The U.S. Economy With Christopher Thornberg #659

Christopher Thornberg blog

On Friday, September 27, the Norris Group proudly presents its 12th annual award-winning black tie event I Survived Real Estate.  An incredible lineup of industry experts will join Bruce and Aaron Norris to discuss perplexing industry trends, head-scratching legislation, massive tech disruption, and opportunities emerging for real estate professionals. All proceeds from the event benefit Make A Wish and St. Jude Children’s Research Hospital. This event is not possible without the generous help of the following platinum partners: the San Diego Creative Real Estate Investors Association, InvestClub, ThinkRealty, Coach Fullerton, Keller Williams Corona, PropertyRadar, the Apartment Owners Association, MVT Productions, and Realty411. Visit for event information.

Bruce Norris is joined this week by Christopher Thornberg. Christopher founded Beacon Economics LLC in 2006, one of the most respected research organizations in California that serves public and private sectors clients across the United States. In 2015, Dr. Thornberg also became director of the UC Riverside School of Business Center for Economic Forecasting and Development and was an adjunct professor at the school. Christopher is an expert in economic and revenue forecasting, regional economics, economic policy, and labor and real estate markets. He consults for private industries, cities, counties, and public agencies across the country. He became nationally known for forecasting the subprime market crash that began in 2007, and he was one of the few economists on record to predict the global economic recession that followed. He is one of the few people that Bruce riks taking a chance to ask questions he does not know the answers to himself.

Episode Highlights

  • Where does Christopher believe the U.S. economy currently stands in terms of a healthy market or heading into a recession?
  • What was the Fed’s intent with raising interest rates, and how has this changed?
  • Will Quantitative Easing be implemented any time soon?
  • What are the demographics like in the world, and are they inherently deflationary or inflationary?
  • What is debt jubilee, and should we expect this in the near future?
  • Where does Christopher expect the ten-year T-Bill to be at a year from now?
  • How big of an impact does the trade war with China have on real estate?

Episode Notes

Bruce started off by asking Christopher how he feels about the U.S. economy, whether we are healthy or headed to a recession. He said we’re healthy. What is interesting is the more things stay the same, the more the court of public opinion changes. The ebbs and flows of these headlines seem to overstate the actual ebbs and flows of our economy today. This latest round of pessimism really started at the end of last year with the slowdown in the residential real estate market and the big sell-off in the stock market. Almost nine months later, it feels like the press is not just saying we’re going to have a recession, they have basically convinced themselves that there WILL be a recession. They’re talking about the consequences for millennials, for the election, and everything else. Even as they continue to just hype this downturn, the economy keeps trucking along.

If you look at the numbers, you see consumer spending is good. Business investment is fine. For all the worries of a trade war, exports are higher today than they were at this time last year. The credit markets look fine. You can go on and on about how really outside of just a couple of things, the U.S. economy looks about as healthy as it has in the last 25 years. We had a 50 year low in unemployment and decent GDP growth. This made Bruce asked what we are doing with a 1 1/2% Ten-Year T-Bill this morning. Christopher said the bond markets would know the answer better than him. Obviously, there are two things around here. One is, at least in the financial world, there has been a degree of panic. When you panic, you run until the safety of bonds. That’s probably one of the short term drivers of it.

The other thing is that we still live in a world that is candidly awash with excess liquidity. You just have a lot of money floating around out there looking for a place to call home, and that kind of world typically leads to lower interest rates. There just doesn’t seem to be any way the 10-year bonds gets to 4 percent in the near if in the near term. He has been sticking to that for a while. Subsiding from a little bit over 3 percent back to where it is right now is just more indication that the true long-run bond rate in this economy is probably in the two and a half percent range.

When Bruce was in high school, the U.S. economy was about 38% of the world economy. Now it’s about 24. Bruce asked if this means what’s happening outside the U.S. has more impact on our economy than it used to. Christopher said yes and no. At one level you could say that the U.S. and its exposure to the rest of the world doesn’t really occur by relative sizes. It occurs through imports and exports. If you think about imports and exports as a percent of GDP, they are higher now than they were 50 years ago. Relative to much of the world, they’re still really not all that high. We have to remember that more and more of the U.S. economy is turning towards services, which really doesn’t compete in the world marketplace. So in a very real sense, we are isolated from global issues, more so than most places in the world. You see that right now because the U.S. economy is hardly noticing some of the turmoil going on out there, particularly in China and in Europe.

Back in the last quarter of 2018, the Fed’s stated intent was that they were going to raise rates until they got to a more normal rate environment. Within 60 days or so, the whole direction changed and is now actually gaining momentum. Bruce asked what the Fed saw that they had not realized prior. Christopher wasn’t sure the Fed actually ever said that they were raising rates to a “normal rate.” If they did, then they should be throwing out the vast majority of chairmen, including Powell, because that’s a ludicrous thing to say. There’s no such thing as a “normal rate.”.

Christopher said that while lawyers have a lot of use in this world, it strikes him that having a lawyer in charge of the central bank seems dangerous at best. Certainly, that kind of rhetoric shows us just what we’re dealing with. There’s no such thing as normal rates. The rates will go where the markets tell them to go. The Federal Reserve has control over the lower end of the yield curve, but everything above that is is driven by the whims of investors at various levels. They did tighten all the way through the end of last year, and then they got caught with their pants down. The stock market went down, the bond market rallied, long-run rates dropped below short-term rates, and suddenly all his plans of “normalization” are gone. Now he has to start unwinding, dropping those lower rates, and then getting that yield curve unwound. An inverted yield curve just creates excessive amounts of unnecessary stress on the banking system.

When the Fed usually starts moving with that tool, they usually have a 4 or 5 percent move potentially. This time, it’s less than half of that. Bruce asked how that impacts the ability for that particular tool to do its job. The question really is whether they have an ability to deal with some sort of business cycle or downturn in the economy. We already saw what happened back in the Great Recession when they didn’t really have the short end to operate with. They pushed rates down to nearly zero, and it just wasn’t working. So they went to quantitative easing. There is a whole second set of tools out there. In fact, there’s even a third set of tools, which is a direct stimulus where they just print money and mail it out to U.S. residents. They have other options; this isn’t the only tool.

He would also argue that in a very real way, maybe it’s time to dump the federal funds rate as a “cyclical tool.” Looking back over the last 40-50 years, Christopher sees the Federal Reserve desperately trying to move the U.S. economy off specific dangerous paths with candidly almost no impact. We are constantly fed the myth of the all-powerful Federal Reserve. Every time you pick up the Wall Street Journal or turn on CNBC, they just go on and on saying “All hail the mighty Fed.” In reality, they don’t have anywhere near the power in our economy people think. Maybe it’s good to burst a bubble a little bit and let people understand that while the Fed has an important job, they don’t have all this power. We have to understand that what they can do is relatively limited.

Bruce asked if Quantitative Easing is the next tool that will be implemented and how soon will it happen. Christopher said yes and that Quantitative easing would be where you go next. That’s just buying up a bunch of bonds and using the cash that’s generated by buying those bonds to stimulate the economy. That’s still while it works through the banking system; and if the banks aren’t willing to lend that money for whatever reason, whether they’re paralyzed, capital constrained, or too risk-averse, that’s when you go straight to direct injections of liquidity in the economy. That’s when the Federal Reserve just writes basically every man woman and child in the United States a $250 check and mails it to everybody. That will get things rocking and rolling. It would certainly seem to spur some things, although it might spur a lot of bad habits too.

Bruce said it would also increase the debt. He wondered if it is a federal debt increase when you decide to give away stuff. Christopher said no because it’s the Federal Reserve, which is independent of the federal government. They are different beasts completely. The Federal government operates on revenues and debt. The Federal Reserve functionally has power over the money supply. Once in a while, you’ll hear one of these anti fed people and they’ll say things like, “Well, what if the Fed goes bankrupt?!” That’s not possible. They’ll ask about their balance sheet, which is completely imaginary. It’s hard for people to understand that when you can print your own money, you don’t operate by the same rules that your average household or business operates by. They do have a lot of power, but the kind of power we’re talking about is more power of the money supply.

One of the things he is worried about is the fact that the growth in the money supply has slowed dramatically over the course of the last four, five, or six months driven by the end of Quantitative Easing. You know if you’re worried about a low-interest rate, you don’t want low inflation. You don’t want low money supply growth. If anything, the Federal Reserve should be turning on the spigot. They should be expanding the money supply quicker because that would actually do a lot to increase inflation and maybe push interest rates up a bit to unwind that yield curve. This would give the economy a little bit of breathing room, and it makes a lot of sense to move to a higher inflation target in this environment. Our government just seems so obsessed with the status quo that there’s just a very little appetite for actually trying to break out and do something different.

Bruce asked about the demographics that are in place, not only in our country but around the world, and if that is inherently deflationary or inflationary. Christopher said none of the above. The kinds of things he’s talking about here are things economists discuss in theoretical ways. But, as a guy who actually sits down with the data and talks about inflation, it’s really hard to pick out demographic and savings effects in the inflation data. The short-run drivers of money supply and economic growth are far more dominant.

Bruce ran across the concept of debt jubilee. Bruce asked what this is and if it is likely to occur at some point. Christopher said he had never heard of it, although Bruce explained it as a forgiveness of debt. Christopher wasn’t sure why this was a topic. He realized that forgiving college debt has been the platform of some of the folks running for president on the Democratic side ledger. But he was confused why they would discuss any kind of debt forgiveness since the debt markets look pretty good right now. Debt-to-income ratios continue to fall, delinquency rates look great, the financial obligation ratio is near an all-time record low. He is not sure whose debt we will be forgiving and why.

Bruce gave two examples. We have promises that we’ve made to people that are retired. Bruce and Christopher had discussed before how the math does not work. A debt jubilee is like hitting a reset button and getting back to a truthful number. Japan, as a country, might have the same scenario where their debt is so high it’s unfixable. Christopher thought these comparisons are completely wrong. While the debt and the need for future social services in Japan are very high, we have to remember that over the past 20 or 30 years, Japan has consistently been earning a trade surplus. What that means is they have been bringing in more assets than selling to the rest of the world. That means that there is a lot of safe things over there that at some level goes to offset some of those obligations.

The other thing about Japan to keep in mind is actually the services they have for dealing with seniors, particularly health care. They are vastly more efficient than they are here. In fact, you could actually argue that levels of health care in Japan are running about 40 percent of what they are here in the United States at a per senior basis. The numbers are obviously a little bit worrisome over there, and surely they need more immigration. But, he would go so far as to suggest they’re in much better shape than we are. We can’t even balance our budget right now. In fact, if anything the Republicans have seemed to have gone out of their way to blow out the federal deficit at a level that almost seems irresponsible. It’s absolutely crazy, particularly given the platform of the Republican Party is a little bit more honest. It’s amazing how they have blown out the deficit.

Bruce receives e-mails from out of the blue from people he doesn’t even know who tells him he might be interested in it. Somebody sent him an e-mail this last week that talked about how in Denmark you can borrow real estate debt on a 10-year loan at minus a half. Bruce wondered how this works for the lender. Bruce asked how the banking system makes money at a minus number. Christopher said negative interest rates are something that a lot of economists have pondered, and he thinks they’re driven largely by issues within the regulatory systems, particularly when it comes to banks and various financial funds over in Europe. They have to put their money someplace, and unfortunately, that could lead to the kind of bidding wars that lead to these kinds of odd outcomes. Ultimately, he wouldn’t I wouldn’t overread into it. It’s easy to get all hot and bothered about such things when realistically the numbers we’re talking about are pretty small.

Bruce next asked Christopher if he expects the 10-year T-bill to be higher a year from now than it is right now or lower. He said he thinks it’s going to bounce back when people realize that all this panic over the economy is kind of nonsensical. He thinks it’s going to start drifting up. For those people out there thinking about refinancing, this is a great time to go ahead and jump in and do it, take advantage of this. When they get up to 3 percent, that will be about as high as they go on the other side of it. That’s double where we are. All the signs show that the panic over real estate is more nonsense. We’ve seen all sorts of statistics that suggest things are starting to turn. There are a lot of folks sitting on the sidelines waiting for prices to fall 20% to get that deal of a deal who is about to be very disappointed in the second half of 2019.

It’s really hard to have a price decline of any significance if you don’t have a lot of foreclosures in the system, and there’s no way we will have a lot with all the fixed-rate loans in place with people with good credit, down payments, and who left their equity in place. There’s no way. Christopher was just laughing over the last 6-7 months again. Everyone’s talking about the end of the big rally when really the economy and housing markets are just fine.

They next went on to talk about the trade war with China. It doesn’t seem like it impacts real estate, but it’s a big topic. He thinks one of the reasons we’re at the interest rates we are is something like that. He asked how big of a deal the trade war is. Christopher said it’s really not. While he doesn’t agree with much of what comes out of the president’s mouth when he says that China is paying the tariffs he is largely right. From a tactical standpoint, it’s the importer that pays that tax. But, you have to remember that the Chinese are far more at risk of a big slowdown in trade with the United States than the other way around, and they know that. They have taken the very strategic approach of saying we have to maintain volume and not worry about profits until we get past this administration. There has been a sharp depreciation, down 12-13 percent from where it was a year ago. A lot of suppliers over there are cutting their prices to American suppliers because the American suppliers tell them they have to do it. They don’t have a lot of option. The net result is that there has been a little bit of a slowdown in imports from China but nowhere near as dramatic as one would have thought given the size of these particular tariffs.

The story is more about exports to China because the Chinese have gone out of the way and try to politically punish the United States by systemically choosi