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Friday, November 30, 2007

Economic Data

Personal Income for October was released. The chatter is about a -0.1 fall in personal income, but what matters to the economy at large is the drop in proprietors' incomes:
Proprietors' income decreased $1.7 billion in October, compared with a decrease of $6.9 billion in September. Farm proprietors' income increased $1.6 billion, compared with an increase of $1.8 billion. Nonfarm proprietors' income decreased $3.3 billion, compared with a decrease of $8.7 billion.
You can't take too many months of that without strong pullbacks in business spending. Wages weren't so hot either:
Private wage and salary disbursements increased $1.5 billion in October, compared with an increase of $35.3 billion in September. Goods-producing industries' payrolls decreased $2.7 billion, in contrast to an increase of $3.0 billion; manufacturing payrolls decreased $1.2 billion, in contrast to an increase of $0.4 billion. Services-producing industries' payrolls increased $4.2 billion, compared with an increase of $32.3 billion.
What we mean by the credit crisis from the Fed's Commercial Paper release:

The injection of all that money recently didn't settle anyone's stomachs. This is a major wrong-way sign on the financial highway. It is keeping AA financial rates from going stratospheric:

The split between high-rated and low-rated debt is becoming less responsive to easy money. Sad thing is, a whole lot more companies are going to end up in the low-rated bucket soon.

Bizarre proposals to fix things are rocketing around:
Last week, John M. Reich, director of the Office of Thrift Supervision, the federal regulator of the nation's savings and loans, came up with a more modest proposal in which borrowers would get a three-year extension of low initial "teaser" mortgage rates. That plan would be funded from surpluses in mortgage-backed securities.
See Calculated Risk. See Tanta's Ubernerd series. Those "surpluses" are what protect the top tranche holders, and as prepayment rates crash, so do the surpluses. If you wanna devalue all the debt at the same time.... This is the strangest thing I have ever read, even including the descriptions of what constituted "A" debt for New Century, which were strange beyond the comprehension of mere mortal M_O_M.

Philly Fed November (pdf). Look at the drop off on the six month expectations index on the graph:
The future general activity index decreased from 41.5 in October to 11.6 this month, its lowest reading this year (see Chart). The indexes of future new orders and shipments followed suit: The two indexes declined 23 points and 20 points, respectively.
!!

Industrial Production
was recently released, showing weakness in October as in -0.5. These numbers are supposed to be seasonally adjusted. There were no positive major market groups, which accentuated the negativity. I almost emailed the Fed to tell them they forgot the seasonal adjustment, but then I took another look at rail figures and figured it was in there. Fourth quarter GDP isn't looking too hot, as in 1% or so even with a hefty helping of deflating imports/inflating exports to make the net export number look better.

Third quarter GDP was hot, but when you look at the details they are disappointing. Private domestic investment would have been negative except for an inventory build, which of course will come off future quarters of GDP. (When you stockpile it it is counted as a positive, when you sell it it is counted as a negative. In terms of actual growth, it's the other way around. In theory your manufacturers could be sitting on a boatload of inventory they couldn't sell and facing bankruptcy while GDP could be reported as a riproaring 10%.)

Corporate profits are slumping. Look at Table 11. The most meaningful number in that table is net cash flow, and here are the last five quarters:
1,343.6
1,272.2
1,291.7
1,343.6
1,286.5
So YoY a decisive negative (-4.2%), and here is the trajectory of quarter by quarter changes:
–5.3
+1.5
+4.0
–4.3
Second quarter looked a whole lot better, didn't it?

Where does the economy get impetus if not from profits or private domestic investment? Ah, exports, and the preliminary release showed better real net export figures. However when you look at current dollar net exports for the last three quarters, the picture looks quite different.
-714.2
-714.2
-694.0
Through the magic of changing those numbers into real dollars, the change in net exports for the last two quarters of GDP was reported as:
38.2
40.5
Lemme put it this way - you can't spend about 20 billion of them thar "real" dollars, even to buy new imports. So we are moving in the right direction, but at a glacial pace that's disappointing. See Table 3 for these numbers.

For a final look at the situation, and a clue as to why private domestic investment was really negative, we go to Table 12 which breaks down corporate profits by financial and nonfinancial companies, and by domestic and rest of the world. We're going to use the figures without inventory valuation adjustments. Here are the last four quarterly changes for domestic industries:
–76.0
–12.7
+84.4
–38.7
Here are the same figures for corporate profits from the rest of the world:
28.0 20.1 16.7 21.9
Much better. We need the rest of the world to keep growing. Because so much of our manufacturing base has been eroded, we want them suckers to get fat like us, so we can ship them doritos in large ships. The problem is that we are not generating the profits to keep building and expanding within the domestic economy.

The relationship between private domestic fixed investment and economic growth is very strong. Private domestic investment drives the economy. Below is a graph generated from the BEA's tables (use the Java option). It should expand when you click on it.

When it dips, so doth GDP follow.


Comments:
MoM,

May I ask if there are discrete data reflecting US corporate investment in, and income from, foreign operations. Or are these reflected in the data you're referencing today?

I am inclined to watch our own metrics more closely than those of our trading partners but, as the global model has so much to do with a good understanding of our own prospects, I'm beginning to resist that habit.
 
MoM,

Thanks for posting this analysis. It looks like the August credit contraction has affected the small business sector of the economy.

The trends in the data ominous: that's because we haven't seen the full extent or effect of the credit contraction. Once, that train gets rolling, how do you stop it? Lower rates? I haven't heard a good case for why that should be the case. In 2003, sure, lower rates sparked the housing boom and saved the economy. This time?
 
Thanks for breaking down the numbers & providing commentary. You provide a valuable service to those of us without CFA's. Great stuff MoM!
 
Burnside - I just read a selection of the big multi-nationals' financials every six months or so to get a feel from it. GDP does break down domestic and rest of the world profits.

I am not sure that there are truly good measures of foreign investment from US or European companies. Even considering profits, currency fluctuations sometimes change the picture substantially.

The nature of modern businesses and capital markets is fluid.

One of the better methods might be to keep track of retail chains. Because of the slower growth in the US, they have tried to expand across other markets.
 
David - next week we get the NACM report, which I think will give us the best guess. It's the drying up or compensation in B2B credit that will be one of the main drivers.

Nonfinancial commercial paper has been rising for a few weeks, which is a good sign. On the other hand, rail figures showed a big increase in vehicle shipments, so that might be mainly dealer credit. I'm waiting for NACM.

Regardless, sustained proprietorship income decreases have to affect spending and employment.

Some degree of credit contraction is going on, and the only way to loosen it up for businesses is to lower rates. But it's going to take a while to provide stimulus, and it is not clear how consumer spending will ride this patch out. If you wanted to keep consumer spending up, the best approach would be to foreclose on a lot of these loans. There are tradeoffs here.
 
Anon - the entire focus of the economic blogging here is to teach people that they don't need a CFA or MBA to form their own economic opinions. Simply using what they know and observe plus reading a few reports will give them better results than a lot of major pay-for-play economists are producing.

Don't get me wrong. There are truly brilliant people in the financial business. Some of them have fascinatingly broad outlooks and a real feel for markets and the flow of money. The very best of them are able to assimilate an astonishing amount of data, have a feel for history and the boundaries of possibility, and think in truly original paths.

There are also a lot of individuals who run numbers and use formulas but don't seem to understand the reality underpinning those numbers. What dingbat, for example, decided that huge pools of loans granted to people without verifying reasonable DTIs (for which you must verify income) would perform over time?

We don't need more CFAs if we are teaching CFAs not to pay attention to economic fundamentals. A CFA can give you a lot of background, but it will never compensate for mentally segregating yourself from reality. Would it have killed Moody, Fitch & S&P to figure out how much income it really takes just to pay for food, fuel, transportation and utilities, and rate pools using real DTIs adjusted for real consumer inflation? I don't think so. They'd have done a lot better by polling a group of supermarket managers around the country every six months, and checking underwriting standards and appraisal controls at originators.
 
MOM, what thinketh you about the proposed subprime "freeze"?

The proposed triage would exclude help for those who are able to make increased payments on their own, while freezing payments for those who cannot (according to whatever criteria) meet the stepped-up payments but could still survive at some lower rate. This would seem to have a definite element of moral hazard.

Also, I'm not clear on whether debt incurred for home-equity cash withdrawal is treated the same as debt incurred for home purchase--maybe it shouldn't be.
 
I'm reading Murry Rothbard's America's Great Depression. He's of the Austrian School and feels that the cause and severity of that depression was the result of too much liquidity and not allowing the free market to work through the excesses. One of the things he mentions was the attempt to hold wages up at the current rate, instead of letting them drop. He also feels that there was an attempt to prevent banks from failing that really needed to go under. It's interesting reading, and I'm wondering if there is something online where they are tracking the amount of liquidity injected into the economy.
 
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