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Now that we’re well into the decade of the 2020s, and now that we’re starting to think about the end of the worst global pandemic in a century, many people are hoping that the coming decade will compare favorably to the decade of the 1920s. That decade followed a global war and, more importantly, a global pandemic that probably killed about 50 million people worldwide. In the United States, about 700,000 died in a country with a third of today’s population. Several clients have asked me if we’re about to repeat the “roaring twenties.” Indeed, for the United States, the 1920s are often called the roaring twenties on the assumption that there was rapid economic growth, a huge improvement in living standards, and a spectacular stock market, all things we’d like to repeat.
This begs the question as to whether the 1920s did, in fact, roar. Let’s consider the data. From 1920 to 1929, real GDP in the United States grew at a compound annual rate of 4.1%—a spectacular record considering that, during most of the past 70 years, real GDP grew at a compound rate of about 2.7%, and grew more slowly in the most recent decade. Yet the lion’s share of rapid growth in the 1920s took place in the first three years of the decade as the economy was catching up following a catastrophic recession in 1920. If we look at the growth rate from 1919 to 1929, it was only 2.4%, which is decent, but certainly not spectacular. Moreover, GDP growth during the decade was very volatile, with some great years and some years with almost no growth.
Meanwhile, there was net deflation in the 1920s, with consumer prices falling about 15% during the decade, including a sharp decline in farm prices, which pummeled the large agricultural population. Farm foreclosures soared during the 1920s. The twenties were not a time of social stability. The decade saw the revival of the Ku Klux Klan, enactment of racist immigration laws, and strong aversion to global engagement. At the same time, there was indeed an improvement in living standards as millions of Americans bought automobiles and radios for the first time, and many enjoyed electric power for the first time as well. There was certainly a sense of optimism about the future, which was reflected in the spectacular performance of the equity market, with stock prices tripling during the course of the decade.
In sum, the US economy did not roar, but the stock market certainly did, until it crashed in 1929, ultimately erasing all the gains of the past decade. That is surely something we don’t want to repeat. Meanwhile, the twenties saw the consolidation of communism in Russia and the rise of fascism or authoritarianism in multiple European countries as well as Japan. It also saw continued unrest and volatility in China. So, in answer to the question as to whether the coming decade will be like the 1920s, my answer is that I certainly hope not.
We now know what we already suspected, which is that China’s economy had positive growth in 2020, likely the only major economy in the world to do so. The government has reported that, Q4 real GDP was up 6.5% from a year earlier, the highest quarterly growth since 2018. For all of 2020, real GDP was up 2.3% from the previous year. This was the slowest growth in 44 years. China’s GDP has nearly doubled in the last decade. Yet the government noted that China remains the largest developing country in the world with per capita GDP below the global average. The International Monetary Fund (IMF) predicts that China’s real GDP will rise 7.9% in 2021 as the economy catches up from the setback of the pandemic. The strength of China’s economy reflects strong growth of industrial production, exports, and investment in property. The consumer sector performed well, yet it lagged the industrial side of the economy. The challenge for policymakers will be to allow the economy to shift toward a more sustainable model of growth, with consumer demand fueling the economy rather than government-inspired investment in infrastructure. Let’s look at the details:
China’s industrial production was up 7.3% in December versus a year earlier, the fastest growth since March 2019. The manufacturing component of industrial production was up 7.7%. For all of 2020, industrial production was up 2.8% from 2019. By industry, output in December was up 11.4% for computers and communications equipment; up 15.6% for electrical machinery; and up 11.1% for general equipment. Production of textiles was up a more modest 5.4%. Some of the increase in manufacturing output supported strong exports, which were up 18% in December versus a year earlier. Some was driven by investments made by state-owned enterprises (SOEs). And some supported investments in property.
Meanwhile, the government reported that fixed asset investment was up 2.9% in 2020 versus 2019, with public sector investment up 5.3%. This involved investment by SOEs as well as regional governments. Investment in the primary sector was up 19.5%, reflecting rising demand for inputs for heavy industry. Investment in real estate was up 7.0%. Moreover, home prices accelerated in December, reflecting strengthening demand.
At the same time, retail sales growth was modest as 2020 ended—they were up 4.6% in December versus a year earlier. However, for all of 2020, retail sales were down 3.9% from the previous year. Still, online retail sales were up 15% in 2020, rising from 4% of sales in 2019 to about one quarter of retail sales in 2020. A retail executive recently said to me, “We’ve been through five years of digital transformation in five weeks.” In any event, the Chinese retail industry had pockets of strength in December. Specifically, December sales were up 9.0% for cosmetics; up 8.0% for personal care products; up 21.0% for telecoms; up 11.2% for home appliances; and up 12.9% for building materials. Sales of automobiles were up a more modest 6.4%. There was weaker growth for apparel (up 3.8%) and furniture (up 0.4%).
About two months ago, the view of many economists, including our own, was that Europe would be better positioned for growth in the first quarter of 2021 than the United States. At that time, both regions were experiencing a surge in infections, but Europe was already seeing a reduction in infections due to economic restrictions whereas the United States was not. This suggested that European services activity would soon revive while, in the United States, there would continue to be trouble. As it happens, the opposite took place. That is, it now appears that, as 2021 begins, the European economy is in trouble while the US economy shows some signs of strength. This conclusion comes from examination of the purchasing managers’ indices (PMIs) for both economies, including PMIs for services and manufacturing.
PMIs are forward-looking indicators meant to signal the direction of activity in either the broad services or manufacturing sectors. They are based on sub-indices, such as output, new orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa.
The latest PMIs show that, in both Europe and the United States, manufacturing activity continues to grow at a healthy pace. The main difference between the two regions is in the services sector. European services PMIs are well below 50, indicating declining activity, while in the United States, the sector appears to be growing despite recent data showing a decline in both retail sales and employment. This difference is driven, in part, by the fact that European governments have imposed severe economic restrictions meant to fight the current surge in infections. In the United States, however, despite a surge in infections, the government response has been more muted.
Let’s look at the details, beginning with Europe. In the Eurozone, the services PMI fell from 46.4 in December to 45.0 in January, a number indicating a significant decline in activity. The manufacturing PMI worsened from 55.2 in December to 54.7 in January, still a level showing strong growth in activity. IHS Markit, which compiles the survey, noted that “a double-dip recession for the eurozone economy is looking increasingly inevitable as tighter COVID-19 restrictions took a further toll on businesses in January. Output fell at an increased rate, led by worsening conditions in the service sector and a weakening of manufacturing growth to the lowest seen so far in the sector’s seven-month recovery.” However, Markit also noted that “the roll out of vaccines has meanwhile helped sustain a strong degree of confidence about prospects for the year ahead, though the recent rise in virus case numbers has caused some pull-back in optimism.” As such, the outlook for the Eurozone economy will be determined by how fast the vaccine is distributed. While the United Kingdom is off to a good start, many Eurozone economies are not. Meanwhile, both Germany and France saw a sharp decline in service sector activity. However, Germany continued to enjoy rapid growth in the manufacturing sector while France saw only modest growth. The difference likely reflected Germany’s strength in exporting of capital goods, especially to China.
Finally, the services PMI in the United Kingdom fell sharply from 49.4 in December to 38.8 in January, largely due to lockdowns associated with the surge in the new strain of the virus. We also learned last week that British retail sales in December were relatively poor, and it is likely that they are worsening in January. In addition, the manufacturing PMI fell from 57.5 in December to 52.9 in January, signaling that the broader economy has been affected by the virus. Moreover, Markit indicated that the economy is “no longer propped up by pre-Brexit stockpiling.” The substantially weakened numbers bode poorly for economic growth during this quarter. Indeed, Markit noted that this puts the “UK economy on course to contract sharply in the first quarter of 2021, meaning a double-dip recession is on the cards.”
In the United States, the story is very different. The PMI for manufacturing increased from 57.1 in December to 59.1 in January, a record high and a level indicating rapid growth of activity. Sub-indices for output and new orders were very high. However, Markit noted that “significant supply chain delays, raw material shortages and evidence of stockpiling at goods producers pushed input prices up. The rate of cost inflation was the fastest since April 2018, with firms raising output charges at the sharpest pace since July 2008 in an effort to partially pass on higher cost burdens to clients.” This augurs a rise in overall inflation. Meanwhile, the services PMI also increased, rising from 54.8 in December to 57.5 in January, a level indicating rapid growth. It was due, in part, to a big increase in output. However, Markit said that new orders and employment softened due to new restrictions imposed to deal with the virus. We have already seen data for December indicating declining retail sales and employment, the decline in the latter primarily focused on restaurants and hotels.
Thus, even as consumer-facing industries continue to suffer, the rest of the economy appears strong—so strong, in fact, that there are concerns about inflation. Markit said that “not only have the last two months seen supply shortages develop at a pace not previously seen in the survey’s history, but prices have also risen due to the imbalance of supply and demand. Input cost inflation consequently also hit a survey high and exerted further upward pressure on average selling prices for goods and services.” Finally, we learned last week that sales of existing homes in the United States continued at a very high level in December, with full year sales at the highest level since 2006. Inventories of unsold homes fell sharply, and prices continued to rise. Housing is one of the strongest parts of the US economy.
Finally, Markit reported the latest PMIs for Japan. Despite not experiencing a sharp increase in infections as has been the case in the United States and Europe, Japan’s policy response to the threat of the virus has influenced the economy. Specifically, Japan’s manufacturing PMI fell from 50.0 in December to 49.7 in January. The services PMI fell from 47.7 in December to 45.7 in January. The weakness of the Japanese economy is reflected in worsening deflation. In fact, core prices (which exclude the impact of volatile food and energy prices) were down 1.0% in December versus a year earlier, the worst performance since 2009. This was despite the hugely aggressive monetary policy of the Bank of Japan.
Once again, there appears to be a disconnect between political/economic/social events in the United States and the behavior of financial markets. In recent weeks, there has been political turmoil in the United States, evidence of a weakening economy, and a rising perception that there is risk of social unrest. Yet equity prices continue to perform spectacularly well.
The current economic situation is worsening and is likely to worsen further. We know that consumer spending fell in November and that retail sales and employment fell in December. It is highly likely that these trends were due to the rising number of infections and their impact on consumer behavior. Moreover, after starting to recede in late December, the number of new infections in the United States accelerated again in early January, likely because of the transmission of the virus that took place when people travelled over the holiday. Given current trends in infections, hospitalizations, and deaths, it is reasonable to expect a further decline in economic activity in January and possibly beyond. That is why the behavior of equity markets is, on the surface, so stunning.
There are, however, reasonable explanations for the financial market behavior. Theoretically, equity prices should reflect expectations about the future, not the current state of affairs. And recently, there have been events that boosted expectations about future economic growth. These included the rollout of the vaccine and shifting expectations about the likely policy mix of the new US administration. Perhaps most important was the takeover of the Senate by the incoming president’s own Democratic Party. Although news of that event was largely eclipsed by the events at the Capitol, it does set the stage for a likely shift in fiscal policy. Specifically, with control of the Senate, the Democrats will control the agenda and will be able to have the Senate vote on extra fiscal measures, some of which are likely to pass through the process known as reconciliation. Many investors likely expect this to have a favorable impact on economic activity if, for no other reason, then that such measures will protect disrupted households and businesses from financial distress. The absence of further stimulus would mean that, when current measures expire in March, millions of households would likely face trouble, thereby having a negative impact on overall economic activity.
That being said, a Democratically controlled Congress is likely to do some things that are not popular with the investment community. These are likely to include boosting the top marginal tax rate, raising the corporate tax rate, and appointing regulators that could impose new costs on business. Ordinarily, the expectation of such policies would have a negative impact on equity prices. Interestingly, investors have evidently set aside such concerns because of the overwhelming need to use fiscal policy to avoid another meltdown.
US President-elect Biden introduced details of his planned stimulus program. He offered the first of two plans. The first is meant to address the immediate issues of household financial security, small business security, virus suppression, vaccine distribution, and state and local government finances. The second plan, to be introduced early in his term, will address longer-term issues, such as infrastructure, climate change, promoting manufacturing, and boosting worker productivity through investments in innovation.
The first program, announced recently, would entail additional expenditures of US$1.9 trillion that would be entirely debt-financed. Biden said that, while longer-term fiscal probity is desirable, the country can afford to do this and cannot afford to allow further financial stress for millions of households. He noted that many respected institutions, which normally counsel against deficits, have proposed massive fiscal support for major economies including the International Monetary Fund, the Federal Reserve, and numerous private-sector financial institutions. The US$1.9 trillion will be in addition to the roughly US$4 trillion already allocated by the government. Over a two-year period, this will amount to roughly 15% of GDP. Considering that, during World War Two, additional military spending was nearly half of GDP, this is not so onerous in comparison.
The proposed spending will involve an additional US$1,400 in stimulus money for most individuals, extension and expansion of unemployment insurance, expanded support for poor households through better food and housing security, money for testing and tracing, money for vaccine distribution, money for small businesses, money for state and local governments, and money to fund a quick reopening of schools for young children. The last is seen as critical given that many women have dropped out of the labor force in order to care for children who cannot go to school. By making the schools safe for those children, the hope is that many women will return to work, thereby boosting output and tax revenue.
Given that Democrats hold a very narrow majority in both houses of Congress, it will be challenging to pass legislation. In the Senate, legislation often is vulnerable to a filibuster that would necessitate a super-majority of 60 out of 100 members to pass. However, for spending bills, the process known as reconciliation would enable passage by a simple majority, although it would take longer to do so. Biden himself has indicated a desire to secure some degree of bipartisan support. It is reported that he has been in contact with several moderate Republicans to seek their support. After his announcement, some leading Republicans criticized the plan as too big. However, some Republican former officials praised some aspects of the plan. The former top economist to former President Bush, Glenn Hubbard, said that it is better to pass a program that is too big than to pass one that is too small. In any event, it seems likely that Biden will get something from the Congress, but not necessarily the specific package he proposed.
Financial markets already expected a large package from Biden, so market reaction was relatively muted. Equity prices fell, but likely due to the surprisingly bad retail sales report. Many investors have been clamoring for more stimulus and are clearly not spooked by a sharp rise in government debt. If they were, bond yields would be up sharply. Plus, it is likely that investors expect the Congress to give Biden a smaller package than he has requested. Since the Democrats captured the Senate and the likelihood of another stimulus package increased, equity prices increased and government bond yields rose modestly on expectations of an increase in government debt. Still, yields remain historically low, signaling that investors are not expecting dire consequences from rising government debt. Meanwhile, China’s central bank indicated that more US government stimulus might boost US demand for Chinese exports.
Although global trade suffered a decline in 2020, China’s trade was strong after an initial decline early in the year. Chinese exports were up 3.6% in 2020 versus the previous year. Moreover, December exports were up 18.1% from a year earlier. In part, the astounding strength of Chinese exports was due to a big increase in exports of personal protective equipment (commonly called PPE) as well as technology hardware used for remote interaction. Both types of products have been in strong demand during the pandemic. Imports grew strongly but more slowly than exports. Specifically, imports were up 6.5% in December versus a year earlier. The result was that, in 2020, China’s trade surplus was the highest it had been since 2015. The rise in the surplus would have contributed to China’s economic growth in 2020. Our own Deloitte estimate is that China’s real GDP grew 1.8% in 2020 versus 2019. Interestingly, the strength of exports came about despite a significant rise in the value of the Chinese renminbi. Normally, a rising currency hurts exports and boosts imports. However, the rising currency likely contributed to an acceleration in inbound foreign investment.
Interestingly, Chinese imports from the United States were up a stunning 47.7% in December versus a year earlier. This likely reflected a serious effort on the part of China’s government to meet the import targets established by the so-called phase one agreement on trade that was signed last year. However, China still lags the targets. By one estimate, China’s imports from the United States in the first 11 months of 2020 grew only half as fast as needed to meet the aggressive import targets. Given the pandemic, it was never expected that China would come close to meeting the targets. That fact caused concern in China that failure would generate trouble with the United States. Indeed, China was keen on pleasing the United States in order to avoid further trade sanctions.
Whether or not this will be as important under a Biden Administration as under the Trump Administration remains to be seen. Meanwhile, China’s exports to the United States were up 34.5% in December versus a year earlier. This was likely due to strong US demand for PPE and online technologies. For all of 2020, China’s bilateral trade surplus with the United States reached a record high. As noted in these pages in the past, a bilateral trade imbalance between two countries is meaningless from an economic perspective. However, it is evidently meaningful to many political leaders and the voters with whom they communicate. Thus, the current US administration made reducing that imbalance a key goal. As such, the goal has not been met.
In December, for the third consecutive month, retail sales declined from the previous month. It is clear that the worsening pandemic during the fourth quarter of 2020 had a negative impact on consumer spending. In December, overall retail sales were down 0.7% from November and were up only 2.9% from a year earlier. Interestingly, there was strong growth in sales of automobiles and gasoline. However, when these two categories are excluded, non-auto, non-gasoline retail sales were down 2.1% from the previous month, a very sharp decline. Some categories experienced significant declines in sales. These included electronics and appliance stores (down 4.9%), grocery stores (down 1.7%), department stores (down 3.8%), restaurants and bars (down 4.5%), and non-store retailing (down 5.8%). The last was surprising given that non-store retailing (most online) had grown strong in 2020, partly offsetting the decline in store-based sales. In contrast, sales at home improvement retailers were up 0.9%, clothing stores were up 2.4%, and drugstores were up 1.1%.
The overall decline in retail sales happened at a time when the number of infections was soaring and when some states were imposing limited restrictions on economic activity. Now that we are in January and the number of infections continues to increase, it seems likely that retail sales will not perform well during this month and could decline again. At the same time, a new stimulus package was passed at the end of December, which provided US$600 to most individuals and provided extended unemployment insurance to millions of unemployed workers. In addition, as discussed below, President-elect Biden has proposed a further US$1,400 cash disbursement to most individuals as well as increased unemployment insurance. It is likely that Biden’s proposal, in some form, will pass the Congress within the next two months. If so, and if the virus is adequately suppressed, it could set the stage for a rebound in retail sales. Moreover, if there is an acceleration in vaccine distribution in the coming months, the result could be a much different environment by the second half of 2021.
While the US consumer sector faltered badly in December, the industrial sector did well. The US government reports that industrial production increased 1.6% from November to December, although it remained 3.6% below the level from a year earlier. The monthly increase was the strongest since July of last year. The manufacturing component of industrial production was up 0.9% for the month. As for product categories, most were up strongly, the exception being capital goods that increased only 0.6%. This included a 1.0% decline in production of information processing equipment. That, in turn, bodes poorly for a pickup in business investment. While production of consumer products increased 1.6%, output of automotive products declined 1.5%.
As the Federal Reserve continues to monitor the economy in order to appropriately set monetary policy, one important tool is the so-called “Beige Book.” This is a qualitative assessment of economic conditions in the Fed’s 12 regional districts based on interviews with leaders in business and finance. The latest Beige Book, published last week, indicated that the economy continues to grow but at a diminished speed. Specifically, the Beige Book noted that economic activity grew in eight of the 12 districts in the past month, with a significant weakening of consumer spending in many districts. It said that “most districts reported an intensification of the ongoing shift from in-person shopping to online sales during the holiday season.” It also said that there had been a weakening of automotive sales. The Fed noted that some sectors are performing well while others are not. Specifically, it said that the manufacturing sector is strong, despite continuing supply chain difficulties. It also heralded strength in the residential real estate sector. On the contrary, commercial real estate is troubled due to weak demand for office and retail space. The Fed said that loan demand is flat, but that many market participants expect it to accelerate once more stimulus is enacted. As for business sentiment, the Fed said that businesses are optimistic about the ultimate impact of vaccination but remain concerned about the current surge in infections.
As for the job market, the Fed said that employment grew in a majority of districts, but at a slow pace. An increasing number of districts are reporting declines in employment. The job market is experiencing a sort of bifurcation. Job growth is strong in manufacturing and construction, but employment is falling in the leisure and hospitality sectors. Regarding manufacturing, the Fed noted a shortage of labor as companies struggle to convince people to come to work in the midst of the pandemic. This situation has worsened lately due to the surge in infections.
The Fed’s assessment of the economy is likely to reinforce its intention to maintain an exceptionally easy monetary policy in the coming year. Despite some investor concerns about a modest rise in inflation, the Fed is likely to ignore inflation and focus on employment and keeping credit markets open. Depending on what the Congress does with respect to stimulus, there is a risk that some segments of the economy could face added financial stress, thereby creating potential problems in credit markets. The Fed is likely to be highly focused on avoiding financial market seizure.
There were two political events in the United States in the past week that generated headlines, but the one with fewer headlines will ultimately have a greater economic impact. On January 5, there were runoff elections for two Senate seats in Georgia. Both seats were captured by Democrats, an unusual event in a state that has gone heavily Republican in recent decades. Consequently, the Democrats will now control the US Senate (by a very narrow margin), thereby enabling incoming President Biden to gain confirmation for his cabinet and judicial appointees as well as to pass some legislation. Specifically, it is likely that Biden will seek further stimulus from the Congress in order to extend unemployment benefits, fund virus testing and vaccine distribution, support distressed state and local governments, and boost infrastructure spending. With control of both the House and the Senate, these measures will likely be voted on. Although the Senate retains the filibuster, which enables a minority of 41 out of 100 Senators to block some types of legislation, there is a rule called “reconciliation” that enables the Senate to pass some types of spending and taxation legislation by a simple majority. It is likely that the Democrats will use this tool to pass stimulus measures. With this expectation, financial markets pushed up bond yields as well as equity prices on January 6. That reflects many investors’ belief that there will be more government borrowing and that the additional spending will have a positive impact on economic growth.
Meanwhile, on January 6, while the Congress was undertaking the ceremonial task of counting the electoral college ballots for president, there was turmoil in Washington, DC as pro-Trump demonstrators broke into and ransacked the US Capitol, forcing members of Congress into hiding. What happened so stunned the political world that it led some members of Congress, who had questioned the presidential election result, to back down. Soon, there were several resignations from the administration and reports of discussions about removing Trump from office. Even the National Association of Manufacturers (NAM), a leading business lobby, called for Trump’s removal given that he may have encouraged and failed to quickly criticize the mob that broke into the Capitol. Foreign leaders expressed outrage about the events, with Germany’s Angela Merkel directly blaming Trump for what happened.
Many major business groups and leaders of major companies have criticized the riot and Trump, with many considering withholding funds for members that supported the objections to count electors. The business community evidently believes that threats to democracy are threats to the vitality of the US economic system. Many leading Republican politicians have been reluctant to publicly break with Trump for fear of encouraging his wrath and that of his supporters. Yet the shock of these events may have broken the fever, potentially setting the stage for Trump having less influence on the Republican Party.
Ian Stewart, Chief Economist of Deloitte UK, discusses the terms of the Brexit deal between the United Kingdom and the European Union (EU). Tom Simmons, an economist with Deloitte UK, discusses the early days of the agreement.
There has been much talk about an economic decoupling of the United States and China. This reflects the rise of restrictions on trade, cross-border investment, technology transfer, and even travel. Yet it appears that decoupling is turning out to be a one-way street. That is, even while the US imposes restrictions on capital flows from China, China is increasingly welcoming capital coming from the United States.
The Chinese government has engaged in a series of reforms meant to open its financial markets to foreign involvement. The larger goal is to boost the sophistication of China’s financial markets by allowing world-class players to participate and, in the process, transfer knowledge to Chinese counterparts. Reform has entailed greater foreign access to ownership of Chinese equities and bonds and greater ability of foreign companies to have majority ownership of local financial businesses. In fact, the value of Chinese equities owned by foreigners increased eight-fold from 2014 until the end of 2020. Foreign ownership of Chinese government bonds has increased as well, reaching 9% of the total by 2020. And, although foreign participation in China’s corporate bond market is very small, it is expected to increase rapidly in the years to come.
Foreign interest in Chinese assets, which includes substantial US participation, has been driven not only by Chinese deregulation, but by other factors as well. These include rapid growth of the market, increased foreign awareness of Chinese assets through their inclusion in global market indices, a high interest rate differential between Chinese and US fixed income securities, the rising value and expected increase in the value of the renminbi, and, most importantly, investor expectations that China’s economic outlook is strong. In addition, the growing interest of US-based financial services companies in the Chinese market is, in part, driven by expectations that the Chinese middle class will continue to grow at a rapid pace. A rising middle class in a country of high savers is attractive for the sale of wealth management and other services.
Meanwhile, the US continues to attempt to restrict the economic relationship between the two countries. Two regulations were recently implemented toward this goal. First, the US administration restricted the listing of Chinese companies that have relations with or are partly controlled by the Chinese military. This led US equity markets to first de-list, then reverse its decision, regarding several high-profile Chinese companies. The effect of de-listing is expected to hurt US-based shareholders. In addition, the intended effect is to reduce the ability of these companies to raise funds in the US market. Second, the US administration banned several Chinese companies that are engaged in money-transfer services. In issuing the directive, US President Trump said that “by accessing personal electronic devices, such as smartphones, tablets, and computers, Chinese connected software applications can access and capture vast swaths of information from users, including sensitive personally identifiable information and private information.”
The big question is what comes next? Will the incoming Biden administration pursue similar efforts to cause a decoupling between the two sides? It is too early to say, but it seems likely that the new administration will, at the least, attempt to lower the temperature and to engage China in discussions meant to ease some economic restrictions. For example, Biden himself said that he will reconsider the tariffs imposed by the current administration. It is likely that he will seek negotiations aimed at cutting bilateral tariffs and other restrictions. At the same time, Biden and his team have indicated concern about many of the same issues that the Trump administration has attempted to address. These include forced technology transfers, lack of protection of intellectual property, national security considerations regarding Chinese technologies, and US concerns about geopolitical and human rights issues in China. Biden has said that he intends to address such issues through multilateral cooperation with European allies. The fact that the EU signed an investment agreement with China absent US involvement was a disappointment to the Biden team and could influence how the United States approaches certain issues going forward.
The US government has released its employment reports for December and the headline results were quite negative, with the first decline in payroll employment since April. At the same time, there were pockets of positive news, indicating that while the spread of the virus significantly disrupted key consumer-facing industries, other industries continued to experience job growth. The government releases two reports: one based on a survey of establishments, and the other based on a survey of households. Let’s start by looking at the establishment report.
In December, the number of payroll jobs fell by 140,000 from November. This was the first decline since April. Moreover, in each of the past several months, the rate of job growth had been consistently declining. In addition, employment was down by 9.4 million jobs from a year earlier. This means that there is a long way to go before the US job market returns to normalcy. The drop in employment from November to December was likely the result of a shift in consumer behavior in response to the increasing scale of the pandemic. Indeed, employment at restaurants and bars declined by 372,000, a 3.6% decline from the previous month. Some state and local governments imposed new restrictions on the industry. Plus, it is likely that some consumers chose to avoid restaurants given the surge in infections, thereby compelling companies to dismiss workers. There were also significant declines in employment at hotels (down 24,000), schools (down 63,000), personal services (down 22,000), and state and local governments (down 51,000). The last likely reflects the stress of declining tax revenue.
That being said, there were significant increases in employment in many categories. Employment in retailing increased by 121,000, which included a 59,000 increase in employment at general merchandise stores, such as Walmart and Costco. These types of retailers have tended to do well each time the pandemic gets worse. Consumers often rush out and stock up on toilet paper and other household necessities. There were 37,000 more people working for couriers and messenger services. In addition, employment increased by a robust 161,000 at professional and business services (which includes Deloitte). Employment at hospitals increased by 32,000, likely reflecting the surge in care of COVID-19 patients. Finally, employment increased strongly in manufacturing (up 38,000) and construction (up 51,000).
The separate survey of households found that there was only a very modest increase in labor force participation, roughly matched by a modest increase in employment (which includes self-employment). The result was that the unemployment rate remained steady at 6.7%. Employment was down 8.9 million from a year earlier. The survey also found that, in December, employment among men was up from the previous month while employment among women was down. Employment was up for White people but down for Black, Hispanic, and Asian people. Employment was down for youth. Finally, employment was down for people with a high school education or less, while it was up for people who have attended or graduated from college. Indeed, employment for college graduates was up sharply. These disparate trends by education are consistent with the kinds of jobs that were lost or gained. Clearly, the trends cited above show that inequality by race, gender, and education level increased in December, one of the sad side-effects of this pandemic. Moreover, there is a risk that these trends will likely persist even after the pandemic ends. In order to avoid persistent unemployment by less skilled workers, there will be a need to invest in human capital in order for the skills mix of the labor force to better match the needs of the business community. This could become a major source of public policy debate in the coming years.
Finally, with the pandemic continuing to ravage the United States, it is likely that there will not be a rebound in employment at consumer-facing industries in January. However, continued gains in other industries could lead to an overall increase in employment. Much will depend on the path of the virus, the speed at which vaccines are distributed, and the sentiment of businesses regarding the potential impact of the new administration. We do know that the new administration intends to pass an additional stimulus measure. With control of both houses of Congress, it is likely that this will happen.
The holidays are over (regrettably) and now it is time to think about what comes next.
A year ago, very few would have predicted a global recession in 2020. And even after the pandemic caused the global economy to crater in March and April, few would have predicted that most types of businesses would be able to function with most of their employees working remotely. The point is that it was a year in which most assumptions went out the window and most predictions were wrong. Thus, one must start 2021 with humility. That being said, I’m willing to offer a few thoughts on where we stand now and what it might imply for the coming year.
As 2021 begins, the world is faced with promise and peril. On the positive side, the distribution of vaccines is under way, offering the promise that, sometime later in the year, the negative impact of the virus could ultimately abate. On the negative side, the virus continues to threaten economic stability, especially in those parts of the world where the outbreak has not been controlled. This is true in the United States and the United Kingdom and threatens to be a problem elsewhere as the new strains of the virus spread further. The challenge for policymakers will be to stifle the current outbreak, protect those who are disrupted by the outbreak, and speed up distribution of the vaccine.
The US economy clearly weakened toward the end of 2020. Personal income and consumer spending both declined in November and some measures of housing activity weakened after many months of stellar performance. The weakness likely resulted from the impact of the massive surge in the virus. Although the number of new infections began to abate toward the end of December, public health officials worry that the increase in holiday travel in late December will result in yet another surge in infections in early January.
Meanwhile, the US Congress finally passed and the president signed a spending package of about US$900 billion. It includes extended unemployment insurance, cash for households and businesses, and money for education and medical care. It will modestly buttress the economy for a few months, but it is likely that more will be needed unless the vaccine is widely distributed earlier than anticipated. As of this writing, vaccine distribution is far behind initial plans. Once Joe Biden becomes president, he is expected to ask Congress for further funding, especially to implement a much greater level of testing as well as to boost distribution of the vaccine. He also wants more money for households and extra money for distressed state and local governments. His ability to obtain anything from Congress will depend on the outcome of the runoff elections in Georgia schedule for January 5. Those races will determine control of the US Senate.
Eventually, the virus will be defeated. The big uncertainty concerns how quickly this will take place and at what cost. Still, when recovery comes, we can expect that middle- to upper-income households will stop saving such a large share of their income and, instead, spend more on consumer-facing services, such as restaurants and travel. This shift in behavior will go a long way toward boosting the rate of economic growth. Yet even a robust recovery later this year will not likely erase the troubles faced by many former employees of consumer-facing industries who are expected to remain unemployed. This will be especially true for workers in retailing. Disruption of the job market will be a longer-term problem, one whose solution will be debated in Congress. There will likely be plenty of talk about the K‑shaped recovery.
The fourth quarter outbreak of the virus on the European continent quickly abated due to the imposition of economic restrictions as well as reduced consumer mobility. In addition, many governments in the European Union (EU) extended support for the labor market well into 2021, thereby averting further economic distress. The result is likely to be a strong upturn in growth in the first quarter of 2021 after a likely decline in activity in the last quarter of 2020. Moreover, vaccine distribution is under way, thereby setting the stage for a significant acceleration in growth later in the year. Still, as of this writing, distribution is slower than planned. As in the United States, full implementation of the vaccine will likely entail a reduction in household saving and an increase in spending on consumer-facing services. For European governments, an improvement in growth will work wonders for government finances, which have been severely disrupted during the pandemic. The European Central Bank will likely continue to provide support to the market for government debt, especially as long as inflation remains muted.
Having lost the United Kingdom and faced tensions with the outgoing US government, the EU remains determined to extend the realm of trade liberalization. In recent years, it has signed trade deals with Canada and Japan and initiated negotiations elsewhere. By the end of 2020, such efforts bore fruit with a new investment agreement with China. The main goal for the EU was to support the ability of European companies to operate profitably in China. The EU claims that the new agreement creates a level playing field for European companies and ends forced technology transfers. In addition, the EU says that the deal eliminates the requirement that European companies have a local partner in China. Officials of the incoming Biden administration in the United States counseled against the deal on the hope that the United States and EU could take a common stance on issues related to China. The US side evidently worries that the EU-China deal will reduce US leverage in addressing its grievances with China. For China, the deal with the EU could be seen as a way to create space between the United States and the EU. In any event, the EU says that the deal does not remove its ability to address human rights and geopolitical issues in China that are of importance to the United States. Finally, the deal might lead US businesses to pressure their government to negotiate a similar deal with China.
The year 2021 begins with Britain finally separated from the EU, with an eleventh-hour deal having been signed at, well, the eleventh hour. The deal allows trade in goods between the United Kingdom and the EU to take place without tariffs or quotas. However, trade will now involve bureaucracy and border controls, adding costs and reducing speed. Service trade, however, remains subject to potentially restrictive rules. Meanwhile, the United Kingdom has exited the single market and the customs union. The single market, which encompasses the EU as well as Norway and Iceland, means free movement of not only goods and services but also people and capital. It also means common rules applied to certain industries and activities. The customs union means barrier free trade and a common external tariff with respect to other countries. The United Kingdom chose to exit both agreements in order to restrict and control migration, implement its own internal regulations, and make trade agreements with non-EU countries, such as Japan and the United States. The passage of a deal is a relief to many observers who worried that a no-deal Brexit would have been catastrophic. Still, the British government’s own Office of Budget Responsibility (OBR) says that in the long run, the current deal will reduce real GDP by 4% versus if the United Kingdom had stayed in the EU. The OBR said that a no-deal Brexit would have reduced real GDP by 6%. Meanwhile, the latest spread of COVID-19 is already disrupting trade. This will make it difficult to discern the true impact of Brexit.
China’s economic growth continues at a healthy pace. Consumer spending has been boosted by confidence that the virus is under control. Fixed asset investment has been helped by substantial funding for state-owned enterprises as well as regional governments. And exports have performed well, in part owing to China’s global competitiveness in technologies for which demand has accelerated during the pandemic. This includes personal protective equipment (PPE) and technologies used for remote interaction.
Yet the strength of China’s economy has come with a cost in terms of rising debt. Moreover, the government is evidently keen to avoid the kinds of financial pitfalls that often emerge when credit creation is excessive. For example, the government has recently shut down so-called P2P lending organizations that raise funds from consumers, promising high returns, in order to provide loans to small businesses that are often excluded from formal credit channels. There was concern that the P2P channels involved poor loan management and even possibly Ponzi schemes. Yet the collapse of the industry has caused millions of investors to lose their life savings. Meanwhile the government is allowing bad corporate debtors to default on loans and bonds rather than encouraging lenders to roll over loans. This suggests that the government wants to create a sounder financial base for the coming decade. Indeed, China’s president recently said that “financial stability is the basis of national stability. Deleveraging state-owned enterprises is top of the top priorities.” Although a system of credit that punishes failure will eventually generate more productive investment and faster growth, in the short term, it will likely create disruption.
While the economic outlook for China in 2021 appears positive, one big unknown is the future of the relationship between China and the United States. With a new US administration, there is clearly potential for change. Yet the Biden team has downplayed the possibility of a swift change in US policy toward China. They prefer to first focus on domestic issues as well as solidifying political support before taking potentially unpopular actions with respect to China. In addition, any action related to trading relations with China is likely to be undertaken after negotiations between the two sides. It is likely that, if there is a modest rapprochement between the two sides involving a reduction of trade barriers, businesses on both sides of the Pacific will take this as evidence of a more stable and predictable environment. Still, the current US administration has recently imposed rules that limit the ability of Chinese companies to raise funds in US capital markets. It will be interesting to see if the new administration leaves these rules unchanged.
Emerging markets have experienced a range of economic outcomes during the pandemic, but the common denominator has been a sudden temporary collapse in economic activity followed by a rise in debt. Although many emerging countries are now growing rapidly, the ability to fully recover from this situation will depend on many factors, not the least of which will be the speed at which vaccines are distributed in poorer countries. Even in the best of circumstances, many countries will remain laden with debts that could stymie growth and create financial vulnerabilities. The ability to service and pay down debts will depend on the path of global commodity prices, the volume of remittances from expats living in affluent countries, the value of the US dollar (in which many external debts are denominated), the ultimate return of the massive tourism industry, and the health of global trade in manufactures. All these factors are, in some degree, dependent on whether or not the world succeeds in suppressing the virus.
Meanwhile, global food prices have risen sharply in recent months, potentially creating economic and social stress. The prices of wheat and soybeans are now the highest they have been since 2014. In the past, sharp swings in food prices often led to politically destabilizing mass protests or a sharp rise in unsustainable government debt when governments attempt to subsidize food costs for consumers. The recent increase in prices is due to several factors, including stockpiling of grain by China, expectations of higher energy prices, expectations that the global hospitality industry will soon recover, and higher freight transportation costs. The rise in food prices and the high level of debts accumulated by many poor countries are factors that might potentially unsettle the emerging world, not only economically but also geopolitically.