The main thing to notice is that the fundamentals driving the US business cycle remain unusually strong. Even after the 6% YoY rises in investment spending during 1Q, capital stock is probably still slightly shrinking (assuming a 10yr straight-line depreciation of all investment spending), so there are big operational leverage gains still to be made by any company that can secure some topline growth. And since nominal GDP is still growing by around 3.9% YoY, that means most everybody. So, as a rule of thumb, US asset turns are rising, and so too therefore are returns on assets - which in the absence of monetary policy tightening, suggests the investment spending cycle still has a long way to run.
But its not just the return on capital that's rising - so too is return on labour, or labour productivity. Adjusting for the (shrinking) amount of capital per worker, the 1% YoY rise in employment goes hand in hand with a 3.6% YoY rise in nominal output per worker. That remains at historically extremely high levels. So we should also expect labour markets to continue strengthening.
So with returns to capital and labour both rising, you'd have to have a powerful opposing factor to expect the cycle to abort any time soon. Could the price of oil be that factor?
Not yet. The second thing to notice is that consumption demand rode out the rise in oil prices, rising 4.4% in nominal terms (vs 3.8% YoY in 4Q10), and 2.8% in real terms (vs 2.6% in 4Q10). Within this, spending on gasoline rose by US$63.7 billion, or 17.5% YoY, out of a total rise in consumption spending of US$453 billion. Even though gasoline represents only 3.6% of consumer spending, the worry has been, and to some extent, continues to be that the rise in oil prices represents simply a tax on consumption, and that money shelled out at the pumping station is also money that can't and won't be spent elsewhere on Main Street.
Yet it hasn't worked out that way - or more precisely, this factor evidently did not trump other factors working in the consumer's favour. In fact, on my analysis, what happened was that the rise in oil prices simply quickened the erosion of the extremely high private sector savings surplus which the US economy now runs. By my calculations, that private sector savings surplus came in at around US$142 billion during 1Q11, which was down by US$174.7 billion from 1Q10. On a 12m basis, it sank to a still-robust 5.8% of GDP, down from the 7% averaged during 2010. The lesson is that the US economy can continue to sustain consumer spending growth at these sorts of levels, despite the rise in oil prices. But only if the private sector remains sufficiently confident about the medium/long term prospects for their financial situation to allow them to scale back excessive saving. Financial confidence, (ie, bull or bear markets), remains an extremely important part of the picture.
My third observation is less cheery: there's still no sign that the relationship between the financial system and the economy is really on the mend. On way of checking this is by looking at monetary velocity. Normally when rates of return on capital are rising, monetary velocity (GDP/M2) tends to rise, as loans deployed end up generating greater cashflow. Now although velocity bounced last year off the previous year's historic lows, the rise was not sustained, and velocity actually fell back slightly during 1Q11. So the banking system remains a serious drag on the economy. On the other hand, if velocity stays down here, then the consensus that the US has little to fear from inflation, despite the Fed's best efforts, is going to be right.
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