More of the Same

I have just finished reading an economist’s projection of 5% real growth in the U.S. economy for next year. Amazing. The optimism stems from a belief that a new administration will be able to dramatically (and immediately) increase economic growth. The problem is that the U.S. and global economy continue to face major structural issues—too much debt, an aging population, declining productivity and a slowing global economy–that are beyond the control of any politician.

But let’s play the game for a minute. What does a year of 5% real growth mean? In the recovery from the Great Recession, we have had only one 5% quarter (3Q of 2014) despite massive stimulus by the Federal Government and the Federal Reserve including an enormous infrastructure program in 2009 that you may have forgotten about. The last time real GDP grew by 5% on a year-over-year basis was 2Q of 2000. The last time we had four consecutive quarters of 5% year-over-year real GDP growth was in 1984-5.

Since 1946, U.S. real GDP has grown at an approximate 3.2% annual growth rate. Returning to this historic growth rate from the recent 2% average is already a huge stretch. For the recovery since 2009 to accelerate to an annual real growth rate of just 3%, GDP would have to grow by 5% for the next 14 quarters.

Perhaps you are excited by Trump’s proposal to spend $1 Trillion on infrastructure over the next 10 years. Infrastructure spending seems to be one of the primary drivers for the market’s recent enthusiasm. The proposed $1 trillion increase in U.S. infrastructure spending by the government over the next decade is just a drop in the bucket compared to what is already being invested in fixed assets. Over the past five years, China has spent over $20 trillion in fixed investment. The U.S. public sector has spent just $1.3 trillion but the U.S. private sector has picked up the slack, investing more than $13 trillion over the past five years.

Trump’s spending plan is simply not a big deal although it is probably more than a Republican Congress will approve without substantial offsetting spending cuts in social security and medicare.

Meanwhile, higher U.S. interest rates are a looming disaster. Debt to GDP has increased significantly over the past decade. Believe it or not, the U.S. government paid slightly less interest expense over the past 12 months than it did in 2007 even though total debt outstanding as a percentage of GDP has increased from approximately 65% to 105%. That’s the miracle of Fed-generated ultra-low interest rates. Now the Fed is promising to raise rates and normalize monetary policy, which the market seems to love. A sustained period of higher interest rates will dramatically eat into the government budget at the expense of many other spending programs including Trump’s promised military build-up, infrastructure spending and tax cuts.

None of this adds up, dear reader. The dollar is supposedly stronger because of rapid economic growth next year and Fed rate hikes. The strong dollar and Fed rate hikes will certainly depress growth. Higher rates will cut into the government spending that is supposed to generate the stimulus for the growth that is supposed to cause higher rates. If you can figure this out, dear reader, please drop me a line. To me, this is a blatant series of circular contradictions that has mania written all over it, not 5% real growth. I see another year of 2% growth ahead of us, at best. More of the same.