Animal Spirits

Just for fun, I compared the lyrics in the song “Physical” by Olivia Newton-John with Janet Yellen’s “Fiscal” lyrics during her press conference performance at the end of last year following the December 13-14 meeting of the FOMC. The word “physical” appears 20 times in Olivia’s song, and “fiscal” was mentioned 20 times during Janet’s press conference. In the minutes of the December meeting, the word “fiscal” appears 15 times, compared to just once during the previous meeting on November 1-2, which was before Election Day on November 8.

Prior to Election Day, a few Fed officials had called on Congress to step in to revive US economic growth with fiscal stimulus. They want to proceed with “normalizing” monetary policy so that they will have room to ease in the event of a future shock. They were looking for a way to continue to gradually raise rates without hampering economic growth, which has been slow. President-elect Donald Trump might just solve their problem with fiscal policy, included cuts in tax rates and more spending on infrastructure.

“Physical” starts with “Let’s get physical” and ends with “Let’s get animal, animal / I wanna get animal / Let’s get into animal.” That’s not appropriate or relevant language in a discussion about the Fed chair. However, President-elect Donald Trump is fair game.

After all, a Google search of “Trump and animal spirits” yields over 2 million links. They include lots of prim and proper ones such as a 1/5 FT article by Gillian Tett titled “Donald Trump unleashes business’s animal spirits.” She reported that Trump’s top eight officials (president, vice-president, chief of staff, attorney-general, and secretaries of State, Commerce, Defense, and Treasury) had only 55 years of government experience but 83 years in business. Obama’s comparable team had 117 years in government, but ONLY five years in business IN TOTAL.

As I’ve observed before, this is a radical change in governing regimes. As one of our accounts observed, government by dealmakers is about to replace government by community organizers. So far, this has all revived lots of animal spirits in the stock market. While the country may be split on Trump, his election has boosted overall consumer confidence. Purchasing managers were also more upbeat after the election, and so were small business owners.

December’s survey of small business owners by the National Federation of Independent Business (NFIB) was released on Tuesday. It was full of animal spirits. This group tends to be conservative. They generally don’t like government. When they are asked about the “most important problems small businesses face,” taxes and government regulation tend to be at the top of their list. They were still the top concerns in December, but Trump’s victory was clearly reflected in the extraordinary ascent in the Small Business Optimism Index from 98.4 during November to 105.8 in December, the highest since the end of 2004.

There’s more: The net percentage of firms expecting the economy to improve soared from 12% during November to 50% last month, the highest since March 2002. The percentage saying now is a good time to expand jumped from 11% to 23%, the highest since June 2005. The net percentage expecting to increase employment rose to 16%, the highest since January 2007.

So who cares? Aren’t these just a bunch of anti-government conservatives who are running minor little businesses and are looking forward to paying less than their fair share of taxes under the new Trump administration? Not so fast: Small businesses account for a very significant portion of jobs and hiring. Consider the following:

(1) Small business is big employer. ADP, the payroll processing company, compiles data series on employment in the private sector of the U.S. labor market by company size. At the end of 2016, the shares of employment attributable to small, medium-sized, and large firms were 40.5%, 37.7%, and 21.8%.

(2) Small business drives jobless rate. There has been a very high correlation between “poor sales” reported by small business owners and the national unemployment rate. If Trump succeeds in boosting their sales by cutting personal income tax rates, the jobless rate should remain low.

There is also a high correlation between the earnings of small businesses and the inverse of the poor sales. Trump’s proposed tax cuts would boost their earnings, which are inversely correlated with the national unemployment rate.

(3) A new problem for small business. Before I put any more twists in this pretzel, I expect that the biggest problem facing small business owners in 2017 is likely to be finding workers. Indeed, during December, 29.0% said that they have openings for jobs that they aren’t able to fill.

By the way, the term “animal spirits” was popularized by none other than John Maynard Keynes in The General Theory of Employment, Interest, and Money (1936) in the following passage:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

This passage has been widely discussed and interpreted. Cutting through the jargon, I think Keynes was saying that the business cycle is driven by the instability of human nature. He seemed to agree that booms might reflect “spontaneous optimism,” which cause instability in a similar fashion as speculation, setting the stage for a bust. Keynes added: “Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before.” Of course, his book heralded the idea that government spending could stabilize the business cycle by at least minimizing the downside of the cycle. How is that working out so far?

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(Based on an excerpt from YRI Morning Briefing)

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