Take Five with economist Elliot Eisenberg: Trade deal could extend recovery
Elliot Eisenberg, the man who makes the “dismal science” of economics both entertaining and informative, returns to Madison this week to give his take on the economy heading into 2020. Eisenberg of Econ70.com, home the appropriately named GraphsandLaughs, will once again be the main attraction during State Bank of Cross Plains’ annual economic forecast, and the title of the Nov. 6 program at the Overture Center is “The Economy in 2020: Turbulent, Tepid, or Tarrifying?” Late last week, we spoke to Eisenberg by phone to get his take on what the events of 2019 means for the U.S. economy in 2020.
IB: Last year, you predicted a slowdown but no recession in 2019, which is basically what transpired. Some are predicting a mild recession in 2020. Is your growth forecast for next year somewhat dependent on what transpires with these forthcoming trade talks between President Trump and Chinese President Xi Jinping, assuming they can reschedule their discussions about a phase one agreement?
Eisenberg: Yes, the trade talks matter. There is no question about it. They would bump up GDP [gross domestic product] by a couple of tenths of a point. It would make everybody happier, right? The stock market would rise. Interest rates would jump up and so on. So, it clearly matters, but we can withstand it. The economy can go on without having a trade deal. You simply don’t want to see the trade barrier problem get worse, either. They postponed one tariff increase and put that off to the side while they negotiate a phase one deal, but there is another tariff increase that’s scheduled to go into effect on Dec. 15, right around Christmastime. If we don’t get a phase one agreement and we have that increase, that won’t cause a recession either. There is nothing single handedly here that will cause a recession, but with weakening growth, poor manufacturing, and higher tariffs, you get the idea. You’d you get a little snowball effect that could — could — get us there. But all else being equal, no I don’t see a recession in the near term. Trade matters but I still don’t see a recession until at the earliest late next year. Q4 of next year.
IB: If we do get a trade deal with China, could that provide enough stimulus to ward off recession for a while?
Eisenberg: Sure, I think it could. It would give us enough of a boost. It would increase corporate expenditures, CapEx would rise, consumers would be a little happier, and business would be happier. That’s really important now. Right now, what’s driving the economy is consumption — household consumption — but if we had the trade deal, business investment would probably improve, and it’s now declining slightly. It would attack a place where we’re weak and it would improve it. That would boost GDP. So, yes, it could well prevent a recession in 2020.
IB: You mentioned consumer spending there. That seems to be the main ballast at the moment. How much longer can U.S. consumers remain confident enough to prop up the economy?
Eisenberg: It’s hard to know. Right now, consumer numbers are really good. Job growth came out yesterday, and it was terrific. There were upward revisions to August and September. They were very good. That said, job growth is slowing a bit, and wage growth is slowing, too, so there are some problems there, but savings rates are high. All in all, households are in pretty good shape. As long as the manufacturing situation doesn’t get worse, and the CapEx situation doesn’t get much worse, households can keep on going. At some point, something is going to trip them up, right? Maybe it’s Europe. Maybe it’s Brexit. Maybe it’s China. Maybe it’s Iran. Maybe not. That’s why with my crystal ball, I used to say we were 18 months away from a recession. Now, I’ve gone from nine to 12 months away from a recession. Not that we’re going to have a recession in nine to 12 months because it could be earlier. There is a little less runway here, but consumers are very strong. There is no question that consumers are strong, and they have shown no weakness. Now, businesses are continuing to hire. Job openings are declining but they are still pretty good.
But we’re late in the [recovery] cycle. Things could go wrong. GDP is weakening. We had 3.1 percent growth in the first quarter. It fell to 2 percent in the second quarter, and 1.9 percent now in the third. It will probably fall to 1.7 percent or so in Q4. When you start slowing down, things can go wrong, but the consumer is a champion now, a super champion.
IB: With the recent $300 billion federal spending increase from a two-year budget deal agreed to earlier this year, the tax cut that went into effect in 2018, the Fed lowering interest rates and buying $60 billion in treasury bills each month, and an annual federal budget deficit approaching $1 trillion … with all this stimulus, are we risking a spike in inflation next year?
Eisenberg: Well, first, the $60 billion that the fed is buying is to inject liquidity into the system because of that craziness that happened about a month ago. They are buying at the short end of the yield curve. It really is 95 percent technical there. There was not enough liquidity in the system. Yes, interest rates skyrocketed like they did 10 or 12 years ago, in 2008, but that was different because back then the problem was the collateral and the repo, right? It was what bonds are you taking? They were bonds of poor paper and some banks and so on — Bear Stearns and Lehman Brothers — and that was just crappy paper, and no one knew who had what paper and where it was lurking. Now, the paper is all treasuries, so there is no question there. The problem was literally a lack of money. So, don’t consider that to be some sort of quantitative easing or anything beyond just some technical fixes. The only failure there was really a failure on the Fed’s part not to have a plan ready when it happened. No one knew when it would happen, but we all knew it would happen.
IB: So, you’re not as worried as other people are about inflation.
Eisenberg: I’m really not. If you look globally, there is just no inflation. Europe has no inflation. Their inflation is less than 1 percent. They are trying desperately to fix it. Japan has no inflation. China has no inflation. If you look at the developing world, where inflation tendencies are much stronger than in the developed world, with the exception of Venezuela, which is just a basket case, and Argentina, which is nearly a basket case, nowhere else is there inflation. Brazil, there is no problem. Even hopelessly mismanaged Turkey has largely avoided inflation, despite gross, gross mismanagement on their monetary and fiscal-policy side.
Could inflation come up a little bit? Sure, but to see it as a “problem” in quotation marks, that is exceptionally unlikely. No, I really don’t see it. Demographic problems prevent it from happening and so on.
IB: Given the tight labor market, and the continuing need to replace retiring baby boomers, will the next recession necessarily result in substantial job losses, or is there too much need for employers to hang on to what they have?
Eisenberg: There will be some job losses, sure. Unemployment will go up. In every single recession that we’ve had in the last 50 or 60 years, unemployment has ticked up by half a percentage point or more. So, we’re going to get some increase in unemployment and these most recent hires that firms have picked up are clearly substandard, right? They are young kids. They are people who have come back into the labor force after being out for a long time and their skills have atrophied. So, they are going to go, and the process has been, in the last couple of recessions, that you fire your lowest-productivity workers when the recession hits. So, recessions hit and productivity skyrockets. So, yes, I would be surprised if unemployment didn’t pick up meaningfully in the next recession. Sure, corporate earnings will be hit. It’s more the speed of the recovery that is really the issue here. That’s going to be more determinant.
IB: Much has been made about yield curve inversions being predictive of a recession. We’ve had several this year, including the closely watched 10-year/two-year curve, but we’re still above water. Are yield curve inversions as predictive as they once were?
Eisenberg: The inversions have turned around, obviously. In the last couple of weeks, the inversions have gone away. The Fed has lowered rates and so on. Look, the inversion is not a good thing, and the near inversion is not a good thing, either. This is not telling us something good, but it’s also not quite as clear a measure as it has been in the past.
There are four reasons why this measure is not so good. One, the U.S. Central Bank owns $1 trillion to $1.5 trillion of long-dated treasuries, pushing down the long end of the yield curve. A second reason is that banks in the U.S. hold a lot of treasuries because of Dodd-Frank and regulations. The third reason is interest rates globally are super low, right? So, if you want to get a return on your money like a Japanese insurance company or German insurance company or a pension fund, they swap out their currency for dollars and they buy treasuries or something. So, that pushes down the long end of the yield curve.
Last but not least, the term premium is not negative. You can sort of calculate and look and see how much extra an investor wants to lend long. Well, they are not asking for more money. It has steadily shrunk and shrunk and shrunk to the point that it’s negative, and I’m not going to get into why this is the case, but what it suggests is a tremendously strong desire to save money and a desire to save it in some very safe assets. This also is pushing the long end of the yield curve down, so I was concerned when it was upside down, when the yield curve was inverted, and I’m still concerned now, but last month when it inverted I was less concerned than the doomsday people and now I’m less optimistic than the happy people. It matters but it doesn’t quite matter as much, but it’s not good news. The flat yield curve suggests weak GDP growth and weak inflation. That’s really plausible.
Oil prices can spike or something, which could bump up inflation, sure, but it’s hard to see prolonged inflation.
IB: Last year, you were concerned about mounting corporate debt, especially the poor quality of it, but with interest rates declining rather than going up, is that less of a drag on growth in the short term?
Eisenberg: I’m still nervous about it. The situation has gotten worse, the amount of debt that’s Convenant-Lite. It has no restrictions on it, really. No ratios-to-earnings or ratios-to-EBITDA or whatever. They have gotten worse. The amount of triple-B debt has really gone up. Triple-B is the lowest-quality investment grade. So, if we have a mild recession or even a meaningful earnings recession, and we’ve had a little bit of that lately but not much, but say earnings start to go down. Some of these companies that are rated triple-B would have to become triple-C plus, and then they would have to be sold by all the places that hold it, and that would jack their interest rates up.
It won’t cause a recession on its own, but it will certainly pour gasoline on the fire. You can see a bunch of places here — consumer spending could weaken, GDP could decline, corporate debt could go bad, and some trade issues could happen. So, there are a lot of things that if layered on top of each other, you’ll end up with a recession, but none of them individually. Right now, energy is in recession. Manufacturing is in recession. Transportation is in recession. Agriculture is in recession. If you add three or four more things to that, you’ll probably get a recession.
IB: Since you think we could enter a recession in Q4 2020, do we have enough stimulus tools in our fiscal arsenal to make it short and sweet?
Eisenberg: Oh, we could have stimulus tools to make it short and sweet. The Central Bank will have a hard time. They will not be able to lower rates much, right? They have just lowered rates three times. They do have a little firepower left. More than any big Central Bank, but there is not a lot of room there. We will need some fiscal stimulus, no question about it. If you hear Mario Draghi, his swan song. He had to retire last week. I think Oct. 31 was his last day at the ECB (European Central Bank). He’s been pushing very hard for the European countries with fiscal capacity to increase fiscal spending. We’ll have to do the same thing — the deficit be damned.
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