State of Economy — HHC 2025
Production
According to gross domestic product figures, global growth across the three major economies (US, EU, China) has been relatively strong, despite repeated exogenous impacts from pandemics, wars, and financial crises. The US remains the world’s largest economy according to current exchange rates, with China and the EU roughly equivalent in size.
When indexed for growth starting in 2019, the US economy grew at the same rate as China, with the EU lagging behind.
Given this headline GDP data, recent US economic performance appears strong relative to other leading economies. That said, a decomposition of growth across the different components of the US economy shows divergent trends. Since 2019, federal government spending drove economic growth, increasing by 54%. Interestingly, consumer spending, which typically drives the US economy, lagged every other component of GDP by growing 16% since 2019. The consumer’s share of GDP declined over this period, demonstrating the concept of “crowding out”, which occurs during periods of expanding government spending. Obviously, COVID drove policy responses, but this level of government spending relative to investment, exports, and consumption typically does not lead to optimized economic conditions for businesses and consumers.
A measure of economic efficiency is GDP per capita — or the total production in an economy per worker. US GDP per capita increased dramatically since 1990, with material outperformance relative to other developed economies occurring since 2010. This metric would imply a healthy, growing level of production per worker in the US relative to other Western economies.
Another method of evaluating the output per worker is GDP per capita assuming purchasing power parity. Purchasing power parity normalizes for the impact of local currency strength relative to another country. When adjusting for the impacts of the strong US dollar, the outperformance of US GDP per capita declines relative to the other leading economies. In absolute terms that exclude the impacts of foreign currencies, US workers produce significantly less than it appears.
Since 2012, the US dollar strengthened relative to other major currencies. The positive divergence from fair value translates into a US dollar that is overvalued. As a result, US production is lower in real terms than in nominal terms implied by current exchange rates. Put simply, the US produces less than it would appear in headline statistics.
It should come as no surprise, then, that the US produces the same amount of industrial output as it did a decade ago. Those who feel that services replace industrial production should think hard about whether Brooklyn cocktail bars and escape rooms can replace industrial output in the competition for global hegemony.
In part due to the decline in industrial production, US net exports continue to deteriorate.
Over the past several decades, the US economy developed a significant reliance on China for its manufacturing capacity. Since 2003, China increased its global penetration of manufacturing from 10% to over 30% of global output, largely at the expense of the US.
Chinese economic output measured in volume of production vastly exceeds US output across many key categories. Nominal metrics indicate that the US continues to be the world’s largest economy, but China outproduces the US in many key industries — giving credence to the purchasing power parity adjustment.
China’s intentional devaluation of its currency contributes to its success in global trade by enhancing the attractiveness of the country’s exports. China transfers wealth from households to businesses through cheap financing provided by state-controlled banks to state controlled enterprises. The lower financing costs enjoyed by state owned enterprises shift capital from households to businesses, resulting in the country’s high household savings rate. As a result, the Chinese currency is undervalued by ~34% according to The Economist Big Mac Index. When factoring in the US overvalued currency and the Chinese undervalued currency, a US exporter faces at least a 50% price disadvantage relative to a Chinese exporter on the global markets. This disadvantage for US exporters in part describes the lack of industrial production growth and deterioration in US net exports.
Employment
At a high level, the US unemployment rate appears to be low relative to historical standards.
While the headline unemployment rate for the US is low, the unemployment rate excludes workers not considered in the labor force. Labor force participation rates across many demographics has been declining, with declines focused within men and youth worker categories.
While the labor force participation declines, multiple job holders are at an all time high.
During the pandemic, job openings vastly exceeded available workers. The decline in job openings since 2021 put the US off trend, meaning workers must try harder to find employment.
Inflation
One of the biggest focal points of economic observers over the past five years has been global inflation that started during 2021. According to the statistics published by the US Bureau of Economic Analysis, personal consumption expenditure (PCE) inflation peaked at ~8% in 2021, with consistent declines since then. While this headline would indicate that inflation is under control, a decomposition of the different components of the PCE index reveals a different story. The PCE of goods spiked during COVID, largely due to fiscal stimulus encouraging unnatural demand for goods, with goods deflation occurring since the pandemic. The US imports a significant portion of its consumer goods from China, which reduces the impact of inflation on the overall PCE index. Non-importable goods, like services and housing maintained above target inflation — with the impact of price increases masked by the deflation in goods imported from China. Overall, this view of inflation indicates an ongoing bout of price rises yet to be quelled by higher interest rates.
Inflation is fundamentally a monetary phenomenon. Tracking M2 provides a helpful guidepost for inflation. M2 growth peaked at over 25% during the pandemic and declined briefly during 2023. Since the trough of M2 growth in 2023, M2 increased by nearly 4% by the end of 2024, likely portending a reacceleration of inflation in 2025.
Reliance on traditional measures of inflation can be misleading, as they’re controlled by governmental agencies and therefore subject to political pressures. In the below example, HHC took a sampling of goods and tracked the cost difference between 2019 and 2024. On average, the price of these goods increased by 40%, while the weighted basket of these same goods indicated a 74% increase in prices. The difference between the weighted and average price increases was driven by the significant increase in the cost of shelter and transportation, as purchasing the average home and car in the US increased by 131% and 118%, respectively from 2019 to 2024.
These numbers conflict with the government’s inflation index — CPI — which shows a mere 20% increase in prices since 2019. As we know, inflation is a monetary phenomenon. M2 has increased by 42.5% since 2019. The HHC survey of goods increased by 40.2% on average. It appears likely that CPI understates the true extent of inflation since 2019.
Inflation erodes standards of living by reducing the real wages that workers earn. Since 2019, real wages either declined or remained relatively unchanged, reducing the standard of living for the average US worker. Keep in mind, the real wage data below is calculated CPI, which underrepresents inflation. As a result, the decline in US living standards exceeds the data presented below.
Housing represents the largest purchase for the US consumer and composes the largest component of the CPI basket. Since 2008, the US has not built enough houses to keep pace with household formation, driving a consistent shortage of housing units. Severe housing shortages exist in the most prosperous areas of the country, like the urban Northeast and West Coast, reducing access to opportunities and limited overall US production.
Inflation impacts not just consumers through nominal and real wages, but also companies who generate their revenue in nominal dollars. Ostensibly, the fiscal stimulus represented a strong operating environment for the largest publicly traded companies in the US. During 2021, each component industry within the S&P 500 experienced significant revenue growth that continued into 2022. Growth normalized in 2023 and 2024 resulting in relatively modest growth for the market, with several industries declining. Consensus estimates expect tepid growth conditions once again in 2025. We operate in a nominal world, so it seems at the surface that there has been a strong environment for public companies since 2019, with modest growth since 2022.
HHC wanted to understand the impact of inflation in real terms on public company performance. Real wage performance for US workers indicated negative growth for a significant portion of the last five years. Applying the same methodology to public companies, real revenue growth appears much more subdued. Using CPI as the inflation gauge, US public companies experienced a recession in 2023 and relatively poor growth in 2024. Using the HHC survey of goods and services as the inflation gauge, US public companies experienced several years of poor real performance. This exercise corroborates the macroeconomic data we observed around industrial production, GDP per capita purchasing power parity, and net exports. US workers and businesses produced vastly less than indicated during the COVID pandemic and years since. The strength of the US dollar masked these deficiencies, but it is only a matter of time before these issues manifest themselves more clearly.
Interest Rates
Over time, forecasters of interest rate policy erred in their predictions of the path of interest rates. The vicissitudes of interest rate forecasts prove a poor guide for future rates. That said, the US Federal Reserve increased interest rates to combat the bout of inflation that began in 2021.
Central banks increase short-term interest rates to reduce capital availability for investment or consumption by consumers and businesses. This reduction in capital availability should reduce economic activity to slow the demand for goods and services that created inflation. During the zero-interest rate period, corporates took advantage of low-rates to “term out” their borrowing at low rates with long duration loans. As a result, corporate net interest expenses declined by 60% despite a 500bp+ increase in the Federal Funds rate. During this cycle, interest rate increases provided stimulus to large corporates.
At the same time, credit card financing rates increased while delinquency rates on credit cards remained flat. The US consumer used stimulus payments to retire outstanding debt balances and purchase durable goods, which reduced the impact of higher interest rates on consumers (and likely the impacts from the extraordinary increases in the cost of purchasing shelter and transportation).
Interest rates move in super cycles. These super cycles occur because the direction and path of interest rates reinforces the increase or decrease of rates over time. As a result, the US will likely experience the inverse of the financial conditions that began in the 1980s — with interest rates moving higher over the coming decades.
Rates matter because they act like gravity for the financial system. Interest rates determine the cost of capital across the spectrum of financial assets, driving investment and consumption decisions for consumers and businesses. As the cost of short-term US federal government financing increases, the cost of other assets increases as well.
In conclusion, the return to normalcy should continue in 2025, with improving operating conditions expected across the economy. It appears large sections of the economy are moving out of a recessionary business cycle into an expansionary one. These recessionary conditions were obscured by unnatural forces like increased government spending or nominal growth in public and private company revenues. Economic growth decelerated from 2022 to 2024, as fiscal stimulus driven inflation wore off. It appears that the legs of a new business cycle began forming in 2024 and should continue in 2025 with a modest acceleration of growth expected. Inflation seems to be stickier than hoped, with the risk that it will begin to accelerate again as it did in the 1970s. Higher inflation and growth means higher interest rates, which increases the cost of capital across the curve of risk assets. As a result, generating your own capital to grow represents a prudent approach to business management during 2025.
