What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
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The eurozone economy barely grew in the fourth quarter of 2019. Real GDP was up only 0.1 percent from the previous quarter, the slowest rate of growth since 2013. In addition, real GDP was up only 0.9 percent from a year earlier, also the slowest annual growth since 2013. Of the four largest economies in the eurozone, only one (Spain) saw positive growth for the quarter. In Germany, real GDP was flat for the quarter and up only 0.5 percent from a year earlier. In France, real GDP fell 0.1 percent for the quarter but was up 0.8 percent from a year earlier. In Italy, real GDP fell 0.3 percent for the quarter and was unchanged from a year earlier. Finally, Spain’s real GDP was up 0.5 percent for the quarter and up 1.8 percent from a year earlier. This made Spain one of the star performers among eurozone nations. The other stars were the Netherlands and Portugal, both of which experienced strong growth in the fourth quarter.
As for Germany, Europe’s flagship economy, there was not much good news. Household spending fell as did business investment in equipment. Exports fell while imports were up. This weakness was offset by a boost to construction activity. Going forward, Germany is likely at some risk from the spillover effect of the coronavirus which has likely hurt investment in China. Germany exports capital goods to China and could face negative ramifications from China’s disruption. German exports to China account for less than 3 percent of German GDP.
So, is there any good news for Europe? Yes. Oil prices have fallen, which should benefit Europe’s oil-consuming economy. The value of the euro has fallen, which should help boost the competitiveness of European exports. And although the coronavirus will likely have a temporary negative impact, China’s economy will no doubt rebound once the virus is contained. That rebound will be helpful to the eurozone economy. On the other hand, there are two significant uncertainties facing the eurozone economy. One is how long the coronavirus will continue. The other is whether or not there will be a significant trade conflict between the United States and the European Union.
If you had purchased Greek government bonds in 2010, you’d be quite well to do by now. The yield on Greece’s 10-year bond continues to plummet, falling below 1.0 percent today for the first time ever (recall that, in 2010, the yield approached 40 percent). This is despite the fact that these bonds still get a junk rating from bond rating agencies. Evidently investors, in their search for a positive yield, are willing to cast aside perceived risk. They are likely not keen on the negative yields offered by German, Dutch, and French government bonds. Greek government debt remains at 180 percent of GDP. Besides, most of that debt is held by official creditors such as the IMF and the ECB, and most of it carries a low interest rate. Thus, Greece’s government is currently able to service its debts without difficulty. Moreover, the Greek economy is expanding, and inflation is positive. Thus, it is likely that the debt to GDP ratio will fall. In that sense, Greece is a success story. However, living standards have not recovered the loss experienced during the debt crisis nearly a decade ago. Plus, Greece experienced a sizable outmigration during the past decade as young people sought opportunities in the midst of high Greek unemployment—which remains high at 16.5 percent.
The US economy continues to exhibit the same bifurcation that was characteristic of 2019. That is, the consumer sector remains reasonably robust while the industrial sector continues to shrink. Here are the details:
Although the US job market has shown exceptional strength lately, with very strong employment growth and a historically low unemployment rate, the number of job vacancies is now falling sharply. Specifically, the number of vacancies was down 16 percent in December versus a year earlier, the sharpest decline since the recession in 2008-09. In professional and business services, vacancies were down roughly 15 percent. In the troubled retailing industry, vacancies were down 29 percent. Overall, the vacancy rate (the share of available jobs not filled) has fallen from 4.7 percent a year ago to 4.0 percent in December. What does this mean? It suggests that, in the months to come, the amount of hiring will decelerate. The strong labor market has probably peaked.
US Federal Reserve Chairman Jerome Powell said that the Fed is keeping a close eye on the coronavirus. He said: “Risks to the outlook remain. In particular, we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy. We know that there will be very likely some effects on the United States. The question we’ll be asking is: Will these be persistent effects that could lead to a material reassessment of the outlook?” He said that “it is too early to say” what impact the coronavirus will have. He indicated that the Fed intends to keep interest rates unchanged unless there is a “material” change in economic conditions that warrant a shift in policy. The interest rate futures market reveals investor expectations of at least one interest rate cut in the coming year.
Powell expressed frustration that, despite the United States experiencing the longest recovery on record, growth has been relatively modest owing, in part, to the slow growth of productivity. However, he noted that there has lately been some modest acceleration in productivity growth. He said that “although it is encouraging that productivity growth, the main engine for raising wages and living standards over the longer term, has moved up recently, productivity gains have been subpar throughout this economic expansion. Finding ways to boost labor force participation and productivity growth would benefit Americans and should remain a national priority.”
In recent Congressional testimony, Powell was asked to comment on the fact that his two recent predecessors, Janet Yellen and Ben Bernanke, have raised questions about the efficacy of monetary policy in a future slowdown. Both Yellen and Bernanke said that, with interest rates already historically low, the Fed might not have adequate tools to offset a recession in the future. Consequently, they called for greater use of fiscal policy, especially automatic stabilizers such as unemployment insurance. Powell said he agreed with his predecessors and said that fiscal policy would be the appropriate tool for dealing with a downturn.
However, Powell expressed concern about the current size of the annual US budget deficit which now exceeds one trillion dollars. He suggested that, with the economy relatively strong, it makes sense to engage in fiscal tightening. He said that “putting the federal budget on a sustainable path when the economy is strong would help ensure that policymakers have the space to use fiscal policy to assist in stabilizing the economy during a downturn.” Powell noted that Federal government debt has risen by US$3 trillion since the current administration came to power and that its latest budget proposal will boost debt by US$5 trillion during this decade with no end of deficits in sight. He said that reducing the deficit would be beneficial to the long-term growth of the economy.
Finally, during Powell’s testimony, US President Trump criticized Powell’s interest rate policy and noted that Germany has negative interest rates, suggesting that this gives German business a competitive advantage. When asked about this, Powell said that negative interest rates are “not a tool we are looking at.” The reality is that, when a central bank is compelled to maintain negative rates, it is a reflection of weak growth and very low inflation. In the case of the United States, the economy is stronger than that of Germany and inflation is higher. Thus, negative rates are likely not warranted for the United States. Moreover, negative rates would likely over-stimulate an economy already at full employment, possibly generating a sharp increase in inflation.
The latest employment numbers from the US government indicate continued strength of the job market. Job growth continues to exceed what is needed to absorb new entrants into the labor force. Moreover, this is being facilitated by an increase in participation in the labor market as formerly inactive workers are encouraged to return to the job market due to an evident abundance of jobs.
The US government produces two reports: one based on a survey of establishments; the other based on a survey of households. The establishment survey says that 225,000 new jobs were created in January, up from 147,000 in December. For the second consecutive month, there was a decline in employment in the manufacturing sector. Evidently, manufacturing continued to reel from the effects of the ongoing trade war. Whether or not this will change in light of the truce between the United States and China remains to be seen. There was also a decline in employment in the retailing sector. Keep in mind that the data is already adjusted for seasonal variation, so the decline in retail employment goes beyond the seasonal decline normally expected after the holiday season. It suggests that store-based retailers continue to be disrupted by the rise of online services. Indeed, employment in transportation and warehousing rose strongly as companies hired in order to meet demand for online retail services. There was modest employment growth in professional and business services, long a significant contributor to job growth. The greatest sources of job growth were health care and the leisure and hospitality sectors. Finally, average hourly earnings accelerated modestly in January, rising 3.1 percent from a year earlier.
The separate survey of households showed that the share of the adult population participating in the labor market rose in January to the highest level since 2013. However, the number of people employed did not rise as fast as the number of people participating in the labor force. The result was a small increase in the unemployment rate from 3.5 percent in December to 3.6 percent in January.
The Federal Reserve indicated that it will leave its benchmark interest rate unchanged for the rest of this year unless there is a change in data suggesting otherwise. Interestingly, based on the interest rate futures market, it is clear that many investors expect the Fed to cut the rate at least once in 2020. Many investors are less optimistic about the growth of the economy than the Fed leadership, and more optimistic that inflation will be kept under control. Indeed, the Fed signaled its relative optimism, saying that “recent indicators provide tentative signs of stabilization. The global slowdown in manufacturing and trade appears to be nearing an end, and consumer spending and services activity around the world continue to hold up.”
Meanwhile, the Fed acknowledged the potential dangers to the global economy stemming from the coronavirus. It said that the virus “could lead to disruptions in China that spill over to the rest of the global economy.” By the end of this past week, investors were once again becoming concerned about the potential impact of the virus. Equity prices and bond yields fell sharply on Friday despite a positive jobs report in the United States.
New orders for US manufactured goods were up 1.8 percent from December to January, the biggest gain since August 2018. The size of the increase was largely due to strong orders for aircraft and military equipment. Excluding transport equipment, orders were up a more modest 0.6 percent. Excluding defense equipment, orders actually fell 0.6 percent. Meanwhile, the two major purchasing manager’s indices for manufacturing both indicated rising activity in January, possibly suggesting that the industry has turned the corner. Notably, the PMI published by the Institute for Supply Management (ISM) rose from 47.8 in December to 50.9 in January. This was the first reading above 50 in six months, indicating that activity in the industry is no longer contracting. The separate PMI from IHS Markit, however, declined from 52.4 in December to 51.9 in January. Still, this number indicates a modest increase in activity. The decline in the Markit PMI was mainly due to a weakening of export orders. Yet the improvement in the ISM PMI was due, in part, to a revival of export orders. How can these contrary indications be reconciled? The answer is that they cannot. It simply means that we don’t yet have sufficient information to draw a robust conclusion about export activity and that we’ll need more information in the months ahead. What we can infer is that, in February, there could be a worsening of US manufacturing activity because of disruption of supply chains due to the coronavirus.
The US trade deficit declined from 2018 to 2019, the first decline in six years. Is this reason to rejoice? Not necessarily. A trade deficit is not necessarily a bad thing. It merely reflects the imbalance between what a country saves and what it invests. In the case of the United States, it invests more than it saves, so it must run a trade deficit which is the counterpart of net capital inflows. Ordinarily, a trade deficit declines when an economy slows down, which is precisely what happened in 2019. A slower growing economy generates less demand for imports. In addition, tariffs reduce imports. Both these things happened in 2019. The US trade deficit with China fell sharply due to trade restrictions imposed as part of the two countries’ trade dispute. As US trade with China declined, trade with other countries increased, especially with Vietnam. If, as many observers now expect, the US economy accelerates in 2020, then it is likely that the trade deficit will rise again. Indeed, the trade deficit rose sharply in December, fueled by an acceleration in imports.
What economic impact can we expect from the coronavirus that is currently frightening China? It is helpful to examine what happened in 2002-03 during the SARS outbreak. At that time, there was a sharp drop in GDP growth in the second quarter of 2003. Yet this was offset by a sharp acceleration in growth during the following two quarters. That is because, once the virus was contained, there was a need to satisfy the excess demand that built up during the period in which the economy was effectively on hold. The end result is that, if you examine annual economic growth data for China during the first decade of this century, it is nearly impossible to spot a SARS effect. Only when you examine quarterly data do you seen an impact, one that was quickly reversed.
Could the same be true again? The answer is yes, it is likely we will see a similar pattern—provided the coronavirus does not spread far more than SARS. However, there are three important caveats. First, the coronavirus is spreading during the first quarter of the year, not the second. The first quarter in China is when the critically important Lunar New Year celebration takes place. It is a time in which there is a surge in gift giving. It is unlikely, therefore, that the decline in consumer spending will easily be replaced in the following quarters. Second, the coronavirus is centered in Wuhan, a large city that is an important industrial and transport hub. It is now nearly completely shut down. Even once the virus is under control, it will take time to bring the city back to normal. It is comparable to shutting down Chicago in the United States. Third, SARS took place when the economy was strong. Full-year growth in 2003 was 10 percent, even higher than in 2002. This year, even without the virus, it was likely to be no more than 6 percent. Thus, the virus could likely bring Chinese growth to a level not seen in modern times.
That said, some of the decline in consumer expenditures at stores will likely be offset by more online shopping. Some of the cancelled holidays will take place later as consumers have likely set aside money for that purpose. And some of the lost production at factories will be made up in order to meet pent up demand. Thus, a case can be made for minimizing the potential longer-term impact. Still, all of this is contingent on the virus not spreading faster than what happened with SARS. A larger and more prolonged pandemic could be more onerous for the economy.
Even if the virus does not spread rapidly in other countries, it could still have a significant global economic impact. First, China’s economy has lately accounted for about one-third of global growth. Any slowdown has a spillover effect elsewhere. Second, disruption of Chinese factory production and distribution has an impact on the supply chains of neighboring countries. This could mean trouble for factories in Southeast Asia, Korea, and Japan as well as for mines and farms in Australia, Indonesia, and elsewhere. Indeed, commodity prices have fallen sharply in recent days. This will make it more difficult for China to meet the import targets set by the US-China trade deal. Third, Chinese tourists play an important role in the economies of several Asian economies, especially Thailand. Their absence could cause a slowdown in growth. In addition, there are many global companies that depend strongly on sales in China. Already we’re seeing problems for many of these companies, with share prices having fallen sharply. Finally, financial markets have taken a beating, with equity prices falling in response to the crisis. The flight from equities has led to the suppression of bond yields, with the US yield curve inverted once again as of this writing. Nonetheless, the SARS experience tells us that, once the virus is contained, equity prices could surge.
Lastly, making predictions is difficult. There is much we cannot know, such as how fast the virus will spread, how successful China’s government will be in fighting the outbreak, how government economic policymakers will respond, and how ordinary citizens will adjust their behavior. For business, it is probably best to plan for the worst and be pleasantly surprised if the worst does not transpire.
Debapratim De, Senior Economist at Deloitte UK, provides a look at the road ahead for the United Kingdom and the European Union (EU).
The United Kingdom formally left the European Union on Friday. Brexit day marks the beginning of a transition period until the end of this year, during which the United Kingdom will continue to apply and be bound by all EU laws but cede its seat at the EU’s decision-making tables. For businesses and workers, this means minimal change, especially with continued free movement of goods and people.
Perhaps the most important aspect of the transition period is its duration. Within these eleven months, the United Kingdom is also to negotiate its future relationship with the EU. While the stated objective of the British government is to thrash out a comprehensive and wide-ranging free trade agreement, policymakers and trade experts point out that 11 months is too short a timeframe for such a deal.
This leaves three alternatives. The first is an extension to the transition period. The British government has ruled this out, even legislating against it. The legislation could, in theory, be amended to allow for an extension but it is a clear statement of the government’s intent. The second option would be a “cliff-edge” Brexit at the end of this year, where the United Kingdom and the EU part ways without an agreement, resorting to trade under the rules of the World Trade Organization (WTO). This would be disruptive for both British and European businesses and is likely to be avoided.
The final option—that of a “basic” trade deal—seems the most likely outcome at the moment. Such a deal could cover tariff-free goods trade, an agreement on direct investment and provisions ensuring a “level playing field”, that seek to prevent either side giving their businesses undue competitive advantage. But substantive agreements on services trade or cross-border data flows are likely to take more time.
Striking even a basic trade deal will not be easy though. The European Commission’s president, Ursula von der Leyen, has clearly stated that the degree of British access to the European single market will depend on regulatory convergence—the extent to which the United Kingdom remains aligned to European regulations after Brexit. This is a thorny issue as many in the British government see the ability to diverge from the European rulebook as the very essence of Brexit.
If the negotiations until last autumn are anything to go by, this subsequent phase will likely include its fair share of political drama, going down to the wire. Any outcome will depend heavily on how the British government balances gains from regulatory divergence in specific sectors against benefits to British businesses from EU alignment.
The US economy grew at a modest pace in the fourth quarter, at a rate nearly identical to growth in the second and third quarters. The only areas of strength were residential investment and government spending. Consumer spending grew at a modest pace and, for the third consecutive quarter, business investment declined. In addition, exports fell. However, imports fell even faster. The government’s GDP report suggests that the headwinds that suppressed growth in much of 2019 remained present at the end of the year. Here are the details.
In Europe, an increasing number of people and institutions are urging governments, especially that of Germany, to borrow more and spend more in order to stimulate economic growth. Germany, after all, runs a budget surplus and has negative borrowing costs. In the United States, however, concern is in the opposite direction. After a tax cut and significant spending increases, which took place at a time of full employment, economic growth has failed to accelerate, but the budget deficit has ballooned. Specifically, the non-partisan Congressional Budget Office (CBO) says that, in the current fiscal year, the budget deficit will exceed US$1 trillion, hitting 4.6 percent of GDP. Historically, deficits this large have been reached either during recessions or wars, but not during periods of full employment and peacetime. Moreover, the CBO says that, in the coming decade, deficits will total over US$13 trillion. The Director of the CBO said, “Not since World War II has the country seen deficits during times of low unemployment that are as large as those we project, nor, in the past century, has it experienced large deficits for as long as we project.” Last year, government debt held by the public (as opposed to that part of the debt held by government entities such as the Federal Reserve) amounted to 79 percent of GDP (the highest in 70 years). The CBO says this will reach 98 percent by 2030 and 174 percent by 2050, in the absence of a significant change in fiscal policy. The latter number would be, by far, the highest level in the US history.
Is this a problem? Conventional wisdom says it is. That is because, when the government borrows in competition with the private sector, theory suggests it leads to higher borrowing costs that stifle private investment and suppresses economic growth. Yet recent experience in Japan suggests otherwise. Japan’s debt/GDP ratio is about twice that of the United States and yet the debt has not had any discernable negative impact on investment or growth. Moreover, borrowing costs have remained historically low despite massive borrowing. For the United States, borrowing costs also remain unusually low. Moreover, the deficits will not necessarily be onerous provided that borrowing costs remain low. If they rise significantly, however, the debt/GDP ratio could spiral out of control, exacerbating the problem of higher borrowing costs and potentially stifling private sector investment. If the Federal Reserve were to monetize massive deficits, it could cause ruinous inflation. This is what has happened in such emerging countries as Argentina, Venezuela, and Zimbabwe. The United States is currently far from that kind of situation and will not likely get there during the life of anyone reading this. Still, the projections by the CBO suggest that, in the long-term, US fiscal policy is not sustainable. Moreover, if the dominant global role of the US dollar were to recede in the coming decade, this would likely lead to higher borrowing costs in the United States, thereby exacerbating the size of future deficits.
Finally, what about those tax cuts? Proponents of the 2017 tax cut indicated that cutting taxes would significantly and permanently boost economic growth. Although growth accelerated in 2018, it has since retreated. Currently, the CBO forecasts average growth in the coming decade of 1.8 percent per year, lower than in the recent past. Thus, from this perspective, the tax cut may not pay for itself and could contribute to a fiscal problem. If the fiscal problem worsens what would be potential solutions to the problem? Some would articulate the solutions should include raising taxes, cutting spending, raising the retirement age (so that retirees obtain their government benefits later in life), and boosting immigration in order to increase the ratio of workers to retirees. Others would argue that the tax cuts need to be made permanent in order to realize the full effect, that mandatory spending needs to be reined in, and immigration restrictions, via a merit-based system, would reduce state, local and federal spending as well as provide the associated jobs needed to fulfil the demands of the economy.