In an early morning keynote address Thursday, Vanguard Chief Economist Joe Davis suggested that the “biggest issue of our lifetime” is how the country deals with the persistent imbalance between our spending and our revenue, an imbalance that he suggested will not get any better for a very long time absent any tax reform.
In an interview after his presentation at Morningstar’s annual ETF Invest conference in Chicago, Davis was cautiously optimistic that one of the “viable bipartisan plans” that have been floated to fix that imbalance can be implemented.
Wistfully recalling 2011, when he said “we were close to a grand bargain,” he argued that a compromise “is needed to preserve the sustainability” of our still-fragile economic recovery.
“By all of us giving up something,” he said of plans like the Bowles-Simpson deficit reduction plan, “we all win.” If self-interest isn’t enough for Americans and their leaders to compromise, Davis suggested that “the bond market at the margins may nudge us” toward a deal with the “market’s invisible hand.”
In his speech, he said that one step toward longer-term deficit control would be to institute a balanced budget: “No country in history,” he said, “has ever had a fiscal when crisis when its budget has been balanced.” But he said in the interview that he nevertheless believes the “chances of a fiscal crisis” for the U.S. in the near term are “very low.”
Not so obliquely referencing the economic recovery and the government shutdown, Davis said in his speech and during the interview that the U.S. was still suffering from an “uncertainty tax” whose “removal would have positive effects” on the economy and the markets. He predicted “modest” economic growth next year, but below the Federal Reserve’s expectations for 2014, due to the effects of the uncertainty tax. He divulged that at Vanguard, “we monitor policyuncertainty.com daily” to keep track of the uncertainty signals.
Longer term, five to 10 years out, he sees not only glimmers of hope, but the real possibility that U.S. growth will “come into the light” and return to its historical levels, mentioning that in every decade since George Washington’s first term, the U.S. has had a healthy growth/inflation experience.
Part of the reason for that optimism, he proposed, is that we stand on the cusp of a “third industrial revolution” fueled by technology advances in everything from computing hardware and software to the Internet, which is “permeating our society like the steam engine and electricity.” Those technologies made possible the first two industrial revolutions beginning in the 18th and 19th centuries, though their adoption took time.
Like the other industrial revolutions, this third one, he suggested, will have “humble beginnings,” arising from a trough of slow economic growth and higher unemployment leading to lower prices and wages, which helps fuel investing in the new technologies. Noting that “80% of the companies in the S&P 500 were founded during recessions or tough economic times,” he described the process as “prices plummet, adoption [of the technology] explodes,” which in turn leads to further innovation, often in places “where we least expect it.”
In the interview, he said that the “pace of global innovation is accelerating,” as evidenced by a surge in new patents worldwide, and helped by the collaborative nature of Internet-based networks.
Yes, for some in society the “creative destruction” that accompany industrial revolutions will be painful — “you can’t sugar-coat creative destruction,” he admitted — but in the long run, society benefits.
One other metric that should be instructive to policymakers: the premium on skilled labor, under which the unemployment rate of the college educated and their income is rapidly diverging from the jobless rate of the only-high-school-educated American. “The cost of education may be rising,” Davis said, “but the retun on education is higher.”
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