The economist who predicts a significant slowdown in the US: “Government spending is falling, the markets are in a fragile state”

The United States economy registered a respectable growth rate of 2.5% in 2023. The American success stands out in a year when most major advanced economies limped: the Canadian economy grew by only a single percent, the United Kingdom experienced a freeze (growth of 0.1%) and in Germany the economy even contracted (negative growth of 0.2%). The International Monetary Fund and the OECD predict that the trend will continue in 2024 as well. But economist Gennaro Zezza thinks otherwise.

“The rapid growth in the US relied on the expansion of government spending by the Biden administration,” says Zeza in an interview with ‘Davar.’

Zeza published at the beginning of the month A report on the US economy, together with his colleagues from the Levy Institute for Economics in New York State. He explains the rapid growth, and predicts a less bright future for the American economy in the coming years. “The optimistic forecasts are based on the assumption that the American public will increase the taking of mortgages, and finance a surge in investments in the housing sector. But since the 2008 crisis, the trend has been reversed: the public is taking on less and less debt.”

According to Zeza, reducing government spending will slow down growth, and therefore may actually increase the deficit. “When the economy slows down, spending cuts, made with the aim of reducing the ratio between the deficit and the GDP, may actually increase it – because the GDP is small.” Zeza criticizes the assumption that the interest rate cuts will rekindle the housing industry, and warns about the price increases in the stock market, which in his view are fraught with the next crisis.

What is the source of the rapid growth of the American economy?
“The US government under Biden has embarked on a number of major government spending projects; The government has pumped a lot of money into the economy, at least until 2023. Unlike the mainstream approach, in our approach demand plays a decisive role in determining growth in the short and long term. One of the sources of high demand is government spending, which also has a positive effect on business investments and consumption – additional elements in the level of demand.”

And why do you think growth will slow down in 2024?
“In 2024 we are already entering the realm of projections. According to the CBO [משרד התקציבים של הקונגרס האמריקאי, ג.ר]government spending is expected to fall in 2024, which is the main reason we are pessimistic about continued healthy US growth.”

“Households take on less debt even when the interest rate is zero”

The CBO, and also the international economic organizations (the International Monetary Fund and the OECD) present their own optimistic growth forecast. What makes the difference?
“They anticipate that the Federal Reserve will lower interest rates, and that this lowering will lead to a significant increase in investment in home construction. We do not know if the predicted interest rate cuts will actually take place, but in any case, according to our statistical analysis, their impact on housing investment is much weaker than the CBO We rely on him. Beyond that, we doubt whether the American public will agree to take on additional debt, mortgages, to finance this increase in investments.”

How are the mortgages related?
“The idea behind the reliance on interest rate cuts is that because they reduce the cost of mortgages, the demand for mortgages, and therefore for housing, will increase. For the CBO’s forecast to come true, households will have to increase the amount of debt they take on.
“But since the outbreak of the crisis in 2007, a stable trend has developed in which households actually choose to take on less debt, a trend that continued even when interest rates were almost zero. We see no reason why this long trend will reverse so quickly, and the CBO’s forecast is based on the reversal this.”

As Zeza explained, until the subprime crisis, the American public took on ever-increasing amounts of debt, mainly the mortgages that financed the real estate bubble. When the bubble burst, the financial crisis broke out. According to data from the Bank for International Settlements, household debt in the US reached a peak of 99% of GDP with the outbreak of the crisis at the end of 2007. Since then it has been on a downward trend, which temporarily stopped during the Corona crisis, and as of the first quarter of 2024 it stands at 73% of GDP.

Tax cuts for the rich do not promote growth

Donald Trump has announced a plan to cut taxes if he is re-elected president, while President Joe Biden has announced that he will tax the super rich. According to your approach, Trump’s plan is more beneficial to the economy because it draws less money from the economy?
“Tax cuts without a change in government spending are supposed to increase disposable income, and therefore support growth. But you have to remember that certain strata of the population will benefit from the tax cuts, and these are probably different strata than those that benefit from increased government spending. I don’t know the details of Trump’s plan, but I doubt it whose cuts are aimed at the lower strata.”

And what does a tax cut mean for the rich?
“An increase in the income of the upper classes has only a small effect on consumption. The rich have the lowest tendency to direct an increase in income to consumption, compared to households from the lower classes, who tend to consume most of their income. When you cut taxes for the rich, mainly their savings increase. They have more money for speculation in the market capital, but only a small part of the growth reaches consumption.”

And what about raising taxes on the rich?
“For the same reason, the impact of such a move on consumption will be small. It’s a good strategy, if you consider the sharp radicalization of inequality in the US in the last 40 years.”

“Expenses should not aim at a deficit level, but at promising investments”

You recommend the government to continue its high level of investments despite a relatively high deficit of 6.2% GDP in 2023? According to your forecast, even if the government reduces investments, the annual deficit is expected to remain at a high level and reach more than 7% of GDP.
“Usually the component that most affects the deficit-GDP ratio is GDP. That is, if GDP grows faster, then the deficit in GDP terms will decrease, even if it increases in dollar terms. When the economy slows down, cutting government spending will fail to reduce the deficit in GDP terms, because it will exacerbate the slowdown in GDP.”

According to your method, the deficit can be increased even more.
“No. When you get close to full employment, you exhaust the ability to accelerate growth, and then you have to stop expanding spending. The ability to accelerate growth is limited by real resources; expanding spending is desirable as long as it accelerates growth. In general, spending should not target the level of the deficit but to promising investment projects.”

like what?
“In my view, the most important investment project that the US needs, and also Europe, is related to the transition to a greener economy. It’s a transition that probably won’t be completed by the private sector because it requires a long-term perspective.”

Why should the private sector not hold such a perspective?
“The private sector wants a quick return. For example, solar panels pay back the investment only after many years. The private sector will not finance them, because investors expect a return long before such an investment becomes profitable. This will only happen if the government supports it – or better, if it invests itself. “

Why is it better for the government itself to invest?
“For the same reason: the long-term perspective. Public companies have the ability to invest in research that develops technologies.
“Take Italy. In the thirty years after World War II, growth in Italy was very fast mainly because of government investments in infrastructure such as roads, railways and a host of other things. This created very large companies that were at the forefront of research. At one point, in the 1980s and -90, there was a change in ideology that said all these companies should be privatized. So they were dismantled and sold, in many cases to foreign parties. But what is important is that they stopped investing in research.”

And in the United States a similar thing happened.
“Yes, but it is unique, because of the importance of the military. Many of the innovations come from the military, whose discoveries for military needs are later used for other needs. These discoveries are the result of public investment, not private. This is one of the conclusions of the British economist John Maynard Keynes : You need an investor who thinks about the long term, and only a public institution can be that investor.”

“When stocks rise too fast, it’s a sign of fragility”

Earlier you said that according to your estimates, the effect of the interest rate is small. What is the role of high interest rates in the performance of the American economy?
“It is not so easy to find a strong correlation between interest rates and real investments. The highest correlation is definitely with housing investments but it is not strong enough to hope that interest rate policy alone will start the economy. In fact, we have a lot of evidence from the slowdown after the 2008 crisis. So download the interest rates to a zero level and the economy still struggled. Of course, the interest rate has significance as a variable that affects inequality.”

how?
“The lenders, who receive income from interest, enjoy high interest rates, and the borrowers are harmed.”

In the report you claimed that the American stock market is overvalued and that there is a risk of a fall. Why?
“The stock markets have risen in value at an extremely fast pace, relative to the economy. To understand why we see this as a sign of a bubble, you need to look at the different ways to value stocks.

“One reason to buy shares is to enjoy the dividends, that is, the profits that the company will distribute to shareholders in the future. The value of the share is determined by the buyer’s assessment of the future profits of the company – the fundamental value. Another reason to buy a share is speculation: if you think the price of the share will rise, you Buy it today to sell it in the future. If most players in the market bet that the share prices will rise, the demand for the shares will rise and with it the price, and the prophecy will come true.”
“When the dominant motive is speculation, a bubble develops. If the trend continues, that is, if the distance between the speculative price of the shares and the fundamental value continues to grow, one of the speculators will think at some point that he should sell. When this happens, the trend will reverse and the market will collapse.”

Can you predict when the market will crash?
“When the indices of the stock markets rise too quickly, we see this as a sign of financial fragility. The market value of the shares moves too far from the fundamental value, so sooner or later there will be a fall. Of course, if we knew exactly when this reversal would happen, we would be millionaires. The problem is that as prices All immigrants want to buy, and it is not clear when the markets will go down. This is the roller coaster of the capital market.”

What happens after the collapse?
“Always when the stock market collapses there is a catastrophe. But the big question is what the authorities decide to do. In 2007/8 they decided to save only some of the financial companies that were facing bankruptcy, and let the others collapse. Once a large financial company goes bankrupt, all its financial obligations, which are the financial assets of other companies, lose their value. That is, all the other financial companies suffer from a decrease in the value of their assets, and as a result they have to sell some of the assets to balance the books. The sale of the assets only increases the trend of falling rates, and intensifies the financial collapse.”

And how does it affect growth?
“The public, which holds its savings in these assets, sees them shrinking, and cuts spending. Similarly, companies reduce investments. Demand is low, and thus a financial collapse translates into an economic crisis. But an increase in government investment can compensate for the lost demand, and encourage households and businesses to consume and invest.”