Thursday, August 1, 2013

Welcome to the Depressing Future?

Yesterday's report that the U.S. economy expanded by +1.7% in the second quarter was largely greeted as "good news" by Wall Street.

Here's an excerpt from what the New York Times reported this morning:

The mixed picture facing the country was evident on Wednesday, as the Commerce Department reported that the economy, adjusted for inflation, expanded at a better-than-expected annual rate of 1.7 percent in the April-June quarter, even as inflation-adjusted growth in the first part of the year now appears slower than first thought....

Optimists point to improved levels of job creation in recent months, a more robust housing sector and a surging stock market that has lifted the value of investment and retirement accounts for millions of consumers. Pessimists focus on the fact that the estimated economic growth rate of about 1.4 percent so far in 2013 is well below last year’s levels of 2.8 percent, even as automatic cuts in federal spending and higher taxes continue to bite.

We are now in the fourth year of an economic recovery that started in the summer of 2009.  However, real wage growth remains non-existent for a large part our country, and the unemployment rate hovers at levels (7.6%) that would have been unacceptable a generation ago:
 FRED Graph

 The growth of real GDP remains depressed, and has never reached the levels seen in the 1990's; note the general decline in the following chart:

FRED Graph

Many analysts blame today's subdued growth rates on the large amounts of debt accumulated in the past decade.  Growth will remain depressed until this debt burden is reduced, they argue, but will once again return to previous levels once more funds are flowing back into investment rather than debt repayment.

Others blame Washington's obsession with deficit reduction, and are urging a new round of government fiscal expansion. Austerity policies are killing the economy, in this view.

But there is another more depressing possibility: Perhaps there are structural reasons that the growth rates that were experienced over the past couple centuries were historic anomalies, and that we are not likely to return to robust (+4% or higher) growth rates for decades.

In this view, there is nothing that any policy changes can do to alter the subdued future.

An aging population, coupled with declining birth rates in many industrialized countries, could be the real culprit for anemic growth. If this is the new reality, no amount of government intervention can make a material difference in the economy.

That's the suggestion that Robert Gordon, a well-respected economist from Northwestern raised in a paper published last year.  The story was picked up by New York Magazine last week.

I hope Gordon is wrong, of course, but this is not another wild-eyed pessimist calling for doom-and-gloom.  Instead, Gordon argues that for much of human history economic growth was fairly minimal.  It was not until the industrial revolution beginning in the 1840's that any significant changes in the human condition occurred.

Subsequent improvements in the global standard of living followed technological breakthroughs. The discovery of ways to distribute electricity, for example, completely changed society, as activities no longer had to be structured around sunlight.

More recent technological innovations have been exciting, but not "game changers" when it comes to the way that most of us live our lives.  Air conditioning may make summers more bearable, but they do not appreciably change our lives in the same way that improvements in public health facilities once did.

I could go on, but here's an excerpt from the New York article:

Then two things happened that did matter, and they were so grand that they dwarfed everything that had come before and encompassed most everything that has come since: the first industrial revolution, beginning in 1750 or so in the north of England, and the second industrial revolution, beginning around 1870 and created mostly in this country. That the second industrial revolution happened just as the first had begun to dissipate was an incredible stroke of good luck. It meant that during the whole modern era from 1750 onward—which contains, not coincidentally, the full life span of the United States—human well-being accelerated at a rate that could barely have been contemplated before. Instead of permanent stagnation, growth became so rapid and so seemingly automatic that by the fifties and sixties the average American would roughly double his or her parents’ standard of living. In the space of a single generation, for most everybody, life was getting twice as good.

At some point in the late sixties or early seventies, this great acceleration began to taper off. The shift was modest at first, and it was concealed in the hectic up-and-down of yearly data. But if you examine the growth data since the early seventies, and if you are mathematically astute enough to fit a curve to it, you can see a clear trend: The rate at which life is improving here, on the frontier of human well-being, has slowed.

There are numerous investment implications if Gordon is right.

It is widely assumed, for example, that interest rates will spike higher once the Fed begins to "taper" its presence in the credit markets.  However, an aging population with a need for fixed income in retirement may continue to keep interest rates lower than the levels seen during more robust growth periods. What if rates stay below 3% for years to come?

The growth companies of the past were companies who offered goods and services to a growing and dynamic population.  However, while there has been no lack of retailing activity, retailing companies themselves are struggling, as more of shopping is done on-line.  Just look at how few of the companies in the consumer discretionary space in the S&P 500 are growing revenue at reasonable growth rates.  And shopping malls - once a mecca of suburban activity - are seeing dramatically lower traffic levels, or are even going out of business.

Worth a read if you have the time.