"Kee" Points with Jim Kee, Ph.D.

The advanced estimate for second quarter GDP growth was released by the Bureau of Economic Research on Friday, and it came in at a disappointing 1.2% (first quarter was revised down to .8%). That number was weaker than “Nowcast” models from the Atlanta Fed (1.8%) and the New York Fed (2.1%), but it is also expected to be revised upward a bit as more complete data become available. Consumer spending is fairly robust, more consistent with 2%+ GDP growth; it is business investment spending that continues to disappoint. Much of this is due to the continued reduction in capital spending in the energy sector, and the correspondent lack of a pickup in investment spending elsewhere.

The press has emphasized the disconnect between jobs growth, which has been pretty strong, and GDP growth, which has been pretty weak. I addressed this during our market updates in January as well as in Kee Points; the apparent disconnect is largely resolved if you look at the entire period from 2007 to present, as some of the new jobs have been the result of overly severe (i.e. unsustainable) layoffs during the Great Recession. Other commentators (most recently JPMorgan Chase CEO Jamie Dimon on CNBC today) have suggested that GDP numbers are missing parts of the economy, understating its growth. I find that reasonable, but recent research by the Federal Reserve suggests that the likely impact on GDP of the underestimation of certain sectors, like technology, is relatively small. In a similar way there are also always stories about how government measures over or understate inflation. But here again, more “independent” measures like MIT’s Million Prices Project indices tend to follow the government inflation measures fairly closely. As an aside, gold is often cited as proof of higher inflation when gold prices surge, but when gold prices collapse that “proof” is suddenly forgotten.

Elsewhere in the world, it appears that the UK’s initiation of exiting the European Union might not begin until early 2017, and my understanding is that some of the legal issues as to whether the Parliament or the Prime Minister (Theresa May) can/have to initiate the process are a little unclear (this and what follows are my notes from a discussion at the University of Chicago’s Booth School of Business). The United Kingdom has some positives in all of this, like more say in its own trade, immigration, and regulatory policies. But policy uncertainty will remain high until these issues get negotiated, and that will “forestall long-term investments, hiring decisions, and other activity” (economist Steven Davis). We will probably see these negative impacts in the data over the coming quarters, as much of the current data coming out of the UK is capturing the pre-Brexit economy.

The United Kingdom is made up of Great Britain (formerly England, Scotland, and Wales), Northern Ireland, and many small islands. Interestingly, Scotland and Northern Ireland both supported staying in the European Union, so there is some tension there. The exit outcome was not obvious, as pollsters, newspapers, and even betting markets got it wrong. One of the things that the exit vote signals is dissatisfaction with EU democratic accountability, a dissatisfaction shared by many other European Union members as well. But this is also a great source of opportunity for the EU to learn lessons and adjust. In fact, the one thing missing from press accounts of all of the European situations are the reasons for and successes of the European Union in the first place. German economist Christian Leuz, currently at the University of Chicago, states this well:

“The Brexit vote should be used as an opportunity to find a new resolve. First and foremost, the EU and its leaders need to do a much better job communicating what the political project is all about. There are actually many successes that are worth emphasizing. There are more abstract ones, such as peace and a staunch defense of basic human rights. Conflicts of interest between countries are dealt with in an entirely different way, instead of the old saber rattling. But there are also concrete achievements. For instance, the EU and its predecessors played an important role in the demise of the dictatorships in southern Europe and the stability of those countries afterward. Another example are EU student exchanges such as the very successful Erasmus Programme (European Region Action Scheme for Mobility of University Students), which has offered millions of students the opportunity to study abroad and has done a lot for joint cultural understanding. In addition, there are concrete economic successes. For instance, the euro has had a profound effect on price competition within the eurozone, ultimately benefiting consumers.”

I know the euro has few fans in the press, but it has actually done a great job at facilitating trade. Fiscal covenants (debt/deficit limits) were violated, but that wasn’t really the fault of the currency but rather a fault of not keeping entitlement spending in line with revenues, as had been promised. That is a problem throughout the developed world, by the way, not just the euro currency area. In my opinion the strongest case for money mismanagement is between the world’s central banks, particularly the failure of the European Central Bank and the Federal Reserve Bank to better manage exchange rate volatility. The huge swings in the dollar/euro exchange rate have been extremely disruptive to global production and exchange.