On Wednesday alone, the day a mob ransacked the U.S. Capitol, Covid-19 killed nearly 4,000 Americans. The total number killed now approaches 400,000. With the economy likely to shrink by about 4% this year, unemployment, poverty and hunger are all too prevalent. This is not America’s finest hour.
Nevertheless, brighter days beckon with vaccinations underway, and with economic fundamentals seemingly well-positioned for a robust rebound. Manufacturing is certainly doing well. The latest word from the Institute of Supply Management (ISM) is that production, orders, deliveries, exports and hiring are all on the rise. All six of America’s largest manufacturing sectors are in fact expanding: petroleum/coal products, computer/electronic products, fabricated metal products (like car parts), transportation equipment, chemical products and food/beverage/tobacco products. The ISM’s separate index for the much larger and harder-hit service sector shows some signs of improvement too. The latest job numbers, however, show regression, with pain concentrated in leisure and hospitality.
Things should quiet some in the political sphere, with Senate control now determined, and with the presidential transition just weeks away. Aside from managing the public health crisis, key economic challenges for President Biden will include navigating tense relations with China, confronting the climate change threat, addressing infrastructure needs, weighing the wisdom of breaking up tech giants, assessing the true risk (if any) of soaring federal debts, addressing income and wealth inequality, and further reforming the problematic health sector, which is becoming an ever-larger part of the overall economy.
We’ll get a clearer picture of the economy with earnings season now underway. A few companies like Walgreens and Micron Technology reported last week. Many more will report in the weeks ahead. Also on the agenda this week: the Consumer Electronics Show (CES), normally held in Las Vegas but this year held virtually. Aside from 5G, video games, new televisions, drones and artificial intelligence, expect lots of talk about the digitization, automation and electrification of cars.
Stocks: U.S. stock markets rose again last week, building on 2020’s bullish performance. Investors weighed the implications of last week’s dramatic political developments in Georgia and on Capitol Hill, and how they might shape future government spending. They’ll have lots more to think about in the weeks ahead as companies report their latest earnings. Speaking of the 2020 stock surge, Visual Capitalist puts the winners into several categories, namely those engaged in software applications, internet retail, basic materials (i.e., copper and lithium), freight/logistics and semiconductors. Loser categories included oil and gas, diversified banks, retail real estate, airlines and aerospace/defense.
Debt: Remember that when talking about U.S. government debt, what you’re talking about are Treasury bonds. The more Uncle Sam borrows, the more bonds it has to issue. Last week, bond prices dropped as investors worried about another jump in supply—the thinking is that a Democrat-controlled Congress will do another Covid relief/stimulus package. Of course, when bond prices drop, it means yields are going up. To be clear, the very long-term trend in the Treasury market is one of rising prices and falling yields. But yields for 10-year Treasuries did creep above 1% last week, the first time that’s happened since before the crisis. Is that a sign the market is losing its appetite for lending to Uncle Sam? Will interest rates continue to rise? It’s way too early to draw that conclusion. But it’s something everyone’s watching.
Debt: The ETF Educator, a website about exchange-traded funds, cited drama with bond ETFs as one of the biggest fund stories of 2020. They faced an existential threat when the pandemic first started. But then the Fed began buying them to support credit markets. Record investment inflows followed. The Fed, for example, now holds $2.5b of Blackrock’s LQD bond ETF, which features debt from investment-grade companies.
Oil: It’s the perennial dilemma for Saudi Arabia: Produce more oil, to net more revenue through volume. Or produce less, eyeing more revenue by driving up prices. Last week, it took the latter approach, announcing a plan to cut output by 1m barrels per day over the next two months. It did so unilaterally, without consulting its fellow OPEC nations. Global oil prices predictably jumped, ending the week at $52 per barrel (WTI). The danger is that higher oil prices could stunt the world’s ability to recover economically from the Covid shock. The U.S. though, is not nearly as exposed to foreign oil as it once was. Incredibly—this fact will really stun anyone familiar with postwar geopolitical history—the U.S. didn’t import a single barrel of Saudi crude during the first week of January, as Bloomberg reports. None. The last time that was true: 35 years ago. The U.S., furthermore, is not just less exposed to foreign oil these days. It’s less exposed to oil, period. Still very exposed, yes. But less than it was thanks to efficiencies and alternatives in energy use for industry, heating and producing electricity. Today, transportation accounts for 68% of all petroleum use in America, according to the U.S. Energy Information Administration. If electric cars become widespread, the age of oil will likely be over.
Labor: Though the unemployment rate remains unchanged at 6.7%, the latest Labor Department statistics show the number of total jobs shrinking in December. Employment had been steadily growing since the early months of the pandemic. The leisure and hospitality sector, which includes restaurants, is taking another hit as surging Covid cases lead to renewed lockdowns. Private-sector education jobs, and state and local government jobs, are also disappearing.
Labor: With so many people working remotely now, companies in high-cost cities have an interesting question to ponder: How should it pay employees who move to much lower-cost places? Should a firm in San Francisco, for example, continue to provide San Francisco-level wages to an employee who moves to Albuquerque, New Mexico? A Bloomberg BusinessWeek report last month discussed this issue, citing the example of Redfin, a real estate tech company. It’s now allowing non-headquarters employees to work remotely full time but only if they accept “localized” compensation. In February, according to the Dallas Fed, only 8% of the U.S. workforce did their job entirely from home. That jumped to 35% in May.” Challenges associated with nationwide cost of living variance aren’t entirely new. Consider an airline with union contracts covering its entire airport workforce. The contract wage might seem high for an airport service agent in Albuquerque, thus attracting many qualified candidates there. But it might barely cover the cost of living in San Francisco.
Tesla said it produced and delivered roughly 500k vehicles in 2020, up from about 200k in 2019. For perspective, General Motors sold about 8m vehicles in 2019. The entire auto industry sold 91m worldwide, about a fifth of those in the U.S. market. Tesla, in other words, remains a niche player. But it’s a massively influential niche player, leading the U.S. in electric vehicle sales. It’s also ramping up production capability with a new factory in Shanghai and another under construction in Berlin. Fans await the company’s futuristic new “Cybertruck.” Under the leadership of celebrity CEO Elon Musk (now the world’s richest person), Tesla saw its stock price rise more than 700% last year. Will it use all the market cap muscle to acquire another company? Blackstone’s Byron Wien and Joe Zidle, in their newly published list of “Ten Surprises of 2021,” think Tesla might buy a major global auto manufacturer and phase out its internal combustion engine vehicles by the end of the decade. That would accelerate the shift to electric vehicles that right now seems inevitable if not imminent.
Fiat Chrysler will manage the shift to electric vehicles as a larger company. That’s after completing a merger with France’s Peugeot first announced in 2019. The combined company will be called Stellantis. It will be the fifth-largest global automaker by sales, according to Bloomberg, after Germany’s Volkswagen, Japan’s Toyota, America’s General Motors and the Franco-Japanese group Renault/Mitsubishi/Nissan. Selling automobiles is no easy business. It’s labor intensive. It’s capital intensive. Profit margins tend to be low. And as The Economist notes, citing IHS Markit, annual worldwide auto sales fell from 94m units in 2017 to 90m in 2019 and just 77m in 2020. But the market strengthened last quarter and should grow significantly in 2021. The key to longterm success, it seems, is cost-effectively producing attractive vehicles that are electric, connected and ultimately autonomous.
Alphabet, better known for its main business Google, is suddenly a unionized company. Workers last week created a new union with the assistance of the Communication Workers of America (CWA). It’s not quite the first union for Alphabet—the firm’s cafeteria workers in the Bay Area have one. So do some contract employees. But this is far more significant, open to all company employees regardless of their role (Alphabet has more than 120k workers in total). It’s a big win for the CWA and unions in general, which are trying to organize workers in the digital economy. A much smaller portion of America’s workers are unionized today (just 10%) than in decades past (it was 20% as recently as 1983). Rates remain higher in some places like Hawaii, New York City, and Las Vegas. In contrast, just 2% of workers in South Carolina and North Carolina are unionized (wondering why Boeing built its new Dreamliner factory in Charleston?). Highly organized areas of the economy include the public sector (i.e., teachers and police officers), and sectors like auto manufacturing and transportation. Why did Alphabet/Google workers decide to organize? It’s not a pay issue. Instead, they cited past disputes with management over contracts with the U.S. defense department and the Chinese government, executive bonuses and sexual harassment claims. Will the trend spread to other companies in the tech sector? Unions hope so. One big target for activists is Amazon.
Haven made a big splash when it was formed in 2018. Three of the most esteemed institutions of corporate America—Amazon, J.P. Morgan and Warren Buffet’s Berkshire Hathaway—joined forces to tackle the notorious inefficiencies of health care. They had money. They had technology. They had gravitas. And they had a base of more than 1m employees to insure. Alas, not even the mightiest of corporate warriors could slay the health care dragon. Haven last week said it would disband. According to Dr. John S. Toussaint, writing in the Harvard Business Review, the venture failed for three key reasons: 1) Inadequate market power (the three companies alone lacked negotiating clout with increasingly consolidated health care providers and insurers, 2) the “perverse” incentives of the U.S. health care system, whereby hospitals and doctors get paid according to how many people they treat and 3) hospitals and doctors unwilling to consider new business models while dealing with the Covid pandemic. Will Haven’s failure discourage others from trying to reform health care? Perhaps, though Amazon seems to retain interest, having recently purchased an online pharmacy. Silicon Valley venture capitalists are also attracted by the sector, which is screaming for technological improvement in areas like billing and administration.
Amazon, as it pursues business in health care and countless other segments, announced a $2b fund to develop affordable housing in three of its largest bases of employment: Seattle, the northern Virginia suburbs of Washington and Nashville. Separately, the company is expanding its in-house delivery capabilities with the purchase of eleven used widebody jets (Boeing 767s) from Delta and Canada’s WestJet.
Bechtel, an engineering giant based in San Francisco, is one of the country’s largest private-held companies, meaning you can’t buy and sell its shares on a public stock market. According to Forbes, it ranks number 13 among private companies, behind firms like Koch Industries, Cargill, Deloitte, PricewaterhouseCoopers and the grocery chain Publix (these are the top five). Private companies tend to be less transparent than public ones, as they don’t have to legally disclose as much financial information. Make no mistake though, Bechtel is enormously influential, involved in most major U.S. infrastructure projects, and many abroad as well. It was heavily involved in building Iraq’s airports, electricity grid and defense and diplomatic installations after the 2003 U.S. invasion. Famous projects include the Hoover Dam, Boston’s “Big Dig” and the Channel Tunnel connecting England with France. It’s heavily involved in the energy and defense sectors. Perhaps inevitably as a big government contractor (it ranked number 16 on a 2018 list), Bechtel is sometimes criticized for its past and present ties to politicians. Sally Denton’s unflattering 2016 book “Profiteers” adds the charges of ultra-secretiveness and shaping U.S. foreign policy to its own benefit.
Retail: Marketplace Pulse, which tracks online retail trends, highlighted four retailing “winners” of 2020: “Etsy, Walmart, Amazon and to some degree, Target.” On the other hand, Google Shopping, Wish and eBay were three notable losers. In general, Americans felt more comfortable than ever buying things online, sometimes because they had no choice (with many stores closed) and sometimes facilitated by services like curbside pickup. Certain products though, saw overall sales plummet last year, notably clothing and fashion items.
Commercial Real Estate: The NPR Indicator podcast warns of a possible “unseen force that could be holding back the economic recovery we’re in right now.” It’s talking about lending to landlords renting their property to retail stores, restaurants and hotels. With these sectors pummeled during the pandemic, loan repayments are becoming a problem. A periodic Fed survey of senior loan officers suggests concern, with more bankruptcies expected. And that could lead to wider economic problems. Commercial retailers are also getting pummeled by the shift away from office work. On the other hand, real estate for warehouses and fulfillment centers is hot.
Health: A newsletter about the U.S. economy can never talk too much about health care, now nearly 20% of GDP and growing. Frustratingly, it’s characterized by various systemic market failures, including imperfect competition and imperfect pricing. MIT professor Jonathan Gruber, an architect of the Massachusetts Romneycare and federal Obamacare reforms, highlights access to quality healthcare as a one of the biggest problems, particularly before 2010. Back then, roughly 50m Americans lacked medical insurance. But they weren’t the poorest Americans, who were covered by Medicare. They were the “near poor.” These 50m uninsured accounted for about 15% of the population. Another 60% were covered through employer plans, 20% through Medicaid or Medicare (for low-income and seniors, respectively) and the rest through individual plans (typically not covering care linked to preexisting health conditions). How to insure the uninsured and underinsured? One option, currently espoused by some Democrats today, is for the government to not just cover the poor and the old (and the military) but everyone—this is the so-called “single payer” idea. But the political barriers are enormous—many Americans like their current plans, and the gargantuan private insurance company will understandably fight for their right to exist. Also, paying for it would require higher taxes, albeit likely offset by higher wages companies could pay if they didn’t have to insure people. The alternative Romney- and Obamacare approach that Gruber helped design involves what he calls the “three-legged stool.” First, preexisting condition discrimination would be banned. Second, to ensure that insurance companies wouldn’t be bankrupted by that ban, all Americans would be mandated to buy insurance (this also incentivized insurers to support the reform). And third, expanded government subsidies would help lower-income Americans pay for insurance. These measures would become simultaneously hyper-controversial and popular. Americans particularly liked the ban on preexisting condition clauses. But only with razor-thin Congressional approvals and Supreme Court rulings does the 2010 Affordable Health Care Act (ACA) survive today (and in somewhat altered form; the individual mandate is no longer enforced through fines). And the verdict? Today, about 45% of the previously uninsured are now covered. The rest are mostly undocumented immigrants (denied subsidies in the ACA) or healthy people ignoring the mandate. A much larger slice of near-poor Americans are now insured. But coverage for many middle-class Americans, especially those self-employed, can be expensive, with high premiums (the monthly price) and high deductibles (what you have to pay before coverage kicks in). Gruber admits that some of the Act’s efforts to lower costs (i.e., tying doctor pay to health outcomes rather than services provided and tests prescribed) haven’t worked as well as hoped. President-elect Biden’s central idea is expanding the ACA to include a government-run insurer competing against the Anthems, Uniteds and Humanas of the world. This “public option” idea was originally part of the ACA but taken out at the insistence of Senator Joe Lieberman, protecting the interests of Connecticut’s large insurance sector.
Health: What are some other problems with the ACA? Opponents for starters cite the increase in insurance premiums and deductibles. Expanded coverage through expanding Medicare, they argue, made a fiscally unsustainable problem even worse (retiring baby boomers are creating greater demand for health care, driving up costs). As it happens, about two-thirds of the newly insured under the ACA were placed into Medicaid, which incidentally isn’t accepted by many doctors (it tends to pay less than private insurers). Essentially, the privately insured are subsidizing the government insured. The ACA, furthermore, hasn’t slowed overall medical cost inflation (costs did come down some but did so in all industrialized countries). Lots of the ACA plans were limited in terms of benefits and doctor networks. The law didn’t address doctor shortages due to obstacles adopted by the medical profession (i.e., restrictions on what nurses can do). The chief goal, argued former White House advisor Scott Atlas in a presentation earlier this year, must be reducing the price and cost of medical care. To get there, patients must have incentives to save, which admittedly doesn’t work in emergencies, but emergencies are a small percentage of overall care.
Energy: Noah Smith, in his “Noahpinion” newsletter, thinks the world could be on the verge of another energy revolution. In 1700, he writes, humanity got its energy from human muscle power, from animals, and from burning wood (and occasionally from wind and water). In the 1800s, it switched to coal, which was much cheaper, more plentiful, more energy-dense and easier to extract. Then came the age of oil in the 1900s, “which was superior in all of these categories.” But the price of oil skyrocketed in the 1970s and remained volatile even when prices fell in the 1980s and 1990s. Prices then spiked again in the 2000s. But to this day, oil remains the dominant form of energy for transport in particular (nuclear fission helped some with electricity generation but never led to fission-propelled cars or planes). That’s the reason, Smith believes, that transport innovation—and innovation for physical goods more generally—has been limited. “Without ever-cheaper sources of energy, physical innovation is certainly still possible, but it just gets harder.” The major innovations of the past 50 years have thus arisen in the information technology arena—a shift from atoms to bits. But IT innovation arguably touches less of our lives than energy innovation (IT itself is nothing without electricity). And it probably doesn’t do as much for overall economic productivity. The stagnation in energy technology, Smith continues, almost certainly contributed to the productivity slowdown of the 1970s. But are we now on the verge of an energy revolution? It looks increasingly so, thanks to major advances in battery, solar and wind power. “For the first time since the advent of oil, humanity might get a new source of cheaper, more plentiful energy. And that has the potential to drive productivity growth of the kind we’ve only rarely seen since the 1960s.”
Housing: A quick note about homebuilding, courtesy of Wells Fargo economist Mark Vitner: More than half of all single-family homes currently built in the U.S. are in the South. Here again, a manifestation of the population’s shift toward the sunbelt, a trend that began decades ago but remains in force.
Agriculture: The U.S. Department of Agriculture said farm profits likely rose a whopping 43% in 2020, to $120b. Adjusting for inflation, that’s the best figure since 2013, and 32% higher than its ten-year average. In other words, it was a good year to be a farmer. Why? Not so much because of higher crop prices or stronger demand for farm products. Thank Uncle Sam instead. Direct government payments to farms more than doubled last year, reaching nearly $50b. Most of that was Covid-19 relief funds. Farmers also received compensation for losses linked to international trade disputes. They continued to benefit from standard farm subsidy programs as well. The average farm household earned about $87k in income, which follows a string of tough years between 2015 and 2018. Roughly 40% of that 2020 income came from the government. And 2021? The site Agweb expects higher farmland values due to rising commodity prices, low interest rates, limited farmland for sale, growing investor interest and ongoing government support. Hogs, cotton and dairy, by the way, were the top-earning categories of farm products last year. And one final note: According to the Cato Institute, farm subsidies have been historically concentrated in just a few states (Texas and the “Farm Belt”), a few recipients (big farms and bank-owned farms), and a few commodities (especially corn, soybeans, wheat, cotton and rice).
Video Games: Don’t underestimate the immensity of America’s video game sector. Visual Capitalist calls gaming the largest media sector, with an estimated $165b in global revenues generated in 2020. There are currently some 2.7b gamers worldwide, equivalent to about 35% of all people on the planet. Superdata, a Neilson company, added that earnings from premium digital games rose 28% last year, compared to 9% growth for free-to-play games. Tech goliaths—Microsoft, Facebook, Amazon, Google—they’re all big players in the space. So are game makers like Activision/Blizzard and Electronic Arts. Leading non-U.S. competitors include China’s Tencent and Japan’s Sony and Nintendo (with consoles that compete against Microsoft’s Xbox). Popular games include Tencent’s free-to-play “Honor of Kings” and “Peacekeeper Elite.” Roblox, a social gaming app for younger children, is on the verge of taking its shares public. There’s “Fortnite,” “Call of Duty” and “Among Us.” Superdata mentioned life simulation game “Animal Crossing: New Horizons” as a breakout hit in 2020.
Air Transport: Passenger traffic at U.S. airports is currently down between 40% and 60% from year-ago levels, according to the TSA. But things are much better for operators of private jets. Sentient CEO Andrew Collins, speaking with Bloomberg News, said his company’s flight volumes are up 10% y/y. Wealthier travelers, it seems, are eager to avoid crowds where Covid might spread. Where are people going? Warm-weather destinations like Florida, for sure. In addition, Collins says, more people are purchasing one-way travel, probably indicative of digital migrants working away from home for extended periods. He’s also seeing lots of first-time customers. More people are flying for personal rather than business reasons right now. But before long, Collins sees professionals like consultants and bankers returning. Sentient and others offer private jet access without having to actually purchase a plane. Trips start at $5,400 an hour for one way on a smaller jet.
Government deficits don’t matter absent inflation (an MMT perspective): When it comes to economic policy, there are two big categories: fiscal policy—that’s taxing and spending—and monetary policy: managing the supply of money to ensure there’s not too much (that would cause inflation) or too little (deflation). Modern Monetary Theory (MMT), a hot topic of debate these days, says the U.S. government, with a monopoly on creating dollars, can simply make as many as it needs to fulfill its spending needs. It can’t run out of money like a business or a household or even a state government. Sound like a free lunch? It’s not, because once inflation becomes an issue, fiscal authorities need to step in to raise taxes or cut spending. In that sense, MMT reverses the roles of monetary and fiscal actors—it’s the fiscal folks—Congress—in charge of handling inflation. But if there’s no meaningful inflation, as there hasn’t been for decades, it’s a sign that the economy isn’t producing to its fullest capabilities. So more money creation is warranted to increase economic activity. For a currency issuer like the U.S. federal government, deficits are irrelevant. They’re merely an accounting entry (if Washington buys a fighter jet, it simply debits its own accounts and credits those of Lockheed Martin or Boeing). Stephanie Kelton, a leading MMT proponent, argues the theory in her book “The Deficit Myth.” Federal deficits, she argues, are healthy when the economy is underproducing relative to its capacity. How does she know that? Because unemployment is high, and inflation is low. Federal debt is not the problem. Far more important are problems like child poverty, student loan debt, aging infrastructure, growing income inequality and climate change. Again, the true limit of spending is inflation, and ultimately the real resources of the economy (labor, capital, land, natural resources) and its capacity to produce. Once a fringe theory, MMT’s is getting more attention because many of its tenets are seemingly holding up in real life. Japan is a prime example of a country with huge debts and deficits for decades without negative side effects (inflation and interest rates remain extremely low). Kelton cites the economist Frederick Thayer, who in 1996 noted that the U.S. to that point had experienced six significant depressions, and all six were preceded by a sustained period of budget balancing. It was certainly true before the severe depression of 1837, right after President Jackson paid off the entire federal debt (the last time that’s ever been done). Kelton then mentions the surplus of the late 1990s, which preceded a recession in the early 2000s. And after the 2008/09 recession, she argues, Congress didn’t spend nearly enough, causing a slow recovery. Now, spending, borrowing, debts and deficits are rising sharply to provide relief from the Covid crisis. Yet still, no inflation. Why does Congress have to spend more to get the economy back to full potential? Why not just print more money? Because, Kelton explains, simply flooding the economy with more money can only encourage households and companies to borrow, which is often not what they want or need to do. Remember, cry the champions of MMT, the punishment for overspending is inflation, not insolvency! The U.S. government can never be insolvent thanks to its currency powers. But doesn’t government borrowing compete with private sector borrowing? If the government borrows too much, won’t it crowd out private investment? The MMT response? No, that’s backward. Higher government deficits put more money into the private economy, which means more savings and investments.
Government deficits do matter: Needless to say, not everyone agrees. MMT, critics sneer, stands for Magic Money Tree, a way to spend and spend without consequence. The critics, moreover, range from devotees of Keynesian theory to those adhering to the Austrian school. The latter in particular, including most politicians associated with the Republican party, see MMT as a means to further enhance the size and influence of the federal government, which is the opposite of what they think will help the economy grow. MMT proponents, because they see the number of unemployed people as the main constraint on inflation, want a federal job guarantee to ensure full employment. But how would that be administered? Who would decide what work would be done? What if someone fails to show up to work or constantly arrives late? Can that person be fired? How about unemployed people in a small rural town? Would there have to be a project everywhere? If the pay were too good or the working conditions too favorable, would it poach talented workers from the private sector? The bottom line: It’s a major expansion of Washington’s role in the economy. Even many economists more comfortable with Washington’s involvement see inflation as a bigger risk than MMT proponents sometimes acknowledge. It’s too simplistic to say that unemployment is the central reason why inflation is low. As Milton Friedman used to say, inflation is always and everywhere a monetary phenomenon. More government spending, meanwhile, will eventually compete with private sector investment and lead to higher interest rates—yes, there’s still that risk even if it hasn’t happened yet. Federal debt, by the way, already stands at 130% of total GDP. What’s more, if MMT champions rely on Congress to rein back spending when inflation arises, well good luck—the independence of the Fed was created precisely because Congress can’t control its own spending. Fed chairman Jay Powell, for one, says deficits do matter. The U.S., some warn, could lose its status as the world’s reserve status if debts grow too large.
Is there a link between lower corporate tax rates and corporate investment? Put another way, will businesses invest a lot more if you lower their taxes, as proponents of the 2017 Tax Cuts and Jobs Act argue? Economist Mark Zandi of Moody’s Analytics for one says no. Or at least not a significant link. While tax cuts certainly let companies keep more of their cash, U.S. companies today are certainly not underinvesting because of a cash shortage. On the contrary, as Zandi explained in a discussion last month with Tri-State Investment Sales, companies are awash in cash. And if they do need more for an investment project, borrowing is extremely cheap with interest rates so low. A study by the Cleveland Fed last summer seemed to validate Zandi’s argument, noting that “business investment… grew more slowly after the tax reform than before it.” The 2017 law, as a reminder, cut the corporate income tax rate from 35% to 22%. It also included changes to rules regarding depreciation, research and development spending, interest deductibility and income earned abroad.
Sarah Quinn is the author of “American Bonds: How Credit Markets Shaped a Nation.” It’s a book about Washington’s prolific use of credit programs—from the earliest days of the country—to advance policy goals. By credit programs, she means the government buying, selling, insuring, or guaranteeing loans with the purpose of incentivizing particular activities that Washington wants to encourage, like home buying. The concept emerged after Alexander Hamilton’s plan to federalize responsibility for all state debts after the revolution. In exchange, Washington took control of large areas of land, which it then sold to help repay all those state debts. The problem was that not enough Americans at that time could afford to buy land. The solution: Washington extended credit. Land sales, importantly, was one of the federal government’s two major sources of revenue in the early 19th century—the other was tariffs (income taxes wouldn’t come until the 20th century). Later in the 19th, with Washington more inclined to give land away for free (to encourage western settlement and develop railroads), east coast banks were the main players in providing capital to western farmers. But a chronic shortage of capital, plus recurrent cycles of boom-and-bust crop prices, made the terms pretty onerous. Quinn describes conditions in California during the 1890s, when farm settlers would be lucky to get three-to-five-year mortgages, paying down a third of the property’s value upfront but still subject to a much higher interest rate than available to industrial companies in the east. That led Washington, under political pressure from westerners, to once again get involved in credit markets. It created state land banks in the early 20th century, capitalized with federal money. During the Great Depression of the 1930s, federal credit support was used to stimulate housing development, and by extension more construction jobs, more business for railroads, and more demand for things like wood, bricks, interior furnishings and minerals. Fannie Mae, born as a federal agency to support home lending, was created in 1938. Politicians saw all of this as a low-risk way to grow the economy, and without the need for Congress to appropriate taxpayer funds. Simply provide a guarantee to private-sector banks. If the borrower doesn’t repay, Uncle Sam will. The policy had a dark side, with unfavored groups—most importantly African Americans—often disqualified from participating (at the insistence of southern legislators with disproportionate Senate influence). But federal credit programs would nevertheless grow in influence, underpinning the suburban housing boom that started after World War II and continues today. The same concept is now used to finance education spending too, in the form of lending support to students attending colleges. America’s exporters get federal help too, via loan guarantees administered by Washington’s Export-Import bank. Farming. Housing. Education. The export sector. Infrastructure too. As Quinn argues, all would have developed very differently in America without so much federal credit involvement. But was it all really low risk? Certainly not, as the epic housing bust of 2008-09 made clear. In a forceful metaphor, Quinn says federal credit support was originally like a flat-bed truck pulling a house up a big hill (high interest rates). It did that job well. But on the other side of the hill, beyond its view, was a future of deregulation (which was like taking cops off the road), IT innovation (like putting hyperfuel in the truck), and ever-falling interest rates driving more demand. In 2008, the truck began spinning out of control. Still, the concept of fostering more borrowing and lending via federal help remains alive and well, most recently in the Payroll Protection Program (PPP) to help small businesses and their workers survive the Covid crisis.
Just to put numbers to these support programs, Washington today, according to Quinn, currently has $1.5t in outstanding direct loans, and another $2.8t worth of loan guarantees, which is really closer to $4t if you include private corporations with implicit federal backing, like Fannie Mae and Freddie Mac.
Another quick note about government land. In the 19th century, according to the Cato Institute, the Federal government transferred 871m acres of land to individuals, companies (notably railroads), and states. Before the Civil War, most of the transfers were via sales. After the war, most were via grants. Today, Uncle Sam owns 640m acres or 28% of the entire country’s land. In Nevada, the Feds own a full 80% of all land. In Texas, it owns just 2%.
St. Louis: If southwest Florida exemplifies a booming American sunbelt city (see last week’s issue), St. Louis represents something less flattering. In fact, it’s sometimes used as a case study in how not to govern a metro area. The city was a rock star of the 1800s, rising from a humble French trading outpost to America’s fourth-largest city by 1900. It saw large waves of German and Irish immigrants. It was an important Union base during the Civil War. It’s the symbolic gateway to the west, hence the iconic Gateway Arch monument towering along the Mississippi River. The Mississippi of course, made St. Louis an important river port when river ports mattered. It became a vibrant railway hub as well. By 1880, it had the country’s third-largest cotton market. Meatpacking and shoemaking were important. The city even played a key role in financing and developing Mexico’s late 19th-century industrialization, according to Henry W. Berger’s book “St. Louis and Empire.” Even in the first half of the 20th century, the two World Wars—notwithstanding the Depression in between—created lots of new demand for St. Louis manufacturers. But the city’s population would drop from 900k people in 1950 to a mere 300k today. What happened? For one, Chicago became a far more important railway hub, and later one of the country’s busiest airline hubs. Well into the 20th century, St. Louis remained uncomfortably dependent on river commerce, which lost its relevance as railways and later highways expanded. Buffalo and Cincinnati, incidentally, were two other U.S. boom towns sent into decline as river commerce gave way to rail commerce, according to Colin Gordon, author of the 2008 book “Mapping Decline: St. Louis and the Fate of the American City.” Gordon, though, highlights another key reason for the city’s decline: Bad public policies. The U.S. Constitution, he notes, doesn’t mention anything about municipal forms of government, just state government. But Missouri’s state government is in Jefferson City. St. Louis wanted to make its own decisions about matters close to home. So in 1875, the state granted it “home rule.” It’s still regretting the move today. The problem is that suburban areas around the city also won home rule, boxing St. Louis into its relatively small geographic footprint. St. Louis can’t just annex territory to expand as many other cities can. In those budding suburbs, meanwhile, federal mortgage loan guarantees that began in the 1930s encouraged real estate developers to create incorporated self-governing towns beyond city limits. The new towns would adopt “deed covenants” that typically restricted dirty industries and non-white residents. Both, alas, remained left behind in St. Louis proper while middle-class white residents and more modern businesses—with their tax dollars—arrived at the suburbs in droves. The city of St. Louis itself became older, poorer, and blacker. Compounding the problem were counterproductive attempts later on to lure back residents; building expressways through the city certainly didn’t help. Why not create an entity to govern the entire St. Louis metro area, optimizing what’s best for city and suburbs? Does it really make sense for a single region to have 12 counties, more than 100 municipalities, and over 200 other government entities (school districts, sewer districts, museum authorities, etc.)? As it happens, there was a major effort in 2019 to merge St. Louis County with St. Louis the city. It ultimately fizzled.
What’s the St. Louis metro area economy like today? It currently ranks 20th in the country with about 2.8m people, surpassed a few years ago by much faster-growing Denver. Of the nation’s 50 largest metro areas, St. Louis ranks 45th measured by population growth during the 2010s—it grew less than 1% last decade. To this day, few major metros have a larger share of residents living outside city limits. It’s still home to some big multinational firms like Emerson Electric, the health insurer Centene, and the agribusiness firms Bunge and Monsanto. Washington University is a leading employer. But many of the area’s top corporate names were swallowed by companies from elsewhere: Boeing bought McDonnell Douglas. Nestle bought Ralston Purina. American Airlines bought TWA. InBev bought Anheuser Busch. Cigna bought Express Scripts. Mallinckrodt Pharmaceuticals, meanwhile, filed for bankruptcy this fall, swamped by litigation tied to its role in distributing opioids. Peabody Coal filed in 2016. Most of these companies, however, continue to operate and employ many area residents. Others like Dallas-based Southwest Airlines have expanded their St. Louis footprint. The area remains a major center of aerospace and auto manufacturing, along with pharmaceuticals and agribusiness. On the other hand, it’s not attracting many information technology jobs or tourists.
Missouri is hardly alone as a state whose largest city is not the state capital. At a Brookings event this fall, David Damore, Karen Denielsen and Robert Lang talked about Nevada’s unique situation. For a long time, Reno was its biggest city, but still not very big. The capital is in Carson City, a largely rural place with roots in mining. Then along came this giant city Las Vegas, which today has more than 1m people but limited home rule. In lobbying Nevada politicians, it can’t even use the well-practiced threat that key companies will leave the state because casinos are illegal in most of America. Nevada, by the way, is one of just four states where the legislature meets only every two years (Texas, Montana and North Dakota are the others). In other late-developing western states like Colorado and Arizona, the situation is different: Denver and Phoenix are both the capitals and the largest cities. Florida, incidentally, chose its capital Tallahassee because it was midway between the two largest cities at the time, Jacksonville and Pensacola. (Pensacola by the way is about the same driving distance from Key West as it is from Chicago; both take about 13-to-14 hours).
According to a Bloomberg News study, no other U.S. city has a bigger brain drain problem then Kalamazoo, Michigan—people with college degrees are leaving for healthier job markets. But good news: It’s now a major hub for Covid vaccine production, thanks to a Pfizer factory in the area.
A separate Bloomberg report looked at Georgia’s economy as the state held consequential Senate elections. As it turns out, it’s in pretty good shape relative to other states, thanks to a few factors. The large Atlanta housing market is strong thanks to low interest rates and federal fiscal stimulus. Dalton to the north is a hub for carpets and other floor coverings, and it’s a good time for that with home improvement spending way up. State and local governments are in relatively good fiscal shape. Low living costs are attracting digital migrants to homes in coastal resort towns like Savannah. The poultry sector is doing well. Unemployment is below the national average. A strong auto sector is relevant because Georgia is home to the U.S. headquarters of both Mercedes Benz and Porsche. Savannah, one of America’s busiest seaports, is handling record volumes (some of its leading import items are appliances, furniture and consumer electronics). Not all is going well in Georgia, however. The ailing airline sector is a huge employer—Atlanta has the world’s busiest airport and Delta is the world’s largest airline by revenues.
What are the nation’s hottest real-estate markets? Realtor.com provides a list, which unsurprisingly consists of booming tech hubs with strong job markets. Also present are state capitals where buyers can get more square footage for their money and smaller cities that are affordable alternatives to the larger, coastal megacities. The list includes Sacramento (Bay Area residents seeking cheaper housing), San Jose (Silicon Valley still booming), Charlotte (increasingly popular with retiring baby boomers), Boise (Californians fleeing high prices), Seattle (a booming tech economy) and Phoenix (sunshine and low costs). Most surprising was Pennsylvania’s capital Harrisburg. It’s within a three-hour commuting distance (not bad if you’re working remotely most of the time) to Baltimore, Philadelphia, New York City, Pittsburgh and Washington). Jobs are plentiful in government, logistics and health care. Also making the list were Oxnard and Riverside near Los Angeles, as well as Denver.
The Indicator, an NPR podcast, spotlights the diverging trajectories of service spending and goods spending during the pandemic. Spending on services (be it doctor appointments, eating at restaurants, staying at hotels, getting a haircut, attending a concert, etc.) was 7% lower in November (adjusted for inflation) than it was just before Covid hit in February. Goods spending by contrast, was up 7%. So they should cancel each other out, right? No, because service spending is a much larger part of the U.S. economy; typically, twice as big.
Oaktree Capital founder Howard Marks, a leading expert in valuing and trading distressed debt, worries about excessive debt among non-financial corporations. “Even borrowers that eventually are profitable may find themselves over-levered after the pandemic and struggle to service their debt,” he tells the Financial Times. Airlines are a good example, having borrowed tens of billions of dollars (from banks and bond investors) to keep running during the pandemic.
Chart of the Week
Largest U.S. Companies by Revenue
Latest fiscal year reported (source: Fortune)
font-family:Arial, sans-serif;font-size:14px;overflow:hidden;padding:10px 5px;word-break:normal;}
font-family:Arial, sans-serif;font-size:14px;font-weight:normal;overflow:hidden;padding:10px 5px;word-break:normal;}
|company||2019 revenues (in \$b)||notes from company’s latest reports|
|1||Walmart (Arkansas)||\$524||Dominated U.S. retail before the rise of Amazon; launched walmart.com (and samsclub.com) in 2000|
|2||Amazon (Washington)||\$281||Saved nearly \$1b in employee travel last year; how much of those costs will come back?|
|3||ExxonMobil (Texas)||\$265||Transition to electric cars and trucks an existential threat to the world’s hydrocarbon companies|
|4||Apple (California)||\$260||Will it get into the car business? Speculation reaching a fever pitch|
|5||CVS Health (Rhode Island)||\$257||Acquired Aetna health insurance in 2018; wants to become “trusted front door to health care”|
|6||Berkshire Hathaway (Nebraska)||\$255||Famed company run by Warren Buffet; owns businesses ranging from Dairy Queen to Geico to BNSF railroad|
|7||UnitedHealth (Minnesota)||\$242||Medicare for all would remove need for private insurers like United, but President-elect Biden not a supporter|
|8||McKesson (Texas)||\$214||As a critical node in U.S. health care supply chain, it’s naturally an important player in Covid vaccine distribution|
|9||AT\&T (Texas)||\$181||No company in the U.S. has more long-term debt; \$153b as of Oct. 1 (Ford Motor ranks behind it)|
|10||AmerisourceBergen (Penn.)||\$180||Recorded \$7b accounting charge last quarter due to litigation related to opioid distribution|
|11||Alphabet/Google (California)||\$162||Waymo, a wholly-owned subsidiary, hoping to be a leader in autonomous vehicle technology|
|12||Ford (Michigan)||\$156||Number one among Detroit’s Big Three by sales, ahead of GM and Fiat Chrysler; Tesla a formidable challenger|
|13||Cigna (Connecticut)||\$154||Improved pharma insurance coverage by acquiring ExpressScripts in late 2018|
|14||Costco (Washington)||\$153||Spends much less on advertising than most retailers; earns large portion of profits from annual membership fees|
|15||Chevron (California)||\$147||Completed acquisition of Noble Energy this fall; provides more exposure to Permian Basin in Texas|
|16||Cardinal Health (Ohio)||\$146||Said flu vaccinations are up significantly this winter; McKesson, Am/Bergen its biggest rivals in medical distro|
|17||JPMorgan Chase (New York)||\$142||Endured the 2008-09 Lehman crisis better than most of its rivals|
|18||General Motors (Michigan)||\$137||Investing \$70m in two of its plants, one near Cleveland the other near Buffalo|
|19||Walgreens (Illinois)||\$137||Reported earnings last week; began administering Covid vaccines on Dec. 18|
|20||Verizon (New York)||\$132||Rolling out 5G across the U.S.; technology promises much higher connectivity speeds|
|21||Microsoft (Washington)||\$126||Looking to give Windows software a new look for users, according to Techmeme Ride Home podcast|
|22||Marathon Petroleum (Ohio)||\$125||CEO Tillman: “Industry consolidation is… a positive for the structure and long-term health of our sector”|
|23||Kroger (Ohio)||\$122||Believes many 2020 supermarket buying trends will continue after pandemic; cooking at home now routine|
|24||Fannie Mae (Dist. Colombia)||\$120||Has been in “conservatorship” (similar to bankruptcy) since the housing crisis of 2008|
|25||Bank of America (North Carolina)||\$114||Has about 4,300 bank branches currently, down from 4,800 in 1999|
|26||Home Depot (Georgia)||\$110||Saw revenues up 24\% y/y in its latest quarter (Aug-Oct); saw “outsized demand for home improvement projects”|
|27||Phillips 66 (Texas)||\$110||What does it do? It “processes, transports, stores and markets fuels and products globally”|
|28||Comcast (Pennsylvania)||\$109||Media brands include NBC, USA, Bravo, Peacock, Golf Channel, Sky in U.K.|
|29||Anthem (Indiana)||\$104||Putting “more and more money into our AI and digital capabilities”|
|30||Wells Fargo (California)||\$104||In 2018, the Fed banned it from growing due to phony accounts scandal; ban remains in place|
|31||Citigroup (New York)||\$103||Has large exposure to the Mexican market with both business and consumer loans|
|32||Valero (Texas)||\$103||Main business is refining oil; owns 15 refineries in the U.S., Canada and U.K.|
|33||General Electric (Massachusetts)||\$95||Large jet engine business, booming for many years, now hurting as Covid disrupts air travel|
|34||Dell (Texas)||\$92||Has a majority stake in VMware, a fast-growing software company; considering whether to sell it|
|35||Johnson \& Johnson (New Jersey)||\$82||Organized into three business segments: Consumer, Pharmaceutical and Medical Devices|
|36||State Farm (Illinois)||\$79||Uses NFL stars in its T.V. commercials; insurance companies among the biggest T.V. advertisers|
|37||Target (Minnesota)||\$78||Four of its five main merchandise categories saw strong growth last year; exception was clothing/accessories|
|38||IBM (New York)||\$77||Calls hybrid cloud and data/AI as the “two predominant technology forces of our day”|
|39||United Tech. (Massachusettes)||\$77||Merged with rival defense contractor Raytheon last year; combined company using the Raytheon name|
|40||Boeing (Illinois/Washington)||\$77||Chinese airlines are critical customers for its planes; trade tensions threaten that market|
|41||Freddie Mac (Virginia)||\$75||A private-sector company but with federal government financial backing|
|42||Centene (Missouri)||\$75||Bought its smaller health provider rival WellCare just before the pandemic last year; paid almost \$20b|
|43||UPS (Georgia)||\$74||Seeing elevated levels of business-to-consumer shipping demand but depressed business-to-business activity|
|44||Lowe’s (North Carolina)||\$72||New strategy seeks to offer customers a “total home solution” addressing all their home improvement needs|
|45||Intel (California)||\$72||Transition from PC to mobile eroded its former dominance in chipmaking|
|46||Facebook (California)||\$71||Has more than 2b monthly active users; total world population is about 8b|
|47||FedEx (Tennessee)||\$70||Critical to the local economy of Memphis, a significantly poorer city than Nashville|
|48||MetLife (New York)||\$70||Life insurance companies challenged by low-interest rate environment|
|49||Disney (California)||\$70||Theme park business obviously hurting during Covid but Disney Plus streaming service a big hit|
|50||Procter \& Gamble (Ohio)||\$68||Well-known brands include Tide (detergent), Gillette (razors), Pampers (diapers), Crest (toothpaste)|
The U.K. faces extreme economic headwinds as it grapples with a severe Covid outbreak while managing its withdrawal from the European Union. Last week, London approved more grants for retail, hospitality, leisure and other businesses hurt by the latest lockdowns. Local governments will get more aid as well. Even after some recovery in the third quarter, the U.K. economy remains 9% smaller than it was at the beginning of the year. U.S. GDP, by contrast, is only about 3% to 4% smaller. The Bank of England (the U.K.’s central bank) has to decide whether to cut interest rates to below zero. Several other European central banks have already done so (i.e., Sweden, Switzerland and Denmark). Interest rates are negative in Japan as well.
Economist Edward Yardeni, in a blog post, revives unpleasant memories of high inflation during the 1970s. In August 1971, President Nixon ended the post-war Bretton Woods system in which dollars could be converted to gold at a fixed value, no questions asked. The system worked well when the rest of the world needed a lot of dollars to rebuild their war-ravaged economies. It worked less well when dollar demand in Europe and Asia declined in the 1960s. As global dollar demand dropped, dollar supply increased (to finance Vietnam War and foreign aid spending). Gold supply was mostly flat. So the system began looking unsustainable. Would the U.S. really have enough gold to satisfy all those new dollar holders showing up to trade them in for gold? Nixon’s policy change led to a sudden plunge in the dollar’s value versus other major currencies. That in turn meant higher import prices for Americans, adding to inflation pressures that already began appearing in the 1960s. The weaker dollar, meanwhile, caused commodity prices, which are priced in dollars, to jump. An oil price shock in 1973, and another in 1979, caused the price of a barrel of West Texas crude to increase from $4 in mid-1973 to a peak of nearly $40 by the 1980s. This meant Americans paid higher prices to gas up their cars. They also paid higher prices for food and clothing as shipping those items by truck became more expensive. Factories were more dependent on oil for their energy at the time too. Workers, more of them represented by powerful unions then than now, demanded higher wages. Nixon responded with wage and price controls that didn’t work—they were quickly abandoned. By 1980, inflation measured by the consumer price index (CPI) reached 15%, from just 3% in 1972. How did the U.S. eventually escape from its 1970s inflation dilemma? President Carter appointed Fed chief Paul Volcker, who sharply tightened the money supply. Interest rates spiked, contributing to a severe recession in the early 1980s. But it was the last American would see of problematic inflation.
The research firm Gartner, in an October report, discussed some of its top technology trends for 2021 and beyond. By 2025, it thinks current computing technologies (specifically silicon processors) will hit their performance limits, driving adoption of new paradigms like neuromorphic computing (that is, a computer that thinks and acts more like the human brain). Limits to data storage will also become an issue, leading to development and usage of synthetic DNA as a means of storage. Digital data like music and video, the report explains, would be encoded in the nucleic acid base pairs of synthetic DNA strands. Gartner also sees businesses that sell physical experiences—rock climbing for example—taking advantage of new virtual and augmented reality technologies. A roller-coaster ride from your living room? Farms and factories will become more automated—think tasks like picking, packing, and shipping. A cottage industry of freelance customer service agents will emerge to help people interact with companies (let someone else call the health insurance company for you). Gartner also expects more companies to record workplace conversations, balancing the usefulness of that information with issues of privacy and morale.
Will the U.S. see a strong recovery this year? Maybe, but a Bank of Montreal podcast outlines what it sees as the top ten risks: 1) longer than expected vaccine acceptance and distribution, 2) elevated levels of household distress early in the year, 3) inability for businesses to raise prices, 4) Washington political gridlock that constrains fiscal support (it wrote this before the Georgia Senate races), 5) temporary job losses become permanent (i.e., young workers in the restaurant sector), 6) negative interest rates overseas, 9) short-term funding market volatility (which became a problem last spring) and 10) geopolitical disruptions.