Economic Outlook Spring 2021

At the start of 2021, The U.S. economy still remains weak. After a surge in economic growth in the third quarter, the resurgence of infections slowed the recovery, especially in already struggling restaurant and services industries. The Federal Reserve’s December 2020 Beige Report found that overall economic activity expanded modestly in the final quarter of 2020. With the vaccine, the economy is expected to rebound slowly. Leading economic indicators point to improved economic growth in 2021. The projected modest recovery can be attributed to a second stimulus package and an accommodating Federal Reserve monetary policy of a “whatever-it-takes" approach to ensure fast recovery in the real economy from the recession. In addition, with excess capital capacity and underemployment, the fiscal policy stimulants are expected to promote economic growth with low inflation in the near term.

The fiscal policy stimulants, though, are projected to increase the Federal Government’s deficit from its $1.02 trillion levels in 2019 to over $3.4 trillion in 2020. The projected deficit, in turn, is expected to augment the Federal debt from its $23.201 trillion levels in 2019 (104.32% of GDP) to $27.747 trillion in 2020 (127.36% of GDP). The Federal Reserve’s purchases of that debt in 2019 and 2020 has led to an increase in the U.S. monetary base from $3.427 trillion in 2019 to $5.003 trillion in 2020 and an increase in the Federal Reserve’s balance sheet as a percentage of GDP from 19.3% in 2019 to 35.10% in 2020. In the long run, the fear is that the current expansionary monetary actions, unless reversed, will lead to high inflation once the economy moves back to full capacity. Furthermore, the unprecedented deficits and federal government debt levels will result in higher interest rates in the future. In the absence of a strong supply-side economic growth, the long-run cost of the monetary and fiscal policy stimulants will be a slower economic growth accompanied by inflation and relatively high levels of unemployment. Finally, there is considerable uncertainty over the impacts that possible new policy initiatives and executive orders of the Biden Administration will have on the overall economy. Policies to monitor include: energy, environment, taxes, infrastructure, immigration, government debt, and trade policies.

The monetary base is the total amount of a currency that is either in general circulation in the hands of the public or in the commercial bank deposits held in the central bank's reserves.

Economic Trends

Production

The decline in GDP in the second quarter of 2020 followed by a rebound in the third quarter was characterized by similar patterns in production. The Industrial Diffusion Index declined 12% in the second quarter of 2020 before rebounding in the third quarter. Of particular note to the production trend was the decline in U.S vehicle sales that decreased 24.6% in April from 11.4 million sales to an 8.6 million level before increasing in May by 41.98% from 8.6 million to 12.2 million sales level.

Also consistent with the economic decline and recent rebound were inventories and capacity utilization. The manufacture and trade inventory-to-sales index spiked in April by 15% from 1.45 to 1.67, before declining 8.67% in June. Capacity utilization declined by 12.67% in April from 73.56% to 64.245 before increasing by 6.26% in June and 4.21% in July.

Industrial production measures the output of industrial establishments in the following industries: mining and quarrying, manufacturing, and public utilities (electricity, gas and water supply).

Capacity utilization tracks the extent to which the installed productive capacity of a country is being used in the production of goods and services. It is reported as the percent of capacity being used for production (as opposed to sitting idle).

Manufacturing inventory-to-sales ratio is the ratio of business inventories to sales in the manufacturing, retail and wholesale trade industries. Business inventories are either goods ready for sale or shipments that are still being held by the producer, or goods acquired for the purpose of reselling them without further processing.

Retail Sales and E-Commerce

Similar to the GDP trends in the second and third quarters, retail sales from February to May declined 26.6%, followed by a strong rebound from May to November in which retail sales increase 26.6%. Of particular note was the growth in E-commerce trade, which increased 44.54% and 36.75%, in the second and third quarters of 2020, respectively. The pandemic, in turn, speeded up the shifts from physical stores to the internet. E-commerce also accelerated globally, especially in China, where Alibaba, Merituan, and Pinduoduo, have expanded and increased competition with the U.S. for the global e-commerce market.

Capital Investment

The pandemic led to a 14.5% decrease in the level of aggregate domestic investment during the second quarter of 2020 from $3.34 trillion to $2.85 trillion. In the third quarter, investment did rebound, increasing 16.8% to $3.33 trillion. Much of the increase, though, was replacing the inventory shortage in production. Overall, new business investment has grown only moderately over the last two years, while corporate earnings have increased, resulting in an increase in corporate cash positions. As a result, many U.S. companies have become net suppliers of funds instead of net users. From 2016 to 2019, cash per share has increased 33.45% from $172.45/share to $229.93/Share. The large corporate cash positions reflect an economic environment of uncertainty, leading, in turn, to lower levels of corporate investments. For investors, the large cash position of corporations creates, on the one hand, the potential for future corporate investments—liquid wealth; on the other hand, a large cash position is also an indicator of a lack of corporate investments—dead money—that could possibly lead to lower growth rates in the future.

In addition to the moderate rate of growth in corporate investments, the second half of 2020 also saw an increase in bankruptcy. Bloomberg’s bankruptcy index increasing 91.5% from 91.5 at the beginning of March to 202.89 at the end of the year. Finally, for the first half of 2020, foreign direct investment declined 48.7% from $52 billion in January of 2020 to $26.66 billion in July.

Housing

After declining by 17.84% in April, existing housing sales increased 75.45% from 3.91 million houses in April to 6.69 million in November. Housing inventory, in turn, decreased 12.33% from 1.46 million houses to 1.28 from April to November, while construction of new houses increased by 0.8%. Median home prices soared in the last quarter of 2020, increasing 11.1%, 12.2%, and 11.3% in September, October, and November, respectively, the S&P/Case-Shiller housing prices increasing 86% from 4.52 in April to 8.41 in November. The uptick in the housing market is a direct result of lower mortgage rates, with the average 30-year mortgage rate declining 38% from 4.75% in November 2018 to 2.93% at the end of 2020.

Fiscal Policy

In 2020, the federal government raised over $3.07 trillion in revenue from income (50.39%), social insurance (35%), and corporate (9.5%) taxes, and it spent over $6.624 trillion on welfare and individual security programs (social security, health care, and income security programs), national defense, interest on the federal government debt, and physical resources (energy, commerce and housing, transportation, and regional development). The government's excess of expenditures over tax revenues in 2020 equated to a deficit of $3.553 trillion.Two trillion of the $6.624 trillion government expenditures in 2020 funded the coronavirus economic stimulus bill. The bill provided $1,200 direct payments to individuals and $2,400 to families, added $250 billion for an extended unemployment insurance program, dedicated $350 billion to prevent layoffs and business closures, allotted $500 billion for loans, loan guarantees, and other investments, with $50 billion allotted to air carriers and $8 billion for cargo air carriers, and provided over $140 billion in appropriations to support the U.S. health system and $150 billion to states and local governments. In January 2020, an additional $900 billion stimulus deal to offset the economic fallout from rising coronavirus infections was also passed. This stimulant package, along with the earlier $2 trillion packages, significantly contributed to increasing the federal deficit to $3.553 trillion. In March, a new $1.9 trillion Covid-19 relief bill was signed into law. The bill provides payments of $1,400, increases aid to state and local governments, and enhances jobless benefits.

Monetary Policy

The Federal Reserve undertook extraordinary monetary measures in dealing with the 2020 financial crisis resulting from the pandemic. The Fed slashed rates to zero, initiated quantitative easing, and implemented a wide range of lending programs under the 13(3) provision of the Federal Reserve Act. The Fed has signaled that it will remain accommodative for a prolonged period of time until the crisis is over. In 2018, the Fed’s balance sheet was approximately 20% of GDP. With the Fed’s policy in 2020 of monetizing the rising federal debt, its balance sheet rose to 35% of GDP.

In the long run, deficit spending and monetizing the debt can lead to higher interest rates and/or high inflation once the economy moves back to full capacity. The long-run cost can be a lower steady-state economic growth accompanied by inflation and relatively high equilibrium levels of unemployment. In a seminal work by Reinhart and Rogoff (This Time is Different), the authors found that public debt above 90% can reduce average growth rates by more than 1%. In 2000, the federal debt was 60% of GDP, by 2013 it had increased to 100%, and by 2020 it is expected to be 127%.

Government Revenues and Expenditures, 2016-2020

Employment

The overall GDP decline in the second quarter of 2020 followed by a rebound in the third quarter was accompanied by similar trends in unemployment and underemployment. From April to July, the average unemployment rate was 12.33% and the underemployment rate was 19.63%, before dropping in the third quarter to 6.7% and 12%, respectively. Paralleling the trends in the unemployment rate were job vacancies, which dropped from 6 million job vacancies in January 2020 to 4.991 million in July before rebounding to 6.527 million in December. However, over 140,000 jobs were lost in December, the largest decrease since April, and the long-run unemployment, consisting of people out of the workforce for over six months, increased from 0.7% to 2.5%.

Underemployment: This measure of unemployment includes the total unemployed, plus all persons marginally attached to the labor force, plus total employed part-time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force.

Inflation

From 2016 through 2020, the U.S. inflation rate remained relatively low, averaging 1.78%. This lowflation environment has persisted even with public debt at 125% of GDP, quantitative easing, a pre-covid tight job market, and high capacity utilization. In the short run, a post-pandemic surge in spending resulting from a pent-up demand could lead to higher inflation. In the long run, there is concern over structural inflation caused by an aging population, budget deficits, and increased health, energy, and commodity costs. From 2016 through 2020, the average price of crude oil, in turn, was $50 per barrel, ranging from a high of $75 in July of 2018 to a low of $18.84 in May of 2020. Following a period from 2000 to 2014 when the major energy companies significantly increased capital spending as the shale market moved the U.S. to a net exporter of oil, Exxon mobile, Royal Dutch Shell, Chevron, and BP have decreased their capital spending in since 2018. The Biden Administration is expected to press for sweeping global climate reform aimed at reducing carbon emissions by 80% by 2050. With the new Administration’s expected emphasis on expanding renewable power, there is a growing concern of an increase in energy prices and inflation, as well as a concern that if the Federal Reserve were to increase the interest rate to slow down inflation, the increased rate could lower capital investment and precipitate a recession.

Trade and Exchange Rates

The Covid-19 crisis led to a collapse in trade flows—both exports and imports. Supply chain disruptions and weak consumer demand also played a major role. The U.S current account trade balance deteriorated from a deficit of $37 billion in March of 2020 to $68.14 billion in December. The increase in the current account balance, in turn, contributed to a depreciation of the dollar against most major currencies during the first part of 2020. For example, from September to the end of the year the price of the British pound increase from $1.21/BP to $1.35/BP, and the price of the Euro increased from $1.10/Euro to $1.21/Euro. There has also been a slowdown in global trade and direct investment as a result of the trade war between the U.S. and China, Brexit, and rising nationalism. With the Biden, Administration expected to launch a “Buy America” Policy creates more uncertainty as to whether the Biden Administration will reverse the current global nationalism trend.

Population and Demographics

U.S. Population growth has flattened over the last decade, growing at an average annual rate of 0.69%, compared to an average annual rate of 1.1% from 1960 to 2010. While the U.S. population has stagnated, states such as New York, California, and Illinois have experienced declining populations, while many southern states have seen population increases. New York’s population has decreased more than any other state, losing 126,000 people during the first part of 2020. California’s population has flattened, with decreases in Los Angeles. Illinois has, in turn, lost 253,000 residents over the last decade.

Poverty and Income Distribution

The U.S. Census Department reported the official poverty rate in 2019 at 10.5% —1.3% less than the 2018 rate. Since 2014, the poverty rate has fallen 4.3%, from 14.8% to 10.5%. The 2019 poverty rate of 10.5% is the lowest rate observed since estimates were initially published in 1959. Per democratic groups, between 2018 and 2019, the poverty rate for Whites decreased 1.0% to 9.1%, for Blacks by 2.0% to 18.8%, for Hispanics by 1.8% to 15.7%, and for Asians 2.8% to 7.3%.

While the pre-pandemic numbers were positive, the poverty rate during the 2020 pandemic year surged in November 2020 to 11.7%—the largest increase since 1960. Moreover, the U.S. Census reported in August 2020 that 12.1% of adults lived in households that didn’t have enough to eat at some point in the previous week, up from 9.8% in early May. The report also found that approximately 20% of Americans with children at home could not afford to give their children enough food, up from almost 17% in early June. Underlying this disturbing trend was the failure of Congress to reach a second stimulus package. Also of note is that the opioid epidemic got worse during the pandemic with over 80,000 Americans dying from overdoes from the summer of 2019 to the summer of 2020.

The U.S.’s 2020 Gini index measuring income distribution stayed at its a five-year average of 0.48. The Gini coefficient ranges from 0 (0%) to 1 (100%), with 0 representing perfect equality and 1 representing perfect inequality. Many European countries have lower Gini coefficients, such as Slovakia, Slovenia, Sweden, Ukraine, Belgium, and Norway. Inequality is generally lower in European nations than it is in non-European nations. In 2018, the top 1% of income earners in the U.S. averaged 40 times more income than the bottom 90%.

Economic Watch·

GDP Gap:

According to Bloomberg’s BIE, the U.S. output gap—the difference between GDP and potential GDP, expressed as a percentage of potential GDP—is expected to remain negative until at least 2024. Bloomberg’s BIE forecast the 2020 deep contraction will leave lasting scars as capital spending and productivity gains struggle to make up lost ground.

Immigration Reform:

In the long-run, increased immigration and higher productivity growth will be essential to offset the drag from an aging domestic population. The Biden Administration is expected to present a sweeping immigration reform bill. ·

Infrastructure Bill:

The Biden Administration plans to spend $1.3 trillion on infrastructure, aiming to reduce carbon emissions, create jobs, and augment the revenues of the Highway Trust Fund.

Tax Plan:

During the election, President Biden proposed a tax plan that departs significantly from the major tax reductions enacted during the Trump presidency. The proposed Biden plan would increase tax rates for individuals whose incomes are $400,000 and higher as well as for corporations which also would be subject to a new minimum tax on book income.

Health Care Reform:

The Biden Administration is expected to expand the Affordable Care Act by increasing marketplace subsidies, adopting auto-enrollment, and offering a new public option available to those in the individual market or with employer coverage. The plan would also reduce the Medicare age from 65 to 60, establish a new long-term care tax credit, and increase funding for rural health and mental health services. The Health Care Reform is estimated by the congressional budget office to cost between $890 billion to $1.6 trillion over ten years.

Student Loans Forgiveness and Tuition-Free Colleges:

With approximately 45 million Americans with student loans, equaling more than $1.5 trillion, the Biden Administration is expected to call for the cancelation of $10,000 in federal student loans debt. According to Brookings Research, Biden’s “education beyond high school agenda” calls for making public colleges and universities tuition-free for all students with family incomes below $125,000.