The Waiting Game
The state and national economies picked up steam in 2017, and more growth is on the horizon if the White House and Congress can agree on health care reform, tax cuts, fewer regulations, and reducing the national debt.
The 2018 economic outlook for Michigan and the nation may soon reach a familiar pivot-point, characteristic of nearly all business cycles. Despite expectations to the contrary, the probable tipping point — from a growth cycle to stagnation — is likely to emerge by year-end 2017, which is something of an anomaly. Here’s why.
Between 2013 and 2016, U.S. real GDP growth rates were waning. National growth consistently slowed from quarterly rates of 2 to 3 percent to below 1 percent. Then, just as an economic plateau seemed to be looming, the outlook began to brighten. From November 2016 into early 2017, consumer and business confidence and expectations of accelerating real GDP shot up.
Surveys of general optimism recorded by the University of Michigan and the Conference Board reported record surges to new levels. Despite the Federal Reserve Bank’s decision to raise short-term borrowing costs by nearly a full percentage point, the stock market resumed its monthly climb into record territory. “Wealth effects” created by a $4 trillion gain in U.S. equity markets translated into broad advances affecting full-time employment, up by more than 1 million jobs by the end of September 2017.
For the first time in many years, disposable real personal incomes (i.e., after taxes and inflation) were on the upswing, especially those wages representing the large cohort of middle-income wage earners — those households in the annual earnings band of $44,000 to $112,000. This constitutes the critical core of economic purchasing power, financial savings, and investment that drives subsequent rounds of GDP growth.
A similar wave of cheer swept over the metro Detroit economy. Reflecting high levels of auto sales, Michigan’s two-year out performance of national expansion enabled the Big Three automakers and many suppliers to declare hefty bonuses, payable in early 2017. As of midyear, there were approximately 525,000 workers engaged in motor vehicle and parts manufacturing throughout the U.S., with 31 percent of them in Michigan.
According to local media reports, 148,000 Michigan auto workers alone received an aggregate of $529 million in bonuses. The University of Michigan estimates the infusion of purchasing power will raise the state’s total personal income level by nearly $600 million in 2017. In addition to the Big Three, many automotive suppliers have seen profits rise over several years to levels that justify even more bonus payments.
In tandem with the automotive sector, Michigan’s residential, commercial, industrial, and construction sectors continue to trend upward. At midyear 2017, comparing the activity levels between the first half of 2017 and 2016, Re/Max’s Metro Detroit Housing report showed home prices rose 8.2 percent. Similarly, an inventory of homes on the market (i.e., average number of days on the market) stood at 38 days, down 10 days from 2016.
The Detroit area commercial real estate sector was also experiencing an upsurge of demand for and occupancy of strip malls, along with a shortage of construction to satisfy the demand for those convenience storefronts. Industrial real estate, according to private brokers, is thriving throughout southeast Michigan, including some properties in Detroit. Activity in the industrial sector of real estate is a key “lagging indicator” for gauging a business cycle’s age.
Customarily, the “industrial” component of real estate (plants and warehouses) is a mighty segment of the real estate industry because it reaches its peak activity levels (pricing, construction, and occupancy) as the last major player in the expansion phase of business cycles prior to a downturn.
With better news through mid-October as it relates to consumer and business confidence, stock and housing prices, low gasoline and natural gas costs, and more buoyant employment, why reference possible stagnation or even recession in 2018? The reason for wariness concerns the facts on the ground. Reality, as contrasted with past performance or “hope” for the future, now weighs heavily against sustainable acceleration of economic activity beyond 2017. Why?
First, enthusiasm for half a dozen crucial and promised policy reforms calling for reductions in overall personal and business tax burdens, along with greater deregulation (akin to further unshackling of U.S. energy markets regarding oil, gas, nuclear, and coal) must await enactment by legislators in Washington.
In turn, how do Illinois, California, Connecticut, and New Jersey, lacking the borrowing capacity of the U.S., hope to meet impending insolvency due to years of overspending on public pension and legacy costs?
Without improvement on each of these fronts, the U.S. can no longer muster the private or public sector resources sufficient to pay for most spending obligations already incurred, much less those promised in 2016 for the next decade. Nor does the nation have the financial strength to service existing interest payments on the national debt of $20 trillion (from $10.6 trillion in January 2009) while leaving room for other contingencies, seen or unseen.
Federal budgeting is nearing an impasse. In the second half of 2017, politicians locked horns on reform (i.e., repeal and replacement) of federally mandated and fiscally failing health care programs. But in October, the White House moved to fix some of the flaws of Obamacare, and in the coming months, following Trump’s lead, Congress now has the cover to move on further improvements.
From the “micro” setting of a patient or a health-care provider to the “macro” scenes of pharmaceutical research, insurance, hospital, or physician group office and adjunct technology centers, it’s clear that more private economic decision-making must be provided for. As we’ve seen with Obamacare, government can’t know or deliver what’s best for the rest of us.
This is why Article One, Section Eight, of the U.S. Constitution never vested the federal government with such powers. This is the essence of why such “efforts” taken by occupants of our executive, legislative, and, yes, even judicial branches in Washington will never outperform the private sector’s ability to choose, learn, adapt, finance, and administer most health care decisions more beneficially than politicians and bureaucrats.
In short, the time and dollars squandered in federalizing our health care industries are crowding out the most essential federal functions, be they defense or infrastructure. Sadly, and in slow motion, efforts to centralize medicine in Washington echo and foreshadow the same sorrowful results witnessed around the world in nations that have socialized their health care industry.
Degeneration predictably ranges from the loss of major pharma discoveries and exports to colossal financial losses, demoralization of professional health care providers, inevitable waste, surging wait times for treatment, fraud, and delayed diagnostics for treatment of serious illnesses.
The pursuit of single-payer, government-provided health care, rather than competitive market choices, invariably inflicts incredible pain on successive generations of citizens. This is why the outlook for 2018 is on hold. It will become increasingly tenuous as months roll by without more concrete and prompt reform.
Now that Trump has acted, something positive can emerge from bitter debates over the efficacy of adopting a health care system responsive to the demands and needs of our population. One catalyst in this adventure may turn out to be an angry public. Many voters may just be learning about the elite subsidies (covering 73 percent of insurance premium and deductibles) that elected federal officials and their staffs wrote into their own special contracts (carve-outs) in the era of Obamacare.
Three of the most reliable indicators for predicting economic conditions six months to 18 months ahead are emitting positive, but less than vigorous, signals.
The first leading indicator is the shape of the yield curve (i.e., the percentage point spread between yield on the 10-year Treasury bond and the 90-day Treasury bill rate). When the long-term bond is higher than the bill rate, it foreshadows growth. A positive spread brings confidence to the market by suggesting that at least another two quarters of real GDP expansion will follow.
As of late July, the bond rate hovered around 2.3 percent and the bill rate averaged 1.1 percent. The point spread is 1.2 — nothing to write home about, but happily a positive spread. This first indicator forecasts modest growth through the balance of 2017. Nevertheless, by falling short of a 2-3 percentage point spread, the indicator fails to predict acceleration.
The second leading indicator is the Conference Board’s index of 11 prominent economic variables, such as the number of new housing permits issued, stock market gains or losses, and the average hourly work week in manufacturing.
The latest numbers for this forecast came in June. The LEI (leading economic index) gained 0.6 percent from May and improved by a full percentage point during the second quarter of 2017. Compared with the prior six months, LEI gained 2.5 percent, thanks largely to the volume of housing permits issued. No question that this suggests a heartening continuity for the existing expansion, with some moderate acceleration possible.
The third leading indicator that acquires special significance for a large automotive manufacturing and engineering economy like our state is the University of Michigan’s Consumer Sentiment Index. The end-of-July release placed the final June index level at 93.1. June’s confidence number, though still positive, is a whopping 10.1 index points below January’s 2017 peak. Yet despite a sizeable drop of household enthusiasm from year-end, the good news is that June’s level is 3.4 percent ahead of the June 2016 level of optimism.
All told, in the first half of 2017, the three leading indicators unanimously support a ninth consecutive year of expansion for the current cyclical upswing.
As forecasted a year ago, 2017 has become the eighth year of business-cycle expansion (July 2010-July 2017). Since the trough of the recession at midyear 2009, Michigan’s manufacturing sectors have regained 300,000 industrial and manufacturing jobs. For Detroit and Michigan, despite the onset of some softness in auto and truck sales compared with 2016, the persistence of very affordable financing rates and continued improvement in real purchasing power and employment assures growth for the balance of 2017 and into next year.
For example, in the first quarter of 2017, Michigan was one of only five states to boast annualized personal income gain rates at or above 3.1 percent. The positive 2017 outlook for the U.S. is also congruent with two economic fundamentals that nearly guarantee prosperity lasting through the end of 2017 for southeast Michigan and the rest of the state.
These two fundamentals are low inflation rates (think gasoline prices and interest rates) and tangible household income gains. Personal incomes are rising at 2 percent. The rule of thumb is that real personal income gains of 2 percent from the prior year correlate with a profitable auto sales year for Michigan’s economy.
As it stands, less than 2.5 percent to 3 percent improvement in real U.S. purchasing power implies a lower volume of vehicle sales. If greater efficiencies in auto firms compensate for lower sales, then conceivably Michigan’s auto industry profits and business activity levels can be maintained, rather than decelerating or declining in 2018. So the rule still holds. “Leaner and meaner” applies, and could furnish enough momentum to keep Michigan’s chief manufacturing and export industry profitable.
Mounting inventories of unsold vehicles were reflected in “days-supply-on-hand” statistics: At the end of June, GM stood at 105 days; Ford at 79; and Fiat-Chrysler at 71. The industry is comfortable with unsold vehicle levels running at fewer than 50 days. Furloughing of staff testifies to automaker caution and adjustment of product lines to accommodate shifting consumer preferences.
Prospects for 2018 have become more confounding than they were when 2017 began. Political conflict and legislative gridlock present an outlook that could suddenly turn disappointing and present severe financial difficulties for many workers and investors. In particular, we recall how America’s middle-class working families, according to surveys that included Michigan and cities like Detroit, suffered wrenching setbacks to real income and savings over most of the past decade.
Household demand for reform and greater opportunity for upward mobility, along with productive full-time work, represented their stake and claim to future financial security.
The election of a president with same-party majorities in Congress and the Senate was a formidable event. After all, the 2016 election promised reform: unprecedented income tax rate cuts; more equitable exchange pacts with our trading partners; less illegal immigration with which to compete or fund with tax dollars; greater choice of health care providers, pharmaceuticals, or other medical care options; and disposal of costly regulations that impede starting or continuing a business of one’s own.
By August, the hopes and promises of catching up with the living standards that had eluded these households were being challenged by what observers increasingly called a disorganized, self-serving swamp of dysfunctional and myopic politicians.
What this means is that eight years of GDP (e.g., stock market) expansion had largely bypassed a great swath of middle-class Americans — some whom had been forced out of full-time jobs and others who were obliged to take part-time work at two or more workplaces because of Affordable Care Act mandates on employers and insurance companies.
Just at a point when average earners could plan for family and future, they confronted other frightening losses of control beyond health care. Prospects for achieving upward mobility via educational choice, affordability, and quality schools seemed more remote. They sought greater security in their communities, and
better protection against internal subversion and rising threats posed by enemies abroad.
Now, tens of millions of these families rely on promises of sustained acceleration in U.S. economic activity to compensate for lost wealth from at least a decade of marginal prosperity. Less than half of these families have participated in the record run-up of stock market values. What initially appeared for many Americans after the election (especially those in states like Michigan) to be an enthusiastic embrace of policies removing counterproductive federal work rules and tax burdens are now starting to bear fruit following an initial delay.
Given disappointment with a midyear turn of events, it wouldn’t be surprising to see the consumer sentiment index issue warnings in the months ahead. After all, households continue to await movement on policies to promote security, rebuild neglected infrastructure, and strengthen energy independence for the 21st century, not to mention the restoration of health care.
As we get through the final quarter of 2017, the year that began with considerable promise — a year that should have laid foundations for 2018’s economic and financial renaissance — we see now that the White House and Congress are working to address growth issues. Still, the most underestimated threat to 2018’s likely expansion is the trauma that can snowball when uncertainty replaces hope and optimism. Bursting housing and stock market bubbles back in 2008 are examples of how untoward events can snowball.
Today, the stark reality is that our equity markets are priced far ahead of corporate profits that can be achieved with 2 percent real GDP growth, even if maintained for another year or two. We need 3.5 percent to 4.5 percent sustainable real growth — for the better part of a decade — to justify recent stock market exuberance.
Relying on eight years of contrived interest rates that the Federal Reserve has mandated or driven to levels at or below inflation is not marketplace reality. Instead, it’s a politically convenient policy that hits the wall, just as gimmicky policies of easy and careless housing credits left us with major bankruptcies and personal insolvencies a decade ago.
Current residential housing starts are still nowhere near the buoyant levels of 2005. Populations in poverty, on welfare, on disability, taking food stamps, or owing on student debt are still immense. The national debt is so large and growing so fast that it has taken on a life of its own. No one in Washington seems willing to grapple with the inevitable consequences.
In fact, this being the year of Alexander Hamilton’s celebration on Broadway, here’s what the builder of the strongest and most enviable financial system ever constructed for a nation had to say 222 years ago: “The debt of France brought about her revolution. Financial embarrassments led to those steps which led to the overthrow of the government and to all the terrible scenes which have followed.” Hamilton laid out a program to Congress for extinguishing the public debt within 30 years. Our elected officials today have no programs addressing this single seminal issue. It remains an existential issue that faces every republic.
Key Tests Lie Ahead
Fortunately, Detroit’s economy has responded well to eight years of recovering auto sales from mid-2009 to mid-2017. Doubling of motor vehicle sales rates throughout the U.S., from 9 million to 18 million units, has worked its usual magic on southeast Michigan and the state as a whole.
Employment gains and sharply declining unemployment rates have been accompanied by swift improvement in retail sales, generally. There’s been a resurgence in the region’s new housing starts, and commercial and industrial construction activity is gaining ground, as seen in rising property occupancy rates and prices.
Reflecting these trends, at least three long-awaited indicators are now reinforcing the current cyclical uplift: (1) signs of slower population loss in Detroit and the return of growth (albeit slow) in Michigan’s overall population; (2) record levels of consumer confidence; and (3) a visible renewal of Detroit’s downtown.
One looming caveat is that projects hooked on government subsidies hide true costs and risks to the public and to taxpayers in general. Subsidies are welfare arrangements, often furnished for those best capitalized and able to compete in the marketplace.
As we learned so brutally in the last downturn, subsidies deaden the ability of firms and individuals to adapt quickly to market changes with innovative and durable goods and services. At the top of a business cycle, these internal forces must be at their finest and fittest to assure survivability.
The economic outlook for the national economy in 2018 is increasingly likely to hand us a critical test of the permanency of gains made by Detroit, our auto industry, and the entire state of Michigan. Reform of budgets, infrastructure, workforce productivity, and industrial diversity are among the features that will be stress-tested in the year ahead.