[This post was co-written with Rafael Wildauer, lecturer at Kingston University Business School, who is doing research on the links between income and wealth distribution, credit, growth and financial stability].
It has been almost one year ago from our latest comprehensive report on the US economy, and although we are currently writing our second report which will be published soon (it took us longer than expected, given that our model has undergone several modifications, the most important one being a private sector split between households and businesses), we wanted to share a couple of thoughts with our readers on the current state of the US economy, especially since the election of president Donald Trump in November. The economic proposals the incoming Trump administration are supposed to bring are important, and if eventually fulfilled, we think they will have a clear impact on the economy over the medium-term. In this first part of a two-post series, we will review the recent evolution of the balance of payments and, in the second one, we will go through the effects of Trump’s economic proposals on the future path of the US sectoral financial balances.
While many observers are bewildered by the first steps of the Trump administration, economically the US seems to be doing fine, with GDP growth around 2.5 in 2014 and 2015 and an improving current account. A closer look however shows that the recovery of the current account was strongly driven by an improving oil balance. The trade deficit ex-oil increased over the last three years. A likely explanation is that the US grew faster than some of its main trading partners (notably Europe), which led to a deterioration of the trade balance. Thus, under the economic proposals by the incoming Trump administration and not much further room for an improving oil balance, the current account might deteriorate again.
Let’s start with a few words about recent developments in the US economy and its balance of payment position. In the international arena, the European economy continued to grow at a reasonable pace (withstanding Brexit) and the commodity-driven emerging economies recovered thanks to the rally in commodity prices. The announcements from the Chinese government that i) it will aggressively implement ‘supply policies’ (i.e. reducing overcapacity in steel, coal and other heavy industries) and that ii) it will tighten capital controls, allowed commodity markets to recover and increased investor confidence that Beijing is committed to defending the value of the renminbi. All these developments were good for the US economy – and the evolution of its balance of payments.
Domestically, US unemployment kept falling, there was were no major disruptions in financial markets (despite a bumpy start of the year in the high yield market), wage growth started to rise more pronouncedly and, most importantly in our view, the sectoral financial balances (the net accumulation of assets/liabilities by households, businesses, government and the external account) did not deteriorate, as can be seen in the following graph:
The government deficit improved somehow but remained high in comparison to the Congressional Budget Office numbers published in the NIPA Translation of the Fiscal Year 2016 Federal Budget  – the latest available numbers when we published our report last year. On the other hand, household and businesses financial balances did not change in any meaningful way: Households kept deleveraging with net lending rates much higher than in the period 1995 – 2007 and businesses improved their net borrowing positions, reaching an almost balanced position in the third quarter of 2016. This recovery was fuelled by a recovery in profit margins, which reverted a decline that started in 2013, as it can be seen in the following graph:
Last, but not least, the balance of payments remained stable, in contrast to our prediction from last year and in contrast to what many other commentators were expecting. The continuation of growth in many economies mentioned above contributed to a decent performance in US exports, and a stable US Dollar helped not to exceed the 3% threshold current account deficit:
This recovery of the US current account is strongly driven by the balance of trade. The trade deficit in the post-2008 years peaked at 3.8% in the first quarter of 2012. From then it started to improve and reached its low at 2.5% in the third quarter of 2016. This looks like a shift away from the debt-driven growth model towards a more balanced path which does not require the foreign sector to finance a large part of US expenditures. However a closer look at the trade balance reveals that this development is driven by a fall in the value and volume of oil and oil related imports. The fall in the oil price from 100$/bbl. to 40$-50$, together with the rise in shale oil production, has meant that the US has been able to reduce oil imports in nominal prices substantially. Once the ‘oil effect’ is discounted, the improvement in the balance of trade (ex-oil) is not as big as it appeared, as can be seen in the graph below. Furthermore, between the fourth quarter of 2013 and the fourth quarter of 2015 the trade balance excluding oil deteriorated from a 1.4% to a 2.5% deficit. Only in the third quarter of 2016 the trade balance excluding oil recovered slightly but that by no means necessarily represents a trend reversal.
These figures demonstrate why in our last report we predicted a much more severe decline in the US trade balance: We did not account for the oil factor so to speak. Beyond that, the most likely reasons for the recent deterioration of the trade balance are i) the fact that the US economy grew faster than many of its trading partners, specifically Europe: US growth was 2.4% and 2.6% in 2014 and 2015 whereas the Eurozone only grew by 1.2% and 2% in these two years, whereas in 2016 US growth is estimated to be 1.6% vs 0.5% in the EU28, and ii) the appreciation of the dollar that occurred in 2015, and that was finally gradually trickling down to the balance of trade (there are estimations suggesting that it takes up to two years for exchange rate effects to fully materialise). The next version of the Kingston Financial Balances model will incorporate separate forecasts for the trade balance and for the oil balance. Before we publish this next report, we will briefly discuss some of the mechanisms and scenarios related to the new administration which we plan to explore. This will be done in another post next week.
 Ludwick, M., & Tsehaye, B. (2015). NIPA Translation of the Fiscal Year 2016 Federal Budget.