Tag Archives: economic growth

Don’t Compare Stocks to GDP

 

Economics – the Dismal Science – is hard for most people. It’s even hard for economists who rarely agree on anything. But here’s an argument from Brian Wesbury of First Trust who thinks that the stock market is till under-valued.


The bull market in U.S. stocks, which started on March 9, 2009, gets little respect. Those who have been bullish, and right, are mocked as “perma-bulls,” while “perma-bears,” who have been repeatedly wrong, are quoted endlessly.

We don’t have enough fingers and toes to count the number of times a recession has been predicted. Brexit, Grexit, adjustable rate mortgages, student loans, the election of Donald Trump, tapering, rate hikes, a 3% ten-year Treasury yield, Hindenberg Omens, Death Crosses, and two fiscal cliffs are just a few of the seemingly endless list of things that were going to end the bull market. (And the pouting pundits of pessimism are never held accountable for erroneously spreading fear.)

One staple of the bearish argument, and the one we want to discuss today, is that corporate profits have grown faster than GDP. This, the bears have claimed for years, can’t last. The argument is that there will be a reversion to the mean, profit growth will slow sharply and an overvalued market will be exposed. A close cousin to this argument is that stock market capitalization has climbed above GDP, signaling over-valuation.

Both of these arguments make fundamental mistakes: first, about the relationship between GDP and profits; second, about the correct measurement of GDP.

The economy is a combination of the public sector and the private sector. Most people think direct government purchases of goods and services, which were 17.2% of GDP last quarter, represents the full impact of government on the economy. But total Federal, State and Local spending (which adds in entitlement spending, welfare, and government salaries), as well as the cost of complying with government regulations, raises the number to 45% of GDP. And because the private sector pays for every penny of government spending, resources directed by the government are significantly larger than just purchases.

There is little doubt that the growth rate of productivity in the private sector is much stronger than in the public sector. In fact, it is probably true that productivity growth in the public sector is negative – directly, and indirectly – through the burden of regulatory costs. If 55% of the economy (private spending) experiences strong productivity, but 45% of the economy (the public sector) experiences negative productivity, overall GDP and productivity statistics are dragged down.

In other words, secular stagnation is a figment of the average – government has grown too big and is a drain on the economy. Yes, private sector growth (and profits) can grow faster than GDP. It’s not a bubble, it only looks like a bubble when looking up from the hole government has created.

The second important point is that GDP is a flawed measure of economic activity. It tracks final sales, but not “total” economic activity. A new car may cost $42,000, but the total amount of economic activity to build and sell that car (the total of all the checks written between businesses and consumers) is significantly more than the final cost of the car. Much business-to-business activity is not captured directly in GDP.

Mark Skousen has pushed for years for the Bureau of Economic Analysis to publish “Gross Output (GO),” which includes all economic activity. And in Q4-2017 GO was $34.5 trillion, nearly double the $19.7 trillion reading for GDP.

If you really want to compare the market cap of U.S. corporations to the correct measure of economic output, it is much more logical to compare it to Gross Output, not GDP. By that measure the market cap of the U.S. stock market is still well below overall economic activity.

The real issue here is that investors should care little about GDP. No one buys shares of GDP. Investors buy shares of companies, and profits are proof that productivity is strong in the private sector. Government distorts the picture, showing both a secular stagnation and “bubble” that don’t really exist.

 

 

 

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Stay Invested: Economy Looks Good

One of our favorite economists, Brian Wesbury, Chief Economist of First Trust, offers this advice:

The current recovery started in June 2009, 105 months ago, making it the third longest recovery in U.S. history.

The longest – a 120-month recovery in the 1990s – saw real GDP expand an annual average of 3.6%. The current recovery has experienced just a 2.2% average annual growth rate – what we have referred to as “plow horse” economic growth.

That’s changing. In particular, the labor market is gathering strength. In February, nonfarm payrolls rose 313,000, while civilian employment, an alternative measure of jobs that includes small-business start-ups, rose 785,000.

Hourly wages rose a tepid 0.1% in February, but in the past six months, average hourly earnings are up at a 2.7% annual rate while the total number of hours worked is up at a 2.6% annual rate. Total earnings are up at 5.4% annual rate in the past six months, which is faster than the trend in nominal GDP growth the past few years.

New orders for “core” capital goods, which are capital goods excluding defense and aircraft, were up 6.3% in the year ending in January, while shipments of these capital goods were up 8.7%. Sales of heavy trucks – trucks that are more than seven tons – are up 17.4% from a year ago.

The pace of home building is set to grow in the year ahead, in spite of higher interest rates or the new tax law limiting mortgage and property tax deductions. In the fourth quarter of 2017, there were 1.306 million new housing permits issued, the highest quarterly total since 2007.

A better economy also means higher interest rates, but this doesn’t spell doom. Housing has been strong despite rising mortgage rates many times in history. In fact, both new and existing home sales were higher in 2017 than they were in 2016 in spite of higher mortgage rates.

Yes, the new tax law will be a headwind for homebuyers and builders in high-tax states, but it’s going to be a tailwind for construction in low tax states like Texas, Florida, and Nevada. Housing starts have increased eight years in a row. Look for 2018 to be the ninth.

In the past two months, both ISM surveys – for Manufacturing and Services – have beaten consensus expectations. The US economy is not going to grow at a 3.0% pace every quarter, but all this data suggests that our forecast for an average pace of 3% growth this year is on steady ground.

The bottom line is that the U.S. economy is accelerating, not decelerating, and the potential for any near-term recession is basically zero. Corporate earnings growth, and forecasts of future earnings, have accelerated, and our 2018 year-end forecast for Dow 28,500 and S&P 500 3,100 remain intact. Even with higher interest rates! Stay invested.

Have questions? Contact us.

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Clear Skies Ahead

Brian Wesbury of First Trust:

You know the old saying about every cloud having a silver lining? Well, if you listen to some of the financial press, you’d think their motto was that clear skies are just clouds in disguise.

Friday’s GDP report showed the economy grew 2.5% in 2017, an acceleration from the average rate of 2.2% from the start of the recovery in mid-2009 through the end of 2016. Notably, what we call “core” GDP – inflation-adjusted GDP growth excluding government purchases, inventories, and international trade – grew at a 4.6% annual rate in the fourth quarter and was up 3.3% in 2017.

However, some pessimistic analysts were calling attention to a drop in the personal saving rate to 2.6% in the fourth quarter, the lowest level since 2005. The pessimists’ theory is that if the personal savings rate is so low, consumers must be in over their heads again, so watch out below!

But this superficial take on the saving rate leaves out some very important points.

First, consumers don’t just get purchasing power from their income; they also get it from the value of their assets. And asset values soared in 2017 as investors (correctly) anticipated better economic policies. The market cap of the S&P 500 rose $3.7 trillion, while owner-occupied real estate looks like it increased about $1.5 trillion. That could be a problem if we thought stock market or real estate was overvalued, but our capitalized profits approach says the stock market is still undervalued and the price-to-rent ratio for residential real estate is near the long-term norm, not wildly overvalued like in 2005.

Second, the tax cut that’s taking effect is going to raise after-tax income. According to congressional budget scorekeepers, the tax cut on individuals should reduce tax payments by $189 billion in 2019, which is equal to 1.3% of last year’s after-tax income. So, consumers are going to be able to save more in the next few years, even if we don’t include the extra income that should be generated by extra economic growth.

Third, the personal saving rate doesn’t include withdrawals from 401Ks and IRAs, many of which are swollen with capital gains. So, let’s say a worker contributed $5,000 of their income into a 401K at the end of 1988 and kept that money in the S&P 500 ever since. Today they can withdraw more than $97,000 and spend it. When calculating the saving rate, the government counts every penny of that spending while not counting a penny of it as income. As the population ages and spends down wealth they’ve already made, the saving rate tells us less and less about the saving habits of today’s workers.

Sometimes good news is really just good news. Unfortunately, some analysts can’t look at clear skies without imagining clouds.

 

 

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No More Plow Horse

Brian Wesbury, Chief Economist of First Trust gives his take on the economy under the Trump Administration.

We’ve called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse. It wasn’t a thoroughbred, but it wasn’t going to keel over and die either. Growth trudged along at a sluggish – but steady – 2.1% average annual rate.

Thanks to improved policy out of Washington, the Plow Horse has picked up its gait. Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter. There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out. Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we’ve had three straight quarters of 3%+ growth since 2004-5.

Some say a government shutdown would make it tough to get another 3% quarter to start 2018, but we disagree. Yes, some “nonessential” government workers might pull back on their spending temporarily, but there’s no historical link between government shutdowns and economic growth.

The economy grew at a 2.8% annual rate in late 1995 and early 1996 during the two quarters that include the prolonged standoff under President Clinton. That’s essentially no different than the 2.7% pace the economy grew in the year before the shutdowns. The last time we had a prolonged standoff was in late 2013, under President Obama. The economy grew at a 4% rate that quarter, one of the fastest of his presidency.

Right now, taxes are falling, regulations are being reduced, and monetary policy remains loose. With these tailwinds, the acceleration of growth in 2017 should continue into 2018.

 

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A prediction for 2018 from Brian Wesbury of First Trust

Last December we wrote “we finally have more than just hope to believe that this year, 2017, is the year the Plow Horse Economy finally gets a spring in its step.” We expected real GDP growth to accelerate from 2.0% in 2016 to “about 2.6%” in 2017. Our optimism was, in large part, based on our belief that the incoming Trump Administration would wield a lighter regulatory touch and move toward lower tax rates.

So far, so good. Right now, we’re tracking fourth quarter real GDP growth at a 3.0% annual rate, which would mean 2.7% growth for 2017 and we expect some more acceleration in 2018.

The only question is: how much? Yes, a major corporate tax cut (which should have happened 20 years ago) is finally taking place. And, yes, the Trump Administration is cutting regulation. But, it has not reigned in government spending. As a result, we’re forecasting real GDP growth at a 3.0% rate in 2018, the fastest annual growth since 2005.

The only caveat to this forecast is that it seems as if the velocity of money is picking up. With $2 trillion of excess reserves in the banking system, the risk is highly tilted toward an upside surprise for growth, with little risk to the downside. Meanwhile, this easy monetary policy suggests inflation should pick up, as well. The consumer price index should be up about 2.5% in 2018, which would be the largest increase since 2011.

Unemployment already surprised to the downside in 2017. We forecast 4.4%; instead, it’s already dropped to 4.1% and looks poised to move even lower in the year ahead. Our best guess is that the jobless rate falls to 3.7%, which would be the lowest unemployment rate since the late 1960s.

A year ago, we expected the Fed to finally deliver multiple rate hikes in 2017. It did, and we expect that pattern will continue in 2018, with the Fed signaling three rate hikes and delivering at least that number, maybe four. Longer-term interest rates are heading up as well. Look for the 10-year Treasury yield to finish 2018 at 3.00%.

For the stock market, get ready for a continued bull market in 2018. Stocks will probably not climb as much as this year, and a correction is always possible, but we think investors would be wise to stay invested in equities throughout the year.

We use a Capitalized Profits Model (the government’s measure of profits from the GDP reports divided by interest rates) to measure fair value for stocks. Our traditional measure, using a current 10-year Treasury yield of 2.35% suggests the S&P 500 is still massively undervalued.

If we use our 2018 forecast of 3.0% for the 10-year yield, the model says fair value for the S&P 500 is 3351, which is 25% higher than Friday’s close. The model needs a 10-year yield of about 3.75% to conclude that the S&P 500 is already at fair value, with current profits.

As a result, we’re calling for the S&P 500 to finish at 3,100 next year, up almost 16% from Friday’s close. The Dow Jones Industrial Average should finish at 28,500.

Yes, this is optimistic, but a year ago we were forecasting the Dow would finish this year at 23,750 with the S&P 500 at 2,700. This was a much more bullish call than anyone else we’ve seen, but we stuck with the fundamentals over the relatively pessimistic calls of “conventional wisdom,” and we believe the same course is warranted for 2018. Those who have faith in free markets should continue to be richly rewarded in the year ahead.

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Don’t Fear Higher Interest Rates

Here’s some weekly commentary from Brian Wesbury of First Trust 

The Federal Reserve has a problem.  At 4.1%, the jobless rate is already well below the 4.6% it thinks unemployment would/could/should average over the long run.  We think the unemployment rate should get to 3.5% by the end of 2019 and wouldn’t be shocked if it got that low in 2018, either.

Add in extra economic growth from tax cuts and the Fed will be worried that it is “behind the curve.”  As a result, we think the Fed will raise rates three times next year, on top of this year’s three rate hikes, counting the almost certain hike this month.  And a fourth rate hike in 2018 is still certainly on the table.  By contrast, the futures market is only pricing in one or two rate hikes next year – exactly as it did for 2017.  In other words, the futures markets are likely to be wrong for the second year in a row.

And as short-term interest rates head higher, we expect long-term interest rates to head up as well.  So, get ready, because the bears will seize on this rising rate environment as one more reason for the bull market in stocks to end.

They’ll be wrong again.  The bull market, and the US economy, have further to run.  Rising rates won’t kill the recovery or bull market anytime in the near future.

Higher interest rates reflect a higher after-tax return to capital, a natural result of cutting taxes on corporate investment via a lower tax rate on corporate profits as well as shifting to full expensing of equipment and away from depreciation for tax purposes.

Lower taxes on capital means business will more aggressively pursue investment opportunities, helping boost economic growth and the demand for labor – leading to more jobs and higher wages.  Stronger growth means higher rates.

For a recent example of why higher rates don’t mean the end of the bull market in stocks look no further than 2013.  Economic growth accelerated that year, with real GDP growing 2.7% versus 1.3% the year before.  Meanwhile, the yield on the 10-year Treasury Note jumped to 3.04% from 1.78%.  And during that year the S&P 500 jumped 29.6%, the best calendar year performance since 1997.

This was not a fluke.  The 10-year yield rose in 2003 and 2006, by 44 and 32 basis points, respectively.  How did the S&P 500 do those years: up 26.4% in 2003, up 13.8% in 2006.

Sure, in theory, if interest rates climb to reflect the risk of rising inflation, without any corresponding increase in real GDP growth, then higher interest rates would not be a good sign for equities.  That’d be like the late 1960s through the early 1980s.  But with Congress and the president likely to soon agree to major pro-growth changes in the tax code on top of an ongoing shift toward deregulation, we think the growth trend is positive, not negative.

It’s also true that interest on the national debt will rise as well.  But federal interest costs relative to both GDP and tax revenue are still hovering near the lowest levels of the past fifty years.  As we’ve argued, sensible debt financing that locks in today’s low rates would be prudent. However, it will take many years for higher interest rates to lift the cost of borrowing needed to finance the government back to the levels we saw for much of the 1980s and 1990s.  And as we all remember the 80s and 90s were not bad for stocks.

Bottom line: interest rates across the yield curve are headed higher.  But, for stocks, it’s just another wall of worry not a signal that the bull market is anywhere near an end.

 

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Consuming doesn’t produce wealth, production does.

Our favorite economist, Brian Wesbury of First Trust just published and article discussing the Christmas shopping season and “Consumer Fundamentals.”  We changed his headline because there is something fundamentally more important in his comments, and it’s this:  consuming doesn’t make people wealthy, producing does.  No one ever got rich by sitting around consuming; people producing stuff is what makes communities, nations and cultures rich.

Now on to Brian’s commentary on the economy:

Now that Black Friday has come and gone and Cyber Monday is upon us, you’re going to hear a blizzard of numbers and reports about the US consumer. So far, these numbers show blowout on-line sales and a mild decline in foot traffic at brick-and-mortar stores. Both are better than expected given the ongoing transformation of the retail sector.

But Black Friday isn’t all that it used to be. Sales are starting earlier in November and have become more spread out over the full Christmas shopping season, so the facts and figures we hear about sales over the past several days are not quite as important as they were in previous years. Add to that the fact that this year’s shopping season is longer than usual due to an early Thanksgiving holiday.

But all this focus on the consumer is a mistake. It’s backward thinking. We think the supply side – innovators, entrepreneurs, and workers, combined – generates the material wealth that makes consumer demand possible in the first place. The reason we produce is so we can consume. Consuming doesn’t produce wealth, production does.

Either way, we expect very good sales for November and December combined. Payrolls are up 2 million from a year ago. Meanwhile, total earnings by workers (excluding irregular bonuses/commissions as well as fringe benefits) are up 4.1%.

Some will dismiss the growth as “the rich getting richer,” but the facts say otherwise. Usual weekly earnings for full-time workers at the bottom 10% are up 4.6% versus a year ago; earnings for those at the bottom 25% are up 5.3% from a year ago. By contrast, usual weekly earnings for the median worker are up 3.9% while earnings for those at the top 25% and top 10% are up less than 2%.

Yes, that’s right, incomes are growing faster at the bottom of the income spectrum than at the top. A higher economic tide is lifting all boats and helping those with the smallest boats the most. This is not a recipe for stagnating sales.

And so the voices of pessimism have had to pivot their story lately. Just a short while ago, they were still saying the economy really wasn’t improving at all. Now some are saying it’s a consumer debt-fueled bubble.

It is true that total household debt is at a new record high. But debts relative to assets are much lower than before the Great Recession. Debts were 19.4% of household assets when Lehman Brothers went bust; now they’re 13.7%, one of the lowest levels in the past generation. Meanwhile, for the past four years the financial obligations ratio – debt payments plus the cost of car leases, rents, and other monthly payments relative to incomes – has been hovering near the lowest levels since the early 1980s.

Yes, auto and student loan delinquencies are rising. But total serious (90+ day) delinquencies, including not only autos and student loans, but also mortgages, home equity loans, and credit cards are down 61% from the peak in 2010.

The bottom line is that investors should be less worried about consumer debt today than at any time in recent decades. Some think this could change if the Fed continues to raise interest rates, while selling off its bond portfolio. But interest rates are still well below normal levels and the U.S. banking system is sitting on trillions in excess reserves.

The US economy is less leveraged and looking better in recent quarters than it has in years. And better tax and regulatory policies are on the way. The Plow Horse is picking up its pace and consumer spending is in great shape.

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The Economy is Accelerating

Economic commentary from Brian Wesbury, Chief Economist at First Trust

The Economy is Accelerating

We’ve called it a “Plow Horse” economy, which was our metaphor invented to counter forecasters who said slow growth meant a recession was on its way. A Plow Horse is always slow, but that slowness hides underlying strength – it was never going to slip and fall. Now, the economy is accelerating.

Halfway through the fourth quarter, monthly data releases show real GDP growing at a 3%+ annual rate. If that holds, it would make for three consecutive quarters of growth at 3% or higher. Believe it or not, the last time that happened was 2004.

Last week saw retail sales, industrial production, and housing starts all come in better than expected for October, the latter two substantially better.

And while retail sales grew “just” 0.2% in October, that came on the back of a 1.9% surge in September. Overall sales, and those excluding volatile components like autos, gas and building materials, all signal a robust consumer.

Meanwhile factory output surged 1.3% in October, tying the second highest monthly gain since 2010. Production at factories is now up 2.5% from a year ago, and accelerating. By contrast, factory production was down 0.1% in the year ending October 2016 and unchanged in the year ending October 2015. The current revival is not due to the volatile auto sector, where output of motor vehicles is down 5.9% from a year ago while the production of auto parts is down 0.3%.

The last piece of last week’s good economic news was on home building: housing starts surged after a storm-related lull in September. Single-family starts, which are more stable than multi-family starts – and add more per unit to GDP – tied the highest level since 2007. Housing completions hit the highest level since 2008.

As a result of all this data, the Atlanta Fed’s “GDP Now” model says real GDP is growing at a 3.4% annual rate in Q4. The New York Fed’s “Nowcast” says 3.8%.

Of course, if we get anything close to those numbers, some analysts will claim the fourth quarter is just a hurricane-related rebound. But the conventional wisdom has been way too bearish for years, and Q3 is likely to be revised up to a 3.4% growth rate from the original estimate of 3.0%. Put it all together, and things are looking up. It’s no longer a Plow Horse economy. In fact, after years of smothering the growth potential of amazing new technologies, the government is finally getting out of the way.

The Obama and Bush regulatory State is being dismantled piece by piece, and spending growth has slowed relative to GDP. Tax cuts are moving through Congress. These positive developments have monetary velocity – the speed at which money moves through the economy – picking up. “Animal spirits” are stirring. We don’t have a cute name for it, but growth is accelerating.

This reduction in the burden of government would be easier, and much more focused on growth, if Republicans had fixed the budget scorekeeping process when they first had the chance back in 2015, or even in the mid-1990s, after having gained control of both the House and Senate.

Instead, they took a cowardly pass. As a result, when assessing the “cost” of tax cuts, Congress still ignores the positive economic effects of tax cuts on growth. Oddly, while refusing to “score” better GDP growth, we understand the budget scorekeepers assume tax cuts lead to higher interest rates, which add to the cost of the tax cuts. In effect, the scorekeepers will use dynamic models to count the negative effects of tax cuts on the overall economy, but not the positive ones!

This kind of rigged scoring system is why the current tax proposals don’t cut tax rates on dividends or capital gains, and why some of the tax cuts are temporary. It’s also why the top tax rate on regular income for the highest earners is likely to end up near the current tax rate of 39.6%.

We were never satisfied with Plow Horse growth, but we always thought it showed the power of innovation. The power of new technology caused the economy to grow since 2009, despite the burden of big government.

Now with better policies, growth is on the rise. We haven’t fixed enough problems to get 3% real growth in every quarter, and maybe not even as the average growth rate over time. That would probably take some major changes to entitlement spending programs. But the recent improvement is hard to miss and signals that entrepreneurship is alive and well in the United States.

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Can We Afford a Tax Cut?

 

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Our favorite economist, Brian Wesbury of First Trust says “yes.”:

Congress took a big step last week toward enacting some sort of tax cuts and tax reform.

That big step was the US Senate passing a budget resolution creating the room for ten years of tax cuts totaling $1.5 trillion with a simple majority vote. This procedure means there is no need to break a filibuster by getting to 60 votes.

So right about now is when self-styled “deficit hawks” will start to squawk. They will claim the federal government simply can’t afford to boost the federal debt, which already exceeds $20 trillion, with no end in sight.

Let’s put aside the issue that between 2009-12 many of these deficit hawks were supporting new spending, when annual federal deficits were $1 trillion plus. Let’s just take them at their word that they don’t think any policy that increases the deficit can be good for the economy.

One problem with their argument is that the $1.5 trillion is an increase in projected deficits over a span of ten years, not a definite increase in the debt. If tax reform focuses on cutting marginal tax rates, particularly on overtaxed corporate capital and personal incomes, and can thereby generate faster economic growth, the actual loss of revenue could be substantially less than $1.5 trillion or maybe nothing at all.

The estimate of a $1.5 trillion revenue loss is based on “static” scoring, which means the budget scorekeepers on Capitol Hill make the ridiculous assumption that changes in tax policy can’t affect the growth rate of the overall economy. Just a 1 percentage point increase in the average economic growth rate over the next ten years would reduce the deficit by $2.7 trillion, easily offsetting the supposed cost of the tax cut.

Another problem for the deficit hawks is that despite a record high federal debt, the servicing cost of the debt is still low relative to both the size of the economy and federal revenue.

Late last week, we got final numbers for Fiscal Year 2017 and net interest on the national debt was $263 billion – that’s just 1.4% of fiscal year GDP. To put that in perspective, that’s lower than it ever was from 1974 to 2002. The peak during that era was 3.2% of GDP in 1991. The lowest point since 1974 was 1.2% in 2015, not far from where we are today.

The same is true for interest relative to federal revenue, which was 7.9% in Fiscal Year 2017, lower than any year from 1974 to 2013. The high point during that era was 18.4% in 1991 and the recent low was 6.9% in 2015. Again, we’re still pretty close to the recent low.

Yes, interest rates should move up in the years to come, but it will take several years to rollover the debt at higher interest-rate levels. Even if interest rates went to 4% across the entire yield curve, the interest burden would remain below historical peak levels relative to GDP and tax revenue.

The US certainly has serious long-term fiscal challenges. The US government has over-promised future generations of retirees and should ratchet back these spending promises to encourage work, saving, and investment. Meanwhile, we need the US Treasury Department to issue longer-dated maturities like 50-year and 100-year debt to lock-in low interest rates for longer.

However, the absence of these changes should not be an obstacle to boosting economic growth by cutting tax rates and reforming the tax code. Plow Horse economic growth is certainly better than no growth at all, but turning the economy into a thoroughbred would make it easier to handle our long-term budget challenges, not harder.

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Monday Morning Outlook

Our favorite economist Brian Wesbury on the Economy:

GDP Growth Looking Good 

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/16/2017
Next week, government statisticians will release the first estimate for third quarter real GDP growth. In spite of hurricanes, and continued negativity by conventional wisdom, we expect 2.8% growth.

If we’re right about the third quarter, real GDP will be up 2.2% from a year ago, which is exactly equal to the growth rate since the beginning of this recovery back in 2009. Looking at these four-quarter or eight-year growth rates, many people argue that the economy is still stuck in the mud.

But, we think looking in the rearview mirror misses positive developments. The economy hasn’t turned into a thoroughbred, but the plowing is easier. Regulations are being reduced, federal employment growth has slowed (even declined) and monetary policy remains extremely loose with some evidence that a more friendly business environment is lifting monetary velocity.

Early signs suggest solid near 3% growth in the fourth quarter as well. Put it all together and we may be seeing an acceleration toward the 2.5 – 3.0% range for underlying trend economic growth. Less government interference frees up entrepreneurship and productivity growth powered by new technology. Yes, the Fed is starting to normalize policy and, yes, Congress can’t seem to legislate itself out of a paper bag, but fiscal and monetary policy together are still pointing toward a good environment for growth.

Here’s how we get to 2.8% for Q3.

Consumption: Automakers reported car and light truck sales rose at a 7.6% annual rate in Q3. “Real” (inflation-adjusted) retail sales outside the auto sector grew at a 2% rate, and growth in services was moderate. Our models suggest real personal consumption of goods and services, combined, grew at a 2.3% annual rate in Q3, contributing 1.6 points to the real GDP growth rate (2.3 times the consumption share of GDP, which is 69%, equals 1.6).

Business Investment: Looks like another quarter of growth in overall business investment in Q3, with investment in equipment growing at about a 9% annual rate, investment in intellectual property growing at a trend rate of 5%, but with commercial constriction declining for the first time this year. Combined, it looks like they grew at a 4.9% rate, which should add 0.6 points to the real GDP growth. (4.9 times the 13% business investment share of GDP equals 0.6).

Home Building: Home building was likely hurt by the major storms in Q3 and should bounce back in the fourth quarter and remain on an upward trend for at least the next couple of years. In the meantime, we anticipate a drop at a 2.6% annual rate in Q3, which would subtract from the real GDP growth rate. (-2.6 times the home building share of GDP, which is 4%, equals -0.1).

Government: Military spending was up in Q3 but public construction projects were soft for the quarter. On net, we’re estimating that real government purchases were down at a 1.2% annual rate in Q3, which would subtract 0.2 points from the real GDP growth rate. (1.2 times the government purchase share of GDP, which is 17%, equals -0.2).

Trade: At this point, we only have trade data through August. Based on what we’ve seen so far, it looks like net exports should subtract 0.2 points from the real GDP growth rate in Q3.

Inventories: We have even less information on inventories than we do on trade, but what we have so far suggests companies are stocking shelves and showrooms at a much faster pace in Q3 than they were in Q2, which should add 1.1 points to the real GDP growth rate.

More data this week – on industrial production, durable goods, trade deficits, and inventories – could change our forecast. But, for now, we get an estimate of 2.8%. Not bad at all.

I like the way he puts it: The economy hasn’t turned into a thoroughbred, but the plowing is easier.

 

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