Salvadore Dali: The Persistence of Memory. Source: MOMA
There’s a disconnect in the economy: the statistics generally look pretty good. But if you ask people how they’re doing, you don’t get a lot of positive feedback. There aren’t a lot of layoffs, but people aren’t getting big raises, either. What’s going on?
Part of the answer has to do with the time-lags inherent in the economy. The price of oil started falling almost two years ago, and oil exploration companies immediately started cutting back on their capital spending plans. But it’s taken a while for the extra cash from lower gas prices to find its way into consumer spending. It will get there, eventually. But it’s taken longer than many thought it would.
There’s also the local effect. Our conversations are limited in scope. We simply can’t talk to the millions of people who make a modern economy—people in all different kinds of occupations and walks of life. So our experiences—and those of our friends and families—play a much bigger role in our perceptions. That’s why it’s said that the plural of anecdote is not data.
But another big reason is the “nominal effect.” Economists talk about the real economy—adjusting for inflation. And that makes sense. If your paycheck goes up 2%, but the price of everything goes up by 4%, you aren’t any better off, are you? Economists apply “deflators” to their statistics to get a sense of how many cars, haircuts, and knee replacements we are producing and consuming. And the real level of economic growth has been pretty steady. Not great, but around 2% for the last five years. That’s just a little less than it was for the five years before the financial crisis. And a five year expansion is pretty long, historically.
People don’t buy and sell with inflation-adjusted dollars, though. They use nominal dollars—the ones we’re paid with and put in the bank. And in nominal terms, this has been a lousy time. During the 80’s and 90’s, our nominal economy grew by about 6 ½% during expansions. Even during a downturn, the nominal economy grew by 2%.
But during this latest period we’ve only managed to eek out 3 ½% growth—about half of the last couple expansions, and just above the previously recessionary level. This is part of the “butterfly effect” of global deflation. Falling prices overseas are limiting inflation here. Too many cement kilns in Shandong, China really do impact the animal spirits in Kalamazoo, Michigan. And animal spirits are what lead us to start businesses, invest in disruptive technologies, and pioneer new innovations—the real engines of economic growth.
Nominal GDP. Source: Bloomberg
Still, real effects do matter. Lower inflation for the past two years means that real incomes have been rising—and rising more rapidly in recent months, as the labor market has gotten tighter. The numbers don’t lie—the economy really is getting better.
But like the old Louis Armstrong song, it takes time—and a little animal spirits—to make it happen.
Douglas R. Tengdin, CFA
Chief Investment Officer