How long can the American economy keep on surging?
President Trump’s tax cuts boosted US manufacturing, but trade war and tariffs are coming down the track. Tim Wallace reports
‘It’s unquestionable that Donald Trump brought back the resurgence of American manufacturing.” The president has won some serious fans in US industry, and this mining boss is not afraid to shout his praises from the rooftops. “The actions taken by the Trump administration, mainly tax reform, have brought a massive positive impact to the economy in general and to the steel business, in particular.”
This is C Lourenco Goncalves, the chairman, president and chief executive of Cleveland-cliffs, an iron ore mining business based in Ohio.
He is on top form, reporting his “money printing machine” is ramping up investment in part thanks to those tax cuts which have slashed his bills. It is not only the tax reforms which the $3.3bn (£2.5bn) business chief is cheering – he supports the tariffs on steel imports which have pushed up the price of his product and metals overall within the US.
“Countries are no longer taking advantage of the United States in trade,” says Goncalves. “Thanks to Wilbur Ross [the Commerce Secretary], Peter Navarro [a top trade adviser in the White House], these guys that have been defending the United States out there, and we appreciate that.”
Such high praise comes at a time of surging economic growth. US GDP grew at an annualised rate of 4.1pc in the second quarter of 2018, its fastest pace in four years. President Trump pledged to double GDP growth in his election campaign. If this continues, and he carefully chooses which years he wants to compare, he could have a chance to declare victory.
But what has caused it? And can the growth spike last?
Lower taxes were designed to boost investment, hiring, dividends and other activity to fire up the economy. Goncalves is not the only boss who took the chance of public statements in earnings season to revel in the result. “The economy is being energised by tax and regulatory reform,” says John Ferriola, chief executive of Nucor, a steel company headquartered in North Carolina.
The good cheer extends beyond the mining and metals sector. Medical and consumer group Johnson & Johnson has used the cash freed up by tax reform to increase its research and development spending by 16pc this year. John Fawcett, CFO at finance group CIT, is even looking forward to Trump’s next act. “If Trump were able to do the same thing for infrastructure, as he’s been talking about, that would potentially be a fairly decent lift,” he says.
Blackstone, the $43bn investment titan, is seeing confidence surge across the board, with earnings up 20pc for S&P 500 businesses. “When companies’ earnings are up, they tend to be more inclined to hire. They tend to be more inclined to capex [capital expenditure],” says its president and chief operating officer Jonathan Gray. “I would say what we’re seeing on the ground is positive and some of that, I think, has to be attributed to the tax reform.”
Economic data show a strong story too. Unemployment is down to 3.8pc. Incomes are responding slowly, growing at about 4pc per year. Consumer confidence is up at levels not seen since the dot.com bubble, as measured by the Conference Board. The Federal Reserve raised its growth assessment from “solid” to “strong”.
Randy Kroszner, a former Fed governor and now professor of economics at Chicago Booth, says it is “very robust”. “It was driven by both strength in consumption and strength in investment. The investment numbers are being boosted by the incentives in the tax reforms passed at the end of last year,” he says, comparing the effect to Ronald Reagan’s programmes in the Eighties.
“The real question is whether this a one-off or will it be sustained? That is the debate on whether the tax law is primarily a short-term stimulus, or a fundamental change in long-run incentives. If it is the latter, you will see investment sustained at a higher level and that will sustain higher economic growth going forward.”
Investment has been relatively sluggish in this economic cycle, so its re-emergence could be a key boost to growth, productivity and wages.
This latest expansion has been running since June 2009, according to the National Bureau of Economic Research’s analysis. As a result it is closing in on the record set by the 1991 to 2001 cycle – raising worries it must end some time soon. Inflation is creeping upwards and is now at 2.9pc.
The Federal Reserve has ratcheted up interest rates to combat this but, so far, it has avoided spooking markets or the economy, dodging the classic risk of monetary tightening causing a recession. Instead, the economy has boomed despite higher rates with surging business sentiment and extra cash from the tax reforms.
But that is not the whole story. Scores of businesses from Wall Street giants to mid-sized manufacturers and services groups have warned that the trade tariffs are a threat. Michael Happe, chief executive of mobile home company Winnebago, says the firm buys almost all of its steel and aluminium from US suppliers but their prices are going up anyway because of tariffs – which can only hit consumers.
“One of our very real concerns with the tariffs and really the overall sort of trade war climate that is building is that, ultimately, the North American customer will end up paying for those tariffs in that trade war,” he says.
Erik Gershwind, chief executive of industrial tools distributor MSC Industrial Direct says the tariffs could push up prices and are “a little bit of a spectre looming” over the industry.
Vehicle manufacturer REV Group found the announcement of tariffs created a run of demand on some of its inputs, sending its costs up by $1m in the past 60 days alone.
Economists are clear they expect the tariffs to do damage to the economy. Andrew Sheets at Morgan Stanley believes the second quarter GDP numbers received an artificial boost from the tariffs, which will disappear as they are introduced.
“Countries have dramatically increased the volume of goods they import from the US, likely with a view towards securing goods before new duties are applied,” he says.
“If you don’t believe us, we’re open to other suggestions on why US soya bean exports were up almost 9,400pc annualised over the past three months.”
Without that stockpiling, GDP growth may have been as much as 1.5 percentage points lower. Add in US companies building up their own stockpiles and the figure rises to 2.2pp.
In a Chicago Booth survey of several dozen top academics, almost every economist – 94pc – said the border taxes are doing harm.
Oxford Economics has estimated the scale of the damage if the conflict accelerates. An extra 10pc tariff on $400bn of imports into the US combined with Chinese retaliation of 25pc tariffs on all of its US imports would hit US GDP by 0.7 percentage points in 2019 and China’s by 0.8pp, estimates its chief US economist Gregory Daco. “By 2020, the cumulative GDP loss would reach 1pc in the US, and 1.3pc in China, eliminating 700,000 US jobs and a multiple of that in China,” he predicts.
If any further evidence is needed, ask the Trump administration. It pledged $12bn of support to farmers affected by the trade war. Yet the trade war is not yet at the stage projected by Daco, and Kroszner believes there are few signs of the tariffs hitting the macroeconomy just yet.
Forecasters, however, suspect this quarter was probably the peak for US growth. Garry Young at the National Institute for Economic and Social Research in the UK predicts US GDP growth will rise from 2.3pc in 2017 to 2.9pc this year, falling back to 2.7pc in 2019 and 2.2pc in 2020.
The effect of the tax cuts could support growth for longer, he says, but growth will come off the boil again.
But mining chief Goncalves is having none of it – he does not fear the impact of tariffs on steel customers or the wider economy. “You only need to drive by Toledo or any other Midwestern little town to see that there is hope out there. There are jobs out there. Restaurants are open. Cab drivers are working again,” he says.
“We are seeing American jobs being generated.”