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Thursday, June 25, 2009

The Titanic Sails

Weekly claims came out higher - 627,000 SA this week, and last week's was revised to 612,000. That boosted the 4 week running average.

However, this is not significant, just as the earlier drops weren't significant. One factor about the June claims reports are the seasonal adjustments, and this year the seasonal adjustments were likely to be distorted lower earlier and higher later. The reason is that there is a big pulse of claims from closing school systems, and last winter was quite a brutal one in many areas. The probability is that calendars were adjusted later to account for snow and adverse weather days. Not that claims in the 600,000 range are ever a sign of green shoots!

Q1 final GDP was released today and it came out as -5.5%. Not that this is really final - GDP gets revised for quite some time. For the US, two consecutive quarters of annualized drops in excess of 5% are really shocking. Notable factors in Q1 were the drops in real government spending (-4.5% federal and -2.2% state), drops in real gross domestic purchases (-7.5% compared to -5.9% in the fourth quarter), and real gross GNP of -5.6% in Q1 and Q4. GNP includes net receipts from outside the US, whereas GDP does not. However GNP has a lot to do with whether corporations can spend more and corporate income tax receipts. So this is not a favorable factor and it highlights concerns over the future.

I would like to call your attention to Table 8 in the link above. This shows the rolling 4 quarter percent change (change over the past year) for the various categories. The rolling four-quarter change for GDP is now -2.5%. Far more frightening is the same figure for gross private domestic investment, which in Q1 was -23.6%, and has now been falling since fourth quarter 2006! Gross private domestic investment is the fundamental driver of this economy and just about every other economy, and at no time can one ever rack up a such a string of GPDI decreases in an economy without generating a pretty intense recession.

That is the first thing on which every realistic economist must stay concentrated. Talk about a credit crisis does not address the fundamental economic operator, and dumping a lot of stimulus money into the economy will not overcome a recession produced by collapsing GPDI unless it boosts domestic investment - which our stimulus package does not.

Since we aren't bothering to boost domestic investment much, improvement will wait upon a stabilization and then increase of corporate profits. And not only that - the stabilization and increase of corporate profits must come from non-financial companies, because financial companies have a huge line of waiting losses queued for the next couple of years.

If you refer to Table 12, you'll see that domestic industries racked up a 76.2 billion dollar fall in profits in 07, and a 328.8 fall in profits in 08. However, in Q1 profits from domestic industries increased by 120.3 billion. That would bring a large smile to our faces, except that in fact 118.8 billion of that came from financials, and only 1.6 billion originated in other industries.

The problem with the financial profits is that at least half of them are fake, having been generated by highly creative accounting and overly low loss reserves, and about a quarter of the rest were generated by the very low interest rates and rolling of loans. Thus, do not expect financial profits to carry the economy forward in the coming year. The financials are still a black hole sucking up US income. In fact, this is the US money hole discussed by an eminent panel of scholars rounded up by the Onion (video).

The stabilization of non-financial profits in Q1 is favorable. Much of it was generated by the pronounced drop in producer prices. Indeed, the net of all other industries except for utilities was negative - utilities racked up a 12.7 billion increase on mostly lower input costs. Thus we have a picture of a first quarter economy which was struggling to readapt and reach a point of stability. Profit declines in wholesale trade were -44.4 billion, for example. Profit in retail increased by 13.3 billion. Manufacturing came in about at 0 for durables, but turned in non-durable declines of 16.2 billion, which were all attributable to the declines of oil and coal. ROW turned in a decline of 16.6 billion.

In 2006 the ratio of financial/non-financial profits was 49%. In 2007, it was 49%. In 2008, 38%. In Q1 09, just under 34%. Since the maximum sustainable US ratio of financial/nonfinancial profits is probably in the 25-30% range going forward, we have further to travel. If we do not plan on being very poor, obviously we need to expand non-financial profits.

And that raises a dire question about the Waxman energy plan and the Obama administration's energy policy. If we raise energy costs, we must further constrain non-financial profits in an environment in which individual incomes are dropping.

Thus, the major questions facing the US economy are based on government policy initiatives, which is rarely a positive factor in forecasting. Barring massive investment in nuclear energy and further hydropower projects (the scope for which is limited in the US), there is no way to obtain "green" energy that is not considerably more expensive than current energy sources. This will cut US disposable personal and business incomes significantly, and strike another blow at domestic manufacturing. There is no way around it. All countries which have heavily invested in "green" power have cut jobs, raised consumer energy costs, and impaired their own economies. We will not be any different.

Further, any long-term shift to electric vehicles would certainly rely on steady, reliable and cheap generation of electricity. I experienced the oddest sensation of sheer incredulity when watching the Obama press conference this week. Economically, the Obama administration's plan amounts to finding an iceberg and running the ship of state into it, apparently on the theory that we are unsinkable.

Consider this: any realistic plan to substantially expand US medical insurance coverage will involve very substantial tax hikes on US workers. Private insurance isn't even the main factor - to expand Medicare to all Americans would involve an additional wage tax of about 14.5%, and that would have to rise as the population aged.

To combine substantial tax hikes on workers with an energy policy which will substantially increase energy costs to workers, raise the price of goods, and diminish US profits is to theorize that we are going to cut real US consumer disposable incomes on the order of 20%. Needless to say, the havoc produced in retail and housing and consumer debt would be immense. US citizens may believe that things can't get worse, but things can!

One bright note: China would be even worse hit than the US. Not only would their dollar holdings devalue, but US living standards will plummet, which means that China's exports to the US would continue to plummet.

Comments:
MOM,

You are on a roll today!

"The problem with the financial profits is that at least half of them are fake..."

It's an illusion of prosperity. ;)

"Further, any long-term shift to electric vehicles would certainly rely on steady, reliable and cheap generation of electricity."

I've often thought that cheap electricity would power the first few thousand cars but expensive electricity would power the last million cars. The latter would "tax" our current electrical infrastructure to the point it would require major improvements. For example, my house isn't all that old but I blow a fuse every now and then. I already use more electricity in some rooms than the builders imagined (big screen TV, portable air conditioner, portable electric heaters, ...). I'm fairly sure plugging in my car would trump them all. If everyone did, the power company would be blowing fuses more than likely.

"Consider this: any realistic plan to substantially expand US medical insurance coverage will involve very substantial tax hikes on US workers."

I retired in 1999. If there is one thing that I can count on it is the government offering me aid. I don't ask for it and I don't require it. The capital gains tax cuts allowed me to exit the stock market fairly painlessly before it crashed. The stimulus check that was sent to me was deposited and saved. I pay for my own healthcare right now. The government clearly wants "workers" to help pay it for me. I don't see how any of this is fair. I keep getting rewarded (much more than most) even though I no longer do anything productive (other than use a blog to heckle our "Titanic" that is).

"One bright note: China would be even worse hit than the US."

Yeah. It's like there is a certain amount of financial despair that must be distributed. If China could decouple from us then we alone would bear the full burden (probably through hyperinflation). That said, I was not a believer in the China decoupling story before and I'm not now.

China appears to be where we were during our Great Depression, right down to hosting the Olympics (we were the rising manufacturing juggernaut back then and hosted both the summer and winter games, go figure). We could not decouple either.
 
MOM - A data point for you.

I had a meeting with a prospective client yesterday. This company is a medical equipment manufacturer, although they might expand into consumer goods. They are gearing up to do some fairly sophisticated simulations and testing for their new product development.

The client informed me that the company's executives considered hiring permanent staff to accomplish these tasks, but decided to bring on temporary staff, due to fear of the new fiscal and regulatory environment in Washington. The development will not be cheaper for them (the work requires highly-skilled personnel), but they are not committed to anything beyond the product they are currently developing.

This fills a need for me, but it's probably a loss for the local economy.

Additionally, I've lost two prospective clients this year after doing feasibility studies, which had never happened to me before. Basically, I wrote white papers (for which I got paid), sold the engineering personnel on the ideas, and lost the work when the finance departments axed the projects. Previously, I had never lost a client once I got to the white-paper stage.
 
Neil - the uncertainty is a major economic anchor.

I am not sure that economies need hope so much as businesses need forecastable business conditions.
 
Mark - your comments on fairness do highlight a real problem.

From decent motives, the US has excluded a lot of income from taxation. Surely our first fiscal priority should be to sit down and reassess that. There is no financial legerdemain that will not require spending more on care for an aging population. But rather than taxing corporations, we should be looking at spreading the individual income tax burden more broadly.

It is, however, quite frightening to think of Congress Critters with a federal property or sales tax clutched in their joyous, grubby fingers. Cry havoc, and loose the dogs of poverty....

Therefore I would advocate doing away with many of the current tax exclusions (munis, retirement funds) and swapping that for generally lower taxes on dividend income, etc. I'd also be a strong proponent of not taxing the first say 5K of retirement fund income.

All our policies should be focused on allowing people to build capital and allowing businesses to thrive. All of them. That is the only thing which will generate the growth we urgently need. Only a flatter tax system will do that.
 
"All our policies should be focused on allowing people to build capital and allowing businesses to thrive."

I think you will see pigs fly, before you see this happen in the current administration ;)
 
MOM - About electric vehicles...

I have worked most of my adult career on the technologies involved in electric- and hybrid-electric vehicles, so this is not easy for me to admit. But nobody can get around the physics and economics of the problem.

All-electric vehicles are not going to work out on a large scale. Mark hit the nail on the head. Batteries are just not good enough, and neither is the generation/transmission system (the grid). If government forces us to use them, then we will find a way, but it will be terribly expensive and not nearly as useful as what we've already got.

Hybrids are more promising, but only in the larger vehicle sizes; let's say from full-size pickups on up to tractor-trailers. Probably also in racing vehicles and high-end performance cars. Electric transmissions are relatively expensive, but they are really the bee's knees for performance.

But barring a revolution in solid-state batteries, storage, generation and transmission are too tough a problem. Liquid fuels (whether fossil- or bio-origin) are the only way to go for energy storage.
 
Lot's of good stuff as always. The investment numbers are especially worrisome. I wish the net investment figure in the GDP were broken out so that business-to-business spending could take its rightful place alongside consumer spending.

I'm sick to death of the media hanging out at malls and gas stations to gauge the state of the economy.

Finally "running the ship of state into it, apparently on the theory that we are unsinkable"

Doesn't it seem that he thinks it is. I have to credit a lifetime of being surrounded by vulgar Marxists for that. Business, in their eyes, is a bottomless pit of plenty that exists only to controlled and milked. I think they're in for the surprise of their lives.
 
"Economically, the Obama administration's plan amounts to finding an iceberg and running the ship of state into it, apparently on the theory that we are unsinkable."

Nice.
 
Regarding profits:

I work in a semi hi-tech area in the engineering and production side of things. What I see occurring is a slow decline in the profit margins in all producers. The component manufacturers are cutting prices where they can to retain market share, surely we are seeing our component cost decline more than can be accounted for by the gradual pay off of NRE associated with components. That means most suppliers are making less profit. At out level (turning components into finished products) we are seeing less profit due to our customers requiring us to met rather aggressive cost reductions, as well as smaller than expected sales, which results in much lower margins and profits. Our customers, (Cable MSO's) are seeing declining profits due to a price war between Comcast and Verizon, which is resulting in a gradual decline in the operating margins of both.

Key to this decline is the appearance of a fat or declining market, which does not allow for any pricing power on the part of any firm in the chain of product. I do not see that changing until there is a pick up in the consumer purchases, which seem to be at least one to two years out at best.
 
MOM,

"I'd also be a strong proponent of not taxing the first say 5K of retirement fund income."

It would certainly seem fair. It would be interesting to see what would happen to the Roth in that world though. For many, they've already been burned once by pre-paying taxes on gains that vanished (TWO stock market crashes). I never converted my IRA. I expect to pay less taxes by the time I start drawing from it if only because I expect to be poorer (as I spend my nest egg to pay my ongoing expenses).

Neil,

"All-electric vehicles are not going to work out on a large scale."

People sure do like extrapolating what works on a small scale though. Don't they? Take China. Grew at 10%+ per year for many years without many problems. At some point they became "large scale" though and some began to wonder what might happen to the price of oil if a billion more people drove cars.

"Large scale" speculators then pushed the price of oil past $140. How anyone could think a billion Chinese could each afford $140 oil is another question entirely though. Heck, I doubt very much $70 is affordable.

"The client informed me that the company's executives considered hiring permanent staff to accomplish these tasks, but decided to bring on temporary staff, due to fear of the new fiscal and regulatory environment in Washington."

Apparently my girlfriend's former employer asked her former coworkers how best to fill my girlfriend's former position. They said with someone experienced who knows a lot about benefits. They chose instead to hire a temp who knows nothing about benefits. The job mostly consists of answering benefit questions to employees on the phone (which now amounts to the temp giving incorrect information and/or simply relaying the questions to her overworked coworkers). Needless to say, morale within the department continues to degrade.

As a side note, my girlfriend got a phone call out of the blue the other day by a coworker asking if she'd been given a warning before she was fired. She hadn't been given any warnings, only praise. Clearly morale is not good for her to be getting that call like that a full two months after she was let go. Black Sabbath said it best. Paranoia may destroy ya.
 
Mark - do you think the coworker is worried about being fired herself with no warning?

I have not been a big fan of IRAs and the like because I always assumed the government would be pulling the plug about when mine got large. The whole thing never seemed viable to me.
 
Craig - I was absolutely stunned by the press conference. It does seem as if he still thinks the situation will right itself.

Like you say, a bunch of people are in for a very big surprise.

Mr. Sensitive - this post got a bit long. I was going to include another report that is very rarely discussed on profit margins. Tomorrow. But I think you are right. I think the squeeze is still on.
 
Neil - I think smaller electric vehicles could work in some metro areas. The electricity supply would have to be there. For more rural populations, at the current time with the current technology I cannot see it working. Nor can one postulate $6 gas, because the economy will bust before it ever gets there.

This fad about trains is just a no-go. I like public transportation myself, but a passing familiarity with working patterns even in well-developed areas shows that public transportation has limited applicability. Buses are a lot more flexible, but if they are not filled they don't save any energy whatsoever.

Hybrids are workable, but the cost is still prohibitive for most. A small, cheap all-electric vehicle for urban use might work better. We have yet to even figure out how to charge the things in a truly urbanized setting, though.

A lot of the discussed goals are fantasy. The stuff that's not fantasy seems to be off the table. I don't know what to think, but reality has a way of knocking your head in when you try to ignore it, and I assume that reality is preparing to give the US one hell of a kick in the collective butt.

Personally, I thought and do think that as soon as the pain seeped through to the Ivy League/Non-profit level (impacting their incomes and jobs) economic fundamentals would abruptly assume more importance.

We will see what happens in Congress. Obama is an absolute clueless idiot. Hillary would have been way better. Any governor would have been better. McCain would have been better.

After I stopped mentally stammering over that press conference, my first thought was "Now his presidency really has failed."
 
MOM,

"Mark - do you think the coworker is worried about being fired herself with no warning?"

Yeah, that's why she called. No doubt about it. It wasn't like she was a close friend.

There's a lot of fear in that department right now, and justifiably so. My girlfriend was fired due to her boss's mistakes. Several days later he was asked to leave and his boss was apparently demoted (fewer responsibilities). A coworker finally told her this recently even though they were told to say nothing. Her coworker finally capitulated though. Figured they can't put a gag order on honesty.

Further, the department is under enormous pressure. It was taking on more responsibilities that were supposed to go "flawlessly or else". Meanwhile, they hire temps who can't do the work and overtime is not allowed. The new boss is resorting to the same tactics her last boss tried. He's apparently offering comp time under the table.

Just a few problems with that.

1. Comp time is illegal for hourly employees.
2. Comp time does not actually solve the problem of two few workers to do the work.
3. Most think my girlfriend was railroaded when the company couldn't prove she worked from home and fired her for it (she offered proof and they then fired her based on how she proved it). If she had actually been allowed to use comp time given to her under the table, she clearly would not have been able to prove anything though.

Her coworkers are scared and it goes way beyond the economic downturn.
 
Oops.

I said "two few workers" when I meant "too few". Oddly enough, both seem to apply. Two more workers who actually know benefits would probably do wonders. What they've got is a new boss who doesn't know benefits and a temp who doesn't either. Go figure.
 
MOM -

I'm highly skeptical of NEVs. Structurally, they are basically fancy golf carts. They might gain traction if they are given regulatory advantages over other automobiles (primarily if they are given a pass on safety standards). But for a given price (and barring a magic battery), they will simply not match the utility and safety of a normal sub-compact car. They also have the problem of any other electric vehicle--they require you to conform your schedule to their needs, rather than enabling you to have freedom in your schedule. All in all, it's better to take the bus.

I agree with you on trains, too. You would all laugh at me if you knew what a train geek I am (you should see my library of rare books and papers from the 1930s & 40s). I do think there's a major place for passenger trains in urban rapid transit (NOT streetcars), and in medium-distance interurban travel. But much of rail policy seems to be utterly disconnected from reality, just a "build it and they will come/won't need new roads" mentality. Bah.
 
What is needed on both a state and federal level are intelligent and sensible policies that are implemented effectively.Given the political realities,this is impossible.Don't worry, it only hurts while you breathe...
 
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