THE INTERNATIONAL ECONOMY: A VIEW FROM THE UNITED STATES

Adam Creighton is The Australian’s Washington correspondent who, in 2021, began filing stories from a very much locked down Washington DC. He also took up his position during the first months of President Joe Biden’s Administration and as such has provided valuable insights to a US economy emerging from both pandemic and four years of the Trump Administration. On Monday 21 February 2022, The Sydney Institute held a zoom meeting with Adam Creighton which took up discussion on the state of the International economy as seen from the US. This was at a time when Russia’s invasion of Ukraine was yet to impact on the growing US inflation rate and supplies of world commodities. The paper which follows has been taken from the zoom discussion.

THE INTERNATIONAL ECONOMY: A VIEW FROM THE UNITED STATES

ADAM CREIGHTON

Thank you very much for that introduction. And thanks for having me back to The Sydney Institute, as you say I appeared a number of times before and I very much enjoy the support and appreciate it. I thought in my remarks, I would give a brief overview of the US economy and where I see it at the moment. Then I’ll broaden it out into an argument, or a discussion, of the huge increase in public debt that we’ve seen throughout the world and, in particular, in English speaking nations, which I think is something that’s not being commented on enough.

It’s a cliche to say that there’s a great deal of uncertainty about the economy. If you read the financial press, economists are always saying there’s a great deal of uncertainty. It’s a somewhat frustrating cliche, but I think it’s more appropriate now than at least since the financial crisis to say that. In the last few years, we have been through an extraordinary economic period in terms of policies that governments have pursued around the world. Very, very unorthodox policies, if you like. And the US has been at the forefront of those, in terms of spending and so forth which I’ll get to a little bit later. Its massive increase in public debt. The bottom line on the US now, the superficial bottom line, is that everything’s hunky dory, everything’s going well. The jobless rate in the US is very low, we’re back to 4 per cent here, which is only slightly higher than it was at the beginning of 2020. And that historically was a very low unemployment rate.

The stock market has fallen a little but is still very high. That suggests confidence for the future. Of course, inflation is up a bit, but the consensus is that it’s going to fall and gradually come down this year. But one of my points throughout is that the real costs, though, are not really embedded in these headline statistics yet. It’s still too early to say whether it’s been a success. It’s worth pointing out that since February 2020, before the pandemic struck, the S&P 500, which is the main index here, was at a record high. And it’s now 30 per cent higher than it was then, in February 2020 – an extraordinary increase in just two years. And since the decline at the start of the pandemic, where it fell quite considerably, it’s now 88 per cent higher.

The S&P 500, the broadest index of US stocks, is the benchmark. That’s a view to the future, if you like, because the stock price is still very, very bullish. That’s even with the prospect of war around the world and there’s a high likelihood that Russia and Ukraine will be a full scale war in coming weeks. That’s factored into markets and they still haven’t fallen very much. So it’s fair to say that the fact that stocks are so high here is a very positive indication of the future,.

I want to digress a little about COVID-19 because there’s a perception in Australia that the US did nothing so to speak and just let the virus rip. This is not true. The pandemic hit the US very hard. I don’t just mean in terms of lives lost, and there were certainly lots of lives lost. But, in terms of the restrictions, too; they were enormous. And they were just as restrictive as in many other countries around the world. Most states in the US locked down very hard, and multiple times, throughout 2020 and 2021. The country is still living with the legacy of those decisions. The jobs lost, for instance, were greater as a proportion than almost any other Western country. I’ll get to that a little bit later. Also, the restrictions around COVID are still very much in place. And they are politically very resonant. They are still debated every day in the media, and very vigorously so. So, it’s very much still an issue here.

The economy overall, has bounced back very strongly in the US, more strongly, basically, than in any other western country, which some economists put down to a relative free market system here. There are relatively fewer restrictions in general on the labour market, compared to countries in Europe and Australia. GDP growth, for instance, the most important economic indicator if you talk to economists. Last year, the US economy grew 5.5 per cent. That’s over the 12-month period to the end of 2021. That was the strongest growth rate since 1984. This is extremely significant growth, and faster than the Australian economy has rebounded, faster than European economies have rebounded. Indeed, in the final quarter of last year, the growth rate even accelerated.

That said, the composition of GDP growth is quite different. Business investment is much, much lower than would have been predicted, based on 2019 trends. That’s perhaps not surprising given the huge uncertainty that I mentioned earlier. Especially for smaller businesses. If you’re thinking of starting a business or thinking of expanding, the uncertainty around future COVID restrictions would certainly weigh heavily on your decision to invest. If you’re in the accommodation business, or the restaurant business, or anything like that, you’d be extremely hesitant to expand, or to invest given what might occur down the track. So, the composition of GDP has changed.

It’s important to know that the US economy, even though it has grown very strongly since March 2020, bouncing back from all the restrictions, it’s still smaller than it would otherwise have been. You hear politicians here, and also in Australia, indeed, every Western country, always saying how strong growth is, which is a good thing. But remember, the growth is from a very low base, that they themselves created. The restrictions came in, growth was crushed, the economic output was crushed. Economies around the world are only slowly creeping back to where they were before. Even in the US, which has bounced back probably faster than any Western country, it’s still 1.5 per cent smaller than it would have been had there been no pandemic.

Turning to the jobless rate, the unemployment rate, that is back to 4 per cent. That said, it obscures quite dramatic changes in the labour market in the US, which I think have had huge political resonance. The main change is the participation rate here has fallen so much. So many people have exited the labour force, during the pandemic. They’ve decided not to look for work anymore. The total employment rate here is still 3 million workers less than it was in February 2020. So, even though you have the unemployment rate back to roughly where it was in February 2020, that’s based on a smaller potential workforce, because people have left. There are three million fewer jobs. That’s a huge difference, even in a country as large as the US, to have seen that decline. Those people who are still working are working longer hours overall. And productivity is up. Potentially, you could say that some of the jobs that have vanished weren’t efficient or productive. Maybe in the long term you could say this is not necessarily a bad thing. Nevertheless, the labour market is three million workers smaller.

The number one challenge in the US, which I’m sure you’ve all heard about, is inflation. It is a serious situation here. Inflation in Australia is still around 3.5 per cent over the past 12 months. In the US, it’s now 7.5 per cent, which is the highest in 40 years. That’s quite something. And it’s not just an aberration, not just a one off. The inflation rate here has been above 5 per cent for about six months which is a very significant period of time. And it’s not just a few items that are dragging up the index. Certainly, petrol has gone up greatly here, and so have gas prices. But even if you strip out petrol and food, the two volatile items that are often stripped out of the CPI, inflation is still 6 per cent, which is triple what it’s meant to be, according to the Federal Reserve and its promise to keep inflation at 2 per cent. So, a huge change. This occurred quite suddenly after January-February 2021 when inflation was still very low. Then suddenly, in March-April, it went up to 4 per cent. And it continued to accelerate despite, President Joe Biden saying that inflation would be transitory or temporary.

Federal Reserve officials said the same thing. And they kept saying this for a few months, but now they’ve given up on that rhetoric. So has the White House and the president. And inflation has continued to rise. The consensus is that the headline rate will gradually decline this year. But the experts were completely wrong for all of last year. So, who knows. And if the war between Russia and Ukraine escalates, the oil price will shoot up again greatly. That’s going to undermine all these forecasts. A worrying situation.

Rent is now rising in the US at the fastest pace in 20 years. In January, rent rose by half a per cent in one month, which if you extrapolate across a year is a huge increase. The inflation issue is a huge deal. And politically, this has massive consequences. It has undermined the Democrats’ popularity in the US and the president’s in particular. He’s now the most unpopular president, depending on how you define it. The most unpopular in modern history at this time into a presidency. He’s recently, on some polls, dipped below former President Trump, largely because of the inflation problem. It’s a very different economic problem from unemployment. Unemployment only affects those who are unemployed. But inflation affects every single voter. And it’s particularly very toxic when it gets out of control. As it was in the 1970s. As it was in the 1980s and it could be again.

I do have some sympathy for the Biden administration, because it’s not necessarily the fault of the Democratic Party. They have inherited the policies of the Trump administration. And they have inherited the policies of, if you like, of all Western governments in terms of spending much more during the COVID pandemic. You certainly can argue that the $1.9 trillion that the White House spent last year as part of its pandemic measures was not necessary, because that came after $3-4 trillion from the Trump administration. But since then, the Biden administration has not really done anything in a legislative sense. It’s not spent greatly more. It’s not changed many rules.

This inflation is occurring as a function of things that have happened in the past. Of course, the Biden Administration is going to get blamed for it, but it’s hard to know what it can really do about it. In public, the President and the White House have started to shift the blame to the Federal Reserve, which is fair enough. It is the responsibility of the Federal Reserve to keep inflation at 2 per cent. Yet, more and more, the Federal Reserve has been ratcheting up the level of concern it has about inflation.

The outlook for interest rates is that they’re going to increase greatly this year. About one month ago, the probability of seven interest rate increases this year was one per cent. According to financial market pricing, it’s now about 70 per cent. There’s been a huge increase in the likelihood of a number of interest rate increases. Right now, the expectation is that there’ll be two interest rate increases in the same month – from zero to point five. These sound like low rates of interest, but the consequences of even small interest rate increases from relatively low levels can be very significant for repayments, and for pricing and financial markets. The big question this year is, how does the central bank here increase interest rates without causing a recession or without crashing the US economy, as happened in the late 1980s. That’s the last example of anything like this that we’ve seen, where there’s a rapid increase in rates to reduce inflation. Now, we haven’t got there yet  but this is the forecast. Forecasts are often wrong in central banking land and in economics land, so we don’t know what’s going to happen. But nevertheless, that is the forecast.

Wages in the US are rising very rapidly, much faster than in Australia – at 5 per cent over the last 12 months on average. That’s still a 2 per cent decline because of the headline inflation rate. So the inflation situation is undermining economic confidence. And ordinary Americans are very upset about the situation. If you look at all of the polling and surveys, they say that the economy is in a bad way, despite the strong GDP growth. In fact, the most important consumer sentiment index here, which is conducted by the University of Michigan, just recently fell to the lowest level in 10 years. It’s lower now than it was in March 2020, when the pandemic struck almost two years ago. That gives you an idea of the despair or the disappointment of ordinary Americans about the outlook for the economy. They’re feeling their wages go down.

Washington is not a normal city, because it has such a large government sector. But even here it’s extraordinarily expensive. I often think to myself, how does someone here on an ordinary income actually live and save anything? In Washington, you can’t get a coffee for less than $7 Australian. That is much more expensive than Sydney or Melbourne. It’s not just coffees, it’s everything. It’s haircuts; a glass of wine is around $24 Australian. Life is unbelievably expensive. That’s just Washington. Prices are going up all around the country. And people are starting to feel it. In the conversations I have with colleagues and friends in Washington, everyone does talk about the cost of living in a way no one did in Australia when I was there. No one talked about that as an issue. Inflation and an expected interest rate increase is the big issue.

I want to talk now about the huge debt surge. This really is a phenomenal thing. We’ve junked a lot of the principles, ideals and economics that we formulated in the 1980s and 1990s and held as very important. And the increase in debt amongst the world’s English-speaking nations has been bigger than anywhere else, by far. I’ve been so struck by it. Of course, governments around the world have borrowed a great deal during COVID. They all have, but especially the US, Australia, Canada and New Zealand. New Zealand is number one with an increase in their public debt to GDP by 26 percentage points just in two years. This is extraordinary. Second is Malta, which I’m counting as an English-speaking country because it was run by Britain for a long time. Straight after that comes the US, the UK and Australia.

They stand out massively amongst the 35 nations that the IMF tracks closely. There’s been a massive increase in debt. And these are huge sums. The US spent some trillion dollars on the Vietnam War in today’s figures. It was a huge war that went for a decade. But their spending on COVID packages has been $5 trillion. So, just a fifth of what was spent on the Vietnam War. These are huge, huge sums. It’s very hard to explain why.

Australia and New Zealand began with relatively low levels of debt. You might argue that because they had lower levels of debt, they could spend more. But the UK and the US did not start with low levels of debt; they’ve just simply added to it. There’s been a huge change there. It’s hard to know why these countries have spent so much. I spend most of the day thinking about it and trying to explain it. Part of it could be that perhaps the English language media was more hysterical about COVID. It created a political environment where you could spend so much.

Another reason perhaps could be modern monetary theory, which has become increasingly popular in the English-speaking world among some economists. This is the idea that budget deficits are not a problem and governments can spend whatever they want. That idea is much more embedded in the English-speaking world than in Europe or elsewhere. Perhaps that’s a reason. Or maybe the financial sector is much stronger in English-speaking countries. I think that’s true. As a lobby group, the banks and investment banks are much more powerful in those countries. And they benefit from a lot of public debt because they get to trade it. So maybe that’s one reason.

I don’t have an answer. But the outcome of all this is that these English speaking countries are at the vanguard of a giant experiment, a giant experiment in economics, where you can spend an enormous amount of money and basically tell your voters that there’s no real cost. That’s effectively what’s been going on for an extraordinary increase in debt. Taxes will actually fall in Australia soon.

So, there’s a total disconnect between this extraordinary spending and taxation. It is the same in the US; there’s been no increase in tax anywhere near commensurate with the huge increase in debt. Even Democrats in Congress have no interest in huge increases in taxation, only very token increases, to signify that they’re doing something.

The real test here is whether this experiment will fail or succeed. It’s too early at this stage to know. Bond rates and borrowing rates are still fairly low in the US and in Australia. Governments in both countries can still borrow for about 2 per centr for 10 years, which is very low historically. So far, I feel like the experiment is working, but my fear is that in the next five to 10 years it won’t work. And all these enormous costs are going to come home to roost, either in much higher inflation or a huge increase in taxation to pay off these debts.

I’ll just finish there and leave you with the idea that we are at a kind of inflection point, if you like. We have borrowed massively and, so far, there’s no cost to that. But in the next few years there could be a problem. And the countries at the forefront of it are the canary in the coal mine, so to speak. Those countries are the five English speaking countries of the world. That’s what Australia and the US at the moment have in common, an extraordinary increase in public debt. And, so far, no cost. But we shall have to wait and see.