Global Market Commentary

Yes, Higher GDP Growth Is Possible In the U.S. — and Here’s How It Can Be Achieved


Sometimes, academic economists are worth paying attention to. A recent paper published by the Hoover Insti-tution provided one of the best sum-maries we have read of the current state of the U.S. economy, its recent history, its troubles and the reasons behind them, its future prospects, and the policy changes that will be neces-sary to realize them. Interested read-ers can find the complete paper here.


The authors include three econo-mists linked to Stanford University and its associated Hoover Institution


  • Hoover fellow John Cogan, Stanford professor John Taylor, and Hoover fellow and former Fed governor Kevin Warsh — as well as the Dean of Columbia University’s business school, Glenn Hubbard. Warsh and Hubbard have both been mentioned in the press as possible candidates to take over the position of Fed Chair from Janet Yellen in the event that the President does not ask her to serve another term.


The authors take issue with the neg-ative views of those economists who believe that the U.S. is stuck in a secu-lar low-growth trap that can be blamed on intractable social, geopolitical, or demographic causes. Their analysis supports what we have argued for some time: that GDP growth is deci-sively influenced by capital investment, productivity growth, and labor force participation — and that these factors in turn are profoundly shaped not by nebulous and intractable processes, but

by policies. Therefore, policy changes have the potential to reverse neg-ative trends. In short, we are not doomed.


On the next page, you can see the long-term chart of U.S. productivity growth illustrates the point clearly.


The long cycles visible in these data seem to us — and to the paper’s authors — to correlate pretty clearly with large shifts in U.S. tax and regu-latory policy. The nadir now being seen is near the bottom that was seen as the policy milieu of the 70s ran its course and reversed during the Reagan administra-tion.


The authors write:


“Economic theory and historical experience indicate economic pol-icies are the primary cause of both the productivity slowdown and the poorly performing labor market. High marginal tax rates, especially those on capital formation and business enter-prises, costly new labor market and other regulations, high debt-financed government spending (largely to fund income transfer payments), and the lack of a clear monetary strategy have discouraged real business investment and reduced both the supply of — and the demand for — labor. The policy changes of the kind proposed by the Congress and the Administration, if enacted, would significantly improve

the economy’s growth prospects.”


They make the case, based on an analysis of past trends, that taken together, tax reform, regulatory reform, and entitlement reform would allow the U.S. economy to make another long cyclical turn towards more robust GDP growth — by encourag-ing capital investment, drawing workers back into the labor force, and reducing the burden of exces-sive debt. All this in turn would deliver the growth in living standards that middle-class Americans have been missing for the past decade, and that they demanded in the 2016 presidential campaign by voting for insurgent campaigns such as those of Donald Trump and Bernie Sanders.


The critical question is simply whether the new administration can deliver the necessary reforms, or if the inertia of the status quo will prevail and deliver instead the continued anemic growth that the Congressional Budget Office has predicted.


Leaving aside the hyperbole of some of the new



administration’s critics, the open question is simply whether it can muster the political skill and politi-cal capital necessary — or if the opportunity for re-form will be lost. The sharp post-election increase in business and consumer optimism suggested that many Americans believed the new administration’s business experience could translate quickly into political effectiveness. Subsequent events — some directly due to the administration’s failings, others due to intransigent opposition which deems par-tisan victory more important than the country’s welfare — have called into question the adminis-tration’s capacity to move from business sense to political effectiveness.


Perhaps the demise of efforts to repeal and replace the Affordable Care Act will now give the adminis-tration the chance to move forward meaningfully on other reform efforts — especially regulation and taxes. In the meantime, markets wait with baited breath.


Investment implications: As much as we prefer to base our market views on eco-nomic realities rather than on political prognostications, there’s no way to avoid the current entanglement of economic and political reality. Investors therefore need to keep watching the administra-

tion’s progress towards its stated reform goals. We stress that this is not a matter of partisan judgment; it is a matter of assess-ing prospects for future economic growth in the U.S. — and therefore for future cor-porate profits and stock-market returns.





Indian Tax Reform Is Already Easing Business and Boosting Growth



As we read recently in The Wall Street Journal, Indian truck drivers are happy. They’re happy because Narendra Modi’s goods and services tax (GST) tax reform came into effect on July 1, eradicating much of the country’s hopeless tangle of local taxes. That means drivers no longer have to endure painful, extended waits at checkpoints when they pass from state to state while their cargoes are examined and assessed — and they also no longer have to pay bribes to the petty officials doing the examining and assessing. Logistics costs country-wide are anticipated to drop by 20–30%, so truck drivers — who can now calculate their travel times reliably and know when they’ll be home with their families — are not the only ones rejoicing.


The change is a huge one — one that basically brings India into the company of countries where foreign investors can see the benefits of doing business, and local manufacturers and retailers can conduct their operations rationally without so much jump-ing through hoops in an effort to deal with logisti-cal nightmares. The International Monetary Fund (IMF) is consequently raising its long-term GDP growth estimate to 8% — suggesting that India is slated to remain the world’s fastest-growing major economy.


Our readers in the U.S. and even those in Europe will have to be imaginative to appreciate how sig-nificant this reform is. U.S. readers would have to imagine what it would be like if interstate cargoes had to pass through customs and be assessed for state taxes each time they crossed state lines. Eu-ropean readers with long enough memories could remember what it was like before Europe em-braced open commerce across national borders with agreements like Schengen. And both Ameri-cans and Europeans can add corruption to the mix


  • imagining what it would be like if bribes needed to be paid at every border crossing and to any tax enforcers with a mandate to perform random cargo checks.


The map below shows a trip from Delhi to Cut-tack. Google Maps estimates 32 hours driving time for a car. However, the trip goes through seven tax checkpoints, and the total waiting time for these checkpoints would add an additional 78 hours to the trip for a truck driver.


Needless to say, this state of affairs has acted as a huge brake on the development of Indian com-merce and manufacturing, as well as on the for

eign investment in India that could help make it the manufacturing powerhouse that Mr Modi believes it could be. As the Journal observed:


“Before GST was implemented, it would take 11 days for a container to travel from Shanghai to Mumbai, but almost double that to get from Mumbai to Delhi… Up to a quarter of the journey time was spent at checkpoints.”


Many Indian companies maintained warehouses in different states simply to avoid having to ship goods across state lines. And that’s just the legal hurdles — in addition, all the checkpoints and assessments provided lots of opportunity for cor-rupt officials to extract bribes. According to one Indian analyst, the GST will mean a savings of $115 in bribes on the average trip.


Spot checks of drivers’ paperwork will still offer a chance for graft, but even so, the change is momen

tous. In essence, Modi’s reform has begunto make a real “common market” from an India that was fragmented, divided, and mired in inefficiency.


Thus far, Modi has implemented two major poli-cies that at first garnered extreme criticism from analysts and policymakers outside India. The first was the initiative to tackle tax evasion and the gray market by taking 500- and 1000-rupee notes out of circulation; the second was the goods and services tax (GST). Many observers thought that both were ill-considered, ill-planned, and danger-ouslydisruptive, and that they would cause signifi-cant harm to the Indian economy.


In fact, the opposite has proved to be the case. The effort to root out corruption and tax evasion with the currency reform proved so popular among Indians that it significantly boosted Mr Modi’s political capital, handing his party a resounding vic-tory in elections in Uttar Pradesh — India’s most populous state — in March. Ordinary Indians saw that it was corrupt elites that Modi was fighting through this reform — and that he had their backs.


The same is proving true for the imposition of the




Market Summary


Global markets continue to move ahead, and we expect this to be the case for at least the next week or two. We must remember that August and September are historically weak months for world markets, and it is quite possible that we will get a normal correction in these two months.



U.S. Stocks


Within the United States, the best sector remains technology. Also enjoying favorable conditions


GST.  Critics thought that it would be a disaster


  • that the IT infrastructure was not in place; that merchants would be too confused; that prepara-tion had been insufficient. In fact, so far, it’s going swimmingly. It remains to be seen how everything will go when the first payments need to be made by businesses in September — but if Modi’s track record holds, we predict it will be less problematic than feared.


Modi’s shock and awe seems to be turning out to be an effective way to handle India’s corruption and unruliness.


Investment implications: Each time one of Prime Minister Modi’s disruptive reforms starts to succeed, it will reinforce the long-term case for India’s potential to become a stronger emerging-market manufac-turing economy, and that will continue to support positive sentiment for Indian equities. We believe that the GST will prove, in the mid-term and longer, to be a key element in supporting robust eco-nomic growth for India, and to be a critical piece of India’s development as a manu-facturing hub.










are quality momentum growth companies; some return of trading demand for copper and industrial stocks can continue if corporate profits this quar-ter are strong. Copper stocks are in demand, as global economic activity is rising. Copper is a good indicator of global economic activity. In general, we believe the investors who have taken profits would be wise to keep some cash handy so that they might take advantage of any market pullback in the August/September time frame.

Market Summary, cont’d


Europe Stocks and Currencies


European stocks have not done much because the euro has risen so strongly versus the dollar. The euro is due for a correction, but remains a great long-term hold. On any U.S. dollar rally, we will recommend shorting the dollar and buying Euro-pean, Japanese, Canadian and Australian currencies.



Emerging Markets


We will deploy any cash into emerging markets during the expected correction in August and Sep-tember; in our view, emerging markets are strong






and can be bought — especially the markets of India, Indonesia, Singapore, Taiwan, and Thailand. In the past, we have been positive on South Korea; we now think it should be avoided due to rising political risk.





Technically, gold remains in a trading range, with a technical sell below $1240 and a technical buy above $1260.


Thanks for listening; we welcome your calls and questions.