilizing. In the figure above, investments fluctuate wildly:

  • Down 26.4 percent in Q2 of 2009;
  • Up 21.1 percent in Q3 od 2010;
  • Growth plummets to 1.3 percent in Q3 2011;
  • Next growth peak is 13.5 percentin Q1 2012.

From thereon the amplitude declines, forming a “confidence cone” where the annual rate stabilizes around 5.7 percent per year. A good number, the stability of which makes it even more impressive.

At the same time, no story of capital formation is complete without a detailed look at what kinds of investments businesses make. Here, again, there is an encouraging pattern of stability. Fixed investment falls into two categories, non-residential and residential, with the former constituting about 80 percent of total fixed investment. In this group spending is divided into structures, equipment and intellectual property products. Again the proportions between the different categories remain stable over time, with the equipment category representing 45-47 percent of non-residential investments.

While homes construction was weak in 2014 – growing by only 1.64 percent – it finished strongly in the fourth quarter at 2.6 percent over Q4 2013. But the residential investment numbers for 2012 and 2013 were downright impressive: 13.5 and 12 percent, respectively.

Finally, a word about government spending. Many people unfamiliar with national accounts make the mistake of looking at total government outlays as share of GDP, whereupon they understandably get outraged about how big government is. However, in order to understand the role of government properly one has to remove the financial transactions from government spending: GDP only consists of payments for work – by labor or capital – or for products. A financial transaction such as a cash entitlement does not pay for work or products, and therefore has no place in GDP.

The government spending included in GDP is payments for teachers in public school, police officers and tax collectors, as well as products such as tasty lunches for middle-school kids and gasoline for the presidential motorcade. It is also investments such as new highways and faster trucks for the postal service.

This kind of government spending has actually been shrinking in the past few years:

  • 2011 -3.04 percent;
  • 2012 -1.45 percent;
  • 2013 -1.49 percent; and
  • 2014 -0.18 percent.

All in all, then, the U.S. economy is in reasonably good shape. This does not mean that cash entitlements such as food stamps are not a problem. They are. But with this stable macroeconomic foundation the U.S. economy is well suited to handle reforms to entitlement programs.

Check back after the weekend for the two remaining installments in this series.

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* The two-percent mark is arrived at through an adaptation of Okun’s Law. See:

Larson, Sven: Industrial Poverty – Yesterday Sweden, Today Europe, Tomorrow America; Gower Applied Research, London, UK 2014.

State of the U.S. Economy, Part 1

The U.S. economy stands as a contrast to the European misery. This is particularly interesting given the fact that the United States has a president that came into office with the most radical statist agenda since the FDR presidency. In fact, President Obama still gets a lot of criticism from libertarians and conservatives for his ideological stance. Some of that criticism is no doubt well deserved, but there are areas where the president has earned more accolades than he gets.

In fact, if you listen to the common conservative wisdom about Obama, we have an economy that is on the verge of being socialized. That may very well be correct when it comes to regulatory incursions and irresponsible environmental policies, including the legislative monstrosity known as the Affordable Care Act. But beyond regulations and the occasional run-amok entitlement program, Obama’s economy has been reasonably good.

Last summer I expressed my appreciation of how well the American economy was doing given the circumstances – see the firstsecond and third parts – with particular emphasis on the permanent nature of the nation’s economic performance. In the third part I explained:

If the spending growth that drove the GDP number were of a more transitional nature, then I would agree with [the skeptics]. But … the numbers indicate strengthening confidence among consumers and entrepreneurs. It is very likely, therefore that this is a sustainable recovery. Not a perfect recovery, but a sustainable one. We should be happy for it. After all, things could be much worse. We could be Europe.

The most recent GDP numbers, covering all of 2014, point in the same direction. Let us go through them in four parts.

1. The composition of GDP

A healthy economy is heavily dominated by private-sector economic activity. Europe’s welfare states are dominated by foreign trade and government spending. Consequently, unemployment is almost twice as high as here in the United States, GDP is barely growing and the general economic outlook is dystopic.

GDP Components

As shown in Figure 1, the U.S. economy is better structured today than it was 15 years ago. In the fourth quarter of 2014 private consumption constituted 68.1 percent of the U.S. GDP (measured in 2009 chained dollars). That is up from 64.2 percent in Q1 1999. Under the first six years of the Obama presidency private consumption has averaged 68.1 percent of GDP. Compare that number to the 66.9-percent average under Bush Jr.

Another piece of good news is that gross fixed capital formation – business investments in street lingo – have returned to a healthy level of 15+ percent of GDP. At 17.2 percent in Q4 of 2014, investments are far higher than the 12.5-percent share they commanded five years earlier.

On this front the Obama years have not been quite as good as the preceding eight years under Bush: business investments under Bush averaged 17.7 percent of the economy, compared to 15.2 percent under Obama. That said, by global comparison American corporations are fairly confident in the future.

There are two more components of GDP, in both of which the Obama years have been better for the economy than the Bush years:

  • Net exports, the balance between exports and imports, averaged -4.8 percent per year under Bush. The Obama years have thus far shown a better foreign trade balance, with a net exports only -2.9 percent per year. A smaller foreign trade deficit, in other words.
  • Government consumption and investment has been smaller under Obama. This may come as a surprise to many, but since Obama took office federal, state and local spending has been, on average, 19.6 percent of the economy. The Bush years saw relatively more government spending, at 20.2 percent.

It is important to understand that these government-spending figures do not include cash entitlements and other financial outlays. To qualify as a GDP expenditure, a dollar must be spent either on compensating someone for work or on making an investment that, in turn, pays people for work. If I buy a share in Coca Cola it does not count toward GDP, but if Coca Cola builds a new production line it does count toward GDP.

With this qualification in mind, we can again conclude that Obama’s first six years have not done too much damage to the economy. On the contrary, the private sector continues to grow, government is showing some restraint and our perennial balance-of-payments deficit is actually in better shape than it has been in 15 years.

There is a lot more to be said about the current state of the U.S. economy. This is the first installment in a four-part series.

Caritas and Social Justice

Two years ago Caritas, the charity arm of the Catholic church, published a study of the socio-economic effects of the European crisis. They reported:

The prioritisation by the EU and its Member States of economic policies at the expense of social policies during the current crisis is having a devastating impact on people – especially in the five countries worst affected – according to a new study published today by Caritas Europa. The … failure of the EU and its Member States to provide concrete support on the scale required to assist those experiencing difficulties, to protect essential public services and create employment is likely to prolong the crisis.

Their report presented…

a picture of a Europe in which social risks are increasing, social systems are being tested and individuals and families are under stress. The report strongly challenges current official attempts to suggest that the worst of the economic crisis is over. It highlights the extremely negative impact of austerity policies on the lives of vulnerable people, and reveals that many others are being driven into poverty for the first time.

This was, again, two years ago. Since then, things have gotten worse, which Caritas reflects in its 2015 study of the European crisis. Sadly, the report not only accurately presents the socio-economic disaster in southern Europe, but it also makes requests for a bigger welfare state.

Starting with the effects of the crisis, Caritas points to widespread cuts in income-security entitlements and health care, especially in the worst-off countries like Greece, Italy, Rumania, Portugal and Cyprus:

[From] 2011, social expenditure declined … and social challenges have grown further during the second dip of the recession … for example, in a number of countries the number of long-term unemployed losing their entitlements has increased, the level or duration of benefits has been reduced, eligibility rules have been tightened to increase incentives to take up work and this has also led to excluding beneficiaries from some [entitlement programs].

The study also criticizes the hand of austerity that has been particularly heavy on southern Europe:

[The] policy of requiring countries with the weakest social protection systems to impose fiscal consolidation and successive rounds of austerity measures within very short timetables is placing the burden of adjustments on the shoulders of those who did not create the crisis in Europe and are least able to bear the burden.

And so…:

[Austerity] policies pursued during the crisis in Europe and the structural reforms aimed at economic and budgetary stabilisation have had negative effects with regard to social justice in most countries

 This is the problem facing Europe in the next few years. An economic crisis hit; governments responded by slashing welfare-state entitlements and raising taxes; people respond by getting angry – not over the crisis, but over lost entitlements. As a result, socialist parties are gaining strength from Paris to Lisbon, from Athens to Madrid, pushing an agenda of restored entitlements. Caritas reinforces this movement by suggesting that “social justice” – a politically undefinable concept – should be the guideline for post-austerity policy.

A battle cry for more social justice is a battle cry for higher taxes and more income redistribution. Or, as Caritas puts it, “the impacts [of austerity] have not been shouldered equally”. If by “equally” they mean “spread out evenly across the citizenry”, then yes, they are entirely correct. But the reason for this is – obviously – that only a select segment of the population receives entitlements from the welfare state. That is the very reason for the welfare state’s existence.

Caritas and other advocates of social justice would respond that this is a moot point: those who earn the least cannot afford lose the entitlements they have. Others have money, they contend.

If the argument about the frugality of welfare-state entitlements were applied to the United States, it would not stand up to scrutiny. Michael Tanner and Charles Hughes have proven this beyond the shadow of a doubt. Things are a bit different in Europe, though, as Caritas actually show in their study. However, this does not mean that austerity could have been executed differently. More burden on those who do not receive entitlements automatically means higher taxes; as I show in my book Industrial Poverty austerity based on tax increases has even worse macroeconomic effects than austerity biased toward spending cuts. This means, in a nutshell, that if austerity had been profiled according to some “social justice” scale, it would have deprived even more Europeans of jobs and entrepreneurial opportunities.

Plain and simple: Europe must not fall for the temptation of “social justice”. It must charter a course away from collectivism and government “solutions”. The way to the future goes through fundamental, structural reforms toward a permanently smaller government.