Income Inequality, Taxation, and Redistribution

Monday Morning Outlook

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/11/2019


One of our favorite economic parables is the Fish Story, from Paul Zane Pilzer's 1990 book, "Unlimited Wealth." It is an excellent tool for thinking about wealth creation, inequality and redistribution.

Imagine 10 people live on an island. Each day they wake up, catch two fish, eat them, and go back to bed. Its subsistence living at the most basic level. There are no savings – no stored or saved wealth. If someone gets sick and can't fish, there's no way to help them. No one has any extra.

Now imagine two of these people dream up a boat and a net. They spend six days catching one fish per day, slowly starving, but they make the boat and net. On the 7th day, they go out into the ocean and catch 20 fish in the net – it worked!!!!

At this point, the island can go one of two ways. First, since two people now produce what previously took ten, resources are freed up to do other things. Farming corn, picking coconuts, cleaning fish, cooking, repairing the boat and net, the possibilities are endless. The island ends up with more (and better!) food, new technologies, higher standards of living, more assets, more wealth, and they can now afford to take care of their sick and vulnerable!

Or...the eight people who don't have a boat and net could become envious. Two now produce ten fish per day, while everyone else can only produce two. Income inequality now exists: it's no longer 1:1, it's 5:1. So, they devise a plan to tax 80% of the income of the boaters (16 fish) and redistribute two fish to each of the other inhabitants.

If the second plan is adopted, no one is better off. Each inhabitant still only has two fish. Moreover, the entrepreneurs have no incentive to fix their boat and net. The island will eventually revert to subsistence.

This is the problem with taxation for redistribution: it robs the economy of the benefits of new technology. Certainly, some of our brothers and sisters need help, sometimes permanently; sometimes temporarily. However, taxation for redistribution doesn't make the economy stronger; redistribution hurts growth.

Everyone on the island is better off because of the boat and the net. Taxing the inventors' wealth or income and redistributing it removes resources from a highly productive new technology. Moreover, the income inequality that exists on the island is a sign of more opportunity, not less.

There are things the government can do that add to productivity – police and fire protection, national defense, enforcing the rule of law and protecting private property – but once government goes beyond this, it begins to undermine growth.

Today, 17% of all personal income is redistributed by government, while around 40% of all income is taxed and spent by the federal, state and local governments, combined. This is the reason the US economy has not attained 4% real GDP growth. European economies tax and spend even more and this is why they have grown slower than the US in recent decades.

In the meantime, government leaders around the world blame slow growth on a lack of investment by companies and attempt unsuccessfully to use negative interest rates to stimulate lending and investment. They also propose even more government spending and redistribution to help those that big government is holding back.

These policies won't boost growth, and proposals to tax wealth and income because of the perceived problem of income inequality will ultimately reduce living standards. Increasing living standards requires less government, not more.

To view this article click the link below:

https://www.ftportfolios.com/Commentary/EconomicResearch/2019/11/11/income-inequality,-taxation,-and-redistribution

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

No Recession on the Horizon

First Trust Monday Morning Outlook

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 11/4/2019

Since the earliest days of the current economic expansion, there have been naysayers asserting the US was on the brink of another recession. Remember all the fear about another wave of home foreclosures, or a disaster in commercial real estate, or the Fiscal Cliff, or Greece potentially leaving the Eurozone, or German bank defaults, or even the inverted yield curve earlier this year? The list goes on and on.

One by one, the pessimistic theories have been proven wrong. Yes, the US will eventually fall back into a recession. But we don't see it happening this year or next, and probably not in 2021, either.

It's early, but we think the US economy is poised to grow around 2.5% in 2020, about the same pace as this year. Earnings remain at solid levels in spite of the headwind of trade uncertainty, which should diminish in the months ahead. Technological innovation is proceeding at an amazing pace. The key M2 measure of the money supply has accelerated; M2 is up 6.6% in the past year versus a 3.5% gain the year ending one year ago. Businesses are continuing to adjust to a lower corporate tax rate and a better regulatory environment.

This does not mean that every aspect of the US economy is going to be rainbows, teddy bears, and flying unicorns. We are not experiencing the rapid economic growth we had back in the mid-1980s or late-1990s. But the economy has picked up from the Plow Horse pace of mid-2009 through early 2017.

While we expect the economy to grow around 2.5% next year, some sectors won't do quite as well. For example, fundamentals like driving-age population growth and scrappage rates suggest sales of cars and light trucks (like pick-ups and SUVs) will probably continue to slow somewhat in the next few years. This isn't reason to shed macroeconomic tears, however. Autos sales have been gradually slowing since 2016 while the overall economy has accelerated.

Just look at Friday's employment report, which beat consensus expectations and revised up job growth for prior months. Unemployment ticked up to 3.6%, but essentially it was unchanged (from 3.52% to 3.56%) and is at a 50-year low. And, just about every category - female, non-college graduate, minority groups - are seeing unemployment rates near the lowest levels on record.

Although some analysts are bemoaning softness in business investment, "real" (inflation-adjusted) business investment is still 14.3% of real GDP, which is a higher share of real GDP than in any previous business cycle expansion. As a result, while productivity growth looks to have been tepid in the third quarter, the underlying trend has picked up, and that means faster growth in living standards than during the Plow Horse phase of the expansion.

Perhaps the biggest oddity is that Federal Reserve just finished cutting interest rates at three consecutive meetings. At the end of 2018, the Fed was projecting it would raise short-term interest rates 50 basis points this year, while forecasting the US economy would grow 2.3%, unemployment would drop to 3.5%, and PCE prices would increase 1.9%. The forecasts for growth and unemployment look solid, although PCE prices will be up more like 1.5% this year versus 1.9%. That shortfall in inflation doesn't justify a turnaround from planned hikes to three cuts.

In turn, the current stance of monetary policy - and the Fed looking unlikely to raise rates anytime soon - suggests the path ahead is solid for economic growth and bullish for equities.

Settle in for Continued Election-Related Market Shifts

Economy and Policy

Washington Policy Article 11-4-19.jpg

October 31, 2019

“What I hear [from investors] is a lot of anxiousness,” says Washington Policy Analyst Ed Mills – and that unease will likely translate to market uncertainty for at least the next twelve months.

Washington Policy Analyst Ed Mills shares his thoughts on the upcoming 2020 election and how unease could translate to market uncertainty.

Watch the video to learn more: https://go.rjf.com/2WA5AfB .

Morning Brew

Portfolio Strategy Published by Raymond James & Associates

Michael Gibbs, Director of Equity Portfolio & Technical Strategy

Joey Madere, CFA

Richard Sewell, CFA

10/23/2019

The S&P 500 futures trade six points, or 0.2% below fair value following some disappointing earnings results and guidance from Caterpillar (CAT 131.95, -1.74, -1.3%) and Texas Instruments (TXN 116.70, -11.87, -9.2%).

Both companies missed top and bottom-line estimates, with Caterpillar issuing downside FY19 guidance and Texas Instruments issuing downside Q4 guidance. Shares of Caterpillar, however, have significantly cut losses after being down about 4% earlier.

Boeing (BA 340.85, +3.50, +1.0%) missed earnings estimates, too, but investors have been comforted by the company still expecting the 737 MAX to return to service this year. Shares initially fell 2% as the company also pushed back 777X first deliveries to early 2021, but the 737 outlook has given the battered stock some reprieve.

U.S. Treasuries are up in textbook fashion following disappointing guidance from economically-sensitive companies. The 2-yr yield is down six basis points to 1.55%, and the 10-yr yield is down four basis points to 1.73%. The U.S. Dollar Index is little changed at 97.55. WTI crude is down 1.0%, or $0.54, to $53.96/bbl.

On the data front, the weekly MBA Mortgage Applications Index fell 11.9% following a 0.5% increase in the prior week. Later, investors will receive the FHFA Housing Price Index for August at 9:00 a.m. ET.

U.S. equity futures:

  • S&P 500 Futures -5 @ 2990

  • DJIA Futures -34 @ 26729

  • Nasdaq Futures -3 @7856

Overseas:

  • Europe: DAX +0.1%, FTSE +0.3%, CAC -0.6%

  • Asia: Nikkei +0.3%, Hang Seng -0.8%, Shanghai -0.4%


To view the full report please follow the link below:

https://raymondjames.bluematrix.com/sellside/EmailDocViewer?encrypt=4464a2d1-3b2c-44fc-b894-f58d867c80ae&mime=pdf&co=raymondjames&id=matt.goodrich@raymondjames.com&source=mail



Economic Brief -- A Field Guide to Recessions (updated)

Economic Commentary Published by Raymond James & Associates

Scott J. Brown, PH.D.

10/22/2019

A Field Guide to Recessions (updated)

  • There are few signs that the U.S. economy is currently in a recession. The odds of entering a recession within the next 12 months remain elevated, but are somewhat lower than they appeared in August.

  • Slower global growth and trade policy uncertainty have weakened business fixed investment. If sustained, this would eventually lead to weaker labor market conditions, dampening the growth of income and consumption.

  • The Federal Reserve’s cuts in short-term interest rates ought to help insure against downside risks in 2020. While the financial system is better positioned to withstand a recession, the ability to respond to a downturn is more limited than in the past.

Introduction:

The timing and severity of recessions is difficult to predict. They often depend on mass psychology. That is, if enough businesses and consumers expect a recession, then we may well have one. We are never “due” for a recession, but we know that downturns are inevitable. This Economic Brief covers the definition of “recessions,” how to tell if we are in one, and how to tell if one is coming.

To view the full report follow the link below:

https://raymondjames.bluematrix.com/sellside/EmailDocViewer?encrypt=15a22b66-f249-4ce3-9a14-63c384a0768a&mime=pdf&co=raymondjames&id=matt.goodrich@raymondjames.com&source=mail

Trade Clouds Parting

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 10/14/2019

Trade disputes have been an ongoing soap opera since President Trump took office. From steel tariffs to trade skirmishes with China, Japan, Canada, Mexico, South Korea, and the European Union, among others, it's been hard to keep track!

But over the past few months we think a trend toward settlement of these disputes has emerged. Congress must still act on the new version of NAFTA with Mexico and Canada – USMCA – but as Democrats in the House of Representatives consider impeaching the president, they should also become more interested in showing they're not only interested in all scandal, all the time. Passing some broad bi-partisan legislation and USMCA would be a good start. Look for it to get passed by early 2020, putting our disputes with our two largest export markets behind us.

From the perspective of US economic growth, the relationship with China has received way too much attention in the past couple of years. Even before the trade dispute started, US exports to China were a smaller share of our GDP than exports to Japan were before the Japanese economy went into a long-term funk in the early 1990s. If the US could prosper in the 1990s in spite of Japan's problems, the US economy overall should be able to absorb softer demand for our products coming from China, which lags well behind Canada and Mexico as an export market.

But last week's news indicates a deal is getting close. It will not be a huge deal that comprehensively puts all our trade issues with China to rest; not even close. But it will likely mean no new additional restrictions from now through 2020, and some rolling back of tariffs put in place in the last couple of years.

Meanwhile, the US recently concluded a trade deal with Japan.

None of this suggests we are fully out of the woods on trade issues. We doubt China will stop its theft of intellectual property, and so, expect a trade dispute with China to re-emerge in 2021 no matter who wins the presidential election next year. In the meantime, tariffs and the threat of other economic sanctions on China were always more damaging to China than the US. That's why we never worried as much as the conventional wisdom.

But nothing that's happened in the last few years suggests we are entering some sort of Smoot-Hawley-like downward spiral in international trade. US merchandise imports dropped 70% from 1929 to 1932 while exports dropped 69%. That's a downward spiral! US imports didn't reach 1929 levels again until 1946.

By contrast, even before the recent trade deals with Mexico, Canada, and Japan have been implemented, US trade with the rest of the world has been rising. In the past twelve months, exports and imports of goods and services combined have been $5.65 trillion, versus $5.63 trillion in calendar 2018, $5.26 trillion in 2017, and $4.93 trillion in 2016. Even without deals, trade could be hitting a record high this year.

The US economy has been and will continue to be much more resilient than many think. Trade has increased uncertainty, but was never as big a threat as feared. And, as trade relations improve, stocks will make up lost ground. We were never as worried as the conventional wisdom, and now it will come around.

Weekly Economic Monitor - The Economy, Trade Policy, and Other Things

Economic Research Published by Raymond James & Associates

Scott J. Brown, Ph.D.

September 27, 2019

Financial market participants have generally reacted little to economic data reports over the last several months. On a daily basis, the two key drivers have been trade policy and the Fed, and that’s expected to continue for the foreseeable future. However, tensions in Washington have escalated and are about as bad as they can get. The financial markets weren’t much perturbed by developments, but that may change.

The economic data reports have remained mixed, suggesting moderate growth in consumer spending, but general weakness in business investment. That pattern is expected to continue in the near term.

For more information on this article please follow the link below:

https://raymondjames.bluematrix.com/sellside/EmailDocViewer?encrypt=c38c9fe2-6f0c-49f9-9239-7d738c695b84&mime=pdf&co=raymondjames&id=matt.goodrich@raymondjames.com&source=mail

Repo Turmoil

First Trust Monday Morning Outlook

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist


Date: 9/30/2019


In Ronald Reagan's famous A Time For Choosing speech in 1964, he said "...the more the plans fail, the more the planners plan." We were reminded of this recently after pundits freaked out when the New York Federal Reserve injected reserves into the banking system to keep some short-term rates from rising.

A few things to keep in mind:

1) The jump in the overnight repo and federal funds rates was at the "tail" of the market. Most trading in the market was "normal," with average rates rising just a little, but some small amount of trading went off at a higher bid. In other words, this was NOT a serious system-wide shortage of reserves.

2) The reason most trading saw little impact is because there are $1.4 trillion of "excess reserves" in the banking system. So, contrary to much of the press coverage of this issue, the NY Fed repo operations were not due to a shortage of reserves.

3) The actual amount of reserve operations, somewhere between $45 and $75 billion per day, is well below the level of daily trading in reserves in previous decades. During the 1990s, for example, $150-250 billion in federal funds traded each day. In the 2000s, it went above $300 billion.

The recent turmoil is because two things have changed since 2008 that have created new problems for the banking system and the Fed. First, the Fed decided to stop managing policy like it used to. Second, new banking regulations have created liquidity problems in the banking system even when banks have ample capital, liquidity, and profits.

Central banks used to add and subtract reserves in order to stabilize overnight rates. Now, central banks globally have injected massive amounts of excess reserves into the system and attempt to manage those reserves by moving interest rates directly. Excess reserves are potential money supply growth, and the Fed believes it can simply pay banks to hold those reserves, avoiding inflation. In Europe and Japan, central banks are trying to use negative rates to "force" banks to lend. In other words, central banks have upped their influence over the banking system through control of even more assets.

At the same time, post-2008 banking regulations have handcuffed banks in significant ways. Central banks may have injected massive reserves, but they then offset this by forcing banks to comply with the Liquidity Coverage Ratio (LCR), which forces banks to hold enough liquidity to last a month in a significant financial and economic crisis scenario where unemployment climbs to roughly 10%.

The result? In spite of excess reserves in the system, banks can still run into liquidity problems even when they are in great financial shape.

This leaves the Fed with a dilemma. Will they relax these overly strict rules, even during short periods of stress, or will they use the repo craziness of recent weeks to justify even more Quantitative Easing?

Jerome Powell, at his press conference in September said, "I think if we concluded that we needed to raise the level of required reserves for banks to meet the LCR, we'd probably raise the level of reserves rather than lower the LCR." Once the planners fail, they end up planning and micro-managing even more. Student loan problems and the government's role in subprime loans suggests this isn't a great idea.

The attached information was developed by First Trust, an independent third party. The opinions are of the listed authors at First Trust Advisors L.P, and are independent from and not necessarily those of RJFS or Raymond James.  All investments are subject to risk. There is no guarantee that these statements, opinions, or forecasts provided in the attached article will prove to be correct. Individual investor's results will vary. Past performance does not guarantee future results. Forward looking data is subject to change at any time and there is no assurance that projections will be realized. Any information provided is for informational purposes only and does not constitute a recommendation.

Rorschach Economics

Brian S. Wesbury, Chief Economist, First Trust
Robert Stein, Deputy Chief Economist
Date: 9/9/2019

We've all heard of the Rorschach test - you know, the one where you look at an ink blot and say what you see. The theory is that it's a tunnel into someone's subconscious thoughts or desires. If you're obsessed with hockey you might look at an ink splotch and see hockey sticks, or pucks, a Stanley Cup, or even Bobby Orr; if someone is obsessed with outer space, she could look at the same picture and see flying saucers or aliens. These tests come to mind because lately, three dominant types of economic thought seem to analyze every data point and come to conclusions that always support their particular interpretation of the US economy.

One group is obsessed with President Trump's tariffs, thinking they are slowing the economy. They even search the internet and earnings calls to find mentions of "trade uncertainty" to prove their point. But uncertainty is one thing, data are quite another. Total US trade in goods and services (exports plus imports, combined) was $4.9 trillion in 2016. In the past twelve months, it's been $5.7 trillion, an increase of 16.3%. In other words, trade has grown faster than the overall economy.

Yes, we know trade tensions with China are real and important for some companies. And yes, we look forward to the US reaching an agreement with China. But the Middle Kingdom is not the be-all end-all when it comes to world trade. Supply chains are moving - trade is dynamic - which is why the costs to the US economy have been far less than static analysis predicted.

So far this year, US imports from China are down 12.3% from the same period in 2018, but imports from Vietnam are up 33.2%, and they are up 20.2% from Taiwan, 9.8% from South Korea, 9.7% from India, and 6.3% from Mexico. Meanwhile, we're confident that Congress will pass the new version of NAFTA by early 2020, facilitating stronger trade ties with Canada and Mexico. Trade is moving forward, not dying.

The second major thought group consists of those who oppose the president's policies in general and are looking for any way they can to discredit the tax cuts and deregulation. They love to focus on supposedly weak business investment, which they say signals the ineffectiveness of the president's policies.

The problem with this theory is that, since the tax cut was enacted at the end of 2017, "real" (inflation-adjusted) business investment in equipment has grown at a 3.4% annual rate, while real business fixed investment (equipment, structures, and intellectual property) has grown at a 4.5% annual rate. These are respectable numbers. It was inventories that held down GDP growth back in Q2, and this can't last with a strong consumer.

Moreover, productivity growth (the growth in worker output per hour) has accelerated, growing at a 1.7% annualized rate since the start of 2018 (and up at a faster 2.9% annualized rate so far in 2019), versus a 0.9% annualized rate for the four years ending in 2016.

The last of the three thought groups have been obsessing about the next recession since the moment the last one ended. Any day now they expect the "sugar high" to end.

They celebrated when the ISM Manufacturing index dropped to 49.1 last week, but then the ISM index for the much larger service sector surprised on the high side at 56.4. For every data point that signals a slowdown, there are nine that don't.

For example, a soft 130,000 gain in headline payroll growth for August dominated headlines, but civilian employment (which includes small business) surged 590,000, wage growth picked up, labor force participation moved higher, initial claims remained low, and auto and truck sales rose. Not exactly negative news.

If someone has an axe to grind about the US economy, we're sure they'll see a recession in whatever blot or piece of data they look at. They can always find something to worry about. Nonetheless, we continue to believe that optimism should be the default position for investors when it comes to the US.