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.
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.
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
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.
* 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.
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 first, second 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.
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.
Sweden has joined the club of runaway monetary policy. From Reuters:
Sweden shocked markets on Thursday by introducing negative interest rates, launching bond purchases and saying it could take further steps to battle falling prices. The central bank joins a list of those including the European Central Bank, the U.S. Federal Reserve and the Bank of England, to resort to unconventional monetary policy steps to confront an unusual combination of economic problems.
No. The Federal Reserve has reversed course. And together with The Bank of England the Fed has been helped by the fact that it is operating in an economy with moderate taxes and relatively relaxed fiscal policy. The ECB has opened the monetary flood gates in an economy that is plagued by statist austerity and more or less zero growth.
In fact, the slight uptick in economic activity in the third quarter of 2014 that I reported on earlier this week is closely correlated to the all-out liquidity bombardment that the ECB began early summer last year. On the margin there are those who will take advantage of declining interest rates. According to data from the ECB, euro-denominated loans to non-financial corporations declined noticeably in 2014. In the group of loans with a 5-10 year rate fixation, the interest on loans above 1 million euros fell by more than one percentage point, from 2.9 percent to 1.73 percent. Other collateral loan categories saw smaller declines, but the downward trend is unmistakable.
It is likely that the same thing will happen in Sweden; the question is what effect lower interest rates will have on economic activity. In the EU, gross fixed capital formation – a.k.a., business investments – did actually increase in 2014. However, broken down by quarter, the annual growth rate (i.e., over the same quarter the previous year) looks much different:
- Q1 2014 up 3.78 percent;
- Q2 2014 up 2.35 percent;
- Q3 2014 up 1.86 percent.
In other words, the largest annual increase was recorded before the ECB declared a negative interest rate. It remains to be seen what happened in the fourth quarter, but even if there was an increase somewhere in the same territory as earlier in 2014, the big question is what the lasting impact is going to be on GDP growth and employment. One indicator of this is private consumption, which seems to have benefited a bit more from the ECB’s desperate interest rate cuts. Again measured as annual increases by quarter:
- Q1 2014 up 0.68 percent;
- Q2 2014 up 1.27 percent;
- Q3 2014 up 1.4 percent.
For the two years Q3 2012 to Q3 2014 the annual increase was, on average, 0.3 percent. Nothing to be jubilant about, but the modestly accelerating trend during 2014 indicates a stabilization (rather than some sort of genuine recovery).
What does this mean for Sweden? The problem with that particular country is that its private-consumption increase is inflated by recklessly high household debt levels. These levels, in turn, are held up by mortgage loans with absolutely irresponsible terms, such as interest-only payments or basically life-long maturity periods. As I explained in my book Industrial Poverty, if Swedish household debt had remained a constant share of disposable income from 2000 and on, its private-consumption growth rate would almost have stalled.
Put bluntly: Sweden appears to be in reasonable economic shape only because households have increased their debt as share of disposable income from 90 percent 15 years ago to 180 percent today.
What this means is, plain and simple, that it is exceptionally irresponsible to make more credit available at even lower costs. But it also means that on the margin, the Swedish Riksbank will get less new economic activity out of every negative interest point than the ECB gets; the higher the household debt, the less inclined banks are to let people pile on new debt.
Unfortunately, the Riksbank president, Mr. Stefan Ingves, does not see this problem. Reuters again:
“Should this not be enough, we want to be very clear that we are ready to do more,” said Central bank governor Stefan Ingves. “If more is needed, we are ready to make monetary policy even more expansionary.” The central bank said this would mean further repo-rate cuts, pushing out future rate hikes and increasing the purchases of government bonds or loans to companies via banks.
As the Reuters story also explains, the Riksbank is ready to move into debt monetization – unthinkable only a year ago:
The Riksbank said it would “soon” make purchases of nominal government bonds with maturities from 1 year up to around 5 years for a sum of 10 billion Swedish crowns ($1.17 billion). But with the ECB printing 60 billion euros a month in new money the Riksbank’s much more limited program may have little effect on bond yields – already at record lows. “In terms of GDP, the mini-QE program amounts to about 0.25 percent,” banking group Morgan Stanley said in a note. “Therefore, this measure should be seen more as a signal that the Riksbank is ready to do more and remain dovish for the foreseeable time.”
In other words, here again the marginal payoff is going to be small. The only exception would be if the Swedish government decides to throw out its balanced-budget rules and start a major spending drive funded by the Riksbank. This seems unthinkable today – just like negative interest rates and a QE program seemed unthinkable a year ago.
Quantitative Easing is not a recession remedy. It is a defensive monetary strategy. So is the negative interest rate. Together, these two measures declare that a government and its central bank has reached the end of the road in trying to get their economy moving again. The big problem for Europe, Sweden included, is that they have come to this point almost seven years after the Great Recession started. With a recovery being half-a-decade overdue, with tapped-out monetary policy and fiscal policies restrained by ill-designed balanced-budget measures, Europe is firmly planted on the road straight into industrial poverty.
Sweden, with its imbalanced real estate market and very deeply indebted households, is on the same road, only with a more volatile ride.
Today it is time to review in more detail the latest national accounts data from Eurostat. A disaggregation of the spending side of GDP reinforces my long-standing statement: the European economy is in a state of long-term stagnation.
To the numbers. We begin with private consumption, which is the driving force of all economic activity. It is not only a national-accounts category, but an indicator of how free and prosperous private citizens are to satisfy their own needs on their own terms. It is a necessary but not sufficient condition for economic freedom that private consumption is the dominant absorption category.
Once consumer spending starts ticking up solidly, we can safely say there is a recovery under way. However, little is happening on the consumption front: over the past eight quarters (ending with Q3 2014) the private-consumption growth rate for the EU has been 0.3 percent per year. While the increase was stronger in 2014 than in 2013, only half of the EU member states experienced a growth in consumer spending of two percent or more in the last year. The three largest euro-zone countries, Germany, France and Italy, were all at 1.2 percent or less.
One bright spot in the consumption data: Greece, Spain and Portugal, the three member states that have been hit the hardest by statist austerity, now have an annual consumption growth rate well above 2.5 percent. Portugal has been above two percent for three quarters in a row; a closer look at these three countries is merited.
Overall, though, the statist-austerity policies during the Great Recession have caused a structural shift in the European economy that may be hard to reverse. From having been a consumer-based economy with strong exports, the EU has now basically been transformed into an exports-driven economy. On average, gross exports is larger as share of GDP than private consumption.
In theory, one could argue that this is a sign of free-market trade where people and businesses choose to buy what they want and need from abroad instead. I would be inclined to agree – but only in theory. In practice, if households and businesses freely made their choices on a global market, then rising exports would correlate with rising imports and, most importantly, rising private consumption. However, that is not the case in Europe. On average for the 28 EU member states,
- Exports has increased from an unweighted average of 59 percent of GDP in 2007 to an unweighted average of 70 percent in 2014;
- Net exports has also increases, from zero in 2007 (indicating trade balance) to six percent of GDP in 2014 (indicating a massive trade surplus).
If the rising exports had been a sign of increased participation in global trade on free-market terms, then either of two things would have happened: consumption would have increased as share of GDP or imports would have increased on par with exports. In reality, neither has happened, which leads to one of two conclusions:
- There has been a massive increase in corporate investments, which if true would indicate growing confidence in the future among Europe’s businesses; or
- Exports is the only category of the economy that is allowed to grow because it is not subject to the tight spending restrictions imposed by austerity.
Gross fixed capital formation, or “investments” as it is often casually referred to, was an unweighted average of 26 percent in the EU member states in 2007. Seven years later it had fallen to 21 percent. This is clearly a vote of no confidence from corporate Europe. Therefore, only one explanation remains: the discrepancy between on the one hand the rise in gross and net exports and, on the other hand, stagnant private consumption and a declining investment share, is the result of a fiscal policy driven by statist austerity.
The purpose of fiscal policy in Europe since at least the beginning of the Great Recession has been to balance the government budget at any cost. If this statist austerity leads to a painful decline in household consumption or corporate investments, then so be it. As shown by the numbers reported here, years of statist austerity have depressed corporate activity. In fixed prices, gross fixed capital formation in the EU has not increased since 2011:
- In the third quarter of 2011 businesses invested for 607.8 billion euros;
- In the third quarter of 2014 they invested for 602 billion euros.
The bottom line here is that the only form of economic activity that brings any kind of growth to the European economy is – you guessed it – exports. But it is not just any exports. It is exports outside of the EU. How do we know that? Because of the following two tables. First, the average annual private-consumption growth rate, reported quarterly, for the past eight quarters (ending Q3 2014):
|Private consumption growth|
With private consumption growing at less than one percent in 19 out of 28 countries, households in the EU do not form a good market for foreign exporters.
Things a not really better in the category of business investments:
|Gross fixed capital formation|
What this means, in plain English, is that the European economy still is not pulling itself out of its recession.
But is it not possible that things have changed recently? After all, the time series analyzed here end with the third quarter of 2014. There is always that possibility, but one indication that the answer is negative is the latest report on euro-zone inflation. From EU Business:
Eurozone consumer prices fell by a record 0.6 percent in January, EU data showed Friday, confirming deflation could be taking hold and putting pressure on a historic bond-buying plan by the ECB to deliver. The drop from minus 0.2 percent in December appears to back the European Central Bank’s decision last week to launch a bond-buying spree to drive up prices. Plummeting world oil prices were largely to blame for the fall in the 19-country eurozone, already beset by weak economic growth and high unemployment, the EU’s data agency Eurostat said.
If the EU governments let declining oil prices trickle down to consumers – and avoid raising taxes in response – there could be a positive reaction in private consumption. However, lower gasoline and home heating costs will not be enough to turn around the European economy.
More on that later, though. For now, the conclusion is that Europe is going nowhere.
Recently Eurostat released national accounts data for the third quarter of 2014. Here is a review of those numbers in the context of historical GDP data. All growth rates are in 2005 chained prices.
First, the growth rates of 28-member EY and 18-member euro zone:
The real annual growth rate of the EU-28 GDP is 1.51 percent, compared to 1.34 percent in Q2 of 2014 and 1.61 percent in Q1. Euro-zone growth is markedly lower – for first, second and third quarters of last year, respectively: 1.08, 0.65 and 0.79 percent. The difference between the euro zone and the EU-28 is primarily the work of a recovery in the British economy. In the three quarters of 2014, Britain saw its GDP growth at 1.8, 3.6 and 3.2 percent, respectively. If we subtract the U.K. economy from the EU-28 GDP, the European growth rates for 2014 fall to (with actual rates in parentheses) 1.58 (1.61), 0.89 (1.34) and 1.17 (1.51) percent. A distinct difference, in other words.
As the aforementioned numbers report, there is not much to be joyful of inside the euro zone. There are member states with strong growth, but they tend to be of marginal importance for the entire zone. In the third quarter of 2014 the strongest-growing euro-zone countries were Luxembourg (3.99 percent over Q3 2013), Malta (3.82) and Ireland (3.54). By contrast, the three largest euro economies have a tough time growing at all: Germany (1.24 percent over Q3 2013) and France (0.24) kept their nose above water, while third-largest Italy saw its GDP decline by half a percent.
Here is the growth history of the three largest euro-zone economies:
We will have to wait and see what the new Greek government will do to the future of the euro and the confidence of private-sector agents in the European economy. With Syriza teaming up with a distinctly nationalist party, the message out of Athens could not be stronger: Greece is off on a new course, and it won’t be with the best interests of the euro zone in mind.
There is a lot more to be said about these GDP numbers. It will be very interesting to look at what sectors are driving whatever growth there is – and which ones are contracting. I suspect that exports will play a larger role than domestic demand. Hopefully I am wrong, because if I am correct it means that there is still no change in overall private-sector confidence in the euro zone. But that remains to be seen; I will return to this dissemination of Europe’s national accounts as soon as possible.
The truth about the European economic crisis is spreading. The latest evidence of this growing awareness is in an annual report by the European Commission. Called “Report on Public Finances”, the report expresses grave concerns about the present state as well as the economic future of the European Union. It is a long and detailed report, worthy of a detailed analysis. This article takes a very first look, with focus on the main conclusions of the report.
Those conclusions reveal how frustrated the Commission has become over Europe’s persistent economic stagnation:
The challenging economic times are not yet over. The economic recovery has not lived up to the expectations that existed earlier on the year and growth projections have been revised downwards in most EU Member States. Today, the risk of persistent low growth, close to zero inflation and high unemployment has become a primary concern. Six years on from the onset of the crisis, it is urgent to revitalise growth across the EU and to generate a new momentum for the economic recovery.
Yet only two paragraphs down, the Commission reveals that they have not left the old fiscal paradigm that caused the crisis in the first place:
The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past. … this has allowed Member States to slow the pace of adjustment. The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.
If Europe is ever to recover; if they will ever avoid decades upon decades of economic stagnation and industrial poverty; the government of the EU must understand the macroeconomic mechanics behind this persistent crisis. To see where they go wrong, let us go through their argument in two steps.
a) “The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past.” There are two analytical errors in this sentence. The first is the definition of “fiscal picture” which obviously is limited to government finances. But this is precisely the same error in the thought process that led to today’s bad macroeconomic situation in Europe: government finances are not isolated from the rest of the economy, and any changes to spending and taxes will affect the rest of the economy over a considerable period of time. The belief that government finances are in some separate silo in the economy led to the devastating wave of ill-designed attempts at saving Europe’s welfare states in 2012.
Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.
b) “The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.” Here the Commission says that if a government runs a deficit, it causes a “drag” on macroeconomic activity. This is yet another major misunderstanding of how a modern, monetary economy works.
Erstwhile theory prescribed that a government borrowing money pushes interest rates up, thus crowding out private businesses from the credit market. But that prescription rested on the notion that money supply was entirely controlled by the central bank; in a modern monetary economy money supply is controlled by the financial industry, with the central bank as one of many players. Its role is to indicate interest rate levels, but neither to set the interest rate nor to exercise monopolistic control on the supply of liquidity.
A modern monetary economy thus provides enough liquidity to allow governments to borrow, while still having enough liquidity available for private investments. In fact, it is rather simple to prove that the antiquated crowding-out theory is wrong. All you need to do is look at the trend in interest rates before, during and after the opening of the Great Recession, and compare those time periods to government borrowing. In a nutshell: as soon as the crisis opened in 2008 interest rates plummeted, at the same time as government borrowing exploded.
This clearly indicates that the decline in macroeconomic activity was not caused by government deficits; it was the ill-advised attempt at closing budget gaps and restore the fiscal soundness of Europe’s welfare states that caused the drag. And still causes the drag.
In other words, there is nothing new under the European sun. That is unfortunate, not to say troubling, but on one front things have gotten better: the awareness of the depth of the problems in Europe is beginning to sink in among key decision makers. What matters now is to educate them on the right path out of the crisis.
There is a lot more to be said about the Commission’s public finance report. Let’s return to it on Saturday.
It is very easy to establish that Europe’s economy is stuck in a state of deep, solid stagnation. As I have explained recently, you have to look carefully to find any exceptions to that rule. However, those exceptions exist in the form of Greece and Spain. So far neither country has reached a state of real recovery – so far their economies have elevated themselves out of the deepest part of a depression, but their economies have so far only risen to the same state of stagnation that has slowly but steadily spread to the entire continent.
That is not to say Spain and Greece can’t do better. They can. To find out more about their economies I decided to review the value-added side of their economies. For those of you who are not macroeconomic nerds, there are three ways to calculate GDP: the income approach, the expenditure approach and the value added approach. The third is the least commonly used one, mostly because it does not say very much about the two major forms of activity in an economy such as the European: private consumption and government spending. However, value added can tell us a great deal about what industries are flourishing and which ones are doing poorly.
The following four industries represent almost 40 percent of the Greek economy:
Correction: the industry labeled “Tourism etc” should really be “Wholesale trade, tourism etc”.
This is unfortunately not the image of an economy in steady recovery. Manufacturing, which is only responsible for nine percent of the added value in the Greek economy, is definitely in a state of stagnation; if all the talk about an exports renaissance in Europe were true, Greek manufacturing would be surging.
Instead, it is “Wholesale trade, tourism, etc” that is on a clear trajectory to recovery. Producing 22 percent of the value added, this industry is labor intensive and close to consumers. The sustained improvement in activity is encouraging and has a potential for spreading its upturn to other sectors. First and foremost, it could mean that the young in Greece, whose chances of finding a job – any job – is the worst in the industrialized world, might regain some sort of faith in the future. That would be good for the long-term stability of both the economy and the Greek democracy.
That said, the figure of the Greek economy also shows that the other major industries are still in decline – or at least were in decline through the second quarter of this year. Greece needs a lot more to regain some of its status as an industrialized economy with a future.
Things look a bit different in Spain:
Together, these four industries are responsible for 46 percent of the total value produced in the Spanish economy. The three recovering industries represent 38 percent of total value added, a share big enough to positively affect the rest of the economy.
Adding to the cautious optimism about the Spanish economy is the fact that the growth rate of value added in two of the three recovering industries is actually accelerating. Manufacturing saw accelerating growth in five consecutive quarters:
|Wholesale, Tourism etc||-2.45%||-0.64%||1.07%||1.35%||1.69%||2.83%|
It deserves to be repeated that in total, the Spanish economy is still very much in recession mode. Austerity is still a real fiscal-policy threat, and the declining euro-zone interest rates pose a threat in terms of renewed financial speculation. However, the sectorial recovery has enough momentum that if it is allowed to continue, it will give the Spanish economy a reasonable shield against moderate negative shocks.
That said, should austerity again come to define fiscal policy at the levels it saw in 2012, there is a substantial risk that the recovering industries will fall back into recession mode. They will then pull the entire economy back down into the hole of depression.
Bottom line: Greece is far from out of its depression, farther than a cursory analysis would show. Spain on the other hand is worth watching closely.
European third-quarter GDP growth data is beginning to make its way out in the public. What we have seen so far is just more of the same new normal – the same new stagnated way of life in industrial poverty.
Starting from the aggregate level, Eurostat’s third-quarter growth report says that the EU-28 grew at 1.3 percent per year in Q3 of 2014 over the same quarter 2013. The euro zone’s growth rate was half-a-percentage point lower at 0.8. This difference is the same as over the past few years: the last quarter where the euro zone grew faster than the entire EU was in Q1 of 2011. It shows that austerity is still taking a tougher toll on Europe’s core countries than its non-euro members on the outer rim.
Or, to make the same argument from the other side: if you are a European welfare state, it pays to keep your own currency.
The growth numbers for the EU and the euro zone are poor in and by themselves. By not even coming close to two percent per year, Europe is not even able to reproduce its own standard of living. But even worse is the fact that the U.S. economy grew by more than two percent annually for the second quarter in a row: 2.3 percent in Q3 of 2014, compared to 2.6 percent in Q2 of 2014. This growth disparity is slowly becoming a self-reinforcing phenomenon: when global investors see that the U.S. economy is growing while the Europeans are standing still, they choose to reallocate their investments to the United States. That way investments and new jobs go to where investments and new jobs are already going.
But does not that mean that the U.S. economy will run into inflation problems that, in turn, will even out the differences between the United States and Europe? No, not necessarily. In fact, that is a very unlikely scenario. We are now rising to become the global leader in producing energy, with costs far below those of European countries. Right-to-work states offer a union-free manufacturing environment, something that, e.g., Volkswagen successfully took advantage of when they opened their new plant in Tennessee. The large US-only Passat they build there is a runaway sales success, $7,000 cheaper and selling ten times more (100K units per year) than its German-built predecessor.
Long-term, it looks like manufacturing is making its way back to the United States. This does not bode well for Europe, whose exporting manufacturing industry has, basically, been the only part of the economy that has not sunken into the three shades of gray that is industrial poverty. That European manufacturing is in trouble is well proven by the Eurostat report, according to which Germany has seen a decline in growth for two quarters in a row: now down to 1.2 percent on an annual basis.
Another supposedly big manufacturing economy, France, barely finished the third quarter with growth at all: 0.4 percent over Q3 of 2013. Austria’s growth is also dwindling, with 0.3 percent this quarter compared to 0.5 in Q2 and 0.9 in Q1.
The only real positive news is that the Greek economy showed annual growth for the second quarter in a row – at 1.4 percent this quarter – with growth numbers improving steadily for a year now. Spain also shows positive growth, 1.6 percent, with a similar upward long-term trend.
Neither the Greek nor the Spanish number is anything to write home about, but it looks like the two countries are slowly recovering from the bad austerity beating they took in 2012 and 2013. It is an extremely hard journey back for both of them, though, especially for Greece which lost one quarter of its economy to destructive austerity policies. The welfare states of both Spain and Greece have now been recalibrated, so that government budgets paying for the welfare states will balance at a much lower employment level than before. This means, effectively, that government will begin to net-tax the economy and thereby cool off a growth trend long before full employment is restored.
This structural problem is entirely unknown to Europe’s lawmakers – and, frankly, to almost every economist on the planet. I defined the problem in my book Industrial Poverty; if unsolved, this problem will guarantee permanent economic stagnation in Europe for, well, ever.
That said, I don’t want to spoil the fun for Greek and Spanish families who are now seeing the first glimpse of daylight after a long, horrible nightmare. Let them celebrate today; tomorrow they will still be living in industrial poverty.
Today’s blog will be a short one, just a reminder of some vital statistics relating to the liquidity trap – an important topic now that Sweden, a non-euro member state of the EU, has joined the euro-zone in the trap.
The practical meaning of the trap is a situation where GDP is stalled – in other words the economy is stuck in a recession – and there is so much liquidity available in the economy that adding another euro (or krona) will not make any difference at all. Monetary policy is useless. That is where the euro zone is now, something that ECB leader Mario Draghi is well aware of, as he recently sent out a desperate call for help from Europe’s political leaders. He knows that monetary policy has reached the end of the road and that the only remaining options are within the realm of fiscal policy.
Despite this, Draghi continues to pump out M1 money supply into the euro zone like the recovery actually depended on it. Consider Figure 1:
Fig. 1: Quarterly growth rates. Sources: ECB and Eurostat
The blue line, depicting growth in euro-zone M1 money supply, deserves an explanation. The two growth peaks, one at the end of 2005 and one in late 2009, are largely related to the expansion of the euro zone, which went from 12 to 16 member states between 2006 and 2009. (Since then Estonia and Latvia have also joined.) If we adjust for the enlargement, money supply is fairly well in tune with GDP growth – until we get to 2012. That is when the ECB started making promises to buy any and all treasury bonds from “troubled” euro-zone countries, as well as to participate in the massive austerity programs that the EU and the IMF convinced the worst-off member states to adopt.
On top of that, the ECB decided this summer to take its interest rate to zero, and to punish banks – charge a negative interest rate – for depositing cash in overnight accounts with the ECB. This has flooded the euro zone with liquidity; if the theory behind this policy were right, we would see a major upturn in business investments and notable workforce expansion. However, we don’t see that; at best, year-over-year quarterly GDP growth rates show an economy barely struggling to stay afloat.
The inevitable – and from both a Keynesian and an Austrian viewpoint rather obvious – conclusion is that the theory behind the liquidity expansion is flawed. In fact, the ECB is playing with fire: sooner or later the massive supply of liquidity will go look for profitable investment opportunities. So long as the real sector of the economy remains essentially stagnant that search for profit will rapidly climb the speculative hills in the real estate and stock markets.
Again: welcome to life in the liquidity trap.