With the United States now more than 10 years into a period of economic recovery and growth – approaching the longest-ever expansion in its history – there is no shortage of speculation about when the next downturn will occur, and why. But despite uncertainties at home and abroad, economists interviewed by the Business Journal aren’t expecting another recession any time soon.
“Growth is the default mode of the economy. But for some severe shock to the economy, there is no reason in the world to have a recession,” Christopher Thornberg, founding partner of Los Angeles-based Beacon Economics, told the Business Journal. To say that we could have a recession because we’re due for one “simply doesn’t cut it,” he added.
The country’s rate of economic growth is slowing – both Thornberg and Wells Fargo Managing Director and Senior Economist Mark Vitner predict a 2% increase in gross domestic product (GDP) this year versus 2018’s 2.9% growth rate. “The slowdown in the U.S. economy is primarily due to the slowdown that we are seeing in global economic growth,” Vitner said. “A lot of that is tied to the uncertainty surrounding the ongoing trade negotiations with China. China’s economy has slowed a great deal. And companies [and] countries that export a lot to China have seen business fall off.”
In May, the Trump administration increased tariffs on $200 billion worth of Chinese imports from 10% to 25%. In response, the Chinese government increased tariffs on about $60 billion in American imports by the same amount. President Trump and China President Xi Jinping were expected to meet at the G20 summit in Japan on June 29, after the Business Journal’s press time, to discuss the ongoing trade dispute.
“I do think that if the trade war escalates significantly and persists for a very long time that it could plunge the global economy into a recession, and that could pull down the U.S. economy,” Vitner said. Still, he said that’s not in Wells Fargo’s forecast. “I think it’s going to be contentious right up until the moment an agreement is reached. . . . And then, as we have seen so many times with Trump, out of the blue – boom, there is an agreement.”
Thornberg pointed out that slowing economic growth could be tied to the waning effects of the tax cuts, which were primarily felt last year. “Remember, last year’s growth rate was in part driven by the fact that in the midst of a full employment expansion economy, Congress went and passed fiscal stimulus, which is typically something used during recessions to reduce the impact of that negative shock [to the economy],” Thornberg explained.
The Tax Cuts and Jobs Act of 2017 acted as something of a steroid to the economy in 2018 – GDP increased 3.5%, 2.6 million new jobs were created, wages increased, and the national unemployment rate dipped just below 4%. The economy continues to add jobs, wage growth continues and the unemployment rate remains low at 3.6%. But Thornberg noted that the initial shot in the arm from the tax cuts has likely worn off.
“You’ve got the big short-run bounce, which is just what happens when you put a big surge of extra money in people’s pockets. And that kind of fades away relatively quickly,” Thornberg said. “But the long-run impact is there, [although] probably much smaller.” He noted that the Congressional Budget Office has estimated that the annual impact of the tax cuts will shape up to a one-tenth of a percent increase per year, a figure he called “miniscule.”
While Vitner felt that the initial boost the tax cuts gave to consumer spending may have passed, he said that the cuts are still acting as an economic stimulus. “We are seeing that businesses are investing more in capital improvements and process improvements in their workplaces, which is boosting productivity growth and allowing the economy to grow a little bit faster,” he said. Still, he qualified, “I think the benefits in tax cuts are more long term, but those long-term benefits are going to be far less dramatic than what we saw last year.”
Consumer spending has increased by about 3.5% this year, according to Vitner. “My general sense is that the consumer is in pretty good shape,” he said. “On the plus side, wage increases are picking up. The unemployment rate is low, jobs still seem to be readily available. Inflation has come down, and gasoline prices are coming down a little it.” To that last point, Vitner noted that Californians, who are subject to a state gas tax with another increase scheduled to take place July 1, are less likely to benefit from lower gasoline prices.
Wage growth is continuing this year at a rate of about 3-3.5%, according to Thornberg. However, he noted, this figure does not account for employment benefits, which are also improving. “People are getting ahead for sure,” he said. “The labor market is super tight, and it’s good for workers.”
Current economic uncertainties primarily have to do with concerns abroad and the domestic housing crisis, based on feedback from Thornberg and Vitner.
The German and French economies are losing momentum, Italy is experiencing sizable budget deficit challenges, and the threat of Brexit is still looming on the horizon, Vitner pointed out. Although the domestic economy is “looking fairly good,” Vitner said, “There are a lot of issues in the global economy that are likely to come to a head in the second half of the year.” He added, “Most of them have negative implications for global economic growth.”
A short housing supply has been exacerbating affordability issues in California and nationally. Here in the Golden State, if the issue isn’t resolved, expect the labor market to become even more constrained, according to Thornberg. “Labor force growth is terrible because we’re not building enough housing,” he said. “It makes me crazy that the state has done basically nothing to actually start to alleviate things. All their grand ideas were stalled in committees and it’s like, c’mon, man.”
Thornberg emphasized that the root problem is one of supply. “Affordability is driven by the lack of supply,” he said. “It’s not really an affordable housing crisis in a direct sense, and it’s dangerous to use those terms, because then we run around and talk about rent control. Well, rent control doesn’t increase supply. Are we talking about affordable housing mandates? That doesn’t increase supply. Ultimately, if you come up with plans that actually reduce supply, the reduction in supply is going to worsen affordability for everybody else.”
Thornberg said that cities must be incentivized to build more housing rather than new commercial projects. “The problem here is cities just don’t want housing because 80% of their revenues come from business, [and] 80% of their expenses come from residents,” he said. “There are all sorts of road blocks and too much downzoning and everything else. They need to get serious about what to do about it.”
Vitner made a similar assessment of California’s housing situation. “We’re going to continue to see an affordability problem until the government finds a way to reduce the up-front cost of building a home,” he said. “We have to streamline the permitting process. We have to find a way to reduce entitlement costs. Because the homes are almost unaffordable even before you pour the foundation, and it’s just so expensive to develop the land.”
A commonly cited indicator of an incoming recession, an inverted yield curve – a phenomenon that occurs when long-term debts have lower yields than short-term debts – is currently present in the U.S. economy. But Thornberg doesn’t find it to be an indicator of tough times ahead. “The inverted yield curve is not a sign that we’re going to have a recession. The inverted yield curve is driven by the Fed,” he said. The Federal Reserve controls interest rates on debts through its federal funds rate. Last year, the Fed raised this rate multiple times, resulting in higher interest rates for short-term debts, and contributing to the inverted yield curve.
“In ’06 we had an inverted yield curve because the Fed thought the economy was overheating, and then they were trying to slow things down. They didn’t slow it down enough and we had a recession anyway,” Thornberg recalled. “This time we have an inverted yield curve because the Fed thought we had an inflation problem. But we don’t have an inflation problem.”
Vitner said he expects the Fed to reduce interest rates in response to the inverted yield curve. “It has been a fairly good predictor of a recession because every recession we’ve had since World War II has been preceded by an inverted yield curve,” he said. “But not every inverted yield curve has been followed by a recession.”