In his wonderful 1979 book, “The Old Patagonian Express – by train through the Americas”, Paul Theroux notes that you can tell a lot about the state of a country from the condition of its railway stations. As I marvel at the beautiful domed structure of Boston’s South Station, built in the great era of American rail infrastructure expansion, I’m inclined to agree. These days, the state of any country’s roads, airports and rail infrastructure reveals much about the priorities of contemporary society.
In short, if your airports, roads and railways are tatty there’s a good chance there’s not enough productive investment going on. These are litmus tests. If you doubt that, compare the sparkling Asian airports to our own dog-eared affairs in the English-speaking world.
I’ll put this theory – the Theroux rule – to the test soon as I am leaving America through the underwhelming portcullis that is JFK at the end of this train journey which takes me from Harvard in Boston, to Queens, via Penn Station in Manhattan.
Harvard Yard is privilege squared. It is everything America does best: massive amounts of private philanthropy fusing with generations of public investment to create the perfect seat of learning, attracting the best of academic and student talent, in an unrivalled environment.
Let the journey begin and let’s see if the Theroux rule still holds.
As I wait in the queue for tickets at the subway station (one of the machines is broken), I’m reading over the shoulder of the man in the Brookes Brothers suit and see that the Wall St Journal is praising the fact that the Fed didn’t raise rates or, in the parlance of Wall Street, didn’t move ‘off zero’.
With the next interest rate decision in mind, we’ll use this trip through the New England countryside to take stock of the US economy. Let me share with you my thoughts and observations from a short time spent in this affluent corner of God’s own country.
Boston’s old subway system has hardly changed since I washed dishes here as a migrant student way back in the 1980s. The Green Line out to Brookline still rattles away alternating above and below ground – a bit like London’s Northern Line with better views. The Red Line from Harvard is Boston’s equivalent of the Central Line – quicker than the rest, and therefore, jammed.
Moving from private Harvard to public transport, takes you from one world to another. Boston’s South Station echoes its splendid past and the plaque to governor Mike Dukakis reminds me of my time here when the so-called ‘Massachusetts Miracle’ was the envy of the US. Like most miracles, it proved to be nothing more than a large overdraft, fuelled by low interest rates, excessive bank lending and a property boom. Couldn’t happen again surely?
For now though, don’t worry about overvalued assets, just sit back, relax and enjoy the trip through leafy, yet nautical New England towards New York’s Penn Station.
The first thing you notice about American trains is that they are expensive, slow and crowded. At $159 one-way for a cramped seat and a journey that takes over four hours to travel just 200 miles – a Japanese bullet train it is not! However, the scenery is beautiful, the sky is Massachusetts Indian summer blue and we have plenty of time.
I am going to gather up my thoughts by way of seven points that explain where the US economy is now and may help us assess where policy goes from here.
1. Repaired balance sheets
The first thing to appreciate is that the American economy has gone through a remarkable healing process over the past few years. Its battered balance sheets have been nursed back to health.
The three balance sheets are now in much better shape. The government balance sheet looks impressive, particularly when compared to those of other western economies. Although debt ceiling issues continue to rankle, the budget deficit has fallen to $412bn and is now as low as it was before the financial crisis. For a $16 trillion economy with a so-called tax and spend President, this prudence deserves recognition.
The household balance sheet is also in decent shape, driven as it is in the main by house prices. The continued upward tick in home prices is doing wonders for the average American family.
On the face of it, corporate balance sheets are in rude health but the data is heavily influenced by the titans of corporate America. The niggle here is the extraordinary level of junk debt that has been issued by smaller but still substantial businesses in recent years, much of it used to buy back equity in order to flatter earnings and allow management teams to feather their beds with earnings-linked bonuses. More on that later…
Overall though, the healing of America’s balance sheet is well advanced. A combination of zero-bound interest rates, rapid and prolonged asset price inflation and that great healer of all ailments, time, appears to have done the trick. The country is on the verge of escaping the clutches of a vicious liquidity trap – the fact that it has done so using monetary policy alone, should be a cause for celebration. They said it couldn’t be done.
2. Rise in employment
The second factor has been the rapid and sustained rise in employment. The ‘animal spirits’ that characterise this society and which were hindered by broken balance sheets after the 2008 crash, have been released anew. Unemployment has fallen rapidly and jobs are being created in significant numbers, particularly in the domestic services sector, so much so that we are close enough to full employment or, at least, getting there.
As we move through southern Massachusetts, there are ads at each station promoting college courses, new housing developments and health insurance deals, all of which nicely capture the job-creating service sectors of 2015 America: education, health, housing and the broader financial sector.
The participation rate remains a cause for concern, however. Millions of workers have left the workforce completely over the last decade, disillusioned by the prospect of getting the job or the salary that they feel that they deserve. The US labour force participation rate hasn’t been this low since the late 1970s and this phenomenon poses more questions than it answers. Have these workers priced themselves out of work? There are jobs for burger-flippers and lawyers but what about the myriad of tiers in between? Are these people lost from the workforce forever? And what does this new labour force dynamic mean for the age-old relationship between labour market capacity and wage growth? Only time will tell but it is fair to suggest that the American labour market is in better shape than most.
3. Business investment
Despite the rehabilitation of balance sheets and the decline in unemployment, business investment is still on the canvas.
Half a decade of buoyant financial markets and explicit incentives that link corporate bosses’ wealth to their share price has led to corporate America buying back their own shares and paying themselves. So rather than investing in real productive capacity which we could term ‘productive engineering’, that which drives industrial productivity, corporate America has fixated on ‘financial engineering’, which usually only drives personal wealth.
Normally at this stage in a recovery, the economy would be registering big-ticket capital investments but this is not happening.
In 1979, the same year Paul Theroux started his epic train journey through the Americas, further along these train tracks towards Washington, Bruce Springsteen released “The River” with its tale of New Jersey’s industrial workers, steel men and blue collar Americana. These men worked in big, loud factories making American stuff for American people. Springsteen’s working class heroes were the human face of business investment. But they are not here now. America is not investing, it is disinvesting. Why is this? Is there anything else apart from share buy backs and financial jiggery pokery?
We are now pulling out of Providence, Rhode Island and moving towards the inflated property hot-spot of the hedge fund capital of the country, Connecticut. Nowhere in the country has benefited more from QE and zero-bound rates than this place. With its super mansions and long/short trades, Connecticut is buoyed up by the accounting trickery of share buybacks and the financial alchemy of QE, making it not only the richest part of America, but also – and this too is the consequence of QE – the most unequal.
4. The global capacity glut
Here’s where we have to leave leafy New England and go a bit global to understand the soft state of corporate America’s long-term expectations. If companies are confident, they will invest so why aren’t American companies confidently investing?
Sometimes visitors marvel at how insular the average American can be, for example, I was reading in the Boston Globe about the baseball ‘World Series’ league. The American baseball league has nothing worldly about it. It’s a glorified game of ’rounders’ that only the Cubans play properly and they are still embargoed.
But while the average Joe mightn’t have a passport, corporate America is hyper-global. Its worldwide footprint makes it highly sensitive to the global economy and the reluctance of America’s biggest companies to invest is a function of global conversations at board level.
Those conversations will start with the observation that America is on its own in terms of having a growing economy. There simply has not been a period in recent history where global growth rates are so divergent. Europe is still gripped by austerity, Japan hasn’t been right for a generation and the Chinese economy is facing a rapid post-boom contraction. Elsewhere, the big commodity-based emerging markets like Brazil, South Africa and Russia are simply derivatives of China as their wealth is largely a function of China’s demand for their raw materials.
So global aggregate demand is too soft to justify new large-scale investment. There isn’t enough aggregate demand in the rest of the world to make large corporations commit to investment. Remember that real investment tends to be in big machines that make big stuff.
This lack of demand is unfortunately coincident with a massive glut of supply. There’s over-capacity everywhere, particularly in China. Five years of hyper-investment in China has led to over-capacity in almost every major industry. How else can you explain slumping commodity prices and deflationary pressures everywhere?
Against such a background, can you imagine what would happen to the career prospects of an American steel executive who suggests to the CEO that they build a massive new plant to export steel to China?
Therefore, the short-term implication of the Chinese investment boom is far too much supply in the global economy. All the heavy equipment that the world needs is already in China and this will take quite a while to use up. Corporate America faces a global supply chain – not a national supply chain – too much capacity in China actually means too much capacity in America. As a result, it would be wrong to expect a material pick-up in large-scale US business investment.