Trade policy puts the brakes on capital spending for businesses
Slowing could be a sign of weakening economy
Nick Penze, CEO of Zerelli Technologies, had a long holiday shopping list for his company.
He wanted the Park City, Utah, designer of industrial seals to acquire a smaller manufacturer and possibly upgrade its factory, and buy new furniture and computers for Zerelli’s headquarters.
But the Trump administration’s 10 percent tariff on $200 billion in Chinese imports has reduced both Zerelli’s cash flow and the revenue of its customers – such as makers of washing machines and transmissions. As a result, Penze has put his plans on hold.
“I wouldn’t feel comfortable doing it, not knowing what’s going to happen in the next six months to a year,” Penze says.
President Donald Trump and Republicans in Congress vowed that this year’s big tax cut would unleash a wave of business investment that would juice economic growth. But increases in capital spending for businesses of all sizes slowed dramatically in the third quarter, raising questions about whether any tax-cut benefits already are fading. Some economists say the pullback reflects business worries over the tariffs and likely foreshadows a broader slowdown in the economy.
“It appears that the hard economic data … is finally exhibiting the negative hit to planned capital spending from trade policy,” research firm Morgan Stanley wrote in a recent note to clients.
Increased business spending on new equipment, structures and intellectual property can be a key driver of the economy and jobs. Manufacturers of factory machines, computers and trucks need more workers to make the products while businesses that buy them need more employees to run them.
Yet such business investment edged up at an annual rate of just 0.8 percent in the July-September period, down from 11.5 percent and 8.7 percent in the previous two quarters, and the smallest
advance since late 2016, the Commerce Department said last month. The performance was the biggest weak spot in a report that showed the economy grew at a healthy 3.5 percent rate, following 4.2 percent growth in the second quarter.
The last time capital spending flatlined in late 2016, a downturn in oil prices was still damping investment in drilling. While volatile oil prices also played a role last quarter, business outlays would have been anemic – even without a pullback in the oil industry, says Barclays economist Jonathan Millar.
Is it a blip?
Joe LaVorgna, chief economist of the Americas for investment bank Natixis, downplayed the soft business spending, noting the figures can be volatile. “I just don’t get worried over one quarter,” he says. The increase could be revised higher or it may be a blip, he says, with business invest- ment resuming its robust growth clip in the current quarter.
LaVorgna adds that he never believed the tax law – which allows companies to deduct capital purchases from their income more rapidly – would provide a short-term boost to investment. Rather, he thought it would make the U.S. a more appealing location for multinational firms by cutting tax rates. Yet with the economy still growing strongly, and 3.7 percent unemployment spawning more worker shortages, firms will need to step up their purchases of laborsaving technologies, he says.
Morgan Stanley has a less sanguine view. It notes that businesses’ capital spending plans fell in four of five Federal Reserve regional bank districts last month. And the research firm’s national index for capital spending plans has tumbled in six of the past seven months after peaking in March.
One explanation is that the trade war with China is denting business confidence. A survey by executive coaching company Vistage showed that small and midsize business optimism fell in the third quarter, reversing all the gains of the prior three.
Take Zerelli, the Utah company. Most of its seals are made in China. It’s pass- ing along the 10 percent tariff – which is slated to rise to 25 percent in January – to its manufacturing customers. But the company doesn’t get reimbursed by customers for up to 90 days, crimping cash flow and squashing its investment plans, Penze says.
Some see economy slowing down
Barclays’ Millar says a more fundamental problem is the prospect of weakening consumer demand. The effects of the Republican tax cuts and federal spending increases are likely to start fading by next year, he says. The 9-yearold economic expansion is getting long in the tooth. And the Fed is raising interest rates to temper growth and head off a spike in inflation.
“We think GDP growth is going to slow” after reaching about 3 percent in 2018, Millar says. That would undermine Trump’s promise of 3 percent or better growth for a sustained period. Millar says the unusually weak capital spending total last quarter likely overstated the trend. But he projects investment will slow to about 5 percent in the current quarter and 2 percent to 3 percent by the end of next year as the economy begins to sputter.