Ubiquitous consumption

Strong consumer spending is driving economic growth, but how much longer will consumer confidence last?
Econforecastfeature Issue 1

From the pages of In Business magazine.

American consumers are in a very good mood, if decreasing monetary anxiety is any indication, and they are propping up an American economy in spite of multiple anchors threatening to weigh it down. While one lament about the “Trump economy” is how much economic growth we’ve been sacrificing by engaging in a trade war with China, consumer spending remains the one strong undercurrent that is preventing a slowing but still growing economy from dipping below sea level.

When preliminary third quarter GDP came in at a mediocre 1.9 percent, the lack of business investment was most often cited as the main culprit, but strong consumer confidence was hailed as the savior, and why not? According to the Money Anxiety Index, which measures actual financial behavior, consumer money anxiety declined 2.6 points in the third quarter of 2019, from 43.6 to 41.0, and it reflects high financial confidence which enabled consumers to increase their Q3 spending by a 2.9 percent annual rate.

A declining Money Anxiety Index means higher financial confidence. Right now, this economic indicator is trending in the right direction, and it’s not the only one. In the closely watched University of Michigan index, consumer sentiment climbed higher than expected in November, to 96.8 from 95.5 the previous month. Economists had expected consumer sentiment to slip, but in this particular survey, consumer sentiment has been at 95 or higher in 30 of the past 35 months.

This level of optimism has not been seen since the economically robust dot-com expansion between January 1998 and December 2000, when the index remained at 100 or above in 34 of 36 months. Ironically, both periods featured impeachment proceedings.

Risks from the ongoing U.S.-China trade war and slow global economic growth still could shock consumers out of their optimism, but that hasn’t yet happened. The holiday shopping season will yield more clues, but to avoid a recession in 2020, consumer spending must remain strong.

Staying above water

Led by both consumer and government spending, the nation’s gross domestic product grew at a revised 2.1 percent in the third quarter, up from 2 percent in Q2 but down from 3.1 percent in Q1. As was the case in quarter number two, consumer spending — a key component of GDP, along with investments, government spending, and net exports — led the way. Of those four factors, consumer spending is the largest contributor to GDP, representing two-thirds of the U.S. economy.

With consumer spending — driven by historically low unemployment — as the main ballast, how much longer can U.S. consumers remain confident enough to keep the economy afloat? “It’s hard to know,” says economist Elliot Eisenberg: “Right now, consumer numbers are really good. Job growth came out and it was terrific [in October and November]. There were upward revisions to August and September. That said, job growth is slowing compared to 2018, and wage growth is slowing, too, so there are some problems, but savings rates are high. All in all, American households are in pretty good shape.”

U.S. manufacturing data is weak based on the declining ISM Purchasing Manager’s Index. The trade war and escalating tariffs continued to hammer manufacturing, as national employment in that sector decreased by 36,000 in October but grew by 54,000 in November. As long as the manufacturing and CapEx (business investment) situations don’t get worse, Eisenberg believes that households can keep on going.

Also telling is that the labor force continues to expand, with 325,000 new entrants in October and more than a million since July. As a result, the labor force participation rate rose to 63.3 percent despite the relentless march of baby boom retirements — an estimated 10,000 per day. Still, the labor market is so tight that there are roughly 1.19 jobs for every unemployed person.

While the economy still is growing, it’s late in a long recovery cycle that dates back 10 years. Gross domestic product has weakened from 3.1 percent growth in the first quarter and some signs point to further weakening in the final quarter of 2019. GDP growth is inhibited by weak population growth and weak labor productivity growth, and in an increasingly service-oriented economy, productivity gains are harder to come by.

Since consumer confidence is considered a leading economic indicator, it usually starts to drop about one year before a decline in the economy, and there is no evidence that consumers have soured on the economy, their personal finances, and the buying climate. “When you start slowing down, things can go wrong, but the consumer is a champion now, a super champion,” Eisenberg says.

Although small business confidence also is historically strong, the biggest disappointment of Q3 was business investment, which saw its steepest decline since the fourth quarter of 2015 and a back-to-back decline of greater that 1 percent for the first time since 2009. With respect to business investment and the economy as a whole, a fair amount of hope is riding on the trade talks between the U.S. and China. Eisenberg has been saying a recession could occur as early as the fourth quarter of 2020, but he acknowledges that a trade agreement between the U.S. and China could further extend the recovery.

As more recent negotiations unfolded, Eisenberg acknowledged the trade talks matter because they would bump up gross domestic product by a couple of tenths of a point, boost the stock market, and help CapEx. As our writing deadline approached, another potentially damaging round of tariffs was scheduled to go into effect on Dec. 15, and they would apply to $160 billion in imported goods from China. “The economy can go on without having a trade deal,” Eisenberg says. “You simply don’t want to see the trade barrier problem get worse.”

A good trade deal with China could provide just enough stimulus to ward off recession. “There is nothing single handedly here that will cause a recession, but with weakening growth, poor manufacturing, and higher tariffs — you get the idea,” Eisenberg says. “You’d get a little snowball effect that could, 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 the earliest, the earliest, late in 2020.”

In late October, the Fed cut interest rates another quarter point, but Eisenberg believes the benefits of recent interest rate cuts are waning as home construction’s share of GDP has shrunk from about 5 percent to 3.5 percent.

Meanwhile, small businesses have some reason for optimism. According to the National Federation of Independent Business, small firms are eager to hire, but the continuing worker shortage still frustrates them. In November, job creation held steady as the NFIB reported an average addition of 0.29 workers per firm, and while that’s well below the brisk pace set in February 2019, when small businesses reported adding 0.52 workers per firm, it’s up from the 0.12 workers per firm reported in October. William Dunkelberg, the NFIB’s chief economist, says finding qualified workers remains the most-cited business problem, and it serves as a drag on economic growth.

Sixty percent of business owners report hiring or trying to hire in October, but 88 percent of those reported few or no qualified applicants for their open positions. They are attempting to fill positions by increasing compensation, as 30 percent reported raising compensation in October and 22 percent plan to do so in the coming months. “So, they are paying more, which is the way the market should work,” says Bill Smith, president of NFIB-Wisconsin. “If there is less of something, you should have to pay more.”

According to Smith, another emerging issue is the increasing level of uncertainty, and that won’t begin to subside until the trade war comes to an end. “One of the problems with uncertainty is that it’s the enemy of economic progress,” Smith states. “That uncertainty is woven into several different components. One is the tariff issue. A lot of the smaller manufacturers, and probably large manufacturers, but a lot of that part of our economy doesn’t see an end game. The battles continue. The tariff war continues, and it’s an important piece of the uncertainty that’s starting to show up in our economy now.”

The trade war’s impact on Wisconsin agriculture has been well documented, as Wisconsin leads the nation in farm foreclosures. The agricultural economy in Wisconsin is a $105 billion industry, and with the loss of two farms per day on average, that also has a tremendous impact on the state’s small-business economy. “Many of those farms drive the local economy, and as they go out of business and we have fewer of them, it has a negative impact on our Main Street small businesses throughout the state,” Smith notes. “We lose literally thousands of small businesses in hundreds of towns across the state that depend on those small dairy farmers for their economy to be sustained and to hopefully grow.”

Asked whether NFIB members are angry with President Trump for waging the trade war, or whether they understand the importance of fashioning a better deal and are willing to be patient, Smith says it’s a mixed bag. “I think there is some of both,” he states, before adding that NFIB research shows the majority of small business owners (54 percent) believe the tax cuts Trump signed into law had a very positive impact on the general economy and on their own business, and 65 percent said the tax cuts had a positive impact on their personal tax liability.

According to the NFIB, 26 percent of the small business owners who reported tax savings increased spending on employee compensation. “We need to get that renewed,” Smith states. “Those are temporary tax cuts. So, the push now is to make sure those cuts become permanent. That would eliminate another very uncertain component of making decisions on Main Street.”

Based on third quarter corporate earnings, which were down for the third consecutive quarter but not by as much as forecast, recessionary fears had eased by year’s end. Most publicly traded companies beat expectations in Q3, and projected earnings are expected to accelerate in 2020. While some believe expectations are too high, much of the renewed optimism was predicated on a potential end to the trade war between the United States and China.

State of the state

Job growth has clearly slowed in the past year, led by a decline in manufacturing activity. Manufacturing is 11 percent of American GDP, but it’s even more important in Wisconsin, as one in every five jobs in the state reside in that sector. In October, Wisconsin’s unemployment rate ticked up for the fifth consecutive month and now stands at 3.3 percent, compared to April’s rate of 2.8 percent.

Quarterly data released in November shows that state job growth slowed considerably in the first half of 2019. In what some economists consider a sign of labor constraints — simply not enough workers available — Wisconsin finished June with 2,945,000 nonfarm jobs, up 9,340 from June 2018, but that was well below the year-over-year increase recorded the previous June. On average, the state gained 11,000 jobs per month during the first six months of 2019, compared to 28,000 per month in the first half of 2018.

Kurt Bauer, the president and CEO of Wisconsin Manufacturers & Commerce, sensed a slowdown in Wisconsin’s manufacturing workforce, as preliminary monthly data signaled a modest drop. However, a different survey based on a larger sample size indicates that Wisconsin’s manufacturing sector added more than 8,800 jobs by mid-year. Bauer, who sees a lot of “Now Hiring” signs at manufacturing plants, says there is concern among Wisconsin manfucacturers, but  it’sbased on more than the effects of the trade war with China.

First, there is the difficulty of replacing retiring baby boomers, which exacerbates factors such as low population growth. In addition, he cites Congressional inaction (until December) on the new trade agreement between the U.S., Mexico, and Canada — 47 percent of Wisconsin exports go to either Canada or Mexico — and what he calls the chilling effect of Gov. Tony Evers’ failed attempts to eliminate the manufacturing part of the state’s manufacturing and agricultural production tax credit. He also cited Evers’ desire to repeal the state’s right-to-work law. From a manufacturing perspective, business operators believe both the production tax credit and the RTW law have made Wisconsin more competitive.

Interestingly, Bauer isn’t as concerned about the lack of a trade deal as he was six months ago because the once-disrupted supply chain is finding other pathways, including nations like Vietnam and Thailand. Interviewed in November, Bauer finds it hard to believe the Chinese government, no matter how much the trade war weakens its economy, will cut a deal before the November 2020 election. “Now, it’s possible because their economy is suffering a little bit and part of that has to be because of the trade tensions between the United States and China, the two largest economies in the world,” Bauer says. “To be honest with you, I’m less concerned about that than I was six months ago or a year ago, and the reason is that trade between nations is very similar to damning water. The water will find another path, and that’s what we’re seeing. Trade is finding other ways in other countries. The supply chain has adjusted, and businesses have adapted remarkably well. They have moved production to other locations.”



Inflationary risk

Economists are always looking for things that can change the game, and truth be told, there are some funky things happening that distort certain markets. One such distorting phenomenon is investor interest in purchasing negative-yielding bonds, which have negative yields at maturity but can still produce a positive return in the short run. Analysts say the rise of negative-yielding bonds is warping U.S. treasury markets, stock market returns, and corporate financing to the point where some well-known corporations are not forced to earn a profit to remain in business.

John Thompson, president and chairman of Thompson Investment Management Inc., and his colleagues spoke of the rise of negative-yielding bonds during the company’s annual symposium in late October, but Thompson’s biggest short term concern is a resurgence of inflation. He cited the two-year federal budget deal that will add $300 billion in new spending, and the Fed’s decision to accommodate this spending surge by buying $60 billion worth of treasury bills per month, which pours in all the money the financial system needs when the federal government is running a nearly $1 trillion annual budget deficit.

Since the federal government gets first crack at borrowing to cover its deficit, large federal budget deficits raise concern about the private sector being “crowded out” of its own borrowing needs. In fiscal year 2019, the federal budget deficit was $984 billion, the largest deficit in seven years and the fourth year in a row the deficit has risen. In fact, it has risen 68 percent since FY2016, even with low unemployment and solid wage growth. In the most recent fiscal year, tax receipts totaled $3.4 trillion, up 4 percent, while spending was $4.4 trillion, up 8 percent.

“The trade situation seems to be very important in the short run, but in the long run there are other factors that are dominating,” Thompson says. “That could be fiscal policy and what the Federal Reserve is doing. We’ve lowered interest rates three times in the last few months, and there is a lot of stimulus domestically. So, our outlook is all going to propel the economy forward, and probably the markets are at an all-time high and will stay strong, but the fly in the ointment is that we are likely to ignite inflation, and that would make interest rates go up.”

A spike in inflation would be caused by a number of already-existing factors, Thompson adds. “Inflation really is rooted in having the unemployment rate at a 50-year low, and if you stimulate the economy, everyone would need to hire more workers,” he notes. “They aren’t available, so they [employers] have to bid them away from somebody else and pay a higher wage to that person, and that would get the wage inflation producing a cost-push inflation like we saw back in the 1970s.”

The results of the 2020 election could well exacerbate inflationary conditions because with new promises come new spending or new tax breaks. “Sometimes going into an election, people say and do a lot of things just to get elected,” Thompson says. “I worry that we’ll become even more fiscally irresponsible than we already are.” At the moment, neither the stock or bond markets are complaining, “so our concern is when will both of those markets start to scratch their heads and question whether or not we’re doing the right thing?” Thompson asks.

Eisenberg, in contrast, isn’t as worried about inflation. He notes that globally, there is very little inflationary pressure. “Could inflation come up a little bit? Sure, but to see it as a ‘problem’ in quotation marks, that is exceptionally unlikely,” he states. “No, I really don’t see it. Demographic problems prevent it from happening and so on.”

Madison’s resilient economy

About the time First Business Bank began reaching out to local business operators for its 17th annual Economic Survey, the national media was filled with talk of recession, the trade war with China appeared to be heating up (not cooling down), and the economic toll of higher tariffs was becoming more apparent on Wisconsin agriculture and, to a lesser extent, manufacturing.

So, it was a bit of a surprise when the First Business survey revealed subdued but continuing strong optimism heading into 2020 among Dane County business leaders. How strong? Ninety-seven percent of companies expect improved or unchanged performance, up from 93 percent last year. Nearly seven in 10 (67 percent) expect to do better in 2020 (down from 74 percent the previous year), but only 3 percent expect to do worse and that’s down from 7 percent the previous year.

Local employers appear to be largely unaffected by the trade war and other damaging economic forces. What’s more, the combination of low unemployment rates and the labor-skills shortage resulted in a record number of companies — 88 percent — reporting wage increases. That’s up six points over last year’s 82 percent and it’s a trend that’s very likely to continue.

For Jim Hartlieb, president of First Business Bank, among the themes that came out of this year’s survey are the continued optimism for 2020 — despite some headwinds — and the resiliency of the local economy. “Either they [local employers] are not impacted, or they have found ways to deal with those headwinds because the results from 2019 were strong,” Hartlieb says. “There is as much, if not more, optimism about 2020 as we had going into 2019. So, that tells me that business owners in general have figured out a way be successful in spite of those things.”

The survey was completed by 330 respondents in three regions in Wisconsin — Greater Madison area, southeastern Wisconsin, and northeastern Wisconsin — and metro Kansas City. The survey focuses on the current year’s actual and next year’s predicted results in seven categories, including sales revenue, profitability, and hiring plans.

Nearly three out of four Greater Madison business executives (73 percent) reported that they met or exceeded expectations in 2019, and while that was down from the sky-high 79 percent that met or exceeded expectations in 2018, their continued strong performance in 2019 clearly impacted their expectations for 2020.

Amid continuing optimism, one cautionary note was sounded by Dr. Moses Altsech, who conducted the annual survey. Altsech, who serves on the faculty of the Wisconsin School of Business at the University of Wisconsin–Madison, acknowledges the optimism of business operators despite global headwinds and operational challenges posed by the labor shortage. But he adds that while consumers are buoyant given their upper hand in the job market, perceptions can change quickly. “People usually are optimistic,” he says, “until we’re at the brink.”

2020 offers hope for farmers

Wisconsin farmers have suffered down periods before, but rarely have they seen the piling on that has occurred in recent years. From low milk and commodity prices and a trade war with China in which they have been the most devastated casualty, farmers have faced one obstacle after another.

Wisconsin is leading the nation in farm bankruptcies, as more than 600 of the state’s roughly 8,000 dairy farms have closed through Thanksgiving weekend, an average of about two farms per day. Since 2014, the last time the price of milk was healthy enough to keep farm incomes above water, more than 3,000 farms have closed in Wisconsin.

While there are signs of a rebound — in October, hopes were raised as the price of milk reached $20 per hundredweight — the damage has clearly been done. “In talking to our farm center staff, they’ve been saying we’re losing in the neighborhood of 50–60 dairy farms per month,” notes Randy Romanski, interim Secretary of the Wisconsin Department of Agriculture, Trade, and Consumer Protection. “We talk to them frequently, just to stop in and see how things are going, and they have said there has been a bit of a slowdown in the number of calls, and the kinds of calls they get are more about farms in transition — people who are potentially interested in staying on the farm but picking up other income or potentially finding a way to transition the farm to another farmer.”

A breakthrough in the trade war with China, and passage of the proposed new trade agreement with Canada and Mexico, would certainly help, but as of this writing, the immediate prospects for both were in limbo. Whatever happens, Romanski believes farmers will adjust because that’s what they’ve always done. Agriculture is a nearly $105 billion industry in Wisconsin, as about one in nine people working here holds a job related to farming, but while America’s Dairyland is on every license plate, the dairy component isn’t all there is to it. Here, farming is a diverse industry that also is among the national leaders in the production of various crops such as cranberries, potatoes, and ginseng.

This diversity was born of necessity, so even if milk prices continue to rebound, diversity will continue to be a feature of Wisconsin agriculture. So will adaptability, as some failed dairy operations transition to different kinds of farming such as a grazing footprint or a move from dairy to beef or crops of some sort, or perhaps they simply lease their farmland to a neighboring farmer.

“The way we look at it is that farmers have their own blueprint,” Romanski says. “Each farmer makes their own decision. They are their own individual businesspeople.”

While they wait for elected officials in Washington to get off the dime, nothing prevents them, or the state of Wisconsin, from trading more within the existing framework. Romanski notes that 95 percent of the world’s dairy customers live outside the United States. In addition, 90 percent of Wisconsin milk is made into cheese, and 90 percent of that cheese is sold outside the state. So, no matter the current price of milk, DATCP is working to find open markets for Wisconsin’s ag products — at home and abroad.

“We have an international agribusiness center here and they have done work in export markets like China, but they have also been working in Vietnam, Indonesia, the Middle East, Mexico, and Canada,” Romanski notes. “They are wherever possible trying to open markets for Wisconsin products.

“It’s really important that we maintain productive trade relationships there for our agriculture and food businesses,” he adds. “Trade deals are helpful. They are part of the puzzle, but we do everything we can to promote Wisconsin products.”

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