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Monday, April 30, 2007

Chained 2000 Dollars

Sorry, the Personal Income and Outlays report is not good news. In fact, it pretty much confirms everything I was going to write about my road trip observations.

Last year the theory was that business investment and consumer spending would keep this economy from contracting, and neither is currently hauling its weight. If you look at the report and scroll down to Table 7, which reports personal consumption expenditures in Chained 2000 Dollars, you see that real PCE dropped in March:
Aug06: -9.4; Sept06: 22.1; Oct06: 43.0; Nov06: 29.3; Dec06: 31.7; Jan07: 34.4;
Feb07: 26.4; Mar07: -15.6
The change is large enough that it is unlikely to be revised away, even though this is an advance report. Spending on durable goods rose 1.4 billion; spending on non-durable goods fell (-2.8), and here's the kicker - spending for services fell (-13.2). August of 06 was the last time PCE in chained 2000 dollars fell, but it was much less and services increased that month. The reason why real expenditures matter is that they really forecast profits. Either people are buying less, or the businesses are sacrificing profits to raise volume in a dollar-competitive market. Capital markets may be awash with liquidity, but it's certainly not sloshing freely among the general population any more.

A drop in service spending forecasts restricted services employment growth.

The story is inflation - if you scroll down to Table 9 and look at the percent change for price indexes from the previous month, you can see the markets adjusting for the inability of the consumer to spend. Durable goods are not inflating, but nondurable goods are. If you look at PCE ex food and energy, the change is 0. But inflation for nondurable goods from February to March was a ripping 1.2%. That is for one month, rather than annualized. If this trend kept up, it would amount to more than 12% over a year. Needless to say, income increases for most of us are not going to support that. Market-based PCE (which excludes those funky "implicits", and is a better measure of consumer spending power):
Aug06: .2; Sept06: -.4; Oct06: -.3; Nov06: .0; Dec06: .4; Jan07: .2; Feb07: .4;
Mar07: .5
The September and October drops were really from gas.

Table 1: From August 06 to March 07, the monthly negative savings rate reduced from -1.5 to -.8. Per capita disposable income in chained 2000 dollars really doesn't look that hot, moving only from 27,641 in August 06 to 28,280 in March 07. Keep in mind that the higher end group is getting most of these apparent increases.

Compare that to Table 7, which gives real personal consumption expenditures. In August 06 the total was 8,100.7, which increased to 8,272.0 in March 07. According to Table 7, real personal consumption spending dropped from 8,287.6 in February to 8,272.0 in March of this year. The difference between income and consumption is going to decrease the gap in savings, which seems to have arisen from borrowing in order to spend.

What this looks like on the ground is that housing seems generally on a downward trend, but the real change is what is happening in stores. The contrast between parking lots filled with very nice large vehicles and customers sifting carefully through aisles is quite remarkable. Food pricing, especially, seems to be bonking around like a ping-pong ball. This is a sign of very severe inflation moving through the system. No matter what happens, in normal times you just will not see prices for frozen food items doubling in a matter of a month or two, but that is what I saw in several stores. The best run seem to be trying to keep something on sale, and I noticed a real shift in brand shelving, especially on frozen items.

One of the big surprises was in Bucks County, PA, which borders Mercer County in NJ. In the slightly outlying portions of Bucks, a whole lot of small commercial property (storefronts and land) was on sale. A lot of empty stores. Closed or closing dealerships. Big price drops on services, such as labor at auto dealerships and office visits for some medical providers.

I have been concentrating on Bucks and Mercer for about a year, because I think NJ's housing woes are partly related to wildly disproportionate rises in property taxes, and Bucks should prosper from that. If you look at the traffic coming over the bridges into NJ in the morning, it certainly seems to have! Yet Bucks County now looks rather weak, and it is a wealthy place relatively. Particularly noticeable was light teller staffing at off hours in small banks in Bucks County. As you move away from the NJ border, quite a few homes seem to be for sale.

The Carolinas were another big surprise. The Raleigh-Durham Triangle area has a great economy with relatively affordable housing, but based on radio advertising and traffic, things are getting significantly softer there. It's still going great guns compared to most of the East Coast, but there is a perceptible weakness emerging.

Up and down the East Coast, restaurants seemed to be feeling the pressure. Fast food restaurants are definitely moving more towards more low-price options on menus. There is some competition emerging in gas prices at concentrations of gas stations. I talked to what looked like senior staff members when I could, and they confirmed that business wasn't great. At banks in off hours, you get kidnapped and dragged into offices if you walk in and ask a teller about CD rates! I started wondering if some of those branches had installed a silent alarm system for sales prospects. It's difficult to escape.

I usually try to buy a lot of the local newspapers. There's a lot of personal stuff for sale. More houses for sale, obviously. Less jobs, relatively. Construction equipment, trucks, boats, campers.

Georgia, aside from being on fire (literally, not metaphorically), seems to be relatively prosperous. There is an awful lot of building still going on in these southern states. When it will stop I don't know. It is possible that the relatively healthy looking Georgia might in part be due to a Florida exodus. Nonetheless, the car dealerships still look pushed. I drove around Valdosta (close to Florida border in central GA) this weekend, and wasn't all that surprised to see a 72 month 0% APR financing sign up on a Chevrolet dealership.

Overall, I was surprised to see more rural areas areas looking healthier than I suspected and more urban/wealthier areas looking more pressured than I expected. Is this a sign of extreme overleverage among the higher income brackets? I don't know, but I am beginning to suspect it.

The only sudden change I noticed was in the grocery stores and some of the restaurants. In the grocery stores, inflation is busting loose, with prices rising by 40 cents or so, being cut back in a week or two when customers apparently don't buy, and then busting up and out again a week or two later. The yoyo effect on a lot of items is not seasonal - it must be the effect of a system at capacity being punched by pricing pressures and not adapting well. Most notable are some price increases on the really cheap brands. I suspect that inflation in Asia and the declining dollar is going to place some additional pressure on the whole system.

I guess vacancies will have to wait, but the high metro home vacancy figure (4%? unbelievable!) might be related to the signs of pressure I saw in more built-up areas. Maybe the majority of mid-to-high wage earners spent until they can spend no more.

Thanks for the report - interesting, as always. Will this morning's PCE and construction spending data cause revisions to the 1Q GDP? If so, we can look for the revised GDP to be lower, subject to the direction of revisions in other areas.
Early construction spending data (it gets revised for months and months) is largely "imputed". As the actual data comes in later, revisions can be relatively significant. Revisions to Jan, Dec, for example, were down. So it is way too soon to predict any impact on GDP one way or another.

If you look at quarterly Income and Outlays, it is pretty consistent with the advance GDP release. We just seem to be in a cycle in which rapid fuel cost increases and other basic needs type costs are throwing a spanner in consumer spending. It is probably exaggerating the effects of mfg and housing weakness.

One thing about these March figures - they got a bit of a boost spendingwise from a relatively early Easter, so if anything April's figures may look a little worse.

The markets are taking these figures as an indication that inflation will begin to come out of the system as constrained sales constrain price increases. I am not so sure. I think inflation in Asia and a weak dollar may be inducing some additional cost increases for imports that will combine with high fuel prices to give us slowing consumer spending, place downward pressure on employment, but not control inflation enough to allow a rate cut.

According to the Beige Book for KC "The share of manufacturers reporting rising materials costs continued to grow, and most firms expected further increases, particularly for steel, oil-based products, and food inputs. However, the share of factories raising finished goods prices fell slightly, as some firms were unable to pass-through recent cost increases."

In other words, a constraint on profits, which would imply a constraint on business spending and wages.
Small but indicative data point for food: we like to buy handheld pre-cooked pies at Walmart. The pecan is very nice.

Until recently, 50 cents/ea. Now, 58 cents/ea. A 16% inflation in one step, at Walmart! Who knows what the annualized inflation will end up looking like..
Yup. I've just been wandering around looking at food stores in GA. Same deal. More than 10% price increases on a lot of items in three months.

Oil is still stuck up around $68, and if this continues Congress had better start thinking about expanding WIC and food stamps. This is going to hurt a lot of people very, very badly.
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