It’s been a month since my last post was published. I apologize for the delay. My office flooded 2 weeks ago and I’ve been temporarily working out of a cubicle and conference room while my office is being repaired. I’m hoping to move back in by mid-April. Here’s a look at the restoration crew destroying my office!
Nevertheless, the time off has really given me the time to evaluate this crazy market we are in. Since my last post in February, the stock market completed an about-face and nearly pushed the major indices positive for the year. As it currently stands, the S&P 500 is at 2040, a 10% increase from the Feb 11th lows!
The Federal Reserve
With 1/3 of all of the major global central banks adopting a negative interest policy, all eyes were on the U.S. Federal Reserve this week. The Fed released their FOMC meeting minutes yesterday. Heading into yesterday’s meeting, the Fed indicated that they intended to raise rates 4 times in 2016 with the following economic targets driving their decision:
- Unemployment below 5% (currently 4.9%)
- Inflation target at 2.00% (currently 1.67%, up sharply from 1.31% last quarter and rising)
- The Fed uses Core PCE (officially) to read inflation levels, though there are many different ways to evaluate current inflation levels
However, yesterday’s meeting indicated that they will NOT be raising rates 4 times, but probably only 2 times. Even though U.S. economic data has improved over the past month, the Fed indicated that they are worried about global growth and they are backing off of future rate increases. Not surprisingly, the U.S. Dollar index plummeted with the news. Of course, if this trend continues, a cheaper dollar will help U.S. exports and other companies competing overseas.
This is a bit of good news as I was beginning to worry about the full impact of a diverging U.S. monetary policy. With the Bank of Japan, the ECB, and many other European banks adopting a negative interest-rate policy, it did not make sense to have the United States increase rates, especially in a world where global growth is stalling.
What’s Driving The Slowdown?
The easy answer to this question would be to say that China’s economic woes are impacting the rest of the world, but this wouldn’t be telling the whole story. Why this is happening? Is China’s economic problems the sole variable behind Europe’s sluggish growth? What about Japan? As Eric Sussman (a popular UCLA professor!) pointed out last week, this has more to do with demographics than anything else. There are not enough young people to replace the retiring population. As a result, GDP growth is stalling. Growth Rate of GDP is a simple equation: GDP Growth = Growth Rate of a Population + Growth of GDP per Capita. For all of you who took a global economics class, you know that the Production Function is another way of looking at the same relationship: the relationship between output (GDP growth) and its inputs (Labor and Capital).
In short, the concern is that the number of retirees is increasing and those retirees are living longer lives. For many western countries, the number of births is too low to replace those that have left the workforce. The Trillion-Dollar question then becomes: where is the growth going to come from?
Here in the USA, we are lucky to have a well-distributed population. If this remains to be the case, the labor force should remain full (in theory). When looking at Western Europe and Japan, you can clearly see that the number of births is not keeping up with the number retirees / potential retirees. Both show an inverted triangle. Japan’s aging population has been a thorn in their side for years. It’s the primary reason why their growth has lagged for decades. And by taking a look at China, you can see how their One-Child policy, introduced between 1978 and 1980, is likely to lead to the same troubles (is it already happening?).
If a country cannot replenish it’s labor force, what else can it do? GDP growth can also be born from productivity. Technological progress can lie at the heart of an economy and the types of jobs it employs. The concern with this, of course, is that technological progress can lead to a higher unemployment rate. Computers and robots (yes, robots) are more efficient and predictable than humans. This helps reduce production costs which, of course, increases profit margins (think online universities, Detroit’s robots on the production line, Google’s driverless cars, Amazon replacing brick and mortar bookstores, etc.). While these efficiencies are a boon for the average consumer and for GDP growth, it does not require a lot of people to deliver these products. In a world like this, very few individuals will be making a lot of money.
Here is the paradox in all of this: if technological advances increases productivity (driving GDP growth), it will also likely lead to higher levels of unemployment and inequality. If a country is experiencing an aging population with a low birthrate, future economic growth is likely to be muted. Those with computer and technological skills will be of the highest demand, but those without these skills will likely have a difficult time finding a job. I don’t have a solution to this problem and I’m not even sure if the world will certainly face this problem, but I think this is an issue that deserves more attention.