Janet Yellen: Trade War Could Trip Up a U.S. Economy on Solid Footing

CHICAGO — Riding the strength of a strong labor market and robust consumer spending, the U.S. economy remains healthy, asserts former Federal Reserve Chair Janet Yellen. But she cautions that a weak business investment climate, fallout from President Donald Trump’s escalating trade war with China and the slowdown in the global economy have led to increased downside risks to the near-term outlook.

“There are a lot of recession fears out there. There are reasons to worry, but I think saying the economy is in a good place and is doing fine so far is an important starting point,” says the 73-year-old economist with the Brookings Institution and a proud baby boomer.

Still, it’s possible that a trade war with China could ultimately be the shock to the U.S. economy that triggers a recession, according to Yellen. “It certainly resulted in a downturn in investment spending. It’s led to a moderation in growth throughout the global economy, although that’s not the only factor,” points out Yellen, referring to Brexit and other geopolitical risks.

Yellen’s comments came last Thursday, Sept. 12, during a nearly hour-long interview with Kathleen Hays, Bloomberg Media’s global economics and policy editor, at the 2019 NIC Fall Conference. The three-day event at the Sheraton Grand Chicago attracted more than 3,300 professionals from across the seniors housing industry, two-thirds of whom were senior executives. The National Investment Center for Seniors Housing & Care (NIC) presents the conference each year.

Yellen, who served as chair of the Board of Governors of the Federal Reserve System from February 2014 to February 2018, highlighted the current strengths and weaknesses of the U.S. economy.

The positives

At 3.7 percent, the national unemployment rate is the lowest in nearly 50 years. “Every firm that has tried to hire workers knows how tough it is to do it. It’s a tough environment for business, but it’s a very good environment for workers,” says Yellen.

“Wage increases are not tremendously high by historical standards, but they’ve moved up. And they’ve moved up the most for the least-skilled workers, which is something that — given trends in income inequality in our country — is a very welcome development,” she adds.

In August, average hourly earnings for employees on private nonfarm payrolls climbed 3.2 percent on a year-over-year basis, according to the Bureau of Labor Statistics. The inflation rate for the 12-month period that end in August was 1.7 percent.

The Fed’s goal is to achieve an annual inflation rate of 2 percent. For much of the past decade, the inflation rate has been running below 2 percent, but there is now ample reason to believe it’s moving up toward 2 percent, says Yellen.

Historically, Yellen has expressed concern over the inflation rate reaching too high of a level. “But we’re actually in a very different world now. We’ve had a decade or more in which inflation is running at very low levels. Not only is inflation at very low levels, interest rates, both nominal and real —or inflated-adjusted — are at very low levels,” she explains.

In a low-inflation world, negative economic shocks such as an oil embargo pose a real risk to the U.S. economy, she points out.

Meanwhile, U.S. economic growth appears to be moderating, but is still healthy. The gross domestic product (GDP), the economy’s total output of goods and services, grew at a 2.1 percent annual rate in the second quarter, down from 3.1 percent in the first quarter, according to the Commerce Department.

The slowing growth in U.S. GDP is being closely monitored in financial markets across the world. “Frankly, that is something one should have expected, and in a way even welcomed, because if you go back six months and look at the pace of job creation in this country, monthly job increases were running around 200,000,” says Yellen. Monthly job gains have moderated to an average of 150,000 over the past six months, according to the Bureau of Labor Statistics.

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“The unemployment rate was dropping very rapidly, and if that had continued with unemployment at a 50-year low, eventually inflation probably would have risen to unacceptable levels. So, the Fed fully expected to see economic growth slow down to a more sustainable trend.”

An unsustainable level of household debt is not looming over most consumers today, unlike the run-up to the financial crisis in 2008, says Yellen. That’s significant because consumer spending accounts for two-thirds of the U.S. economy.

Retail sales — including purchases at stores, restaurants and online — rose a seasonally adjusted 0.4 percent in August from a month earlier, according to the Commerce Department.  That figure, which beat expectations, was partly due to a 1.8 percent increase in spending on vehicles, The Wall Street Journalreports.

“Households are basically in healthy shape, and consumer spending is propelling the economy. Fiscal policy (the Tax Cuts and Jobs Act) gave a big boost in 2018 to the economy, and it’s continuing to provide a boost now,” says Yellen.

The negatives

Business capital investment fell 0.6 percent in the second quarter, according to the Commerce Department, marking the first contraction in three years. Business capital investment includes spending on software, research and development, equipment, and structures.

Yellen describes the current level of business investment spending as “very weak” and that the indicators on that front don’t look encouraging.

The Business Roundtable’s CEO Economic Outlook Index — a composite of CEO expectations for sales and plans for capital spending and hiring over the next six months — decreased 5.7 points in the second quarter to a value of 89.5.

More broadly, the global economy is slowing. The British Chambers of Commerce just this week cut its economic growth forecast for 2019 to 1.2 percent from its June forecast of 1.3 percent, and lowered the figure for 2020 to 0.8 percent from 1 percent.

Germany experienced negative economic growth in the second quarter of this year, and recent forecasts suggest the country may fall into recession, says Yellen.

China’s gross domestic product grew 6.2 percent in the second quarter from a year earlier, the slowest pace since the first quarter of 1992 and down from 6.4 percent in the previous quarter, according to the National Bureau of Statistics of China.

“We’re seeing a slowing of growth in China. What’s propelling that? An important factor, not the only factor, is trade policy,” states Yellen. “The uncertainties created by the ups and downs in President Trump’s tariff wars with other countries — that’s having some negative, direct effects on the U.S. economy and on the global economy. But the most important impact around the globe is that it is creating huge uncertainty about what are the rules of the game.”

Trump has accused China of unfair trading practices and intellectual property theft as grounds for enacting the tariffs. As of early September, the United States had imposed tariffs on more than $360 billion of Chinese goods, and China had retaliated with tariffs on more than $110 billion of U.S. products.

In a separate trade issue, the United States-Mexico-Canada Agreement (USMCA) — the Trump administration’s proposed replacement for the North American Free Trade Agreement — has yet to be approved by Congress.

“Even with our closest neighbors, Mexico and Canada, trade relations have been sufficiently disruptive that firms just don’t understand what the rules of game are going to be. And the easiest thing to do when you feel that way is put things on hold,” says Yellen.

The trade tensions have exacerbated the downside risks to the U.S. outlook, says Yellen. “We are a global economy. The U.S. is not an island. Global growth is important to us.”

 ‘Root Canal Economics’

The growing national debt and the threat it poses to three large entitlement programs — Social Security, Medicare and Medicaid — concerns Yellen. The U.S. government’s national debt now totals more than $22 trillion. The budget deficit for fiscal year 2019, which ends Sept. 30, surpassed $1 trillion in August.

In fiscal year 2020, the federal government expects to spend $4.7 trillion, nearly 60 percent of which will go toward mandatory benefits such as Social Security, Medicare and Medicaid. Another 10 percent will be used to help pay down the national debt, and the remaining 30 percent is discretionary spending.

Since 2007, the ratio of U.S. public debt to gross domestic product (GDP) has doubled, according to Yellen. “We had a big downturn in the economy that resulted in big deficits with tax collections, more spending on unemployment insurance and other things, and some active fiscal policy to try and get the economy back on track.”

U.S. debt held by the public was 38 percent of GDP heading into the last downturn. Now it’s at 78 percent, according to Yellen.

To put those figures into context, some countries are considered to be in a financial crisis if they have a debt-to-GDP ratio of 90 percent.

The federal government has known about this problem for the past 30 years but has failed to act, says Yellen. “This isn’t pleasant; this is painful arithmetic. How do you get more revenues, or how do you spend less, and who is going to bear the burden? This is root canal economics.”

Candidates for public office don’t like to talk about this issue on the campaign trail, says Yellen. She believes Congress will ultimately step up to the plate, as it has in the past, but not without some prodding. “I worry that it will take market pressure for Congress to come to terms to deal with it.”

These three big entitlement programs are critical to the well-being of our nation’s retirees, Yellen emphasizes. “I don’t think [the deficit] will be resolved without some additional revenues on the table.”

— Matt Valley