What’s holding back US GDP? (hint: it’s not the Fed rate hike)

December 21st, 2015 at 9:08 am

The US economy is posting solid numbers in important places: GDP is consistently growing around a trend of slightly north of 2 percent, we’re adding around 200,000 jobs per month, which is more than enough to put downward pressure on the remaining slack in the job market. It’s true that wage growth and especially inflation still show signs that demand isn’t strong enough, but if the job market continues to tighten, wages will pick up, like they have in Lincoln NE, where unemployment is around 2 percent. Last week’s budget and tax bill has some ugly warts on it, but by some estimates, positive fiscal impulse (higher outlays relative to last year) will boost GDP by almost half a percent in 2016.

There is, however, one drag on the US economy of which you should be aware. It’s the strengthening dollar and its impact of the trade deficit. Here are four charts that take you through the facts of the case.

First, the value of the dollar is going up relative to the currencies of our trading partners:


The dollar’s real value, relative to that of our trading partners, is up 16 percent since last summer. That makes our exports more expensive in their markets and their exports to us cheaper in our markets.

More pointedly, the dollar’s rising relative to the Chinese yuan (a higher value of yuan/dollar means a weaker yuan, since it takes more yuan to exchange for a dollar). The decline in the dollar value of the yuan relates to weakness in the domestic Chinese economy, but also to freer capital flows which came as a result of an IMF decision to elevate the global status of the yuan.



Third, the Fed’s recent rate hike adds slightly to the dollar’s strength. Given the Fed’s strong “forward guidance”—telegraphing to markets that they planned to raise, the increase was already priced in to Figure 1 above. Moreover, the mechanism putting upward pressure on the dollar here is not simply our central bank lifting off from zero, but other central banks going the other way (e.g., the ECB). Higher US interest rates relative to those behind other currencies tend to put upward pressure on the exchange rate of the dollar:


Put it all together, and you’ve got a trade deficit that’s a drag on growth. The last figure shows net exports (exports-imports) as a share of GDP. The trade deficit has been stuck at around -3 percent of GDP, and that’s, as the negative sign would suggest, a drag on growth:



Now, there are many other moving parts to the economy, and the other parts of GDP—consumption, investment, government spending—can and do offset the drag of the trade deficit. As you see in the last figure, the trade deficit was -6 percent of GDP at its trough towards the end of the last expansion. That drag was offset, but with a massive housing bubble that was soon to pop and leave a huge mess in its wake (the same dynamics were in play in the late 1990s, when it was the dot.com bubble offsetting the trade deficit). In fact, as I explain in Chapter 5 of the Reconnection Agenda, the capital flows associated with these deficits—deficit countries must borrow to pay for consuming more than they produce—interacted with “innovative” finance to pump up the housing bubble.

So, reviewing, we’ve got a strong dollar, driven up by better relative performance of the US economy, the devaluation of the Chinese yuan, and the Fed’s liftoff of interest rates (while other central banks remain in stimulus mode), leading to a trade deficit of about -3 percent of GDP. My guesstimate is that this will continue to hurt factory employment, which has been flat this year, and shave 0.5 to 1 percent off of GDP (thus reversing the impact of the fiscal stimulus), depending on how much more the dollar appreciates and whether the Fed continues to raise rates this year.

That doesn’t at all mean we won’t keep growing and adding jobs on a monthly basis next year. But it is a drag on growth and one that deserves scrutiny going forward.

What can be done about it? Read Chapter 5 of the RA and then we’ll talk.

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2 comments in reply to "What’s holding back US GDP? (hint: it’s not the Fed rate hike)"

  1. Kevin Rica says:

    I’m going to disagree on one sentence:

    “freer capital flows which came as a result of an IMF decision to elevate the global status of the yuan.”

    More likely, China had a win-win, 1. Opening the capital account helped them get a favorable decision from the IMF, 2. Opening the capital account allowed Chinese flight capital to leave (it had a well-founded fear of persecution or taxation in its home country) and seek safe haven in the U.S. This capital outflow had a huge benefit from the point-of-view of the Chinese government. It financed an expansion China’s current account surplus without the obvious appearance of currency manipulation as continued reserve accumulation would have had. It has the same effect as reserve accumulation without the nasty side effects.

  2. eFilling Plus | eFiling Plus says:

    The USA has proven its hegemony for decades now. And no matter how hard other countries have tried to overrule them, the country remained resilient. Such a setback with its GDP doesn’t affect the country in a big way. As you say, job opportunities won’t stop coming just because of this. Although US products are significantly higher when exported than foreign brands when imported to the US, which can affect the consumption and trade deficit of the US. Nevertheless, the US’ economy, as I mentioned earlier, remains supple despite the aforementioned.