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Tuesday, June 15, 2010


I don't know whether anyone caught my comments about not predicting GDP, but income. And I don't know whether anyone caught my prediction that this recession would result somewhere in declines close to 8-9% - theoretically not quite a depression, which is usually considered double digit, but totally unlike other post-war recessions.

But that is pretty much what happened. Theoretically GDP is supposed to measure national income. It does so by assessing expenditures. In practice, that hasn't worked too well. GDI measures incomes, and the two are often different in practice. GDI is adjusted by national tax data, and is only accurate retrospectively. It's also very variable.

Jeffrey Nalewaik. who is an economist at the FRB, presented a paper at Brookings regarding the "other" measure of national income - GDI. The paper is short, but I think important.

In any case, maybe I'm bragging or maybe I'm just trying to point out that using GDP does not explain our current problems well, but here is the GDI progression in so far as it was then available:

This graph of GDI as measured by BEA (it shows the preliminary vs the revised) explains a lot more about the current state of our economy.

Regardless of your opinion on GDI/GDP, from a banking/business POV, it is incomes and not expenditures that matter over the longer term. If your borrower is borrowing to pay the interest on his loans, the Day Of Default Doom is just deferred a bit, and if you are rolling his loans and essentially advancing him income to pay the interest, you are just playing Russian Roulette with your portfolio, and you've loaded five of six chambers.

But for the national economy the same is true. Racking up debts at one point will allow you to raise your expenditures currently, but it only does so at the cost of future growth. Debt repayments effectively lower incomes, and thus future expenditures.

The paper argues for presenting an average of the two measures as our official economic measurement. That would be wise.

What I do is attempt to forecast changes in incomes more than a year into the future as a way of projecting future risk for the purpose of keeping banks running. It takes a while to build reserves and cut risk in anticipation of such events.

And maybe I'm bragging, which would be stupid, because all economic forecasting is an exercise in humility, but I think I'm trying to point out that my method has its strengths in forecasting events in the real world, and that there is an obvious reason why, and that therefore this is an important distinction.

The above graph appears on page 40 of the paper, and on page 39 appears a similar graph showing GDP over time. And if you compare the two, you'll see that whereas the GDI progression shows the 2006 downturn very clearly, the GDP graph does not. This is important because the 2006 downturn almost fostered the crash, as the gathering forces of speculation were fueled by the drop in other activity. Something similar appears to have happened in China last year, and is one of the reasons I am so worried about China.

The second factor is that we were not really into a growth cycle early this year. I think we have entered one now, but it will also be a squeaker - a growth cycle in income will be difficult to sustain and won't be rapid.

Here I would like to address a recent comment by Craig:
That is what puts the lie to the Keynesian notion that saving is bad for the "aggregate" economy. For most people, the simple decision to buy so much as a new refrigerator requires some saving. Saving does not harm the economy -- it can only help it.

The fact remains that what is good for the family unit is good for the national unit. They are the same thing.
This is not necessarily true; scale matters. It is borrowing relative to future income that matters. In other words, if borrowing to buy a refrigerator would impose a very small change in future income less debt repayment, go ahead and borrow.

But this does not obviate Craig's point - if a family with moderate income has no resources and has to borrow for every unexpected expenditure (car repairs, appliances, medical, etc), that family is racking up a debt burden which will suck up more than the family's expected income gains over a few years to come. That is the point at which a financially responsible unit will sit down and try to figure some way to build current savings plus maintain debt payments (such a family really cannot afford to default, because the family may face a catastrophic loss in income without the ability to borrow for, say, transportation to a job).

So the issue is whether we have borrowed nationally to the point at which we have compromised future income gains. My answer is that we have reached the point at which we have to sit down and reevaluate our net spending, because we are almost at the danger point. Shifting debt onto the government is only productive insofar as the government can consistently maintain lower debt payments than private borrowing would supply. The debt has not gone away - instead it has been mostly written off on private balance sheets only to appear magically on the government balance sheet.

Another comment I have is about predicting GDI. One of the things I watch very carefully are production/sales margins. If margins drop below expected inflation for an extended period of time, it is sure that incomes will follow, because expenditures will drop as companies try to maintain net incomes, which implies job losses. So the drop in some of the commodity pricing was an important factor in my forecast change from a second half drop to a sustained growth cycle through the end of the year.

It follows logically that raising taxes on necessary expenditures (such as energy) will cut profit margins at businesses. We don't have the ability to sustain much in the way of narrowed business profit margins at this time, nor is it at all likely that incomes will grow to the point at which we will be able to sustain it next year. So we are in a very tight cycle. Because DC concentrates on GDP, I do not think policy makers realize our very slim margins.

I strongly suspect that we will raise taxes next year to the point at which we will precipitate another downturn, at which we will achieve a true depression cycle by 2013. We'll get to double digit income declines.

I'm not opposed to raising taxes on imported energy as long as reductions in other taxes are adopted.
Say a rise in gasoline taxes, but a reduction in payroll
taxes paid by the employer and employee. This would enforce efficiency and lower the cost of employment to the employer. Our tax code is way out of whack and
stands in the way of recovery.
Excellent post.

In a way, our situation reminds me of when I turned bearish in 2004.

We have attained an illusion of stability. It cannot be maintained indefinitely though.

In my opinion, you are not bragging. You are evaluating.

Scientific Method

1. Observation
2. Hypothesis
3. Prediction
4. Experiment
5. Evaluation
Mark - yes. I am trying to develop several economic tools that should have better long-term viability. I hate to put it like this, but today's economic situation is a great lab.

Usually such things are developed retrospectively, but IMO they should be developed and proved on the basis of prediction to prove viability.

Some of this has already shown a lot of validity for more localized settings, and so far it is promising.

If we can shake the stardust out of our eyes, the result of our current predicament could be better econometrics. We NEED better econometrics.
A LONG tiem ago I did a post about how the conusmer was "priced to perfection" in a throw back to the dot com days of explaining away CSCO at $500 or whatever it was. The way most operate is to fully account not only for today's income but future higher income to service debt. Of course I argued that only low unemployment (less than 6% at the time) and no serious shocks could allow such a high wire act. And now here we are.

Lost in the race to stabilize things via government spending no one has asked if the old model is really something worth getting back to. But then economics cannot answer questions about the "why" only the "how".
"So I guess that's why the call to the altar at the end of the speech, which is a little too weird for me to quote - the lack of detail in this speech implies that there is no plan, and I guess that's why we need to pray."

The whole environmental idea that we can get to an economy free of fossil fuels in ten years is a religious faith (there is no feasible way except by appealing to the God, TECHNOLOGY, and hope for the best) as pointed out some years ago by the late Michael Chricton. It is a faith fully embraced by Obama. Thus the call to prayer. That and the fact that he's ben schmoozing with some good old Southern Baptists down there on the Gulf Coast. He may have calculated the medicine might go down a bit easier with some old time religion thrown in.

He showed again tonight why he is not qualified to lead this country. He cannot point to any way he is coordinating to bypass the Jones Act and bureaucratic lethargy to speed up the containment and clean up of the spill. To use this crisis as a political ploy to pass Cap and Tax is despicable.
Jimmy - I don't even think that appealing to God is plausible.

Over 50% of petroleum is used in production and transport other than personal transport.

So this was almost at right angles to the Gulf situation. The question of whether this type of well can be made safe ENOUGH is a legitimate question, but the alternative has to be other types of production surely.

We can conserve and limit, but not avoid. And the more we go to the flakier stuff, the less we do of the reliable stuff, which still remains hydro and nuclear.
MoM take credit for what you do.You may actually think of yourself as an ordinary housewife but no one reading your analysis and opinions does.I particularly value your sensibility.I find information here that is clearly presented and available nowhere else.Thank you.

I think liquid fuels are probably the future in transportation, and possibly in residential structures. We can do a certain amount of work on cramming more watts down the same copper, and get a little more out of the grid; but it would be prohibitive to deliver enough electricity from any source as electrons to make a significant dent in transportation.

If you add up the energy content in the petrol-based fuels we use daily, and think about the capital required to build new transmission capacity to satisfy any portion of that demand, you come up with some staggering numbers. Then you have to account for the fact that the grid is owned and operated by government-mandated bureaucracies that, by law, aren't allowed to charge extra for any risks they take with their capital....

It becomes clear that even if we come up with really good alternative energy sources, we're probably going to store and transmit much of the output in the form of hydrocarbons.
M-o-M, I'm late getting back to your post. Siblings from the prosperous South have been home in Western New York visiting their increasingly taxed elder brother. Now, I didn't intend to criticize borrowing in my comment; I only wanted to point out that saving is not (in normal times) a subtraction from consumption.

Absent the Fed's money-creation activities, savings become the reserves that banks can lend out. If I defer immediate consumption, my savings will become part of the funds that other consumers will use to buy cars or that businesses will spend on capital expansion.

Of course, now we are in a situation where business is sitting on its capital expansion plans (as you have since pointed out) because of regime uncertainty. Perhaps my meager savings are just sitting in a bank vault somewhere.

Nonetheless, the economy cannot be more than temporarily goosed through efforts to increase aggregate demand. After all, if we don't want to spend -- we won't. And the government simply cannot make up for it.

In the end, it's only through increased production that consumer demand can rise. Ya' gotta grow the corn, before you can buy junior's school clothes. And you may have to invest in that robotic milking parlor if you ever expect to milk enough cows to pay for his college education. It's only through capital growth (saving!) that our standard of living can rise and that business can expand to accommodate a growing population.

I fear that, until Obama is out of office, we are in for years of economic stagnation. Business will continue to increase production incrementally to meet slow and intermittent rises in demand -- but it will most certainly not risk its capital only to see it expropriated if the One becomes displeased (see Oil Spill: BP).
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