Monday, November 07, 2016

Guest Post: Quarterly Economic Commentary by Dorothy Jaworski

The third quarter of 2016 was relatively quiet after the surprise of the Brexit vote at the end of the second quarter.  There is a Presidential election coming and perhaps people are exhausted by it.  I cannot wait for the political TV ads to end.  But, either way, we will have a new President come January, 2017.  As far as the markets go, volatility has tamed down and prices respond to economic data releases and Fed speak, but not much else.  All I keep seeing is mixed economic data.  GDP for the 2Q16 was +1.4%, following +.8% in 1Q16.  Surely the 3Q16 will be better, but the 4Q16 will follow with a weak reading if it follows the typical pattern of the past several years.

There is NO momentum and really NO catalyst on the horizon to push GDP up above 2% to a more acceptable level, like 3% to 4%, except maybe Lady Gaga’s new album.  Job growth has been stronger than average at +1.7% each year since 2010, despite a declining labor force participation rate.  However, the job growth is not translating into higher consumer spending.  I think that job growth is symptomatic of weak productivity, which has risen by less than half of 1% from 2010 to 2015, compared to an average annual growth of 1.5% from WWII to 2009.

Our Federal Reserve keeps talking about raising interest rates.  Why?  Maybe they believe they must because rates are so low.  I think they are overlooking the fundamental causes of the weak growth - low rate environment- the high debt-to-GDP ratios- involving government, corporate, and consumer debt- and existing in every major country in the world.

Government Debt
Debt keeps mounting, especially government debt.  Let’s look at the US.  In the past 10 years, $7.9 trillion was borrowed to cover deficits but debt increased by $11 trillion, if other “spending” projects are included.  The Congressional Budget Office projects deficits at $9.2 trillion in the next 10 years and total debt issued to be another $13 trillion!  We are already over the 100% debt-to-GDP level that causes indigestion.  Other countries are in the same boat- Japan, China, all of Europe, and Australia.  Why do I write about this debt?  Because it is the high government debt levels that are crowding out private sector investment and that are pushing GDP and interest rates lower.  High government debt levels are hurting productivity, corporate profits, industrial production, and consumer spending.

Government spending is also crowding out consumers and businesses.  Recently, I have read Dr. Lacy Hunt’s materials and seen the research that shows that government spending is actually creating a negative multiplier; that is, every dollar of government spending is hurting GDP growth.  As government spending rises, GDP has fallen along with investment and productivity.  All we need to do is look around; we are living it. 

Investment managers are sitting on a near record level of cash in their funds, currently at 5.8%.  Banks are sitting on huge reserves at the Fed.  We are stuck in this endless liquidity trap for now.  So what does it mean?  Slow growth and low rates should continue.

The Fed
Someone said to me that if the Fed doesn’t raise rates now, they won’t have any tools later to use to fight recession, when it comes.  I disagree.  The Fed can use Quantitative Easing, or “QE,” again to buy bonds to keep rates low.  Janet Yellen recently said she is open to the notion of purchasing corporate debt, as is being done by the ECB in Europe, provided that Congress agrees and approves it with legislation.  Another tool that was fairly effective in the years after 2008 was Forward Guidance, which involved Fed promises to keep rates low until specific dates in the future; this tool was one of Ben Bernanke’s faves.  There is also the negative interest rate path, tried by other countries, but unproven so far.

I have noticed that the future inflation gauge published by ECRI has been rising steadily for months, with increases being larger on a year-over-year basis.  The gauge tries to forecast inflation six to nine months from now and things would be bleak if the projections came true.  I am sure the Fed has taken notice, and they, like myself, are trying to figure out if this is transitory.  I believe that it is, because the producer price index is still low and prices are not yet ready to flow through to consumers, despite higher than average increases in wages.  Average hourly earnings have risen 2.6% compared to last year.  Another factor worth noting is that gold prices have risen 19% year-to-date in 2016, but are off their worst levels; this commodity could be a safe haven for Brits fleeing Brexit.  Inflation is not a problem right now; getting GDP growth to exceed 2% certainly is.

Rates are low for several reasons- low economic growth, high debt-to-GDP levels, low inflation, and low productivity.  What do I see as I look out into 2017?  Low growth, low rates, no momentum, and high debt levels will continue to dominate.  I don’t believe inflation is an imminent threat because growth is so weak.  The Fed doesn’t either, as they project inflation to be under 2.0% into 2018.  Most notably, they seem to agree with me that economic growth will continue to be low.  Or is it that I agree with them?  Stay tuned!

Thanks for reading!   10/24/16

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.


  1. Dorothy -- Thanks for sharing, I always enjoy your commentary. I sat in on a panel discussion with a representative from the Dallas FRB last week. When asked what worries him about the economy, he noted four things: 1) The impact upon GDP as a result of a declining workforce due to aging (see Japan). 2) Government crowding out the private sector (as you noted). 3) Excess capacity overseas and what amounts to "state sponsored" industry sectors that we can't compete against on a cost basis. 4) Overall disruption caused by technology, especially as it relates to displacement of workers. He predicted an extended period of historically low interest rates.

  2. Mike,Thanks for your comments. I am so glad to see the Fed raising these same issues. I continue to worry about the government crowding out effects, declining workforce, and high debt levels all leading to weak GDP growth. I also believe that rates will stay low, the huge selloff in the past week notwithstanding.