Based on the dearth of criticism from Democrats, they must believe that the domestic economic performance since the passage of the Tax Cuts and Jobs Act of December 2017 has been robust. Such an opinion is well-nigh ubiquitous. Beneath such waves of enthusiasm, though, more powerful tides may well tell a different story.

Smaller Swells in GDP Data

On July 26 preliminary GDP data for Q2 2019 were released. The economy grew at 2.1%, down from Q1’s 3.1%, a headline Dave Rosenberg argued was distorted by nonrecurring factors that obscured 1% underlying growth. Almost as an afterthought, the Bureau of Economic Analysis announced that real annual GDP from Q4 2017 to Q4 2018 was revised downward from 3% to 2.5%. This should raise a collective eyebrow given the presumed force of the fiscal tailwind.

Moreover, the detail below on the first six months of 2019 headlines is not reassuring. Rosenberg notes that government spending jumped 5% in the most recent quarter, the strongest showing since 2009. Consumers had to cut their savings rate to post the strong 4.3% growth this quarter. If they had spent in line with income growth, real GDP would have been somewhere around 1%. Adjust for the quarter’s surge in government spending, and the economy actually shrunk at 1.6% annually.

Does the Fed see beneath the surface of these GDP numbers? Under normal circumstances, the Fed’s first rate cut since 2009 should be an ominous sign were it not for blatant attempts to politicize our central bank. The inverted yield curve—when the yield on the 10-year Treasury bond falls below three-month bills—is determined by the unimpeded free market. It’s the end product of hundreds of millions of individual judgments and subsequent decisions. According to the National Bureau of Economic Research (NBER), 11 such inversions have occurred since 1921. All of them, save for the current one at least thus far, preceded recessions.[1]

Nothing written above is news to the well-informed reader. Moving beneath the cyclical vagaries of the wave-tossed surface, a secular ebb tide threatens to pull all ships not firmly anchored in safe harbors out into stormy seas. The alarm bells have been sounding as neither Republicans, supposed debt hawks, nor Democrats have balked at the spending bill just passed by the Congress. It will conveniently postpone the debate on government spending until after the 2020 elections. The self-proclaimed king of debt[2] presently occupying the Oval Office has successfully silenced any outcry from the fiscal conservatives who so loudly swelled the ranks of Republican opposition during the Obama years. As of August 1, both houses have acquiesced to an additional $320 billion in deficit spending over the next two years. Seeing figures below $1 trillion now seem almost tame, but this is a new normal that spells trouble ahead. That is because piling more debt on top of the existing mountain will only make the GDP growth rate fall still farther. Not counting the latest proposed stopgap measures, the Congressional Budget Office projects annual deficits of 4.3% of GDP from 2019 to 2029. Before considering the adverse effect of any recessions, the debt held by the public can be expected to balloon by $12.7 trillion to $28.5 trillion over the next decade, excluding intergovernmental liabilities like social security.[3]

The High-Debt Era’s Ebbing Tide

From 1800 until 1999, or before the U.S. economy became extremely over-indebted, the real per-capita growth in GDP grew at 1.8%, compounded annually. Since then, the rate has declined to 1.2%. Concurrently, the real interest rate on long-term, risk-free U.S. Government bonds fell from 3.1% to 2%.

If we exclude recessions, the current expansion reached its 10th anniversary in July 2019, a record. This accomplishment, however, was clearly a Pyrrhic victory. Real per-capita GDP rose only 1.4% over the period, the poorest growth rate for an expansion since 1950. The expansion from 2001 to 2007 was a harbinger. That first expansion of the high-debt era witnessed real per-capita GDP growth of a somewhat higher 1.9%. Prior to the 2001 expansion, the average growth in real per-capita GDP during expansions since 1952 was 3%.

As debt levels, on average, inched inexorably higher, real growth rates retreated. This highlights the deleterious long-term effects of high debt levels.

Federal spending has a low multiplier effect. Most of the federal budget, which these deficits finance, is spent on Social Security, healthcare, social-safety-net programs, interest expense, and defense. Moral imperatives aside, these sectors contribute little to economic growth. Social Security and the social-safety-net payments go toward sustaining current consumption. This has an economic impact, but it doesn’t directly increase efficiency or output like new bridges or an electric-grid upgrade. Interest expense is most clearly an economic drag. Finally, defense, for all its support of manufacturing, has largely been exporting wealth to other countries around the world since 2001. This isn’t the kind of spending that increases growth. Greater debt incurred for such expenditures will be an even greater drag.

More subtly, higher debt levels cause diminished returns on capital in nonlinear fashion. When real yields are low or negative, investors and entrepreneurs won’t earn returns in real terms commensurate with the risk they take. In the case of negative yields, nothing is earned in the first place. In the case of low interest rates, asset prices are unusually high, including but certainly not limited to marketable securities, as all are priced using low real discount rates. That makes 10-year forward returns minimal at best. Should slowing growth tip into deflation, the distance that risk assets have to fall is extraordinarily great.

Why the Slump in Productivity Growth?[4]

The poor growth of productivity mirrors the anemic growth in GDP. Over the last 10 years, productivity has risen at the sluggish pace of just 1.3% (a record), nearly half of the rate in output growth per worker hour since the quarterly data were first tabulated in the late 1940s.[5] In the last five years the gain was less than 1% and equaled the previous low from 1979 to 1984. Importantly, unlike the past five years, the early 1980s were saddled with three years of recession.

The corresponding low returns on capital mean that we could expect physical investment to fall and productivity gains to continue eroding, as would prospects for growth. Decreased capital returns can be expected to prolong the period of poor economic growth in the U.S., and if the solution to subnormal growth is an even faster acceleration in debt, then this cycle will almost certainly continue to repeat.[6]

Accelerating Debt, along with Declining Economic Growth, May Explain Why Consumer Price Inflation Has Been So Unresponsive to Monetary Stimulus

The nonlinear relationship between accelerating debt and economic growth carries through to inflation—with a major downside effect.

  1945–2000 2001–07 2009–19
CPI 4.1% 2.6% 1.7%
GDP 3.9% 2.5% 1.6%

The Vicious Cycle

Higher levels of public debt have produced successively weaker gains in GDP generated per dollar of debt. The weakened GDP growth has, in turn, resulted in declining real yields, which have discouraged investment. This phenomenon is outside the Fed’s purview! First, debt is a matter of fiscal policy. Second, real yields are determined by the market and its outlook on growth and inflation. Accordingly, the decline in market-determined real yields is not a stimulant to economic activity, as would be the case if debt levels were considerably lower, but a symptom of high leverage and its impact on productivity and GDP growth.

All the while, we believe that Wall Street mistakenly hangs on every utterance from Jay Powell. In reality, the Fed is following rates down. Treasury yields have been in decline since 2018. Low rates are a function of excessive debt. Coincidentally, Congress is seeking to increase the latter as the Fed pretends to control the former.

[1] Historically the curve has been steep at the beginning of recessions. If the Fed doesn’t recognize the impending recession, curve inversion and monetary restraint will intensify. The late response, perhaps precisely what we’re seeing now, may cause a recession to be deeper and longer.



[4] We examined extensively the subject of slow growth in productivity in three earlier posts: “Whatever It Takes,” September 21, 2018; “Productivity Growth I: Can the U.S. Economy Stay Airborne Without It?” October 17, 2018; and “Productivity Growth II: Can the U.S. Economy Stay Airborne Without It?” November 9, 2018.

[5] Hoisington, Q2 letter.

[6] Ibid.

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