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Tuesday, June 30, 2009

Setting Aside The Insanity And Returning To The Economy

It's June. By now, I believe one thing is clear - that there is not enough global economic momentum to emerge into strong growth any time soon.

Here's why in the US, consumer confidence fell heftily in June:
The Index now stands at 49.3 (1985=100), down from 54.8 in May. The Present Situation Index decreased to 24.8 from 29.7. The Expectations Index declined to 65.5 from 71.5 in May.
This really should not be that much of a surprise, because what confidence there was among consumers in these surveys was concentrated on the future. As talk of green shoots fizzles, that fades out, and actual conditions begin to weigh on people's minds.

Anyone who has bought gas recently probably can understand why. Current incomes are falling and prices are beginning to rise as unemployment continues to rise. The number of people who know people who are intractably unemployed must be increasing rapidly, and state and local government employees are also now feeling less secure. Thus we have a very broad-based and widely diffused set of economic difficulties. Both mean and median durations of unemployment have reached remarkable levels. Here is median:

There is really no question that demographics have a lot to do with this, but because demograpics do, don't expect to see incomes rise sharply as minor growth cycles begin to spurt off the bottom of this recession. Note that the employment/population ratio was falling before the recession started:

It's not coming back. It peaked in the 90s. It will bounce around a little bit, but employment is tight and retirements will mount. Further, a lot more people are working part time and will continue to do so. Once they can get on Medicare/Social Security, able-bodied seniors will try to work part-time to maximize their early retirement incomes. Further, a lot of government employees will retire at their first possible moment, because many of them realize that retirement benefits are going to be adjusted down, and that is least likely to happen to those who are already receiving benefits.

Chicago PMI:
This survey confirms the general manufacturing trend - a slow further decline. It is clear that we are getting to the end of the decline, but by the time we do, we will be at such a low level that it appears the economy will be tremendously weak and will have little further forward impetus. In addition, rising fuel and commodity prices are beginning to send some prices up again. A manufacturing rebound is not going to lead the US out of this recession this year.

So, is there any other constituency of the economy that could lead us out? Small businesses. There it is hard to get a feel for things. Some small businesses were staggering along, and have now given up. Some are clearly doing better as competition decreases. But when I look at the details of small business survey's such as Tatum's, I see that the underlying trend in May was still declining expenditures and contracting order backlogs, and most of the improvement in these indexes was due to future expectations. I expect some of these to take another step down in the next two months.

Go to page four of the full Tatum survey, and look at the progression there. The June index was so close to that of last year's that it doesn't offer much hope unless consumers start to spend heavily again. Note also when the collapse in the small business index began - way before the financial crisis of last fall. This recession wasn't spawned by Lehman's demise, and it wasn't spawned by credit difficulties. Both of those factors have deepened the impact considerably, but the real cause of this thing was structural, and unfortunately the structural factors have not yet been worked off.

You might also find this discussion of the NFIB small business survey interesting. Until small business profits improve, we are not going to see the hiring and spending. Note that tighter credit is becoming more of a problem for small businesses now. Again, the steep fall in this index began at the end of 2007. Go to page 8 and notice that profits seem to have stabilized at a very low level. Then go to page 9 and look at the graph for profit expectations/versus current profits. Note that small business profit expectations usually rise well ahead of actual improvement. In small banking, this is a well-known factor! In 92, for example, profit expectations shot way up but actual profits really didn't improve for 9 months more.

One of the reason for the profit expectations report lag is that small businesses often respond to an increase in sales and revenue by buying stuff, which reduces profits. The alternative is to pay more taxes to larcenous federal and state entities, which makes them feel sick. There is no one who is an easier sale than a small business proprietor or principal who's just gotten the bad news from his accountant. Because many small business owners are on the calendar tax year, one might expect that we would see a big uptick in sales to such persons at the end of the year - anything and everything that they could take off their business taxes.

However in this recession I don't expect that to happen in the normal way. There are two reasons. The first is that a number of small business owners are older, and are worried about staggering through to their retirement. They are conserving cash. The second is that I believe that commercial credit conditions are getting significantly worse and that small business owners will have trouble borrowing to buy. Whatever money they can get will be put into inventory rather than capital goods. This will suppress general economic conditions for the rest of this year. Moreover, small businesses will not improve inventory until sales move up significantly, and sales were still at their recession low in May.

Consumer-oriented small businesses seem to be folding up shop at a high rate, or staggering along waiting for the rains to come and water the fields of consumer commerce. I suspect they will not see another really good crop out of those fields for some years to come.

Consumer incomes are falling which leads to this problem:

If interest rates increase, as they should in a recovery, there is the problem that the DSR ratio may grow worse instead of better, because household credit market debt is at remarkably high levels:

In a few years, refinancing your home to cover auto or CC debt is going to be a losing proposition, and those
HELOC lines are going to turn into a big, big ouchie. What's so remarkable about this is the age of the US population. See 2008 ACS data on US population age.

About 82 million are 19 and under, and should not have much in the way of debt. Approximately 70 million are 55 and older. That, in total, is half the US population. Traditionally, the 55 and older group would be expected to have very little consumer debt and to be in the last stages of paying down their mortgages. The goal for the prior group of retirees was to clear their mortgages before 60 and to build up their nest eggs. At this point, they expected to pay for new cars with cash plus trade-in value, etc.

Obviously, the traditional metrics don't hold. The remarkable rise in household debt also occurred among a group of people who are now poorly prepared for retirement. To get further insight into the matter, we turn to the 2007 Federal Survey of Consumer Finances. I will go further into that in the next post.

It's worth noting that our demographics have a lot to do with expected future consumer spending and also with expected medical spending. An aging population is going to spend more on medical care regardless of any other trends, and pretending that it won't is stupid.

2008 Age Brackets:

Under 5 years


5 to 9 years


10 to 14 years


15 to 19 years


20 to 24 years


25 to 34 years


35 to 44 years


45 to 54 years


55 to 59 years


60 to 64 years


65 to 74 years


75 to 84 years


85 years and over


Update: See Rebecca's post on world demographics. I'm not going to get to ROW for a bit yet with this series, but yes, there is a global problem.

An aging population is going to spend more on medical care regardless of any other trends, and pretending that it won't is stupid.

That depends. Are they spending their own money or are they spending MY money?
Charles, it is life. People are going to spend for necessary medical care just as they spend to eat. When you're young you can avoid doctors. When you are older, you can't.

Of course, you are correct that people will spend more if they are not paying for it.
Thank you for the funniest headline of the week.Not quite up to "Democracy restored in Haiti",but close.OT,but interesting to me,I have had several discussions and arguments about the meaning of the word "equity" in regard to housing.To me "Equity is the estimate of an unrealized gain on an asset such as a home" It can be used as collateral for debt but is never Profit.I am amazed at the number of Real Estate professionals and highly educated people who do not understand the very basic fact that an unrealized gain is in fact unreal.It is inherently fictive.Lack of education or cognitive dissonance? And MoM,older people can avoid doctors,they simply suffer more,die earlier and cause increased expenses when what were easily and cheaply treatable problems become acute.
Tom - ah, yes, the equity-is-money-meme. I thought that had been debunked? Because if everyone has to sell to use their equity as money, equity evaporates. Your equity is only really money if the supply/demand ratio is in your favor when you need to sell.

As for older people and doctors, they can't avoid them. It's sort of like that old ad for car mechanics that said "You can pay me now, or pay me later."

Since the US provides insurance in the form of Medicare to the vast majority of seniors (and generally through Medicaid to the rest), we can't fool ourselves that lack of medical care in the 50s is going to save us money.

That's the problem with the whole debate. First, every time some state tries to effectively provide coverage through subsidized care to all its citizens, they make the same mistake. They set reimbursements too low, so then you are spending a bunch of money for expensive care instead of spending far less money on good primary care.

Second, we fool ourselves with the idea that giving people some sort of coverage equates to giving them health care, which it doesn't.

As far as I'm concerned, public health insurance shouldn't cover stuff like MOST organ transplants and some of the extremer cancer treatments. Instead, the money should be diverted to primary care.

The stupidity of not having people in their 50s getting the basic health care is remarkable.
"So, is there any other constituency of the economy that could lead us out?"

There's another segment that could also start the positive momentum - renewable energy. Especially in the US, governmental mandates are going to pump in over a hundred billion into this segment. This massive investment is going to result in over 5 million new jobs - in solar, wind, hydro, biofuels, smart grid, retrofitting homes, and the like. While renewable energy from the private sector has been battered in this economic crisis as well, governmental funding will compensate for that.

Now, I am not saying this will get us out of the recession (though the potential exists), but there is a good chance investments in renewables could lead the way to an economic recovery

Narsi from Alternative Energy Profits
Ecacofonix, have you seen the study of renewable energy in Spain? They spend over $750,000 for each"green" job created. Compare to typical capital investment, which requires less than $350,000 per job created.

As a jobs creation measure, it's only 45% as effective as spending on other capital investment. It's rather like spending on caviar when what you can afford is pork & beans.
Ecacofonix - riiiiight. Sure. Invested with Madoff, did you?

I think some geothermal (highly limited applications) and more thermal solar give pay backs.

Wind is only useful up to a certain percent, and it's a low percentage.

The problem with a lot of these projects is that they produce energy at far too expensive rates not to produce an economic collapse. Economically speaking, what you are suggesting is equivalent to trying to make up your losses on each sale by increasing your sales volume.

There's a reason why corn ethanol and wind power have to be subsidized by the government.

There are smaller applications for energy conservation that will pay, such as lighting changes, insulation etc. But renewable energy is mostly a bust except for hydropower.
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