Growth, inflation and money rates
0US growth has been strong in recent months at around 4%. While the strength in the US economy has been fairly broad, the largest segment of the US economy, household spending hasn’t been quite as strong as earlier in the expansion. However, the recent improvement in consumer confidence, which continued in February, has returned confidence levels back to close to cyclical highs, although in absolute terms confidence levels remain low. Confidence only roughly tracks spending, but this suggests that consumers are still netting out conditions as improving, which should be conducive to spending growth.
This makes sense, as some of the recent negatives such as the rise in oil prices and continued declines in home prices are not yet large, and there has been a significant improvement in employment growth and a rising stock market (up 10-15% since late last year), while interest rates remain near secular lows. The other releases on Tuesday were clearly weaker, but likely don’t yet indicate that growth is slowing. Durable goods orders can be very choppy on a monthly basis, and none of the other business surveys suggest that conditions are as weak as the January drop in durable goods would indicate.
The other weak release was the Case-Shiller home price index for December. Continued declines in home prices tell us less about growth and more about the considerable supply overhang. In fact, housing activity has turned up for the first time in many years, but from such low levels that the overall impact on growth is small. Even with these two weaker data points, overall US growth rates have been strong and if anything have been accelerating.
It’s the received wisdom that growth can be achieved without inflation as activity levels are still down on prior peaks, but the data show that the global excess capacity created during the global financial crisis has largely been used up. World output is now about 3% above the pre-crisis levels, and it looks as if broad capacity utilization rates are back to roughly normal. Of course a 3% global expansion in GDP over a four-year period is a dismal performance. But low global investment rates over the last few years mean that little additional excess capacity was built over this period, and the decline in activity during the financial crisis was from a relatively tight level of capacity utilization. As a result, the cyclical dis-inflationary pressures produced by the global contraction are now largely behind us and current growth rates are enough to produce a further tightening. Of course, there are significant differences in capacity utilization across countries. Cyclical inflation pressures are more likely to be stronger in the emerging world, but would be felt globally to some extent. Recently both emerging and developed countries have been easing, and no meaningful tightening is discounted including in much of the emerging world.
One unusual aspect of the current outlook for growth, inflation and money rates is the required unwind of excess debt. When debt burdens become too large, as is now the case in debtor developed countries, de-leveraging is required and the deleveraging process reduces debt/income ratios. De-leveraging can be well managed or badly managed. Some have been very ugly (causing great economic pain, social upheaval and sometimes wars, while failing to bring down the debt/income ratio), while others have been more successful, with orderly adjustments to the balances of production/consumption and debt/income. The differences between how de-leveraging episodes are resolved depend on the amounts and paces of debt reduction, austerity, transfer of wealth from the haves to the have-nots and debt monetization.
The evidence thus far suggests that the US has experienced well-managed de-leveraging, whereas Spain, for example has not. But the US experience suggests that we could be much closer to rising inflation and money rates than markets and commentators assume.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
