Random Thoughts July 22

A) Growth: Martin Feldstein thinks 'the economy could “flatten out” or “even be positive” in the third quarter, and then it’s likely to contract again in the last three months of the year as the effects of the federal stimulus program wear off and companies finish rebuilding inventories'. My own view about near-term growth prospects is similar (see here) as I think Q3 could even surprise positively in terms of GDP growth amid an end of the inventory correction, less negative contribution from residential investment, strenghtening effects from the fiscal stimulus and a less pronounced than usual seasonal drop in auto manufacturing. However, final demand should remain weak and with that GDP growth should move lower again into autumn/winter (further aggravated by the threat of the swine flu).
Regarding the longer term outlook, I argued frequently that nominal growth should stay low for an extended period of time amid weakness in consumption and investment as households and corporates restore their balance sheets resulting in limited inflation pressures. Richard Bernstein in an FT article - America is for now still blowing bubbles - comes to a similar conclusion but from a different angle (I totally agree with this view). He suggests that 'Financial history shows that bubbles create capacity, which is no longer needed once they deflate. An inevitable and intense period of consolidation follows....History would suggest, therefore, that there should now be massive overcapacity in the global economy. That is indeed the case. Global capacity utilisation was recently at generational lows. Ignoring this history, the goal of Washington’s policies has been to stymie the inevitable consolidation, keeping companies operating – and employing voters – rather than managing the consolidation to maximise the economic benefit. History says that Washington’s is an unwise and ultimately fruitless strategy. Certainly, there may be short-term gains in an economy by keeping a bubble’s unnecessary capacity alive (this may explain the recent improvement in economic statistics), but the continued misallocation of capital significantly hinders longer-term growth....Many observers claim that comparisons between the US and Japanese economies are inaccurate because the US economy is more “dynamic” and less “rigid”. There are, of course, differences between the two economies, but it seems increasingly clear that both the US public sector and, with CIT, now the private sector too are working against post-bubble consolidation, slowing the economy’s dynamism and increasing rigidity.'
In light of my expectations for growth and inflation, FOMC Chairman Bernanke's testimony stated rather the obvious: the Fed has several tools to withdraw the policy accommodation but they wont be used for an extended period of time...

b) Demographics: This UK Telegraph article (World's elderly to overtake number of infants) reports that each month the number of people aged 65+ grows by 870,000. The main conclusion of the article is that 'this will reduce the size of the working population and impose huge new pension costs, threatening to reduce the overall growth of the world economy.'
An ageing society is nothing new amid the drop in fertility rates and the rise in life expectancy especially during the past century and has not threatened economic prosperity, rather to the contrary. What is new is that now more people get older than 65 which is close to the statutory age of retirement in a host of countries. As I suggested in Demographics, the savings ratio and interest rates, that retirement age is not set in stone. It might be difficult to change the retirement age but the pressure to do so will increase in the years ahead given the rising expenses for social security and amid the huge fiscal deficits. George Magnus in this FT article (Older societies have to retire later) makes the same point.