The wait goes on for the business investment boom that Republicans promised the corporate tax cut would unleash.
That warning sign flashed beneath the Friday headline that the economy continued to expand at a brisk 3.5 percent through the third quarter.
It suggests that an economy that just recorded its most robust growth in back-to-back quarters since 2014 may be running on a sugar high that’s close to burning off. And it points to the possibility of a worst-case scenario for the tax cut’s boosters — that the law is failing in its central goal of encouraging the sort of business spending (on improved technology, more efficient factories and the like) that will end up boosting productivity, thereby creating more widespread prosperity.
Specifically, business investment edged up by a meager 0.8 percent during the three-month period, accounting for just .12 percent of total GDP growth. As the New York Times’s Ben Casselman points out, increased spending on intellectual property accounted for most of that activity. Spending on commercial buildings fell by nearly 8 percent after climbing 14.5 percent in the second quarter:
Companies are investing more in intellectual property. But other than that, business investment was anemic in Q3. Not much evidence of a big boost from the tax law. pic.twitter.com/nULbaBdPDO— Ben Casselman (@bencasselman) October 26, 2018
Here's how Barclays assessed the result, via AEI's Jim Pethokoukis:
Barclays: "The weak spot in today’s report was business fixed investment, with structures, equipment and residential investment all slowing considerably in Q3. This suggests that the corporate tax cuts have not induced much capital accumulation. "— James Pethokoukis (@JimPethokoukis) October 26, 2018
It’d be unwise to draw sweeping conclusions from a single report. Independent economists defending the tax cut say it will take years for its full benefits to manifest. But business investment should be on the leading edge of the virtuous cycle the law aimed to spark. And Council of Economic Advisers Chairman Kevin Hassett argued in a presentation from the White House briefing room last month that a new private spending boom initiated by the tax cut was not only well underway and observable in the data but also yielding a pay bump for workers.
At least some of the increased business investment that Hassett attributed to the tax cut has owed to a recovery in oil prices that compelled energy companies to plow back money into new structures and equipment. With oil prices leveling off, that spending binge by the industry looks like it has ended, as former CEA chair Jason Furman notes:
This means that business fixed investment ex oil/gas was actually slightly better than the headline in Q3 (1.7% instead of the headline 0.8%). pic.twitter.com/vNBbBylz5h— Jason Furman (@jasonfurman) October 26, 2018
Instead, spending by both consumers and the federal government helped drive third-quarter growth. But the Federal Reserve, for one, expects a slowdown in the months ahead, predicting 2.5 percent growth next year that will cool further to 2 percent in 2020.
“The big picture… is how little Trump has done to change our long-term economic outlook. His tax cut certainly seems to have juiced growth this past year, but since it wasn’t paid for, it has also made the Federal Reserve raise rates enough that its net effect should be pretty close to zero by the end of the next year or so,” Matt O’Brien writes for The Post’s Wonkblog. “Unless, of course, companies do start investing far, far more than they are right now.”
President Trump’s other defining economic project — reordering U.S. trading relationships — is clouding the picture. Trade proved a drag on the economy’s third-quarter performance. As The Washington Post’s David Lynch points out, economists believe the president’s threats of extra tariffs on Chinese products “may have encouraged U.S. companies to ramp up imports to beat rising prices,” which would help explain the widening trade deficit. Since businesses hate few things more than uncertainty, the prospect of an escalating trade war could also be weighing on investment, as executives hold off on commitments to major new outlays.
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— Earnings are strong but investors are spooked. The Wall Street Journal's Akane Otani and Corrie Driebusch: “Investors are selling the shares of firms that hit quarterly earnings expectations at the highest rate since 2011, a sign of concern over how long the good times can last for American corporations... U.S. companies are on pace to extend a streak of double-digit earnings gains this quarter. The abundance has been widely shared, with energy conglomerates, manufacturers and technology concerns alike posting large increases.
"Yet this robust corporate performance has been largely overshadowed by a monthlong market retreat that has shaved trillions of dollars off the value of major U.S. stock indexes. Among the firms hit have been those that posted earnings that matched or exceeded Wall Street estimates, often while offering soft sales results or mixed guidance for future periods. It’s a development that many analysts and portfolio managers take as signaling that confidence in future earnings is on the wane.”
And they worry things are going too well. Bloomberg News's Sarah Ponczek: “In the economy, things are so good that people are wondering if they can get much better. . . . If there’s no room for improvement, what’s left to get investors excited? ‘The growth surge in Q2-Q3 represents the high-water mark for the U.S. economy,’ said Leslie Preston, senior economist at Toronto-Dominion Bank. ‘Growth is expected to come off the boil over the next year as the fuel from fiscal stimulus is spent, but still grow above the economy’s potential.’ . . . Investors need to come to their senses, according to Peter Jankovskis, co-chief investment officer at Oakbrook Investments. . . . We need to ‘get to the point investors can pause and take a breath instead of having these up 2 percent, down 2 percent days,’ Jankovskis said by phone. ‘Once they do that and begin looking at company results, we’ll see the beginnings of a more sustained recovery.’ ”
— Market drop undermines Trump's case. The Hill's Niv Elis and Sylvan Lane: “A massive drop in stock markets this week is raising concerns that the market is headed for a large correction — and may also put a dent in the economic message in the closing weeks of the midterm campaign by [Trump] and Republicans . . . Economists warn that the falling stock market may not simply bounce back, as it has several times this year . . . Republicans had hoped the economy would help them this fall, and candidates across the country are continuing to try to use it to bolster their cases for reelection . . . Since the downturn, Trump has been mum on the markets, a shift from his complaints on Twitter last week that the media was not paying enough attention to the stock market.”
— Bolsonaro wins Brazilian presidency. The Post’s Anthony Faiola and Marina Lopes: “A 63-year-old nationalist renegade rode a wave of voter rage to Brazil’s presidency on Sunday, marking the most dramatic shift to the right in Latin America’s largest country since the end of the Cold War-era military dictatorship. Jair Bolsonaro, a far-right lawmaker and former army captain, defeated leftist Fernando Haddad in the runoff, receiving about 55 percent of the vote, according to official results with nearly 100 percent of the ballots tallied. His win adds Brazil to a growing list of countries — from the United States to Hungary to the Philippines — where staunch right-wing nationalists have scored victories at the ballot box.
“Bolsonaro ran a social-media-centered campaign similar to [Trump’s] that promised to attack the corruption of political elites and bring an iron fist to fighting crime. He demonized opponents and polarized the nation with his history of denigrating women, gays and minorities… Bolsonaro at times has appeared to mimic Trump, on whom he has lavished praise. He has promised to make Brazil ‘great’ and picked a war with the media over ‘fake news.’”
— China's 2025 plan looms over talks. Bloomberg: "China’s state-sponsored push to dominate technologies of the future is one of the biggest stumbling blocks to prospects for resolution to the U.S. trade war. Officials from both sides are pessimistic about chances for a breakthrough when [Trump] and Xi Jinping meet on the sidelines of the Group of 20 summit in Buenos Aires on Nov. 30-Dec. 1. While Trump is still dangling the threat of additional levies, Xi is digging in for a protracted conflict by cushioning the impact on growth and showing no signs he’s willing to compromise plans to strengthen his nation’s technological prowess."
U.S. firms in China eye relocation. But they aren't coming home. Reuters's Sue-Lin Wong: "More than 70 percent of U.S. firms operating in southern China are considering delaying further investment there and moving some or all of their manufacturing to other countries as the trade war bites into profits, a business survey showed on Monday. U.S. companies operating in China believe they are suffering more from the trade dispute than firms from other countries, according to the poll by the American Chamber of Commerce in South China, which surveyed 219 companies, one-third from the manufacturing sector. Sixty-four percent of the companies said they were considering relocating production lines to outside of China, but only 1 percent said they had any plans to establish manufacturing bases in North America."
— Corn may make a comeback. WSJ's Jesse Newman and Jacob Bunge: “American farmers hit by the U.S.-China trade battle are preparing to reshape the U.S. Farm Belt by planting more corn and less soybeans next year over a land mass potentially equal to the size of Connecticut. . . . U.S. farmers in 2018 planted more soybeans than corn for the first time in more than three decades, betting on that demand. But Chinese tariffs on U.S. soybeans have wreaked havoc: U.S. exporters have sold less soybeans to China, typically the largest foreign buyer of the crop, in the past seven weeks than in a single week last fall.”
— Iran hawks want to strengthen sanctions. The Associated Press's Matthew Lee and Susannah George: “A battle is brewing between the Trump administration and some of the president’s biggest supporters in Congress who are concerned that sanctions to be re-imposed on Iran early next month won’t be tough enough . . . The self-described Iran hawks are concerned enough that they have drafted legislation that would require the administration to demand that Iran be suspended from the international bank transfer system known as SWIFT . . . Despite Trump’s tough stance, the hawks are worried about recent comments from Treasury Secretary Stephen Mnuchin and his staff that suggest Iran will be able to stay connected to SWIFT.”
- “How a Democratic majority could undermine the Mueller probe.” Politico's Darren Samuelsohn.
— IBM to buy Red Hat. WSJ's Jay Greene and Robert McMillan: “International Business Machines Corp. agreed to buy software-and-services company Red Hat Inc. for about $33 billion in its biggest acquisition ever, a deal that IBM hopes will boost a cloud-computing business central to Chief Executive Ginni Rometty’s effort to revive the tech giant. IBM has seen rivals Amazon.com Inc. and Microsoft Corp. jump ahead of it in the business of providing computing power and software for rent. . . . The deal comes nearly seven years into Ms. Rometty’s struggle to revamp IBM by shrinking older, slower-growth lines of business and focusing heavily on artificial intelligence and cloud computing. That effort led to nearly six years of falling revenue, which IBM finally reversed in January with three straight quarters of growth. But in the latest quarter IBM’s revenue dipped 2.1%, despite the booming corporate tech-buying market. IBM’s stock price is down 19% over the past year.”
— UBS wants more business with Americans. Reuters: “Swiss bank UBS may ask U.S. regulators to expand its license to sell more complex products and sophisticated investment advice to wealthy Americans living in Switzerland as it seeks to woo U.S. taxpayers abroad for growth. In an interview published on Sunday, Chief Executive Sergio Ermotti told Swiss newspaper SonntagsZeitung that UBS currently cannot sell some products and investments to U.S. taxpayers in Switzerland . . . Expanding UBS’s license could help it compete against U.S. rivals just as the largest Swiss bank is seeking more business with wealthy U.S. citizens living abroad, to help accelerate its wealth management business where transaction volumes have been modest. ‘Most billionaires are Americans,’ Ermotti said in the newspaper interview. ‘We don’t want to just cede that business to the U.S. banks.’ ”
— Berkshire invests in fintech. WSJ's Nicole Friedman and Peter Rudegeair: “Warren Buffett’s Berkshire Hathaway Inc. is hopping on the fintech bandwagon. Berkshire invested around $600 million in recent months in two big financial-technology companies focused on emerging markets: Brazilian payment processor StoneCo. Ltd. and the parent company of India’s largest mobile-payments service, Paytm. Both investments were spearheaded by Todd Combs, one of Berkshire’s two portfolio managers. Berkshire is best known for investing in blue-chip companies like Coca-Cola Co. and owning steady businesses like utilities and insurance companies. The company generates the majority of its revenue in the U.S. Mr. Buffett, Berkshire’s chairman and CEO, has historically said technology investments are outside his area of expertise. But Mr. Combs and his counterpart, Ted Weschler, have cast a wide net for potential investments and are pushing the conglomerate in new directions.”
— Brady: No tax cut plan until 2019. Reuters: "The U.S. House of Representatives’ leading lawmaker on taxes suggested on Sunday that a new tax cut plan touted by [Trump] was unlikely to see action in Congress before 2019, and then only if Republicans keep their majority in Nov. 6 elections. 'Really common sense tells you that this (Trump’s new tax cut plan) is something, that as the Republicans retain the House and the Senate, that will advance in the new Congress,' Representative Kevin Brady said on Fox News... Brady did not completely rule out that such a measure could be brought to a vote before year’s end, but said the session of the outgoing Congress which begins in mid-November is 'so unpredictable.'"
— Steyer accuses McCarthy of anti-Semitism. Reuters: "Democratic donor Tom Steyer on Sunday denounced as anti-Semitic a now-deleted tweet from Kevin McCarthy, the No. 2 Republican in the U.S. House of Representatives, that said Steyer and two other wealthy donors were trying to buy the November congressional elections. McCarthy’s tweet, posted on Tuesday and deleted the next day, was captured in images on media sites. It referred to financier George Soros, former New York Mayor Michael Bloomberg and Steyer, all billionaires who donate heavily to liberal causes. All three have Jewish family backgrounds... McCarthy’s office did not address Steyer’s charge but said the congressman strongly condemns violence and 'simply points out the enormous financial contributions a select few have made in this year’s midterm campaigns.'"
— Regional banks to get reg relief. Bloomberg's Jesse Hamilton: "Big regional U.S. banks such as U.S. Bancorp, Capital One Financial Corp. and PNC Financial Services Group Inc. are about to get more relief from regulators appointed by [Trump]. The Federal Reserve and other agencies -- responding to legislation that’s meant to soften rules for smaller lenders -- are set to propose this week that a series of complex capital demands only apply to Wall Street megabanks, according to a person familiar with the regulators’ plans...
"At issue is a framework known as 'advanced approaches' that sets out a number of complicated benchmarks that the largest banks must use to determine how much of a capital cushion they need to protect against losses. Current rules say an advanced approaches bank is one with at least $250 billion in assets or $10 billion in foreign exposure -- a measure meant to include the biggest and most internationally active firms. But the new standard, set to be discussed by the Fed at an Oct. 31 meeting, would raise the threshold to $700 billion in assets and $75 billion in international activity."
Capital Alpha’s Ian Katz on what to expect from the Fed: “We presume that regulatory czar Randy Quarles wanted to get a proposal out before his mid-November appearances before Congress. Republicans have asked for more clarity on how the non-GSIB banks will be regulated, and Quarles wouldn’t have much to offer them without some kind of Fed proposal. While we don’t know what the Fed will offer, we suspect that it will want to address the frequency of the ‘periodic’ stress tests required of the $100bn-$250bn banks. The Fed may also shed some light on how the smaller banks in that group would get a lighter form of oversight."
- The Brookings Institution hosts a debate, titled “Are US and Chinese long-term interests fundamentally incompatible?”, in Washington tomorrow.
- The Peterson Institute for International Economics holds a presentation of the book “Crashed: How a Decade of Financial Crises Changed the World” by Adam Tooze in Washington tomorrow.
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