The "Secret Sauce” Helping the US Economy Outpace Other Countries

We hear a lot of negative things about the US economy, or at least a lot of social media and let's face it, the regular media pushes a lot of doom and gloom stories about what's going on fiscally and economically in this country. But today we're going to take a step back and look at how the United States economy today in late 2024 compares to the rest of the world, and we're going to be bringing on one of the best economists and forecasters in the country to share what he thinks is in store for the broader American economy, not just for this year, but well into the future. Hey everyone, it's Dave. Welcome to On The Market. And today we're going to be joined again by Joe Bruselas. He's been on the show before talking about the global economy, super popular show, so we brought him back on. If you don't remember, Joe is the principal and chief economist as RSM. He's been named one of the best economic forecasters out there by Bloomberg. And today we're going to talk to him about where the US sits globally and how we stack up to other economies. We'll talk about China's economic slowdown. We'll talk about the conflict in the Middle East and what that could mean for oil prices. We'll also get Joe's take on the biggest economic risks facing the US and his prediction on where Fed rates will land in the next year. And I'm going to give you a little bit of a spoiler. Joe has a refreshingly optimistic, but very candid view of the US economy. And he understands it as well as anyone. He's got a lot of data, information, experience to back up his opinions. And if you're like me, you'll like what he has to say about the future of the US economy. With that, let's bring on Joe. Joe, welcome back to On The Market. Thanks for being here today. Thank you for having me on. It's always good to talk to you, Dave. Well, we don't always talk about the global economy here on On The Market. So I think it would be helpful if you could maybe just give us a summary of the global economy and sort of where the US sits in terms of competitiveness, growth, inflation, all the key indicators. How does the US stack up against the rest of the world right now? OK, well, I guess two things. The first is that we have seen the first tentative steps of what we can call the global recovery. It would appear that the initial price shock caused by the shutdown of supply chains during the pandemic has now ebbed. Central banks have seen the economy begin to recover. And they're now engaged in a near-synchronized set of central bank rate cuts. And while growth is not going to be spectacular, it's going to be solid probably into 3% to 3.2% variety for the entire year. Now, the United States, because of the combined fiscal and monetary firepower put to work during the pandemic, emerged first. And what we're seeing in this first phase of the post-pandemic economy is that the United States is looking a lot stronger, its growth rate, through mid-year, 3.1% on a year-ago basis. You know, Dave, we spend a lot of time thinking about the real economy in my business. And real final private demand, that's the best proxy for the economy, it's up 2.6%. And it's been pegged there for better part of a year now. So the United States economy is doing pretty well, even as it cools into the end of the year. Now, not just growth, but also inflation. As we speak, the overall inflation rate, the underlying inflation rate is around 2.5%, perhaps a bit lower. And again, the US is just simply outperforming its G7 peers. What's most important is that part of the pandemic, US attracted about 18% to 20% of capital flows around the world. Coming out of the pandemic, it's more than 30%. And one gets the sense that the combined impact of US industrial policy, as policy designed to support infant industries like artificial intelligence, and to make sure that the playing field with respect to trade is leveled out. In addition to the supply chain resilience policies that have been put in place, and the first steps towards a more sustainable set of environmental policies, all are working to attract capital from around the world. Moreover, since 2021, in our own internal surveys, we could see a move by firms to begin substituting very sophisticated technology for a lack of labor. That lack of labor was caused by the demographic changes that we're going through, the grain aging and exit of the baby boomers from the workforce. And then also a long period of investment in technology that's now beginning to reap some gains. Now, it's interesting, it doesn't quite include artificial intelligence. But the point is now that that long period of investment is really beginning to pay off. US productivity is up 2.7% on a year-over-year basis. That's the best since the period of 1995 to 2004. The United States economy is just outperforming. But that improvement in productivity, that's the magical elixir, the secret sauce, if you will, that allows the economy to grow faster, have a lower unemployment rate and price stability. Should we continue to see this, and I think we will, because we're just seeing the tip of the spear around artificial intelligence, it's going to change the underlying structure of not only the United States economy, but the global economy going forward. There are good and great things happening across the American economy. And it's good that we talk about them because too many times the doom and gloom crew out there have the initiative. It's always easier to sound smarter when you're being hypercritical or pointing out the shortcomings about what's going on in the market or the economy. But I got to tell you, what we're seeing here, the baseline, suggests that we're going to be onwards and upwards with this economy for a number of years. And that's a good thing to talk about. I love it. Yeah, I mean, I feel like we hear a lot of negativity about the economy, but so much of the data suggests that the U.S. is still really competitive, even in the light of seeing a lot of recession warnings, labor market softening. I think there are some broader trends that you've been seeing. One question I want to ask, though, is the U.S. outperforming because we're at a period of strength or are some of the previously strong competitors like China just sort of fading away? Well, I think it's a little bit of both, that some of the challenges to the economy around the pandemic have just ended. The economy is normalizing now. On a year-ago basis, we're up 3.1% through the middle part of the year. That's not going to be sustainable. We're going to move back to a trend just below the 2%, right around 1.8%. So as the economy cools, you should expect to see demand for hiring cool. Remember, a year ago, the unemployment rate was 3.4%. Okay, that's too low. Out of 2022 into early 2023, the economy was at risk of overheating, right? The fact that we've been able to achieve that soft landing. In other words, we're moving, we're still in full employment, but the economy cooling and price stability returning means we've achieved the objectives of the exit from the pandemic. The economy didn't crash. Now, I know that there's a big doom and gloom crew out there. For two years, they've been predicting recession. At a certain point, it's like being a broken clock that's right twice a day, right? They'll be right eventually, but it doesn't look like the economy is at risk of recession or will be falling into one in the near term. And it's unfortunate that that discourse gained predominance in some quarters, because there are rational investors and good hardworking people who are really missing out on what's happening right now in the economy. We have to take a quick break, but more from Joe Brusuelas when we return. Welcome back to On The Market. Since we do talk more about the American economy in the show, and you are an expert in the global economy, I'd like to just touch on some of the major storylines in the global economy. Because to me, what you're saying about the American situation makes sense. The variable that makes me a little worried is just sort of like a black swan event, because it just seems like there's so much geopolitical instability right now. So what are the main stories on a geopolitical global economy level that you think are important today? Well, first and foremost, it's the role, status and risks around the People's Republic of China. China for close to 30 years saw near double digit rate growth on an average basis. Well, China's reached what economists call a middle income trap, that their business model that was the primary driver of growth, modernization, massive investment in commercial residential real estate, and then subsidizing industries to become an export oriented growth model, have largely come to an end. That model is going to be required to change. It's going to need to evolve. But because of the unique political economy of the PRC, you have an authoritarian government on top of a market economy. Under certain conditions, that can be very difficult. And those conditions are beginning to approximate. China's true growth rate is probably slowing to somewhere around 2%. Its domestic economy, its household pace of consumption has slowed significantly. Why? They're going through a classic debt into leveraging cycle. Altogether, not too different from what United States went through between 2007 and 2014. And unfortunately, with the Japanese economy went through over a period of decades, starting in the early 1990s, until very recently. And we're not sure how this is going to evolve. Right now, the Chinese domestic political, fiscal, and monetary authority seems entirely reluctant to reflate the domestic sector. By that, I mean, they need to transfer incomes from businesses to households in order to get that economy moving again, because they're uncertain around the true condition of the underlying financial sector. Moreover, in order to keep things moving, because what the Chinese really fears, A, an increase in unemployment and B, an increase in inflation, they're attempting to export the burden of adjustment to its trade partners. What that means is the Chinese have directed, the political authorities directed the financial sector to reallocate risk capital to manufacturing. Right now, China's got a tremendous oversupply of goods. And because they want to make their trade partners absorb their adjustment by basically telling them, you're going to have to accept a smaller share of global manufacturing as we export our surplus capacity. Now, you know, Dave, if this was 1995 or even 2005, the entire world would have said, yeah, we'll do that. Right? Why? Why would they have accepted that? Because at the time, we would have thought that this was part of binding China to an existing global order that it had a stake in, so that it would not seek to overturn that order. Clearly, that didn't end up the way that policymakers 30 or 40 years ago thought. So we're in a very different period where the major economies, the US, Europe, the UK, Japan, South Korea, Australia, are clearly not going to accept a smaller share of global manufacturing. That's why we've seen the tariffs, the trade wars, the geopolitical tensions that have clearly spilled over. I mean, the primary target of US industrial policy is to limit the capacity of China to assume and set global standards around electric vehicles and around sophisticated microchips. Moreover, it's to protect our infant artificial intelligence industry and quantum. Right? So there's a lot there. You know, the two outs for free trade are national security and infant industries. The United States has declared both. That's why we've seen a change in the So we're going to be in a period of some tension for a good time over China's overcapacity and its attempt to export its burden of adjustment to its trade partners. Can you say a little bit more about that, Joe? Because I'm curious what potential impacts on the US economy there are from this situation in China? Well, it's a lot less than it would have been a number of years ago. Each quarter, you can open up what's called the 10 Qs, right? And look at the balance sheets of the banks and see their exposure to different economies. Over the past number of years, the big banks have began to reduce their exposure to PRC. And that lessens the probability that contagion from a real crisis in China would flow through the financial channel. But the point is, if you're a forward looking investor, and you're worried about risk, you can open up the 10 Qs of the 100 or so systemically important financial institutions, the big banks around the world, and see what the exposure is. I mean, there's a lot more transparency than you would think, given the sort of the new conspiratorial talk that masquerades as conventional wisdom in some quarters. Got it. Well, I haven't even heard of that, but I'm reassured a bit, at least, that you feel that most American banks or Western banks are probably not super exposed. I'm curious, though, moving on from China, if you think there's limited risk coming from China right now, are there other geopolitical situations evolving that you think do pose a bigger risk or a bigger opportunity to the US economy? Okay, so when I think about the global economy, right, because my main battle is the American economy, but like everybody else since the Great Financial Crisis, you had to become an expert on global economics, because it's an interdependent, globally interwined, integrated economy. When you think about global economics, you start with commodities and energy, always and everywhere first, then you move to industrial production. Because of the tumult in the Middle East, and we're now 10 months into the latest conflict between Israel and its antagonists, well, you do think about the price of oil. Now, my sense here is that the United States, the Norwegians, the Latins have all stepped up production. Right now, we're awash in a sea of oil globally, and there's more coming online due to what's going on in Africa, and even some of the rehabilitation of some of the states in the price shock via the oil channel. But one always should be concerned about events in the Middle East spilling over into a wider conflagration that involves the Israelis and the Iranians and their supporters. So that's the other major risk out there, I think, right now. Got it. Okay. And that risk would come to the US mostly through oil prices? If you're the oil channel. Now, it's important that we put this in the proper context, right? The US is the leading producer of oil in the world. It is self-sufficient when it comes to energy. We actually produce more oil than we use, so we're now exporting it, right? You might have noticed gasoline prices this year, Dave. They're down almost 9% from the peak in April. And I took a look at wholesale gasoline futures because before we came on, because I thought we might be talking about this, we should see another 6% decline in gasoline prices. And that simply has to do with the pace of domestic consumption. We've become incredibly efficient in our domestic oil and energy business. The same companies that produce oil began to invest in renewables about a decade ago, and it's starting to bear fruit. But nevertheless, the price for oil is set globally. If there is a disruption in supply of the Middle East, it will hit our trade partners. And invariably, that will impact us. So that does remain to me that it's the second biggest risk out of a black swan, if that's how you want to phrase it, to the global economy. Thank you for explaining that. I think those are two global situations that I and our audience can wrap our heads around. So let's just return back to the U.S. You seem bullish on the U.S. economy. What's your forecast for the rest of 2024 and into 2025? What should we expect? Well, we expect to see long-term trend-like growth for the second half of the year and into next year, meaning right around 2% with some upside risk. There's a tremendous fiscal tailwind behind the U.S. economy having to do with the rebuilding of its infrastructure, the supply chains. We have one of those new chip factories about 20 miles from where I live. You ought to see it, Dave. It is fantastic. You got to go? No, I got to go. Yeah, I've been able to tour the factory here in Texas and the two out in Arizona. You know what it's like? Just as an aside, back in the 90s, we used to play this game called Sim City. You sort of build civilization, right? Oh, I know it. Of course. You can go out to Tyler, Texas and watch around Tyler how civilization is being built from the substructure that's being put in to support everything to the highways, to the townhomes, the condos, the single-family residences, and all of the lifestyle centers that are springing up to support all this, right? I'm actually talking to a firm in Europe that's thinking about investing in wealth management in Tyler, Texas to anticipate the explosion of the boom around the building of these fabs. That's why I'm one of the factors and reasons why I'm very bullish on the forward look around the economy, because you're going to see not only central Texas, not only Phoenix, Scottsdale, but you're going to see Ohio and upstate New York, Columbus, Ohio, and the area around Cornell and upstate New York be the recipient of investment due to the basic decision by the United States to create resilient supply chains around the most advanced and sophisticated technology. I'm expecting to see more of this, right? Second, with the U.S. unemployment rate sitting around 4.3, now we think it'll finish around 4.5 at the end of the year. That's historically low. Inflation is ebbing. That means real incomes are going up. For the past 15 months, the average worker has seen an increase in their incomes over inflation. You know the argument we're having with each other about grocery prices? Once you account for hours worked and income above inflation, grocery prices are what it takes to work or to pay for weeks of grocery prices. It's right back to where it was in 2019. Now, that's not saying I'm going to go stand in front of a school board with the PTA and tell them, right? People will throw eggs and tomatoes at you. They simply won't believe you. Yet, it's empirically true. And over time, economics has a funny way of trumping ideology and politics. And that reality will take place because each household is proceeding through the adjustment post-inflation shock in a different way. Some have already made their adjustment and moved on. Others are in the midst of it. And others, it's going to take a while, right? There's no two households that are alike. But I am confident that that adjustment will take place. We've got a dynamic economy that's growing. It's becoming less fragile by the day as we harden those supply chains, as we move towards a different balance in terms of the overall economy. Yes, there are risks. There are always going to be challenges. There are always going to be problems. But to me, the economy looks like it's on a much more sturdier foundation than it did in 2019. Wow, Joe, you're getting me fired up about the American economy. I love this optimistic view. Time for one last quick break. But after the break, we're going to hear from Joe on his predictions about the U.S. economy and where the Fed funds rate might land in the next year. Hey, investors, let's jump back in. You did say there's risks, though. So what are the risks that you see? All right. Well, we clearly have had a structural change in how and where we work. Between 20 and 30 percent of us work at home and work at home permanently. That's caused an issue in commercial real estate. Sure has. I was just reading a story this morning about how in the major metros, there's a juxtaposition that's formed in the Class A commercial real estate sector. The newer buildings with the amenities and the technology, they're full. They're at overcapacity. Office space, you mean? Office space, yeah. The older office space that doesn't have those capabilities. There's some real problems. Now, one does not want to discount the financial workout that's going to go on in commercial real estate. Indeed, in 2023, March, April, remember the mini crisis around the state and local banks? There are banks that are going to fail. There are going to be problems. The majority of those notes are held in those state and local banks, and it's going to take a while to work through that. However, it's not a systemic risk. It's more of a local economic risk, but that's part of it. Second, there's a wall of maturing corporate debt that's going to need to be dealt with. Over the next two to three years, it's about $3 trillion in debt. It's the debt that was issued at the bottom of the pandemic, 2020, 2021, when interest rates were very low. So think of $800 million that was issued near 0% in real terms. Well, most corporate debt's five years. We're going to move into the first vintage that's five years old, and it's going to need to be rolled over. Well, let's say it was issued at 2%. Well, we're going to roll that over. It's going to be closer to 5% to 8%. That's something that could cause a slowdown in hiring and a slowdown in overall economic activity. Now, having said that, because I outlined the risks, commercial real estate and the maturity wall of debt that's going to need to be rolled over, the functioning of American capital markets over the last year has been nothing short of significant. We just haven't seen a real problem rolling over that debt and the financial workout from the commercial real estate sector. And it looks to me, with the Federal Reserve beginning to embark on its rate-cutting cycle here in September, that we're going to be able to do that too. And I think we should talk a little bit about that rate-cutting cycle as we're coming back full circle to the start of the show. Before we go into the rate-cut cycle, which I do want to talk about, we've been hearing and talking about on this show quite a lot, this impending adjustment, correction, reckoning in commercial real estate. Why has it taken so long? Okay. So it's in no one's interest, either the people holding the loans or the entities that to engage in a disorderly panic. Second, US economy's $27 trillion. It's a big, huge, dynamic animal. Those large sums, about $1.5 trillion was the estimate that had to be rolled in CRE at the beginning of the year. Yeah, to the mere mortal, that seems, oh my God, that's huge. That's going to cause a recession. No, it's not. It's simply not large enough. It can cause problems in certain localities where the non-performing loans put constraints on local banks to support regional economic activity. Yeah. Think North Texas, right? We can see things slowing down in North Texas. It's in the Dallas Federal Reserve's regional survey. You can tell that the elevated period of interest rates combined with the ability or constraints around these local banks to make loans due to the fact that they're holding a large portfolio of non-performing loans or semi-non-performing loans is causing some of these areas to slow down. But it's not sufficient in and of itself to cause a systemic problem or to cause the overall economy itself to slow down. I'm just old enough to remember the savings and loan crisis of the 1980s and 1990s. That contributed significantly to the end of the big Reagan 1980s era boom, right? This just isn't that. All right. Well, I guess we'll have to just wait and see how it plays out, but I'm glad to hear that you don't think it's going to cause some systemic shock. Last thing I want to chat with you about here today, Joe, is what you alluded to earlier, the Fed lowering cycle. Tell us what you make of the Fed's position right now and how it might play out over the next few years. Okay. At the Jackson Hole Monetary Symposium, the Federal Reserve Chairman Jay Powell was very explicit. It's time for a policy pivot. Interest rates are going to start to come down. Now, right now, the federal funds rate is sitting between 5.25% and 5.5%. We expect that we're going to get a string of 25 basis point rate cuts. The risk is they could be larger if hiring slows or there's something going wrong in the external economy that impinges on the domestic economy. It's not so much the first rate cut that matters or the second or third. It's the destination. Now, we think, based on what's called estimation of the reaction function of the Federal Reserve or the estimation of what's the optimal interest rate given prevailing conditions in the economy, will cause the Federal Reserve to lower that by about 200 basis points to around somewhere between 3% and 3.5%. And we think they'll get there in the to the domestic economy. It will allow one to refinance their mortgage rate if they bought a home over the last year, year and a half, refinance auto rates if you've taken out a loan over the last two years. It will lower the interest rate charge on revolving debt. It will help the federal government to roll over debt at cheaper rates. As those rates come down, you'll see what we call the term spectrum of interest rates from two to five years reset lower. We think the front end will reset much lower. As the term shifts lower, it will cost you less to expand your firm via American capital markets. That's a fundamentally good thing. We'll put a floor into the economy. We'll put a ceiling on top of how high unemployment can go. And we're all going to finally get on with it. We'll be able to look back and say, the pandemic era is actually over. Wow. You're painting a pretty picture, Joe. I like it. And I hope you're right, but you're obviously very informed opinions here. And I hope that for all of us that this optimistic view of a growing, stable, like you said, dynamic American economy is exactly what we're going to get. Joe, thank you so much for joining us today. We will put links to Joe's research, contact information in the show notes, as we always do. Thanks for joining us today, Joe. Thank you, Dave. It was always a pleasure.