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By Michael Allison, CFA
This week’s Chart comes to us courtesy of my friend and former Eaton Vance colleague, Henry Peabody and his firm, Riverhead Research.
Though by no means do I claim to be a competent macroeconomic thinker, I’ve been spending a lot of time lately considering the long term implications of recent policy shifts under the Trump 2.0 Administration.
For one, the Administration has expressed a desire to move more manufacturing capacity back to the U.S., thus onshoring many jobs that are currently offshore. As a result of increased investment in the U.S. in the coming years, the Return (GDP) on Invested Capital (Capital Stock) is bound to change significantly.
According to this week’s Chart, one could argue that after the Great Financial Crisis (GFC), the U.S. economy grew increasingly capital efficient as it outpaced the rest of the world in the ratio of GDP to Capital Stock.
But (and it’s a big one)…
This increase in capital efficiency occurred in the context of a massive increase in leverage (government debt) in the U.S. economy.
At the outset of the Great Financial Crisis (2007-2009), U.S. debt-to-GDP ratio was around 35%.
Prior to the Covid-19 Pandemic (end of 2019), the ratio had risen to nearly 80% of GDP right before the pandemic.
Today, the current debt-to-GDP ratio is approximately 122.30%.
So here we are. We now have an economy that appears poised to:
De-lever (unsustainable levels of debt service),
Increase domestic investment (privately not publicly funded),
Increase relatively high paying domestic manufacturing employment (inflationary in light of an aging workforce? Not with sufficient productivity growth), and
Decrease government spending (spending which is largely sourced from the private economy here and abroad)
If we zoom out from all the current (scary) headlines, what does this really mean? In my view, it means a reorientation of the drivers of economic growth in the U.S. in the coming years.
Gross Domestic Product (GDP) is comprised of the following:
Consumption +
Investment +
Government Spending +
Exports minus Imports
Leaving aside what may or may not happen over the next few months, my outlook for economic growth over the next decade (or more) is quite positive.
Consumption should be strong in the context of higher wages and increased, AI-driven productivity growth.
Investment in the Capital Stock of the U.S. should increase as a result of the aforementioned onshoring efforts.
Government Spending will likely come down, freeing up capital to be directed to (hopefully) more productive uses.
The mix of exports to imports should improve as a result of a weaker dollar and tariff normalization (moving the tariffs the U.S. imposes to be more in-line with the tariffs already being imposed on the U.S. by our trading partners).
When we put all that together, though we may see some short lived economic weakness as the economy reorients itself, the prospects for accelerated economic growth in the U.S. are quite good. I’m encouraged by what may lie ahead.
Sources:
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