Recent economic data suggest the overall growth was at a moderate pace in the first quarter, respectable, but short of the very lofty expectations seen at the start of the quarter. That’s not terrible. First quarter GDP has tended to be on the weak side over the last several years (exhibiting what is called “residual seasonality”) and growth is still expected to be strong in the remainder of the year. However, the level of uncertainty is high. The economic impact of the Tax Cut and Jobs Act is debatable and trade policy uncertainty isn’t helping. Moreover, the TCJA and the recent spending agreement will add to the federal budget deficit over the next several years.
Consumer spending accounts for about 69% of Gross Domestic Product. Adjusted for inflation, spending was flat in February, following a 0.2% decline in January – on track for less than a 1% annual rate in 1Q18 (assuming a likely pickup in spending for March). The first quarter softness in spending followed a strong 4Q17 (+4.0%). It’s not unusual to see some unevenness in spending across quarters. Still, inflation-adjusted wage growth for the typical worker has been weak. A moderation in gasoline prices and tighter job market conditions (implying better wage growth) ought to help change that.

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Other data have been mixed. Shipments of nondefense capital goods ex-aircraft, a rough proxy for business fixed investment, rose 1.4% in February (vs. +0.1% in January) – on track for a moderate pace in 1Q18, although noticeably slower than in the second half of 2017. Inventory growth picked up in the first two months of 1Q18, which (if that holds up) will add to GDP growth (although if unintentional, that’s not good). The merchandise trade deficit widened significantly in 4Q17. The surge in imports, by itself, subtracted two percentage points from headline GDP growth. The trade deficit widened even further in the first two months of 1Q18, which suggests that net exports will subtract somewhat from GDP growth.
While a wider trade deficit “subtracts” from GDP growth, it’s actually a sign of strength. In a strong economy we consume more domestic goods and we consume more imported goods. Imports have a negative sign in the GDP calculation.
President Trump believes that a trade deficit with any particular country reflects bad deal-making. If so, then I must have made a bad deal with my grocery store, because I have a consistent deficit with it. Should I grow my own food? Of course not. Granted, China is not without sin. It has manipulated its currency and sold below cost (“dumping”), but to complain about that is so 2005. China’s currency is pegged to a basket of world currencies now. Moreover, the U.S. trade deficit with China is a lot smaller than it looks. China imports supplies and materials (mostly from the rest of Asia) and exports assembled products. The value added, the assembly, is about a third of its reported trade surplus with the U.S. Think of the iPhone, which, while imported from China, has most of its value created elsewhere. In short, focusing on the trade deficit with one particular country doesn’t make a lot of sense.
The imposition of tariffs raises costs for U.S. consumers and producers, disrupts supply chains, and increases uncertainty for global investment. The possible end result of White House Trade policy lands on a wide spectrum, with a complete collapse of the global trading system on one end. At the other, we have minor changes in trade policies (such as the new agreement with South Korea), empty saber-rattling, and the declaration of victory (to appease the base), and we all move on. For the stock market, anything that moves us toward a more significant trade conflict is unsettling, and anything that moves us back is welcome. How long this plays out is anybody’s guess, but the markets are clearly hoping for the more benign scenario.
While worrying over the trade deficit with one particular country is silly, worrying over the total trade deficit may not be. Still, the current account deficit, the widest measure of trade, was 2.6% of GDP in 4Q17. That’s moderate by historical standards. In running a trade deficit, the U.S. does not save enough to cover investment. The federal budget deficit is part of national savings. Hence, nobody should expect the trade deficit to go away anytime soon. In fact, we can expect the trade deficit to widen further as government borrowing increases (all else equal). On April 9, the nonpartisan Congressional Budget Office is set to releases its updated budget outlook, which will include analysis of the Tax Cut and Jobs Act and the recent spending agreement.
Expansionary fiscal policy is, well, expansionary. However, it’s unclear how much of a boost to the economy we’ll see given labor market constraints. The economic data for March, April, and May should help to clarify the picture.
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