Two weeks ago the Siouxland Chamber of Commerce sponsored a presentation by William Strauss, a senior economist with the Federal Reserve Bank of Chicago. Mr. Strauss’s data-filled discussion presented a picture of an economy growing at a “trend” pace, defined as GDP growth of 2.0% to 2.5% per year. Trend growth potential was further defined to be the combination of population growth (about 0.5% per year) and productivity gains (about 1.5% to 2.0% per year). Mr. Strauss also noted that employment gains and inflation are approaching levels that some Fed officials believe justify higher short term interest rates.
So far, so good. The U.S. has witnessed a slow but steady recovery from the Great Recession (now approaching a decade ago), and there are few indications that growth will be curtailed in the near future or that imbalances exist in the economy today. Yet it is clear that this time something is different. Progress from the economic trough has been at a much slower pace than that of past post-recession periods. The definition of “trend” GDP growth as 2.0% to 2.5% per year is a full percentage point lower than that recorded for most of the post- World War II era.
Why is this important? In an $18 trillion dollar economy, a one percent drop in the growth outlook translates to nearly $200 billion per year in foregone activity compared to previous cycles. In fact, the Fed’s Open Market Committee summary of economic projections no longer sees 3.0% growth in our future, in either the short or long term. That’s a lot of job creation, housing starts, auto sales, and investment spending that will not take place (not to mention lost tax revenues to Washington).
There was little discussion on the roles of public debt created by deficit spending, or of accommodative monetary policies, in either boosting past growth or impeding future progress. What is clear, however, is that record low interest rates (and negative rates overseas) are no longer having the impact predicted by standard Keynesian models. Community banks aside, the majority of recent low-cost business borrowing is not going to expansion and improvement but to stock buybacks, mergers, and other financial engineering. That’s not how these programs are supposed to work.
And, there were no comments on the impact of slower growth on society’s ability to support steadily rising transfer payments to the elderly, infirm, and others unable to participate in a less robust economic environment. There are no political or sociological criticisms intended here. However, the fact is that our social support models have developed over the years based on economic and demographic assumptions that are unlikely to be achieved going forward. A period of reckoning is coming.
So what does this mean to investors? Hard to tell for sure, since we are in uncharted waters. Logic suggests, however, that future returns in financial markets will be less lucrative than in recent decades. This will place a premium on two things: first, the ability to delineate your goals; and second, the adoption of a comprehensive investment plan that helps to achieve these goals with a controllable amount of risk. That’s where we can help. Let’s work together to meet the challenges ahead.
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