Thursday, January 12, 2017

Economic headwind for Trump

The President of the United States has far less power over the economy than most assume.  Blaming or applauding administrations for economic performance during their administrations is largely misplaced.  The Federal Reserve and energy costs have a far greater impact and are largely outside the control of the president.

President Barrack Obama entered office in 2009 at the precipice of an economic collapse.  By a range of measures the economy was declining as banks failed, housing collapsed, stocks tanked, GDP declined and unemployment rose from 4.5% to nearly 10%.   By the end of the Obama Administration stocks are setting records, GDP has risen (though at a slow pace) and unemployment is below 5%.

Drilling into the details, things are not as rosy as those indicators suggest (e.g. national debt at $20 trillion, median incomes sluggish, labor participation sank to 1970 levels, etc.), but things are measurably better economically than they were at the beginning of 2009.  The credit for surviving the crisis and the improved economic state (and the blame for the negatives) can only marginally be ascribed to Obama.

Federal Reserve Chairman Ben Bernanke can be credited with saving the U.S. from economic meltdown through his swift and effective action of closing failing banks, increasing money supply and zeroing interest rates. During his Chairmanship the U.S. economy grew while Europe’s and others continued to wilt.

The Fed’s continuing near zero interest rate policy throughout the Obama Administration under both Bernanke and his successor, Janet Yellen, provided cheap money that fueled the record stock market, housing recovery, and general economic improvement.

The push from the top by the Fed was buttressed from the bottom by lower fuel oil, gasoline, and natural gas prices.  Lower energy costs have a direct impact on the consumer pocketbook that allows for greater discretionary spending.  From more dinners out to new auto purchases lower energy prices have a significant impact on the economy. By some estimates the average family has seen a $700 annual infusion into their annual pocketbook from lower energy prices.

But the tide is shifting and the economic forces that aided Obama are likely to negatively impact the Trump Administration.

The Fed began raising interest rates in 2015 and that trend is likely to continue.  The effect of rising interest rates on housing markets, business investment, and bond markets could have an overall negative economic impact during the Trump years.   In addition, rising interest rates have a tremendous impact on the annual federal budget.

If projections that interest rates on the ten-year Treasury bonds will go up to 4% by 2019 are correct the annual interest payment on the existing debt will rise from slightly over $250 billion during the Obama low to approaching $1 trillion during Trump’s first four years.

Hydraulic fracking (regardless of its efficacy) doubled U.S. field oil production during the Obama years from 5 to nearly 10 million barrels per day.  Canadian oil production is up nearly 55% due to fracking and other extraction improvements (e.g. from tar sands).  These two developments drove the glut in worldwide supply that forced all energy prices down.

But as prices at the pump decreased investment in high cost extraction was stopped because the profits were not there at low retail price levels. Production in the U.S. declined by nearly 1 million barrels per day over the last few years and that trend likely will continue.  In addition, OPEC finally reached agreement in November, 2016 to reduce production by 1.2 and non-OPEC producers another 600 thousand barrels per day.

Consumers can see prices rising daily and that trend is going to continue for an extended period.  The difference between $2 per gallon of gasoline and $4 is about $300 billion a year out of the American consumer’s pocket and into Saudi Arabia, Iran, and Russia’s pockets.  Add to this natural gas, heating oil, and electric rate energy components and it represents a tremendous impact.

Given that these two powerful economic forces are largely outside the president’s power, what can a president do to contribute to an improved economy?  

President Obama’s signature response to the economic downturn was the American Recovery and Reinvestment Act. The $830 billion program created about 76,000 full time equivalent jobs.  That is about $1M per job created.  It added somewhere between .1 and .4 percent to GDP according to the Congressional Budget Office – a marginal impact, but still positive.

President-elect Trump also proposes a stimulus, but the intent and manner of funding will be different.  The details of the plan are as yet insufficient to make judgement about its potential for success.  However, some analysts indicate the Trump proposal could increase annual GDP by 1% and have a long term economic capacity increase.

Claims and reality are often very different.  As Obama claimed his stimulus would produce 2.3 million jobs and only created 76,000 any outpouring of superlatives should be viewed with a raised eyebrow and solid measures of success demanded.  At the same time, the impact on the national debt and deficit spending in a rising interest rate environment must also temper stimulus enthusiasm.
There are many more differences in the approach that Trump will take.   His focus will be on increasing the economic pie rather than how it is sliced.   His policies on trade, manufacturing, regulation, and immigration can all have an effect on the economy. The impact is smaller than the actions of the Fed, but it can be significant.

The challenge for Trump will be that government policies rarely have immediate impact.  There is a significant lag in the effect.  Trump would be well advised to pass legislation quickly if he expects any impact in his first term.

Economic performance will be the greatest measure of success for the Trump Administration.  The trend in interest rates and energy are likely to work against the administration.  Can Trump in that environment increase the single best measure of a growing pie?   If the GDP in the second two years of a Trump Administration exceeds 3% growth rate one should expect a 2nd Trump term or a Pence presidency in 2020.  Substance will supersede style.

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