(Yicai Global) Sept. 23 -- The US economy is just half way, or a little more than half way, along the second part of a so-called V-shaped recovery, according to Paul Sheard, former vice chairman of S&P Global.
Structural change in the form of Schumpeterian creative destruction is reshaping the economy, Sheard said in a recent interview with Yicai Global, adding that the US is not just recapturing lost ground.
A so-called decoupling of the American and Chinese economies -- a permanent decrease in trade between the world’s two largest economies -- is unlikely to happen, said Sheard, who is now a research fellow at Harvard Kennedy School's Mossavar-Rahmani Center for Business and Government.
Sheard believes decoupling would not be easy to do because of the size of the Chinese economy. “The rhetoric of decoupling tends to run way ahead of the reality,” he said.
Excerpts from the interview with Sheard, an Australian-American economist, are presented below.
Yicai Global: The US jobless rate fell to 8.4 percent last month. Industrial production rose 0.4 percent from July, following a revised 3.5 percent increase in July, while retail spending continues to rebound. Though the unemployment rate was lower than expected, the V-shaped recovery seems not to be happening. What is the outlook for the economy?
Paul Sheard: There is a kind of V-shaped recovery. A V-shaped recovery means you have a sharp downward plunge in activity and that is followed by a pretty sharp rebound that comes quite quickly. Obviously it's an exaggeration to say V, but compared to an L shape or U shape, if you had to pick a letter, this recovery does look roughly kind of V-shaped. But we are only half way, or a little more than half way, up the second half of the V.
There seems to be a lot going on below the surface. The rebound is not just retracing what was lost and coming back. There are structural changes going on in the economy as well.
Digitalization of the economy has been accelerated. There is a process of Schumpeterian creative destruction going on, where a lot of companies, particularly retailers, are going out of business, but companies like Amazon, Apple, Netflix and other high tech ones are benefiting from more economic activity moving online. You have similar things going on in the biotech area as well, with companies scrambling to develop vaccines and therapeutics.
Given that the technology exists now for people to telecommute and the pandemic has forced that change, I think a lot of companies, particularly ones with large white-collar workforces, are going to be looking very carefully at their workforces, their real estate footprints and the way they operate. Longer term, there may be some interesting changes to the very nature of the corporation.
YG: While the US is struggling with coronavirus, China’s economy is back to normal. Export rose 9.5 percent in August. Is the decoupling still going on?
PS: Decoupling of China from the rest of the world is easier said than done because China is such a big economy. It has 1.4 billion people and is either the largest or the second-largest economy in the world, depending on whether you compare economies on a Purchasing Power Parity or nominal basis, respectively. And it's already such a big part of the global economy and already intermeshed in supply chains with the rest of the world.
Over time there will be some re-shoring and near-shoring adjustments made. But the rhetoric of decoupling tends to run way ahead of the reality.
I'm not too surprised by the export number. I haven't dug into those numbers, but you have to be very careful in this period to distinguish between growth rates and levels of activity. Because economic activity was hit so badly by the coronavirus, meaning growth rates went heavily negative. It is easy to get big growth numbers in the rebound. You need to cross-check to see what that means for the levels of various economic variables, like exports, employment and GDP.
I don't think that the Chinese economy is going to be driven by exports or by foreign demand. It's going to be driven by domestic demand, particularly household consumer demand. That speaks to a big thing China has going for it. China’s per capita GDP is still relatively low, about one-third of the US level in PPP terms or about one-sixth in nominal terms. This means it has a lot of headroom to continue on its path of economic development and grow.
There's a lot of room for China to develop internally by raising the standard of living and the consumption levels of its own people -- widening the middle class. So China still has significant growth potential.
And it's going to get more and more powerful in the global economy. So China will have to be managed. It can't be ignored or marginalized. But China will also need to engage with the rest of the world and learn to manage that process better too.
YG: The US Federal Reserve expects to leave interest rates near zero for years -- through at least 2023 based on their September policy statement and economic projections released last week. Is this what you expected? What are your thoughts on this?
PS: The Fed’s monetary policy decision was not a surprise, given its cautious economic outlook. This was the first policy meeting after the Fed incorporated the results of its nearly two-year-long review of its monetary policy strategy, tools and communication into its operating framework.
The Fed made two adjustments to its monetary policy approach as a result of its review. One, it abandoned the idea that sometimes it might have to preemptively tighten monetary policy to head off labor market overheating. In future, the Fed will wait to see evidence of labor market-driven inflation before it tightens policy on those grounds. Two, the Fed is now going to target average inflation of 2 percent over time, meaning that, following periods when inflation has been running below target, it will aim for inflation to run above 2 percent for some time.
To reflect these changes in its monetary policy stance, the Fed strengthened its forward guidance by indicating that it expects to maintain its target rate for the federal funds rate of 0 percent to 0.25 percent until inflation has risen to 2 percent and is on track to moderately exceed it for some time. The Fed does not expect this condition to be met in its forecast horizon, which extends to the end of 2023.
YG: The Fed recently approved a shift in its inflation goal, ushering in a longer era of low rates. Combined with an unprecedented stimulus package, is there any risk that high inflation will result in the future? A lot of people are rushing into gold and bitcoin in anticipation of higher inflation in the future.
PS: The inflation argument is pretty much a copy of what we heard after 2008 when the Fed and other central banks implemented quantitative easing. I wrote piece after piece at the time debunking the idea that QE would lead to high inflation. The Fed's balance sheet has gone from USD4.3 trillion in mid-March to USD7 trillion now and it will probably go much higher.
If you have an old-fashioned monetarist view, this looks very scary. But most of what the Fed is doing is buying government debt and turning it into central bank reserves. That expansion of the Fed's balance sheet is largely a debt refinancing operation of the consolidated government (the government including the Fed). It is just changing the profile of government debt. It's not creating new purchasing power.
The big budget deficits are injecting purchasing power into the economy, but again that's largely serving to keep the economy in suspended animation. If that purchasing power gets unleashed in the future, there will be plenty of spare capacity in the economy to absorb it in the near term, and if it starts to run up against supply constraints after that policymakers have the tools and know-how to rein in excess demand and prevent inflation from getting out of hand.
So I think most of the inflation scare arguments lack a solid foundation. Some investors believe that story and it’s their prerogative to do so. Others may just be hedging inflation risk.
YG: The US stock market has been going up and up. Do you expect a major correction soon?
PS: I don't. There could be a correction of 10 percent or 15 percent, but there is unlikely to be another big leg down like February to March.
The market is looking through this pandemic as a short-term disruption, which may have some positive benefits as well in terms of innovation. So it's not like we're going into a Great Depression. That's giving some comfort to the market.
So is the massive fiscal and monetary policy support. The Fed came out all guns blazing. You can call it the ‘Powell Put.’ The Fed showed to the markets they're prepared to do whatever it takes to stabilize the market and the economy. And there have been a lot of joint operations with the Treasury. That gave tremendous relief to the markets and is helping to keep the market up.
But if you took the tech titans out of the index, the stock market would probably be a ways down. So the market is also reflecting the structural shifts going on in the economy that are being amplified and accelerated by the pandemic.
YG: Powell expects Congress to approve more stimulus. The US budget deficit hit an all-time high of USD3 trillion in the first 11 months of this budget year. Even though interest rates are very low, can the US afford more stimulus packages?
PS: It is the job of macroeconomic policy, whether it's monetary or fiscal policy, to try to get the economy back to full employment as quickly as possible when the economy falls into recession. And it cannot be left just to monetary policy. Fiscal policy has a big role to play as well.
YG: Are you worried about the budget deficit?
PS: I don't see budget deficits as being a policy target. They're more a policy variable in the sense that they reflect what is going on in the economy and can be used to help the economy.
The reason the budget deficit is so big is because net tax revenues have gone down so much. With the collapse of the economy, the government is taking in less tax revenue but also paying out a lot more money so the net tax intake has collapsed.
And the reason for that is everything we talked about before: that the government has to keep money coming into people's pockets and keeping businesses afloat. The (U6) unemployment/underemployment rate went to nearly 23 percent. If the government hadn't put money in people's pockets or done the other things they've been doing, you would have had another Great Depression. The economy would have spiraled down. People would be losing their jobs and their homes and more and more businesses would be going under. It could have been quite terrible.
So I think the blow-out in the budget deficits is a necessary aspect of trying to get out of this challenging situation.
On top of that, you mentioned interest rates. The 10-year treasury yield is now about 0.7 percent. Even the 30-year treasury yield is only about 1.4 percent. I don't think economists fully understand what is driving all of this. But a consensus has emerged, even among mainstream economists, that it's possible for governments to run big deficits on a more sustained basis. And certainly the markets are sending that message via the very low yields on government debt.