Will 2014 spell 'relief' for the economy?
Economist says pent-up demand likely to fuel growth this year
Friday, January 31, 2014 7:00 AM
Bob Baur, global economist for Principal Financial Group Inc., believes that U.S. consumers are ready and eager to again do what they do best - spend money. Many indicators are already pointing to a release of pent-up demand that will fuel stronger economic growth, he said.
Fed’s growth estimate ‘wonderful’
The Business Record interviewed Principal Financial Group Inc.’s global economist for this story on the same day that the federal government revised its growth estimates for the economy upward to 4.1 percent, which included a revised consumer spending growth rate of 2 percent.
“I thought it was wonderful,” said Bob Baur, noting that other key estimates went up as well, among them net exports and capital spending, while the inventories estimate declined slightly.
“If you don’t count the big increase in inventories, we were growing probably at a 2 to 2.25 percent rate,” he said. “So we’ll be increasing at that base rate - without inventories - from the 2 percent average growth we’ve had for some time up to a 2.5 to 3 percent rate, with a decent chance that we could see above 3 percent growth next year.”
The revision is another indication that the effects of pent-up demand will finally be felt, Baur said.
“I jokingly say that consumers have ‘PCRD’ - Post-Crisis Relapse Disorder - where you wake up every morning thinking there’s going to be another recession just around the corner,” he said. “And after going through a severe recession like we did, it’s no wonder people stay cautious and scared and worried for a long time.”
“At the beginning of 2013, we thought we would see the emergence of some of this pent-up demand in the second half of the year,” Baur said. “I think we were a little surprised that we didn’t.”
Baur said a big part of pent-up demand centers on households, or more precisely, on there being fewer households than expected. The recession that began in 2007 caused a significant slowing in the traditional pace of household formation, which for the past four decades had averaged about 1.25 million new households per year.
“We think there are on the order of 2 million households that did not get formed over the last five or six years,” Baur said. “Young people either did not move out of their parents’ homes, or some may have moved back in.”
Only about 500,000 new U.S. households were formed in both 2009 and 2010, and that rate is just barely back up into the 1 million range. “It’s that new household formation that drives housing starts, furniture sales, real estate commissions, new mortgages, and those are the things we haven’t seen get back, and that’s where the pent-up demand is,” Baur said.
Barring a continuation of more bad news that might hold off consumer demand, a number of issues have been resolved that should reduce uncertainty both in the United States and globally.
“Both the Senate and House passed a new budget, so that mostly takes away the odds of a government shutdown in January,” Baur noted. “The debt ceiling increase (deadline) comes up Feb. 7, so there may be some uncertainty about that. But the Volcker Rule has been established, and it wasn’t quite as bad as business was fearing. And it’s clear that the health care law is going to be implemented in some fashion. So that has really created some certainty for business. Both investors and businesses like certainty.”
Additionally, the danger of China’s economy suffering a “hard landing” has gone away, and the recovery seems to have started in Europe, according to Baur. “So there’s a little less uncertainty about global growth than there was a few quarters ago,” he said.
Looking at the state’s economy, Iowa’s growth in the past year has continued to be driven by its metropolitan areas, said Peter Orazem, an Iowa State University economics professor.
Over the past 15 years, the state has added 4 percent to its employment base. Since the recession ended, employment is up 0.4 percent, compared with a net loss of 0.9 percent nationally, Orazem said.
“Iowa’s adding employees at a slower rate than 10 years ago,” Orazem noted, “but we look better in part because everyplace else looks worse. So actually we’re performing worse than we were (since 1999) in job growth. But at least we’re adding jobs.”
At the local level, “when you look at key industry areas for Greater Des Moines – professional and business services, transportation/warehousing and education and health services - those are areas where we’ve been adding jobs, and at a faster rate than the national economy,” he said. “That’s why Greater Des Moines is doing so well.”
3 Highlights from Orazem
“People in Iowa’s smaller towns are disproportionally commuting to cities, and if you’re going to be commuting, you need good roads to these job centers. It doesn’t help that we’ve been trying to run our transportation system on the cheap. The last gas tax increase was in 1989, and the tax is charged on the gallon, not the dollar, so the value of the tax has gone down over time. It’s estimated that 11 percent of bridges in the state are structurally deficient, and 32 percent of our roads are in poor condition, some of the highest percentages in the United States. I think we ought to stop worrying about the Internet superhighway and start worrying about the roads.”
“Iowa Public Employees’ Retirement System (IPERS) is sitting at about 80 percent of its actuarially sound level. Under (federal pension) requirements, a private firm can’t do that; it’s illegal to underfund your plan by 20 percent. We make private firms immediately take steps to address underfunding, but state government is exempt from that - hence all the state governments are underfunding their pension plans to a point that would be illegal if they were private. There’s the argument that their taxing power enables states to make good on underfunding, but that’s saying at some point the state will compel citizens to make up the difference if we have an emergency.”
“Iowa’s labor productivity growth has been lower than the national average for a long time,” Orazem said, a fact that could be explained by its tax policies. The property tax reform measure was a good step, but the state also needs to look at lowering its sales tax, which currently has some 50 exemptions. “What you want is a broad tax base and treat every dollar that’s generated the same,” he said. “If you do that, you won’t create these inefficiences in the economy.”
Simplifying the state’s income tax system, as difficult as that would be, also would boost the state’s productivity, he said. “If you simply made it less difficult to raise the revenue needed to provide government service, you would also raise wages and raise productivity,” he said.
5 Highlights from Baur
“We think 2014 will be a pretty nice economic year. We would expect to see a positive stock market, at least for another year. We’d look for 8 to 12 percent total return. I’ve heard my boss, Jim McCaughan, say 10 to 20 percent this year. I think it will be on the lower side of that range. We think consumers will feel better this year and look back on 2014 and see it as a pretty decent year.”
“We’re really positive about manufacturing, and think that with wages having risen fast for a long time in China and other emerging markets, and with the cost of transportation from China back to the U.S., the U.S. is becoming much more competitive. ... Some businesses that used to build things in China for export to the U.S. are maybe finding it’s not worth it anymore.”
“One, it’s still possible this pent-up demand that we’re expecting from consumers doesn’t happen, that there keeps on being one thing after another that worries consumers so they stay cautious. A second thing is the potential for more problems in emerging markets due to the Federal Reserve slowing its liquidity infusions. That could have a contagion effect for Europe and the U.S. Back in the summer (of 2013) when the Fed first talked about slowing the pace of their bond purchases, if you’ll recall, emerging market currency, bond and stock markets all plunged. A lot of liquidity came out of those markets and currencies weakened. This time, it hasn’t been so bad.
“The third thing (to watch for) is tension between China and Japan in the China Sea over China enforcing its broader international boundary. Some accident could happen there that I’d be worried about. Or if there are more troubles in the Middle East, it could cause oil prices to spike. Every recession since about 1970 has been associated with a big spike in oil prices.”
“You have to differentiate between longer rates and short-term rates. The Fed has promised to keep pressure on short rates through all of 2014 and part of 2015, but we look for longer rates, at least on 10-year and 30-year Treasuries, to continue the uptrend they’ve had through the summer. We don’t see a huge fast spike, but if you round the 10-year yield it’s now about 3.0 percent, and we would see 10-year yields continuing to rise and maybe end the year at about 3.5 or 3.75 percent. We don’t think that would necessarily hurt the economy; both economic growth and interest rates can rise at the same time for a while. If rates would start to get to 4 percent or above, that would start to be a real headwind.”
“The last four monthly payroll figures have averaged 204,000 (jobs added) each month, which is very positive. But frankly, we think businesses still have very lean payrolls, and if we’re right about a moderate pickup in consumer spending, then businesses are going to have to increase the pace of their hiring. So we wouldn’t be surprised to see monthly payroll numbers in the 250,000 range in the first half of the year. And we would guess the unemployment rate would hit the Fed’s 6.5 percent threshold sometime around early summer.”