WASHINGTON — By nearly every metric, the US economy did well in 2019, although growth was slower than in 2018. For next year, contrary to the consensus view from most economists, economic growth will accelerate. And growth could increase even more after 2020. Trump has set the stage for a prolonged period of high growth, full employment and low inflation: nearly perfect economic conditions that should lead to a rosy economic forecast for 2020 and beyond.
Economic growth to slow a bit?
Most economists now forecast that economic growth will slow next year. In 2018, growth hit almost 3%, an annual rate not seen since 2005. This year, while all of the data is not available as yet, looks like growth slowed to about 2.4%. Most economists are forecasting growth in 2020 to be 2% or less. They are likely underestimating. Why?
The tax cut passed by Congress in 2017 and implemented in 2018 accelerated economic growth. At the time, many economists, especially those in the Trump Administration, predicted higher than 3% annual growth. That didn’t happen. As President Trump correctly pointed out, it was the Federal Reserve’s (FED) Monetary Policy that held down growth. Fortunately, the FED realized their mistake in mid-2019.
Because some key interest rates were near zero, the FED was worried about inflation. So they raised interest rates eight times from the end of 2016 to the end of 2018. Just as growth was accelerating in 2018, the FED checked the economy with the rapid increase in interest rates.
Making things worse, the FED decided to reduce its balance sheet. That meant the FED would sell nearly half a trillion dollars of bonds they held. When the FED sells bonds, they remove money from the economy. The reduction in the money supply tends to slow economic growth.
Midway through 2019, the FED realized its mistake. Interest rates were lowered three times and the FED stopped reducing its bond holding. They also injected some cash back into the system, partially reversing the damage done previously. It typically takes six to nine months for the FED’s actions to be felt in the economy. This should lead to a more robust economic forecast.
Growth estimates for the fourth quarter of 2019 by most economists are generally in the 2% range or lower. Yet the strength in the consumer sector probably means 4th quarter growth will exceed 2% and probably be in the 2.4% range.
Going forward, the economy established by President Trump’s policies will be even stronger, although there are a couple of concerns. One is the tight labor market. Since the unemployment rate for virtually all demographics is at historic lows, there is a fear that economic growth could be reduced by the lack of available labor. The tight labor market will also cause wages to rise, which could result in higher inflation.
Fortunately, President Trump realized this when he structured his tax cut. In many cases, industry can replace labor with capital. So Trump geared the tax cut not just to help the middle class, but to create more capital as well. That’s why he lowered the tax rate for the highest income earners and for corporations. That’s where new capital comes from.
The increased capital will also mean that businesses can invest in goods that make labor more productive. That means if wages increase by 3% but productivity also increases by 3%, then the labor cost does not increase, so there is no pressure to raise prices. And the productivity increase also means the economy is growing. Which again makes us question the current economic forecast offered by a consensus of economists.
Another concern is the foreign sector, where the trade war has resulted in a larger trade deficit in 2018. Trade deficits tend to slow economic growth because they result from the US buying more foreign goods than foreigners buy from us. In 2020 that will change, because Trump has essentially won the trade war.
The US signed new free and finally fair trade agreements with Mexico, Canada, South Korea and Japan. The positive effects will be felt beginning next year. China, India and the European Union are all negotiating new deals with the US. And once England exits from the European Union in early 2020, the US likely will negotiate a new trade deal with England. This will significantly reduce the trade deficit, as foreign markets are finally opened to US manufacturers.
Consumers account for 70% of GDP. And currently, consumers are feeling very confident, meaning they will continue to spend. Their wages and total incomes are rising more than 3% annually while inflation is below 2%, so they have real increases in purchasing power. Consumers are also feeling wealthier since their savings and retirement accounts have significantly increased in value because of Trump’s policies.
Settling of the trade disputes will also remove the uncertainty that has reduced business investment so that too should increase next year.
The US is immune to shocks in the energy sector since Trump has made the US energy independent so any disruption in the Middle East will have a negligible negative impact on the US economy.
In total, the economy looks rosy in 2020 and the years after that look even better. Perhaps we will soon see a more optimistic economic forecast as economists revise their numbers in the next calendar year.