FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 8, 2016
- US Unemployment Rate Dropped to 4.9% in October
- Why the US Economy is Weaker Than It Looks
- The National Debt: Why No One is Talking About It
Before I get into today’s topics, I think I speak for most Americans when I say that we are relieved that this election will finally be over late tonight or early tomorrow. This has been the ugliest and most embarrassing election in most of our lifetimes.
Both candidates have the highest “unfavorable” ratings in history, and many Americans had to hold their noses to vote for either one of them. How this came to happen in 2016 will be the subject of countless debates in the months and years ahead, regardless of the outcome.
This election featuring two highly unpopular and ethically-challenged candidates has divided America as never before. And sadly, neither candidate has what it would take to unite the country. Likewise, neither candidate will have the overwhelming support of Congress to get things done going forward.
I predict it will be a long four years no matter who wins. I hope I am wrong but I doubt it.
As for today’s topics, we’ll start with a look at last Friday’s unemployment report for October, which was met with mixed reviews. Next, we’ll look at some new analysis following the better than expected 3Q GDP report which I wrote about last week. Unfortunately, the latest news suggests that the economy is not likely to repeat that performance in the 4Q or next year.
Regarding our ballooning national debt of $19.8 trillion, there is new analysis on what happens when interest rates go back up to normal levels in the next few years. I’ll offer some new statistics that may disturb you, but they are facts we all need to know. Let’s get started.
US Unemployment Rate Dropped to 4.9% in October
The Labor Department’s Bureau of Labor Statistics (BLS) reported on Friday that the official unemployment rate dropped to 4.9% last month from 5.0% in September. That was a little better than the pre-report consensus of 5.0% again.
The economy created 161,000 new jobs last month, down from the 170,000 expected and below the 181,000 monthly average over the last year. That was a little disappointing. The good news is that the BLS revised upward its jobs numbers for September and August by an additional 44,000 new positions created.
Wages in private sector jobs jumped 10 cents an hour to $25.92, up 2.8% (annual rate), the strongest 12-month gain since mid-2009. As you can see below, the trend in wage growth is healthy, but we’re still well below levels seen before the Great Recession.
The Labor Force Participation Rate unexpectedly declined modestly in October, falling 0.1% to 62.8%. The participation rate remains the lowest since the mid-1970s.
Finally, the U-6 unemployment rate – which includes discouraged workers, part-time workers who would like a full-time job and “marginally-attached” workers (who can’t look for a job for one reason or another) – fell to 9.5% from 9.7% in September, an eight-year low.
All in all, the report was judged to be respectable as we head into the election.
Why the US Economy is Weaker Than It Looks
We were all pleasantly surprised when the Commerce Department reported at the end of October that the economy grew at a better-than-expected 2.9% in the third quarter, the strongest reading in two years. That was well ahead of the pre-report consensus of 2.5%.
And let’s not forget that the GDP report at the end of October was the “advance” estimate that will be revised (up or down) two more times at the end of this month and at the end of December.
Unfortunately, new analysis I came across last week suggests – not necessarily that the 2.9% 3Q GDP was wrong as of yet – but more importantly, that it is not likely to continue in the 4Q or into 2017. Here is a summary of that analysis.
On the surface, the advance estimate of 2.9% growth in the 3Q was great news as compared to only 1.1% growth in the first half of this year. Most forecasters’ expectations have been high for a second-half bounce-back in the economy. And Wall Street has been ready for some good news, given the ongoing corporate earnings recession, fears over a Fed rate hike and frayed nerves heading into Election Day.
So why isn’t that headline GDP number as good as it looked? For one, consumers seem to be pulling back on spending, with consumption up just 2.1% in the 3Q, versus a 4.3% gain in the 2Q and less than the 2.6% that was expected. Remember that consumer spending makes up almost 70% of total GDP.
Also, the sudden boost in GDP growth was driven by an unusual surge in agricultural exports (mostly soybeans, actually) and inventory accumulation, which often turns out to be a temporary boost – especially if consumers are cautious heading into the holiday shopping season.
Outside of the increase in exports and inventories, which vary greatly from quarter to quarter, the other news for the economy was less encouraging. In addition to lower consumer spending, residential investment dropped 6.2% and equipment investment fell 2.7%.
Some forecasters believe that without the bump in exports and inventories, the economy expanded at an annual rate of only 1.4% in the 3Q. That’s a far cry from the 2.9% that the Commerce Department estimated.
But what does that mean for the economy going forward? This question has us turn our attention to the critical holiday shopping period which starts now. If the economy really expanded by 2.9% in the 3Q, which remains to be seen, that might suggest a strong holiday shopping season. Yet that’s not what most analysts expect.
Macroeconomic Advisers, a well-known economic forecaster, estimates that the economy will grow at an annualized rate of just 1.5% in the 4Q. If that is true, economic growth this year will fall short of 2% overall. If so, that will be the weakest annual GDP growth since 2013 at just 1.7%.
The bottom line based on this latest analysis is that the economy is not likely to reach 3% growth in the 4Q as some forecasters apparently still believe. If 4Q GDP is only around 1.5%, as noted just above, then the economic news will be very disappointing for the new president when the advance report comes out in late January.
The National Debt: Why No One is Talking About It
To my knowledge, neither Hillary Clinton nor Donald Trump has talked much about the national debt in their campaigns. Hillary has claimed that Trump’s economic plan would add $4-$5 trillion to the debt over the next 10 years, while promising that her plan wouldn’t add a penny to the debt. Both claims are bogus, for different reasons.
Our national debt stands at $19.8 trillion, up from $12.3 trillion when Obama took office. For discussion purposes today, let’s say the national debt is $20 trillion since it will be there before we know it.
As most of us know, the national debt is made up of apprx. $14 trillion of “debt held by the public” and apprx. $6 trillion of “intra-governmental debt” held by various federal trust funds including Medicare and Social Security among others.
In 2009, the year President Obama took office, the national debt held by the public was $7.27 trillion. At the end of fiscal-year 2016 (September 30), the debt held by the public had almost doubled to apprx. $14 trillion.
Given that debt held by the public almost doubled from 2009 to 2016, it’s remarkable that the annual cost of the interest on that debt rose far less, from $185 billion to only $223 billion in FY2016. The reason, of course, is that interest rates have fallen to historical lows during that stretch and have stayed there for several years.
Note that the interest amounts shown above are only for the debt held by the public. The other apprx. $6 trillion in intra-government securities also pay interest. This is one reason why we should always include intra-governmental debt when we talk about the national debt.
Yet the long period of historically low interest rates is coming to an end. The Fed Funds futures now say there is an over 80% chance that the Fed will hike the key short-term rate at its policy meeting on December 13-14.
The Fed’s position has been consistent that it intends to follow the next rate hike with a series of subsequent increases in its effort to “normalize” interest rates. With wages rising and other indicators hinting at a rise in inflation, the Fed has plenty of reasons to get started.
The question is, what is “normal” anyway? Peter J. Tanous and the number-crunchers at CNBC calculated that the average interest rate paid on the federal debt over the last 25 years was 5%. If short-term interest rates get anywhere near that level in the next few years, the results could be disastrous!
Here’s why. The non-partisan Congressional Budget Office forecasts that debt held by the public will rise from $14 trillion today to $16.5 trillion in 2020. I can make an argument that it will be larger than $16.5 trillion, but let’s assume the CBO is accurate for this discussion.
Now if we take the CBO estimate of debt held by the public of $16.5 trillion in 2020, and apply a 5% average interest rate on that amount, we get annual debt service of $829 billion, a staggering increase over the $223 billion in FY2016. Remember, this is debt service alone.
- Under this 2020 scenario, one-half of all personal income taxes would go to
servicing the national debt.
- Debt service in 2020 would dwarf our military spending of $585 billion in 2016.
- Debt service would consume nearly two-thirds of Social Security obligations.
These numbers on the debt held by the public (not total debt) are staggering! And let’s not forget that the numbers will be even larger by the time we get to 2020, since the government will run a larger and larger annual budget deficit each year from now until then.
This trend is the consequence of the ongoing failure on the part of both political parties in Washington to pay enough attention to the national debt and the inevitable effect of rising interest rates in the future.
The point is, the government has been able to nearly double the national debt since President Obama took office, without disastrous consequences – in large part because interest rates have been at historic lows. As a result, debt service has been very cheap, relatively speaking.
But that’s going to change, perhaps dramatically, over the next several years as the Fed seeks to normalize interest rates. As the cost of debt service rises, that will leave only two choices: 1) Either higher debt servicing costs will crowd out federal spending on other programs; or 2) The government will have to run significantly higher annual budget deficits.
Neither choice is a good one.
Finally, to be clear, I am not predicting that short-term interest rates are going to 5% anytime soon. It may be several years in the making. But as rates get up to 3%, 4% and above, debt service costs on our ballooning national debt will skyrocket from today’s levels.
People frequently ask me how long I think this can continue. Of course, I don’t know the precise answer. But hopefully, today’s discussion is helpful in terms of knowing what to watch – interest rates. The higher interest rates rise, the closer we are to the next financial crisis.
Very best regards,
Gary D. Halbert