The U.S. economy showed further signs of strength in November. Employment and manufacturing indicators showed resilience to the hurricane headwinds with some evidence of a slight acceleration beginning to emerge. The Bureau of Economic Analysis revised third quarter GDP growth to an annualized 3.3%, and there are few signs of an imminent slowdown. The New York and Atlanta Federal Reserve Banks are currently estimating 3.9% and 3.5% respectively. Both of those are extraordinary growth rates for this long into an economic expansion, and this pace should be maintained into 2018.

Can this pace of growth be maintained for longer? Probably not. In economics, it is critical to distinguish between the longer-run, structural aspects of an economy and the shorter-run cyclical elements. This U.S. growth surge is cyclical, and even tax reform does not alter the structural.

The structural state of the U.S. and global economy is not particularly uplifting. It is difficult to argue that the long run growth of the U.S. economy is not slowing down. The boomers do not happen every generation, women joining the labor force are a one-off boom to the US growth rate as is life expectancy doubling in a century. Some economists argue this means the U.S. -- and the global economy -- are heading for slower growth, and this is probably correct. There are a few things that could delay or even ward it off, but they do not appear imminent. After all, one of the things that could accelerate the structural growth rate of the economy is innovation, and the internet already happened.

Source: Bloomberg

Combine this with the structural U.S. government deficits, and you have a recipe for much weaker U.S. growth, but not necessarily in the near-term. This is where the cyclical interacts with the structural. In other words, just because long-term growth might be relatively slow, does not mean the near-term must be.

With tax reform passing, there is a good chance that the U.S. growth picks up. Even if this growth is only on the margin, the resultant inflation acceleration could spur the Fed to raise rates modestly quicker than anticipated. The cyclical aspects may have some interesting consequences.

The chart is from Robert Gordon's "Is U.S. economic growth over? Faltering innovation confronts the six.”

Source:

“Is the U.S. economic growth over? Faltering innovation confronts the six.”

“The six” refers to the six headwinds he points out will slow global growth in coming years. Gordon’s work is a sober reading of global growth in the future. How slow does Gordon see U.S. growth going overtime? The chart assumes that growth gradually slows to 0.2% by 2100 from the 20th Century's 2% pace. This does not look so bad in chart form. Though, it would feel exceedingly slow.

In the near-term, the cyclical aspects should win out. For the U.S., this is a moment to savor. Growth at this pace is not in line with the structural capabilities of the U.S. economy. Thanks to tax reform, the US has a respite from its longer-term reality.

Sam Rines

srines@avalonadvisors.com