We caught up with Zach Pandl, Senior Economist at Goldman Sachs to get a reading on the global economy, and his thoughts about our complex financial future and the implications for the retail sector.
Robin Lewis: Let’s start with kind of a general macro scenario. What’s your take on what’s happening in the global economy?
Zach Pandl: Really big picture view, starting in 2007 to 2009, globally, you had a very synchronized recession and then a synchronized recovery everywhere. Some places were hit worse than others. The U.S. had a pretty bad contraction. China had an enormous amount of stimulus so it didn’t have a bad downturn at that time. Depending on a country’s exposure to real estate prices, you had better performers and worse performers. But everything was synchronized. And then you had a worldwide recovery.
Since the end of 2010, the world has become a much more complicated place. Europe has had a double dip recession and sovereign crisis. We have existential questions about the future of the Euro Zone. You have Japan with the Fukoshima disaster and Abenomics in an attempt to get out of deflation.
The U.S. recovery was a conventional slow recovery, and has taken six and a half years. We call it the tortoise recovery, but finally it’s approaching the finish line. Unemployment has fallen from 10 percent down to 4.9 percent. It’s been the steadiest comeback story in the world.
Then you have all the fallout in the emerging markets, which is even more complicated. China went through massive stimulus and avoided the downturn from the financial crisis, but the stimulus has worsened the imbalance in the economy. Fast forward to today, China is doing the right things from a policy standpoint, slowing investment growth, growing consumption growth, but it’s a difficult rebalancing process, and it’s uncertain how the currency thing will play out. But the problem is that the growth model of other countries is being predicated on growth in China.
Right now we’re seeing the reflection of a very mixed economic backdrop. It’s not a big story but many different stories, many different growth trajectories—the impact on currency markets has shown that.
RL: Currency volatility: If China were to force their currency down, would it be enough of a shock to push us into a recession?
ZP: It would certainly be unhelpful, but it would depend on the magnitude. Right now there’s a lot of focus on the currency devaluation in China, and although those things are not unheard of, it’s hard to know how far to go without causing a problem. I don’t think it would be enough to push the U.S. into a recession. There are things we could do here to offset that. The Fed could hold off on raising interest rates.
RL: Do you think the Fed would do what Japan did and try to charge negative interest rates?
ZP: That’s a popular question right now. I wouldn’t rule it out, but I’m not sure the Fed has the legal authority to do that given how their charter is written. Plus, it would make more sense if it were working better in Japan.
RL: If it’s not working in Japan, I don’t understand how that move would work here. For example how do we get big corporations to invest the two trillion dollars they have sitting on the sidelines? Why would they invest in growth when there’s no demand?
ZP: I think it’s mostly a currency strategy; an export promotion strategy. If you’re a Japanese exporter, it helps you because of currency weakness.
RL: Why are companies not investing? Because of demand deficiency? Overcapacity?
ZP: In general, yes. A lot of these arguments don’t hold for the U.S. the way they do in other places, but you do have demand deficiency and a current account surplus in the Euro Zone, and a lot could be done to address that. There’s too much saving and not enough investing. A way to fix that is to use fiscal stimulus, but there’s not a lot of appetite to do that in the Euro Zone. They’re leaning very hard on the monetary lever. The U.S. is in a pretty good spot. We’ve had six and a half years of recovery. The Euro Zone is five years behind the U.S. in the timeline. It’s still going through disinflation. Going through monetary easing, with a long way to go in deleveraging.
RL: In the developed world, where capitalism has worked very well so far, there is this assumption that there is infinite growth. But if you take a raw supply and demand situation, where free market capitalism is supposed to bring equilibrium at some point, there are some theories out there that in the developed western world, the supply/demand equilibrium doesn’t exist anymore.
ZP: On the point about infinite growth, there is infinite growth to some extent, because of human productivity, human capital accumulation. Economies do tend to grow indefinitely. Retail would be a great example. You’re scanning every item at the checkout counter, you can translate that information all the way down the production chain, all the way to China. Firms gain efficiency over time, which translates into profits, which get spent maybe not on more shopping at a store, but on other things.
In the mid-90s, Allan Greenspan said that the total weight of the economy is the same, but growth in productivity is shrinking things down.
On the downside, you haven’t done enough to get the demand to rebound back to supply. There are demand deficiencies. You haven’t done enough to balance demand and supply. So it becomes disinflationary/deflationary, like Japan has been in for some time.
The U.S. has fairly convincingly avoided that. Real estate prices show that. Commercial real estate prices peaked in 2006, then fell, but have recovered and are almost back to where they were. Japan’s commercial real estate prices never recovered.
There is this question of secular stagnation—is this permanent change or not? In real time it’s hard to tell the difference between secular and cyclical, since the recovery has been long and slow. If you look over the last decade of U.S. data, it looks like a big cycle, although a really long one. Unemployment coming down, wage inflation picking up now again, real estate recovery. We are fairly optimistic about it.
RL: Regarding the oil-gas “bonus,” so to speak, is it a 1:1 replacement? Are consumers spending it or saving it? If you talk to retail CEOs, they are not seeing any great daylight. A lot of the money is going into other categories.
ZP: We try to collect anecdotal information by talking to companies as well as doing statistical analysis. The feedback from retailers reporting on their businesses is consistent with previous trends. Interestingly, companies that have other products at gas stations, for example, are seeing an increase in the non-gas spend and an upscaling of the type of products people are buying at those places. It also went into savings.
Eventually households are going to spend any permanent windfall. The fall in gas prices wasn’t immediately thought to be permanent. The Fed did a survey: People expected the decline to be temporary. Now that has reversed as gas prices have stayed low. The savings rate has stayed a little high. We think there’s a little bit more to be spent. Outside of retail, the economy as a whole hasn’t seen a benefit because of the negative effects on the oil sector. The shale activity has fallen off significantly. They’ve kind of cancelled each other out.
RL: Regarding supply and demand and productivity, yes the industry has increased productivity, but it has contributed only incremental growth. Growth that is not due to better efficiency, but due to building more stores, and pushing more stuff out.
It becomes share wars, taking the path of least resistance, which is pricing, and insane discounting mechanisms. We’ve counted 22 different forms of discounting. Many companies are closing full-priced stores, but then opening twice as many outlet stores.
So there’s an increase in supply, but soft demand, and the impact on prices is horrific. CPI is coming down for retail-related stuff, but costs are being forced up, because everyone has to compete with Amazon, and they have to invest in technology to stay afloat.
Just like there’s too much stuff sloshing around the globe, there’s too much capital sloshing around. They have to choose between investing in more capacity or in propping up the losers. Sears is a great example. They should have been dead long ago, but private equity comes in and decides to ’invest in’ this great American iconic brand, thinking they can bring it back.
ZP: I don’t disagree with any of that, it’s just that from a broader overall economy perspective, what you’re talking about is structural change within an industry rather than problems for the overall economy. This has happened in lots of industries, like music, cell phones, computers, finance, etc. It’s a creative destruction process, and certainly not a lot of fun to be going through. Online has been such a potent force in changing retail.
From the economy’s perspective though, what we worry about are these secular changes creating friction because people can’t become re-employed in another sector. That would be a problem. Are firms still creating jobs and paying taxes in the same way? The externalities involving the labor market or the environment or fiscal things are what we have to look at.
Obviously there are regional effects. A dynamic economy is filled with those sorts of things. If you’re in the foxhole, the best you can do is try to compete. Try to live with those changes, and find a niche that can be competitive and fight away.
RL: So add to the over-saturated market, the millennial generation. This is a generation that is bigger than the boomers in population but their wallets are smaller, and they are more into the style of life than the stuff of life. This is a big threat to retail. They’re not into a lot of shopping, which is why the malls are floundering. Plus they can find anything they want on their phones. In a macro sense, like in the book The Demographic Cliff the developed world is getting older, and the younger demographic isn’t big enough to replace them. The world is going into a recession because you don’t have enough young people coming into it.
ZP: Economists and demographers don’t have a great track record for this sort of thing. For an industry like retail, if your growth plan is to supply more stuff to a growing population, and the population isn’t growing too fast, then you have to recalibrate. The U.S. population is growing, it’s changing, it’s becoming more diverse. From an economist’s standpoint, it doesn’t mean you can’t have a balanced growth path with zero or negative population growth. A lot of countries in Western Europe, although they have low population growth, are continuing to grow. Japan, even though it has negative population growth, has a productive economy.
RL: But they’ve been in this state for how long, 20 years?
ZP: Japan is a bit of a misunderstood economy. There’s a saying in economics that there are three kinds of countries in theworld: There are developed markets; less developed markets; and then there’s Japan and Argentina. Unique special cases. The last two are outliers in a lot of ways. Japan has had the malaise, no nominal GDP growth in a couple of decades, but does that matter? It matters for some things. The government debt stock is quite high and can be a problem. Japan has been in this mild deflationary equilibrium, but in real per capita terms, growth has been on par with the rest of the OECD in that period of time. So the economy has been producing growth. If not for the debt stock, they would not have a big problem. There’s no infinite growth, but there’s infinite development.
RL: Retail industry aside, what is your opinion of the U.S. economy overall?
ZP: The U.S. economy is not firing on all cylinders, but the consumer remains the engine of growth, and there’s a very solid consumer backdrop. Why is that? We went through a very difficult decade with the loss of real estate wealth, paying down credit card debt, and deleveraging mortgage debt. With that pain came gain. We now have very healthy consumer balance sheets and the ability to keep spending, even with some moderate market volatility. With consumer spending plus housing growing, plus a little boost in government spending, these sources of core domestic demand have been enough to offset the foreign headwinds that are weighing on energy and manufacturing.
RL: Where do you see GDP going this year?
ZP: We are predicting GDP growth of 2.25 percent for this year. If the markets calm down, we expect three more rate hikes this year, but we need to see a little improvement in markets.
RL: Given the situation in retail, what would be your advice to the CEOs out there?
ZP: If I were hired as an analyst by a large retailer to look at the sources of possible growth, I would say, well maybe the overall population isn’t growing that much. But if we look for the opportunities in population change, we have the large growth in Hispanic population. And we have growth opportunities overseas. So we have to see how to compete online. Is it possible to compete in a more niche way? Maybe smaller stores rather than big box stores? Consumers like to go out and shop on Main Street, but is there a more micro approach? This is just an economist daydreaming about the retail industry. One last thing I’d say is the cost of capital is not high. Take advantage of that if you have some investment plans to finance capital spending, to refinance, or invest right now.
RL: One last thing on this race to the bottom: Price discounting—what do you think about it? Do you think over time that the devaluing of the retail brand names will have an impact? Is undercutting on price going to erode the brand?
ZP: A lot of these brands that have been around for a long time have changed. They’ve had to change the nature of their business or run with two brands: a premium brand and an economy brand. You have to find your identity and change it if need be. Financial services are no different. A lot of firms have had to change their stripes. It’s not surprising that you’ve seen that in retail as well.
RL: One final question. Do you think the election process we are going through is having an impact on our economy? Will it?
ZP: It’s all going to come down to the straightforward levers—fiscal policy, tax policy, and foreign affairs. It’s been more interesting than we’ve seen in the last few election cycles, but I have a hard time seeing how it translates to the economy. From an economic forecasting standpoint, we’re going to have to wait and see how it translates to tax rates—personal and corporate—and infrastructure spending. It’s not only who is in the White House but also who controls Congress.
Senior Economist, Goldman Sachs
Zach is a senior U.S. economist in New York. He first joined Goldman Sachs in 2011 and rejoined the firm as a managing director in 2015. Prior to rejoining the firm, Zach worked at Columbia Threadneedle Investments, where he served as a portfolio manager and head of sovereign fixed income research. Earlier in his career, he worked in the economics research groups at Nomura Securities and Lehman Brothers.Zach earned a master’s degree in economics from New York University and a bachelor’s degree from the University of St. Thomas.