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Wednesday, November 18, 2009

Why I Say We've Already Crested

I think I owe you guys an explanation, and let me know if this does not serve. I am doing my best, and now trying pretty pictures.

The operative forces hauling the economy back down in the short term are energy prices plus lower incomes for a large portion of the population plus underlying cost increases for producers. Because the incomes are lower, producers cannot pass their costs fully onto consumers. Because consumers are still pressured and cannot seek more income from earnings in general, consumers can only increase their financial stability by spending less and paying off debt (if they have it), or just defaulting on it.

The reason that producer costs are rising is basically energy costs.

CPI-U October:

Note the difference between food at home and food away from home. There are increasing cost impulses in this economy, and the only way a majority of the consumers can cope is to cut their spending. Food away from home has a different group of consumers that are somewhat more comfortable, and thus can sustain more of the cost increases.







Today's housing starts report is just another symptom of growing economic problems which are slowly diffusing again through the economy and have prevented us from climbing up that necessary next step to achieve a self-fueling recovery.



One of the broadest measures of economic activity in the US is CFNAI, published by the Chicago Fed. The three-month moving average (CFNAI-MA3) is a broad measure of growth (or contraction) impulses moving through the economy.

Now here I made you some pretty pictures; this data is through September.


Click on this to get a larger image.

Zone A (-0.25 to -0.50) is an adjustment range. Growth can fiddle around here for some time and go either way.

However, if we drop into Zone B (-1.00 to -.75), things get very serious very quickly.

In general, when the economy has been humming along and growth falls into Zone A stimulus measures may be considered depending on other factors. But it is never a time to significantly raise taxes - doing so would often precipitate a correction.

This is exactly the same graph as above rotated to give you a different perspective. The first view conveys the shocking cliff-diving routine we've been through; this view shows you a bit more of what has been happening in the last five months.

By September CFNAI had been going down for three months and had fallen back into Zone B; the latest October releases strongly suggest that it will keep going down. The latest three months of CFNAI (July, August, September) are currently listed as -0.42, -0.65, -0.81. So it now appears that in October we are probably in Zone B; history suggests that over the next four months sorrowful things will happen as growth impulses fade and contraction takes hold once more.

And any talk about good retail sales is missing a very obvious point - the inflation adjustment. Sales tax receipts are a very important component of state revenues; real sales tax receipts have to rise at least at the rate that the population is rising over time, or per capita expenditure needs will not be met. Just from looking at today's CPI release one can tell that real retail sales are still oscillating around the low point (this graph of the real retail sales figures from St. Louis Fred contains data only through September, but October won't rise that much):


Now if you guys will stare thoughtfully at this thing for a bit, you will notice that real retail sales have returned to the 2002-2003 level after the last recession. The reason they have done this is that a bulk of consumers are largely coping with reduced per capita incomes (see this prior post about household incomes over the past decade), and are no longer able to fool themselves into borrowing to spend.

You will also notice that the 2001 recession really began in 2000, and did not really end until 2003. The growth reported was obtained through a monetary easing which created growth, but we really do not have the same options right now due to the prior explosion in debt.

There are two things that will work to provide economic growth. The first would be a government program that would help people write off debt. The Joy-Boots plan is as good as any other. However, it is clear that Congress isn't interested in that. The second is needed infrastructure spending. Just fix the roads and bridges, and you'll send a sharp boost through the economy and generate a ton of jobs.

But the bottom line is that monetary policy cannot accomplish much - we shot those bullets already. The target they could hit was was shot to pieces before the 2008 cliff exhibition. The economy is now being driven by changes in energy prices, not changes in credit. At this point, very low US rates have appear to already have produced a new slide into contraction; the dollar is being carry-traded and everyone's hedging with oil and other commodities. That is a monetary disaster which is going to hurt far more than the US economy. Yes, it's speculation. But internal US financial regulation cannot cure international speculation.

Over the long term, simply producing more energy internally will bolster our trade balance, support the dollar somewhat and ease pressures on other economies. But in order to produce energy internally, it must be cost-effective energy. Spending on conservation will achieve far more that spending on high-cost energy sources such as marginal wind (wind can work in some areas, for a few percentage points) and high-cost solar. Solar also is cost-effective in some applications.

But the US can never fuel a return to growth with current green energy. The reason our stimulus package is not working is that it was badly designed. We keep throwing more and more money into futile projects such as trying to prevent foreclosures for people who don't have jobs, funding home purchases for people at 50% DTIs, building energy production that no one can afford to consume, and giving income tax proceeds from the boom years back to companies (financials and home builders) that profited from the boom.

We can begin the process of stopping the pain whenever we want to get serious. We haven't gotten serious yet. Unfortunately, the next few months are going to prove my point.

We got about what we are going to get from the inventory restocking; that pulse will start to drain by January, and we'll be left with the same old, same old:


The worst of it is that September freight showed indications of trouble. BTS Transportation Index:

To the Anon commenter on the last post who asked about velocity.

Freight is one of the best non-monetary ways to assess velocity (the rate at which money is changing hands). That is one of the reasons I spend so much time on it.

We appear to have hit one trough in May, but we do not see the pattern of rising freight we should at this stage in emerging from a recession. We never achieved escape velocity and thus have not slipped the surly bonds of earthy economics!

October rail showed declining shipments for commodities along with rising intermodal; a classic pattern that bodes no good for 2010.


Comments:
MOM,

Cramer just said that the bear market is over! ;)

I think investors think there's a green light until oil hits $140+ again, not realizing that $80 oil was probably sufficient this time.

I'm deflationary. I'd also like to point out that some of that inflation in the CPI is due to the cash for clunkers program.

When it was in effect, cars were cheaper and the CPI reflected it (I read the BLS report on it). When the program ended, prices bounced back. I doubt very much it can continue though.
 
MoM,

Great post, but I have to disagree with the thought that the stimulus package didn’t work. I think it did exactly what it was supposed to do: save the biggest banks from their folly, buy some breathing room with the hope that the economy would improve on its own, and look as if the package would help the typical American. Frankly, I’d give it a B+ as working as intended (and an A+ for Goldman – near record bonuses for 2009). Now if we grade the package with the idea that the intent was to help the overall economy and the typical American, then it gets an F.

Here’s a simple and easy way to stimulate the economy: 2 year payroll tax holiday for any worker earning less than $50k combined with a graduated increase in the payroll tax pay cap over the current $105k. I’m too lazy to do the math to figure out an exact break even – but that would help most people a great deal. There are other variants – 18 months @ 50% reduction, etc. But something like this isn’t even mentioned.

A billion dollars worth of minimum wage jobs (plus room and board) repairing the National Parks would be money REALLY well spent – most of the parks haven’t had much work done in 40 years. Limit the jobs to individuals under 25. A latter day CCC. To put that into perspective, Goldman could fund that project ENTIRELY by reducing their bonus pool by 6%.

I’m sure that your readers could come up with 25 good ideas by 9am Friday; the question is will these ideas help the big financial institutions? Because helping them was the true intent of the last stimulus plan.

If the past is prologue, another plan will simply result in more sound and fury, signifying (and producing) nothing for most people


Ed S.
 
MoM

WoW--nice post! a step up in presentation that really helps those of us who are tabular analysis challenged. A couple of questions for you:

1. can you comment further about the "classic" pattern of freight vis a vis the commodity/intermodal differential? I'm not well versed in the historical patterns and suspect I'm not the only one;

and

2. I have spoken to a couple of intelligent, relatively well connected (MD level at large IB) chaps who are of the opinion that debt restructuring is actually happening faster now than in the past. These guys are going flat out and hiring people left and right because a lot of the debt they are working on isn't making it to bankruptcy (alternate funding sources like hedge funds and private equity are quickly doing debt for equity swaps/writedowns on both sides of the table). I'm not knowledgeable enough about the amount of bank debt vs alternate source debt to comment, but would be very interested in your thoughts.

Thanks again for all the hard work you put into walking us through the labyrinth of micro- and macroeconomics!

Jon
 
OK, I'll play- what does CFNAI stand for?

I guess it's darkest before it goes completely black.
 
CF - those little linkie things have information on them if you click them. Just like magic, you get to this other web page with all this info n stuff.

Chicago Fed National Activity Index.

No, they did not name it for you.
 
Ed - you may be right to some extent, but if you look at where the money went in the stimulus package, it mostly goes to weird dinguses and government jobs. The bailout for banks is occurring in all other ways.

50 billion more in infrastructure spending, credits directly to homeowners for energy-related improvements, hire people for $8 an hour to pick litter up at the side of the road. Whatever.

What's amazing is that the bill they did pass managed to get so little money into the economy. It's almost an art.
 
JRS - absolutely. Debt mods, restructures and workouts are moving right along, especially CC debt.

But what's not working well are the securitized debt, for legal purposes.

But the debt banks hold - heck yes. They are writing it down and off, and clearing what they can. 50% of CC debt with BK filings this high is pretty good.

Mortgages - high end - are just not being proceeded on. The holders won't foreclose and they won't DIL and they won't approve short sales in all but the worst areas. They are trying to wait it out.

But they will give you a 2% or 4% interest rate if you'll keep paying on that sucker.

It's holy hell year.

More about freight later, I guess.
 
> Solar also is cost-effective in some applications

A very, very limited range of applications.

Most people really, really don't grasp the numbers involved that are law-of-nature based numbers and can't be "tricked", fiddled, futzed-with, or engineered brilliantly past. The most obvious one is the solar constant, which is close enough to 1kw/sq-m for back-of-the-envelope calculations. I detail it out over on No Oil For Pacifists Here It's not as short as some people would like I suppose, but, while mildly technical, I think most people should be able to read it without suffering MEGO ("Mine Eyes Glazeth Over") -- In short, though, to replace the entire US power grid with solar would require the covering of an area the size of 4/5ths the State of Delaware with little-blue cells, along with the associated asphalt and concrete infrastructure to hold 'em. Yes. Delaware. A small state, I grant, but still A State.

What? You only want to get 25%? Ah, so, a fifth of the entire land surface area of Delaware, then...?

And that is based on fairly absolute numbers, not on variable ones like weather/climate, which will raise them even further -- if cloud cover reduces solar supply by 25%, then you'll need to increase coverage by that amount.

There is one possible solar technology that might just work -- and of course that's the one no one is really putting any money into -- Ocean Thermal -- which bypasses that huge-area collection problem by using the ocean surface as a collector. It has problems of its own but they don't require a massive breakthrough in technology to make it work, just some steady developments that might be worthwhile anyway.

==================

Wind has similar problems of its own, but they aren't as easy to quantify so that you really can't argue with them, like you can with solar.
 
> I guess it's darkest before it goes completely black.

The biggest problem is that the next light you'll see is probably a trainload of Obama® brand government freight coming to run you over.
 
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