Of Rates, Jobs, and Trade Wars

Two announcements dominated the economic news this past week. On Friday the government surprised by reporting that the economy added 128,000 jobs, to which add 42,000 to account for the temporary effect of the General Motors strike. The frosting on the jobs cake was an upward revision of 95,000 in the August and September reports. Thank you, free-spending American consumers.The unemployment rate ticked up from a 50-year low of 3.5% to 3.6%, good news because as hundreds of thousands of people who were not counted as unemployed because they were not looking for work, came off their couches or out of their parent’s basements to join the labor force.

Two days earlier Federal Reserve Board chairman Jay Powell announced a one-quarter of 1% cut in the Fed’s benchmark rate, the third and most likely final cut this year. Why an economy at full employment, chugging along at its sustainable growth rate of about 2% (1.9% in the last quarter plus 0.2% for production lost to the General Motors strike) needs a rate cut is not obvious to everyone, including three of the chairman’s colleagues who voted against the seven who favored an increase.

Powell worries that the economy is slowing, which reports from the manufacturing sector suggest is the case. He knows that as a general rule lower interest rates stimulate growth — which is why President Trump favors lower and still lower rates. Morgan Stanley analysts say that consumer spending on interest-rate-sensitive goods such as cars and appliances increased at an annual rate of 14.6% over the six months through August, and accounted for 40% of the gains in total consumer spending.

In addition, mortgage rates, are down a full percentage point since last year, to 3.75% for the conventional 30-year, fixed-rate mortgage. That has two effects. One is to encourage holders of higher-rate mortgages to refinance, giving them a saving on their monthly payments, cash to be used for current consumption. The other is to make it less costly for buyers to acquire new or existing homes. In the July-September quarter lenders extended $700bn in home loans, which researchers at Inside Mortgage Finance say is the largest sum in fourteen years. Home-builders have a new spring in their steps.

Lower rates usually encourage businesses to borrow to fund expansion of plant and new hiring. Not now. Labour shortages make such plant expansion useless, since businesses can’t find workers to operate them. Besides, it is not at all clear that encouraging more borrowing by U.S. corporations is a good idea.

Nonfinancial corporations have taken on about $10tn in debt, an increase of $1.2tn in the past two years and 60% above pre-crisis levels. The Wall Street Journal reports that the level of corporate debt relative to the size of the economy now stands at 47%, a record. Corporate debt, in relation to corporate profits, is now a bit above where it was before the Great Recession, and is approaching the levels reached before the previous two recessions. If demand for the products or services of these debtors should decline, and with it their incomes, they will have to cut back on costs, which usually means Labour costs.

So Powell only might have been right to cut rates, but he certainly is right to signal that’s it for this year and probably next. With the constraint on more rapid growth a shortage of Labour, a complaint I hear from most employers, there is no sense pumping up demand when the supply side of the economy cannot respond by boosting output. And with a recession-style collapse in profits failing to materialize, businesses are not likely to begin massive layups. As Fed vice chairman Richard Clarida told the Wall Street Journal late Friday afternoon, “The U.S. economy is in a good place. Growth has been supported by the continued strength of household consumption, underpinned in turn by a thriving labor market.”

Of course the borrower-in-chief, the U.S. government, has no such problem. It is running trillion-dollar deficits, and no one seems to care, least of all the one-time fiscally responsible Republicans who cheered Trump on as he pushed through tax cuts, and seem prepared to do so again. Bad news for future generations, who will inherit the bills for their parents’ party.

Meanwhile, much depends on the course of the trade war. It is not easy to figure out just what is going on. Trump periodically announces progress in the negotiations, to the applause of investors in shares, but the $40-$50bn of Chinese purchases of American agricultural products fail to materialize. He says he will not sign anything but a comprehensive deal, and then announces that he and his once-again-best friend Xi Jinping will be meeting later this month, pens at the ready, to sign a Phase One agreement, whatever that means. Unless Chile’s decision not to host the APEC meeting forces a postponement. One thing is certain: Trump will not re-offer his reportedly low-occupancy Doral hotel in Miami as a substitute.

Which brings us to another front in America’s war to disentangle from China. Senator Marco Rubio, a Florida Republican, discovered that the congressional retirement fund is about to change its rules to allow it to invest in Chinese companies. Those companies, like the many Chinese firms listed on American stock exchanges, are barred by their government from providing auditors with data as extensive as U.S. companies must provide. More and more senators are pressing the Securities and Exchange Commission and the exchanges to deny these non-transparent companies access to America’s capital markets.

In addition, Chinese companies continue to invest heavily in Silicon Valley, something the government is considering barring, over the objections of Valley start-ups, apparently unconcerned that these investors are de facto agents of the Communist government. Lenin is believed to have said that the capitalists would sell him the rope with which to hand them, a fact of which Xi Jinping is certainly aware and capital-hungry Valley start-ups either are not or don’t care.

“Some people in Washington want to decouple the two economies. We disagree,” Ren Faqiang, China’s deputy counsel general in San Francisco tells reporters. Given the imbalance of advantage in the current relationship, China’s desire to maintain the status quo should come as no surprise.

Denial of access to U.S. capital markets and to intellectual property for sale by Silicon Valley firms should prove much more effective than tariffs as trade-war weapons. But not effective enough to persuade Xi to abandon his plan to use subsidies, cheap credit and intellectual-property theft to propel the regime’s enterprises to dominance of industries of the future. To which America is awakening after a long sleep thanks, dare I say it, to one Donald Trump.