Not So Fancy Economics
We have all been inundated with talk of the U.S. economic climate, especially with the impending ‘fiscal cliff’. Having had exposure to both public and private markets, I’ve been taught that an accurate picture of the economy has to come from both sides of the table – the government and the consumer. Below, I have outlined three simple factors that may help paint the current state of affairs. The article is by no means an exhaustive list - it is quite the opposite (hand-picked). Any and all feedback is welcome!
1) The Rule of No Alternatives: If we compare numbers from the Bureau of Economic Analysis, we see that GDP growth has slowed down significantly from Q2 2011 (2.5%) to Q2 2012 (1.3%).The dreaded fiscal cliff has done its part to increase uncertainty and thus influence consumer intent. But GDP growth should never be analyzed independently. Dept-to-GDP ratio has long been considered an indication of economic health.
Figure 1 below analyzes how our dept-to-GDP ratio has changed over time and how its sharp peaks are identifiable parts of our history. The simple and slightly worrisome takeaway is that our ratio is 73% (not far from our World War II number), which is dangerous in that it continues to grow further from China’s debt-to-GDP ratio (roughly 43%). We don’t want to end up in the same bucket as Japan which is in the 200%+ range, or Italy and Spain which were at 120% and 69% in 2011. In a study by Carmen M. Reinhart and Kenneth M. Rogoff, of Harvard University, a debt-to-GDP ratio of more than 90% leads to growth “over one percent lower than other periods.” We are inching closer to this number.
Figure 1: Source (The Atlantic, Congressional Budget Office).
Here’s the clincher though (and I promise to stop being negative) – due in part to the rise in debt, treasuries are at a ridiculously low price. In our current climate, one would expect foreign investors to flee from US government debt; but, according to the Treasury Department in September 2012, international purchases of Treasuries rose to $50 B in July 2012 from $32.4 B in June 2012. As the European market continues to show instability, America is still one of the safest places for sovereign wealth funds and other international investors to invest their money. Yields go down when there is demand for Treasury products and the 10-year treasury note is at 1.65% today. It hit an intra-day low of 1.442% on June 1, 2012, which was its lowest level since the early 1800s. Whatever doomsday scenario the pundits are painting, America is still the most transparent economy in the world and foreign investors are putting their money where their mouth is.
2) It’s a Slope, Not a Cliff: Few people make more sense to me than Jan Hatzius, Chief Economist at Goldman Sachs and author of a recent paper titled “The US Economy in 2013-2016: Moving Over the Hump.” Central to this paper is a simple theory demonstrated in Figure 2. According to Hatzius, “Every dollar of government deficit has to be offset with private sector surpluses purely from an accounting standpoint, because one sector’s income is another sector’s spending, so it all has to add up to zero.” In simple terms, when customers spend, the government gets a source of revenue, alleviating debt. When they save and opt not to take consumer risk (leverage), government debt widens as they have lost their key source of revenue. Hatzius predicts positive growth post 2013, as a result of increased private sector spend. If the government continues to scare consumers into thinking we are heading into another recession, they will not spend and thus, not offset the government deficit.
Figure 2 - Source: Department of Commerce, Business Insider
3) Protect Innovation: Diversity begets innovation. Innovation spurs economic growth. And nowhere better has that theory proved to be true than Silicon Valley. According to Vivek Wadwha, Silicon Valley is a great example for spurring diversity in the job market. He claims that more than half of the Valley’s tech employees are foreign born. Foreign countries such as Germany and France send their best and brightest to the US to get advanced degrees. This sounds great for our economic growth until we send them straight back, US-trained, and ready to spur economic growth in a country that is not ours. Igor Sill, in a recent article, mentioned: “Early stage entrepreneurs in the US made up 7.6%, compared to China’s 14% and Brazil’s 17% of newly formed businesses.” Silicon Valley is our secret weapon, and we are falling behind.
The STEM Jobs Act, the first foot forward in remedying our past policies, was rejected by the White House after being passed in the House by an overwhelming majority of Republicans. If it hadn’t been reduced to a partisan tug of war, it would grant 55,000 visas to non-citizens who acquired an advanced degree in science, technology, engineering or math at U.S. universities. We will lose our high ground as chief innovators of the world if we don’t retain diverse talent.
To summarize, there are economic indicators that are indeed scary and hard to wrap our heads around. But barring a fiscal cliff fiasco, 2013 actually looks positive. Private sector spend should increase, alleviating government debt; instability in alternative markets should continue to spur foreign investment, and innovation should continue to be our no. 1 strength.
Disclaimer: These views are my own and not those of my employer.