Wednesday, January 30, 2013
The Great Santelli And The EuroTrap
And he was right, except that we are really worse off than Europe. The reason he is screaming hysterically about this is important, because it means we have no real exit from the trap. Here's how this works:
Have patience, and look at this overloaded graph. The bottom two lines, indexed on the left, represent personal taxes (yellow) and personal current transfer receipts (green). Personal current transfer receipts are welfare programs, including food stamps, TANF, SS, Medicare, WIC, Medicaid, etc.
The first problem is that since 2000, our personal taxes have been falling ever shorter of our social benefits to persons. This means that to balance the budget without hugely raising personal taxes, you would have to hugely raise corporate taxes. Given that the US now has close to the highest corporate tax rates in the developed world, this is unlikely. We could, of course, cut corporate taxes and cut our tax gimmes to big corporations, and we'd probably collect more that way. But if we cut corporate tax rates to do that, we wouldn't be able to pay for our social benefits from the proceeds. And if we cut the corporate tax gimmes to the biggies but don't cut our corporate tax rates, we will just slow growth even more. After all, we are competing with countries that mostly have corporate tax rates under 28%. Many, including such socialist havens as the northern Scandinavian countries, have corporate tax rates centering on 25%.
Here is where we're worse off than Europe. Most European countries have high rates of personal benefits, but they also have very high rates of personal taxation, and it is far more regressive than the US tax structure. Lower income people pay high rates of tax in Europe compared to the US through Value Added Tax, which greatly raises the price of goods they buy, and also suppresses consumption.
The second problem is that since 2000, the share of personal income derived from government social benefits has gone through the roof, with most of that occurring since 2009. The big thick purple line is personal current transfer receipts divided by personal income, and you can see what has happened. Nor is it correcting meaningfully. Even a much better economy won't significantly lower that line because of the boomer retirements, and Obamacare is set to hugely raise subsidies to individuals for health insurance and subsidies for Medicare, so next year that purple line jacks right up there again.
The red thicker line (ending third from the top) is private personal income - personal income ex-transfer benefits. Note that this has not recovered to 2008 levels. But you see that personal income (top blue line) and personal consumption (second from the top, black line) have shot right past that line, and that's because the government is paying for it. With deficit spending.
The third problem is that, consequent to the second problem, an ever-increasing share of personal consumption is derived directly from government social benefits. This is worth considering carefully. First, if we tried to raise taxes on most individuals, obviously their consumption would drop as a result. But if we don't raise personal taxes, then we will either have to cut personal transfer benefits, which would drop consumption, or we will have to keep borrowing ever larger amounts of money to fund consumption. That must end, and it will. It will end within the decade. If we don't curb ourselves, Mr. Market will do it for us.
The fourth problem is that the US economy is still around 70% consumption.
I gave you a longer time series in that graph so you could see how historically abnormal all this is. Here's a shorter version:
This lets you look at it in a bit more detail. For example, you can see how government social benefits jacked way up toward the end of the recession, and haven't fallen much since. That occurred because of all of the lost jobs. And even though we are gaining jobs again, we're not adding enough in quality employment to overcome the retirement surge. I must reiterate that Obamacare will shove that purple line way up in 2014 and 2015, no matter how well the economy does, and the retirements will just continue to add to the load.
To understand the trap fully, let's look at some ratios:
The purple line is the same as before - it's the percent of government social benefits included in personal income. The jagged green line is new. It is personal consumption expenditures divided by personal income. Remember that personal income includes taxes! This is not personal income less taxes - it is personal income before taxes!
Since we're running well over 80% of personal income in spending, several things should be intuitively obvious from this graph:
1) Personal consumption will be acutely sensitive to social benefit cuts,
2) Personal consumption will be acutely sensitive to tax increases,
3) Personal consumption will be acutely sensitive to changes in marginal borrowing ability.
I will expand more on this in my next post. But it is an ugly, ugly picture that implies that the US must see a drastic fall in living standards before it can possibly begin to achieve a sustainable growth picture.
GDP Negative, ADP Employment Great
The takeaway from advance GDP, which will probably be revised higher, is that Q3 wasn't really +3% and Q4 wasn't really negative. Shall we say an "election-related" effect is observed.
PCE was generally strong, but the details are more worrisome than the headline. The Q4 spending on clothing, food and gas & energy categories all declined. These are seasonal adjustments, but they point to just how strapped many households really are, and that was before the payroll tax hike, which will have an effect and is having an effect.
ADP reports +192,000 jobs in January, with massive growth in small businesses, moderate growth in medium size businesses, and a decline in large businesses. There are two factors here. First, Sandy should produce a kick up in small business employment in the NE region, and I believe it has. Second, ADP figures are probably biased because more businesses will shift to ADP due to the increasingly complicated federal regulatory environment. For most of this year and part of 2012, ADP should have been picking up small businesses.
Nonetheless, I do not think US growth was "really" negative. I peg US growth at about 1.8% in the third quarter, which would have shifted down to about 1.4% to 1.5% in the fourth quarter, except that there is a pulse effect from Sandy which will run at last through May, which should have shifted Q4 up to about 1.8%, and should add just over 1/2 a percentage point to GDP growth in Q1 2013. Q1 should be positive. After that things get quite ugly.
However, although PCE should remain relatively strong due to the much higher contribution of government transfers to personal income relative to any other post WWII period, the US economy is cycling into recession. The mechanism is declining real per capita incomes which will be accelerated by the payroll tax hike and service company cuts. Manufacturing now is too weak to compensate further, and defense spending can't be used to hold us up.
Monday, January 28, 2013
Durables Fold YoY
Motor vehicles remains one of the more positive segments, but that is clearly coming to an end. If we haven't topped out we are close to it.
There is a notable decline in nondefense capital goods, continuing ex-aircraft. Motor vehicles unfilled orders have dropped over the year (-7.1%) and inventories have risen (+5.3). That's more than just Volts. The durable manufacturing slowdown is taking hold, and one must believe that the Pentagon is going to have to stop spending so much this year, which will have further negative impact. The end of March is two months away.
The other part of manufacturing is non-durable. The energy boom continues at a rapid pace - US production is up about 20% over the year. And there's always a market for oil, so that can continue indefinitely. On the ag side, where exports could also grow, we have to wait and see what the weather brings us. The last segment of manufacturing is non-durable consumers, and there hangs a big question mark. Consumers are short on cash and due to be shorter this year!
I am waiting for CMI January in some suspense. There was a pretty negative trend in December Services, and if it doesn't unbend in January things may get unpleasant fast. Sales fell for December services an epic 6.4 points, suggesting that everyone was kind of hitting the brakes in retail. There was an unpleasant echo of December 2007 about that, and the YoY decline for December 2012/December 2011 was unpleasant. What really bummed me out about it was that the Sandy storm should have picked up that index, so it may be worse than it seemed. Trucking was really good in November and December, which kind of confirms that Sandy did show up.
Rail figures for January really aren't that comparable YoY yet due to calendar effects, but I am taking some hope from relatively good intermodal YoYs through January 19.
Dallas Manufacturing came in just fine, which is what I expected. Prices for finished goods were up notably. Unfilled orders are still declining (-7.9), but materials inventories are low, shipments were up, and finished goods inventories were declining, so those orders are going to come in. It's worth reading the report because it's nice.
Kansas was quite disappointing, so once you apply the protective coating of Dallas to your psyche, you might as well read Kansas. Aside from prices, there's remarkable YoY negativity. There is, however, a grain of hope in that inventories were beginning to fall, so one would hope that we are nearing the lows. Employment was a strong negative in Kansas. Richmond was negative in January, as were Philly and Empire. I wouldn't recommend reading Richmond without an antacid.
I'm waiting for CMI, thouigh.Thursday. Also, with some interest, initial claims. As I have noted, the SA adjustments are producing a very odd discrepancy YoY. I'm - curious.
Pending home sales declined in December. The NAR take is that tight inventory is pushing down sales. I don't buy all of that. In the Midwest, perhaps. Not in the West and in the NE. On a YoY basis, pendings in the West dropped 7%. For the US as a whole they are still up 4.9% YoY. NAHB data is still quite favorable, although the Q4 remodeling index would have been shifted upward by Sandy. Construction activity and remodeling activity has more impact than raw sales. Multi-family continues strong because vacancy rates are favorable.
Friday, January 25, 2013
Decision On Executive's Recess Appointment Power
This is a very powerful ruling:
The power of a written constitution lies in its words. It is those words that were adopted by the people. When those words speak clearly, it is not up to us to depart from their meaning in favor of our own concept of efficiency, convenience, or facilitation of the functions of government. In light of the extensive evidence that the original public meaning of “happen” was “arise,” we hold that the President may only make recess appointments to fill vacancies that arise during the recess.
and by "recess", they mean the period that elapses between the end of one Session of Congress and the next Session:
Not only logic and language, but also constitutional history supports the interpretation advanced by Noel Canning, not that of the Board. When the Federalist Papers spoke of recess appointments, they referred to those commissions as expiring “at the end of the ensuing session.” The Federalist No. 67, at 408 (Clinton Rossiter ed., 2003). For there to be an “ensuing session,” it seems likely to the point of near certainty that recess appointments were being made at a time when the Senate was not in session — that is, when it was in “the Recess.” Thus, background documents to the Constitution, in addition to the language itself, suggest that “the Recess” refers to the period between sessions that would end with the ensuing session of the Senate.Most interesting. The court eviscerated the argument that the President gets to decide when the Senate is in recess or not:
Nonetheless, the Framers recognized that they needed some temporary method for appointment when the Senate was in the recess. At the time of the Constitution, intersession recesses were regularly six to nine months, Michael B. Rappaport, The Original Meaning of the Recess Appointments Clause, 52 UCLA L. Rev. 1487, 1498 (2005), and senators did not have the luxury of catching the next flight to Washington. To avoid government paralysis in those long periods when senators were unable to provide advice and consent, the Framers established the “auxiliary” method of recess appointments. But they put strict limits on this method, requiring that the relevant vacancies happen during “the Recess.” It would have made little sense to extend this “auxiliary” method to any intrasession break, for the “auxiliary” ability to make recess appointments could easily swallow the “general” route of advice and consent. The President could simply wait until the Senate took an intrasession break to make appointments, and thus “advice and consent” would hardly restrain his appointment choices at all.I agree with this court, btw. Because of the breadth of the decision, it is surely going to the SC.
Thursday, January 24, 2013
Stuff You Absolutely Don't Have To Worry About
This looks at changes in the sea surface anomalies. I chose them because there is a very clear urban heat effect contaminating the land datasets.
You could also use troposphere data. The lower troposphere is where CO2-caused warming should be most evident, because the mechanism is an increase in the ability of the atmosphere to trap heat:
It is becoming quite evident that CO2 concentrations in the atmosphere do not have the strong climate effect that was theorized.
Oddly enough, temps seem to be varying more with PMod, which is a composite of solar inputs. We have here two 14 year trend lines. During the entire 28 year sequence, CO2 has been rising strongly. However during the second half of this period, the 400 year high of solar inputs abruptly changed direction.
What you cannot say is that CO2 either has no influence or a strong influence. During the first half of the period shown, both CO2 and solar inputs were pushing "up". In the second half, CO2 continued to rise but solar inputs changed to negative, and the climatic result changed.
When faced with a result such as this, the natural way to resolve it would be to look at longer term trends. Unfortunately our troposphere data is confined to the satellite era and PMod is a more accurate, thus shorter series also. However we do have long term sea surface anomaly data and long term sunspot data:
There has tended to be a pretty strong correlation.
I think it likely that CO2 has some effect, but it clearly isn't the powerful climate driver. Since the overwhelming probability is that solar activity will return to a more typical level, you have no need to abandon Manhattan.
This is good, because it is now India and China which are driving CO2 atmosphere concentrations, and we have no ability whatsoever to change their courses.
I quit posting about this years ago, because a commenter I really liked wrote that because the risk of increasing global temperature was so high, we should ignore doubts and proceed to whatever (global nuclear war?) steps were necessary to avert potential catastrophe. I was awed into silence - we know with absolute scientific certainty that the real catastrophic risk is cooling, since we are entering into the later part of the standard interglacial period. Also temps have been dropping on trend for thousands of years. Also the current interglacial period has tended to have lower temperatures than the one before it. Also the historical record shows that drops in temperatures produce lower moisture on average, so a drop in temps sufficient to knock out much of the Canadian/Northern European/Siberian ag production is likely to produce lower crops in the southern hemisphere.
And guess what, folks? The bulk of arable land is in the northern hemisphere, which means that a relatively small drop in average temps dooms us to widespread starvation.
If you want to be a blazing optimist, you could theorize that the effect of CO2 is such that it will keep us out of the next Ice Age. I have never seen such favorable effects occur by accident, but if they do, we should give China and India the accolades they deserve for being the saviors of the world. The Chinese billionaires are choking on coal fumes for the welfare of the neurotics in the west.
Starting with initial claims:
Once again the seasonal adjustment is a bit puzzling to me. Raw claims last week were well above the previous year's claims, as I noted then, but mysteriously the seasonal adjustment turned that higher number into a much lower number than the prior year's comparable week.
This week raw claims are once again well above the prior year's claims, at 436K this year versus 2012's 416K. Seasonally adjusted claims last year were 372K, but this week with a higher number of raw claims, seasonal adjustment has transformed 436K into 330K. It is entirely normal to have high levels of initial claims in January. It is far rarer to have differing directions of movement between raw claims and SA claims.
Another way to assess this is that in the first three weeks of January last year raw claims totaled about 1,588K. This year raw claims over the first three weeks have totaled 1,551K, so there has been little real improvement over the comparable period of 2012.
The good news is that raw continuing claims are not piling up. They continue to run well below last year's 4,069K at 3,690K.Further, the covered base of insured employment was updated from the previous quarter's 128,066,082 to 128,613,913. This improved at a faster pace than it did from ending 2011 to beginning 2012, which supports the relatively benign indicator of continuing claims.
US Markit PMI flash manufacturing shows a very optimistic headline of 56.1. This is in sharp contrast to the Philly and Empire State surveys. I much prefer this number. Generally Markit PMI has reacted a little more quickly to conditions over the last year. New orders were way up at 57.7. Inventories remained just in contraction at 49.6, which is a good sign for February's numbers. Backlogs of work contracted at 49.5 versus last month's 50.3, which is a less favorable sign. Input prices were rising.
The market this week for shorter-term T-bills was exceedingly strong. The three and six month auctions had stable sizes and showed very strong demand.
I have been meandering my way through the various credit and banking reports, and it is clear that there are allocation changes among financial companies. In particular, rising nonfinancial commercial paper often flags an upshift in production, but that is not what I am seeing on the longer trend, although in January we rebounded off the low:
Financial paper has zoomed up:
I never like to see this type of a vertical spike in Commercial and Industrial Loans. It suggests companies suddenly drawing on credit lines and a degree of stress:
Deposits at US banks are dropping, which suggests that this money may be going abroad or into commodity markets?
However what was really unusual was the spike in deposits in the last few months. The above is other deposits at large domestic commercials. Here are large time deposits for the same:
"Hot money" - large short-term time deposits at large banks are often a product of company money movements. In this case it may be financial companies. Certainly the commercial paper spike is not showing up in bank deposits. The FDIC enhanced insurance program for transaction accounts (covering corporate accounts) did recently end, but it has not shown up in small bank deposits as a negative:
What has shown up for small banks is that Commercial and Industrial loans are pretty darned hot:
This, too, makes me slightly uneasy. First, the environment has not been kind to small banks. Relatively, this is a higher concentration than before the Late Unpleasantness. It is entirely understandable - what else are you going to lend on? But still... Second, deposits at small banks do seem to match C&I loans, which is the normal pattern. However I also wonder if we aren't approaching our natural limit. I always like to feel that there is room to run on credit to keep an expansion going.
This is all just stuff I am watching.
Tuesday, January 22, 2013
Stuff & Grumpiness & My Best Forecast
So the first three Jan manufacturing surveys have been disappointing, to say the least. Dallas should be okay. I'm wondering about Kansas and Chicago PMI, but they will come.
Existing home sales are lala, but not bad. Supply is down, which is good. Sales aren't too hot, but hey, at this time of year you don't expect that. 4.4 months of inventory at a slow sales pace is good for spring, although we'll have to see about mortgage rates (effective). YoY nationally home sales were up 6.9%. The bulk of the improvement is in the Midwest and the South (+10.5% & +9.6%, respectively), with the West barely improving (+1.1%) and the NE coming in at +4.5%. That surprised me a little bit, because I thought we'd have an NE boost from the Sandy effects, but there just hasn't been time, I suppose. Also a lot of the destroyed homes were on the coast.
CFNAI came in nicely for December, because it was static at +0.02. We had a strong upward revision for November (the first month is always tentative), so next month will be interesting.
However here's the problem: In the post 1970s, whenever 65% of the households have to pull back on their spending, the US has gone into overt recession. What I now have shows that on a YoY basis, at least 75% and perhaps 85% of households should slow spending this year, basically because they just don' t have the money due to increasing basic costs plus higher taxes. That doesn't mean that many of the better-off households don't have money, but they are the saving households, and the saving households with relatively high incomes have the capacity to slow spending much more relatively, and will generally respond to a decline in their savings rates by doing so. It's like Snarky Mark walking everywhere, much to his dog's delight, instead of following my advice to buy two cars.
This means that services should continue to be negatively impacted, which can have a pretty strong dampening effect.
Since 2009, the share of government income versus income from the private sector has zoomed up, which means that the GDP inflection curve is slower, but that potential growth is also dampened. The US economy is now functioning far more like European economies, which means the consumer side should be acutely sensitive to base-level inflation, and that we're all getting slowly poorer:
Post WWII, we have never had an extended period during which per capita disposable personal income has fallen from its previous peak. And it's not improving. Obviously it cannot improve this year, since the curve you see here does not show the effect of tax hikes.
There has been improvement in real personal income excluding government transfers, but we're stopping that this year:
Increased retirements plus increased social subsidies (which you would expect given the flat per-capita real disposable per capita incomes) mean that personal current transfers still keep rising:
So since the end of the recession, we've really eked out growth first on the basis of rebound (inventory replenishment) and then on the basis of increased government participation in private spending.
Although interest rates are very low, the massive increase in capital gains taxes taking effect this year must inevitably slow private investment. This is not a favorable effect under the circumstances - if you want to grow your economy, increasing the capital gains tax rate nearly 9% is guaranteed to be a Major Solyndra Fail. It could also be likened to playing Russian Roulette with a six-chambered revolver with all six chambers loaded. Or jumping from a 90 story building and lauding one's brilliance loudly for the first 70 stories of fall.
Then we have the 2% payroll tax increase, which will cut real disposable personal incomes across the board.
So I have two very strong negatives - the top end will be hit by huge tax increases this year, because both the Obamacare surcharges plus the tax compromise increases hit together on the top end. At least 85% of households are going to feel the effects of the payroll tax increase. There will be some households that will see overcoming effects based on wage/employment improvements, but not more than 10%.
Consumer credit indicators were already negative in the fourth quarter, so one would expect relative tightening of credit, which means that the result of lower consumer debt will not be to increase spending through borrowing.
The wild card, then, is the households which receive the bulk of their income from retirement sources or public welfare programs. They will not be affected by either force. However, in checking with them it seems as if most of these households are experiencing very high personal inflation rates, so their spending will at least be constrained. The cost of the basics is what is rising for them, and it is rising faster than their incomes.
Real gross private domestic investment is still rebounding, but now at a much slower pace:
We haven't quite reached 1999 levels yet, and the slowness of RGPDI accounts for the very slack real growth rate of the US economy. It's been greatly assisted by the energy rush - the fracking boom. It's been assisted by other types of manufacturing and insourcing, which should continue.
However last year we saw a worrisome sign in that private nonresidential fixed investment was topping out:
And this is the worst indicator, because it is reflective of lower business spending:
This tends to occur only when the consumer slowing starts to diffuse across the economy. It's predictive.
Now, using the European model, the diffusion through the economy should be very slow. Very slow. However the rebound is even slower, because the diffusion occurs in losses of businesses or spending categories across a service economy with very high government inputs into private spending. In the European economies, we've tended to see overt recessions shifted four to eight quarters later than they would be for equivalent forces in the US. However by the time you see the credit indicators falling and the business indicators falling, the curve seems to be set there as well.
As best as I can figure it, we will enter overt recession in the second half. That's four to six quarters shifted later than would normally have occurred for the US. With no further changes in US spending (no fiscal adjustments later this year), we would not emerge until 2015.
There will not be a huge change in official employment, because the net effect of Obamacare is to generate more part-time jobs but lower per-capita earnings, which effectively conceals negative economic changes, plus we have the assistance of the boomer retirements. Thus the maximum official unemployment rate should be in the range of 8.4% and it is more likely not to go above 8.1 or 8.2%.
The effect through the first half of 2015 should be to suppress interest rates, although perhaps not inflation rates.
The wild card is prices. If inflation should drop out, the curve could be dramatically shortened. But it is hard to see that happening consistently because of Fed policy.
The effect on the US fiscal balance will be quite negative, because the combination of increased spending on Medicaid (low incomes plus Obamacare), SS (retirements), Medicare (retirements) and Disability (retirements plus poor economy), the new insurance tax subsidies (Obamacare) along with very slow increases in income tax collections should really blow up the budget.
Saturday, January 19, 2013
Too Big To Fail
If you underwrite mortgages, you have to sell most of them, because you can't afford the duration risk on that much capital for that long. Or you can do adustable-rates, but current restrictions expose you to considerable duration risks. Only a three-year adustable gives you adequate coverage there, and now we have gone to five years. This leaves you with few options but adjustable seconds (much higher risk of loss) or to originate for Fannie, for example, and sell the mortgage.
Investment banks are in the business of creating investment classes, and they take on a range of very complex risks that are accumulative, often correlated, and often quite obscure.
To understand why the taxpayer should not be insuring investment banking in any way, consider this article on structured notes
Here’s an investment that sounds just too good: You get 150 percent of the upside of the stock market but only 90 percent of the downside. That’s the promise of structured notes issued by companies including JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc.The reason that such obligations exist is that pension-type savings funds have an acute need for more fixed income debt. The Fed's machinations make that need more acute as the desperate search for real returns becomes ever more desperate. Many of the major insurance companies in the world are now investing significant portions of their funds in more or less risky issues such as these and junkier corporate bonds, etc.
Such hybrid securities, which have maturities like bonds but are linked to asset classes such as stocks, currencies and commodities, are increasingly popular. That’s especially true for notes linked to the stock market, which has risen 16.5 percent in the past year and 116 percent since the March 2009 bottom. Some $10.1 billion of structured notes tied to the S & P 500 were issued in 2012, the highest amount in three years, according to data compiled by Bloomberg.
Note that these instruments are also issued for commodities! These types of instruments are one of the ways that Fed buys of bonds move funds into the stock market and commodities.
The problem is that the risk is hidden - if anything goes really bad, investors may not get the deal promised. If the implied principal loss guarantee is only 10%, it's less risky, but less of a good deal. If the market is down 20%, you only lose 10% of your principal, but you are giving up a chunk of potential returns.
The real "pull" of these is that they hide the risk. There is intense correlation in these types of issues - if one set of them goes bad, they all pretty much go bad in a big downturn. The normal hedge for this type of risk would be Treasuries, because when the stock market collapses Treasuries should go up. But it now costs you money to be in Treasuries at these maturities, so that hedge is breaking down by being too expensive for a real hedge. Further, with the Fed buying so MUCH, it's pretty obvious that as soon as it stops the internal pressures will be for Treasuries to lose value (rates to rise) and also for commodities and stocks to lose value in tandem.
To me it looks like there is too much risk out there. Subprime auto loans have breached the pre-crash levels, these types of instruments keep accumulating at much higher levels, newer mortgage issues have real risks (should rates even rise to 4.5%, you are looking at house price declines which cause higher defaults and higher principal losses plus a market value loss, i.e. you lose if you hold 'em and you lose if you fold 'em).
Now combining commercial banking and investment banking creates a degree of economic correlation that is impossible to bear. Therefore no matter what they say, these large bank holding companies will be insured by the taxpayer or the Fed, because if the investment banking side goes down, it takes down the commercial side as well.
Gramm-Leach-Bliley, which eliminated the statutory separation between commercial banking and investment banking existent since the Great Depression, has created a giant pile of correlations. The only thing the Fed's intervention and Dodd-Frank have created is to put the Fed at risk as well. And you know what happens when you bust your central bank and your banking system and your government is insolvent! A panic, and a 20 year depression.
Dodd-Frank is disastrous, and the only way to begin to unwind this terrific heap of risk is to break up these companies. Failure to do so will simply produce more and more hidden risk and ensure calamity. "Too big to fail" = will absolutely fail.
We're still in the land of "let's pretend", and time is getting short to emerge. We will get a bit battered if we try to back away from the abyss, but if we don't back away we are destined to end up at the bottom of the abyss WITHIN FIVE YEARS.
I Want To Bear Richard Fisher's Cognitive Children
Richard Fisher, Dallas FRB, The "John Henry speech". Read it. It has graphs and so forth. This is a ringing call to end the tyranny of the big banks. Here's a bit:
Why Protect the 0.2 Percent?The current setup is an utter disaster, and there is no way to escape from it but to end the federal support system for investment banking components. Commercial banking should continue to receive enhanced regulation and insurance, but investment banking must be split off and exposed to loss.
My team at the Dallas Fed and I are confident this simple treatment to the complex problem and risks posed by TBTF institutions would be the most effective treatment. Think about it this way: At present, 99.8 percent of the banking organizations in America are subject to sufficient regulatory or shareholder/market discipline to contain the risk of misbehavior that could threaten the stability of the financial system. Zero-point-two percent are not. Their very existence threatens both economic and financial stability. Furthermore, to contain that risk, regulators and many small banks are tied up in regulatory and legal knots at an enormous direct cost to them and a large indirect cost to our economy. Zero-point-two percent. If the administration and the Congress could agree as recently as two weeks ago on legislation that affects 1 percent of taxpayers, surely it can process a solution that affects 0.2 percent of the nation’s banks and is less complex and far more effective than Dodd–Frank.
Friday, January 18, 2013
Last Year Turns Into This Year
So it is worth looking at where we stand now, before the effect of those two things has shown up in default rates.
While the composite rate of the S&P/Experian Consumer Credit Default Indices ticked up for the third consecutive month, auto loan default rates stayed flat in December, halting a rising trend that lasted three months. ...Bank card default rates remain extremely low, because banks have been very conservative.
Meanwhile, after hitting a post-recession low of 1.46 percent in September, the national composite rate — a comprehensive measure of changes in consumer credit defaults — increased for third month in a row. The December reading came in at 1.72 percent, following levels of 1.64 percent in November and 1.55 percent in October. ...
First mortgage defaults increased from its post-recession low of 1.36 percent in September to 1.47 percent in October, 1.58 percent in November before reaching 1.68 percent in December.
Article 2 (Wells Fargo):
Wells Fargo — the auto lending market leader according to the latest data generated by Experian Automotive — watched its originations soften as the year closed, but they still improved compared to the last quarter of 2011. Reflecting what they described as seasonality and increased competition, company officials said their fourth-quarter auto originations totaled $5.4 billion, a level 15 percent lower than prior quarter but 8 percent higher than the prior year period.Never believe what they say. Clearly Wells is tightening, because:
The charge-off reading jumped from 1.02 percent to 1.46 percent, while the delinquency reading moved up from 1.27 percent to 1.30 percent.I expect Wells Fargo to do a pretty good job managing its risks, but at the cost of tightening standards. This means that somebody else is picking up the junk, which means it is sitting there somewhere, and those picking up the slack are going to be taking some much higher losses relative to the pool. If you are wondering how that happened, here's a clue - from September of last year.
Here's a paper from 2004 discussing subprime auto loan defaults, which comes up with the absolutely amazing conclusion that households default on their auto loans when they don't have money to repay them.
To the extent that the Fed's efforts have filtered into the Main Street economy favorably, they have done so by two mechanisms. The first is that they have spurred mortgage refinancings which have lowered the consumer monthly debt repayment burden. The second is that they have made subprime auto lending blindingly profitable, and have greatly increased auto sales. Mind you, Fed moves also have negative effects on Main Street by increasing prices of consumables and decreasing real incomes.
This year that tide somewhat reverses. Mortgage credit either has to tighten or rates have to rise, and subprime auto lending has to tighten.
The standard financial press is wandering around staring at the sky whistling Dixie, but the big wave is coming.
AmEx US Card Income
American Express Co., the lender that plans to cut 5,400 jobs this year, said profit at its U.S. card business declined 42 percent in the fourth quarter as the firm set aside more money to cover soured loans.We have, of course, no idea how that happened. They increased their loss reserve 56%. International card income is a big factor here, and when I get time I will read their financials.
We all should be worrying about the bad loans in China, which by now must have reached epic levels. I read all this stuff about recovery there, but it sure looks to me like the bare sea floor exposed right before the big wave rolls in. Their lending is insane.
Thursday, January 17, 2013
Industrial Production Was Strong, But
Unfortunately, the first two January manufacturing surveys both came in solidly in the negatives. Philly Fed (-5.8). Empire State (-7.8). Philly Fed asked questions about constraints on employment:
This isn't wildly favorable. Empire State showed a big pickup in input prices, which makes one wonder.
The Fed seems to be backing and filling on its bond buying plans, but I guess these two will assuage the angst for this month about the effects.
So don't take this one to the bank! Seasonal adjustments sometimes bonk these numbers around.
I have been watching continuing claims most of all, and while the YoY improvement in continuing claims is slack, at almost 260K, it is still there. The next month's worth will tell the tale. There is always a lot of employment churn at this time of the year, and the continuing claims hint at whether it's normal or a depressing factor. So far continuing claims have held in a favorable range. Both SA and NSA insured unemployment (continuing claims) rose one-tenth of a percentage point this week, but that too is well within the normal range.
One of two things is going to happen by early February. Either continuing claims are going to start to ratchet up, which would be a sign that the economy is in trouble, or they will not. If they do not, then my base forecast is for slow growth over the first six months. I now have Sandy as a distinctly favorable factor for growth in the first and early second quarters, because of where the damage occurred. I do seem to see confirmation of that theory in the trucking numbers, in rail, and in a couple of other early stats.
Now, if I'm wrong, things may get rough in the second half, because my forecast diverges rather dramatically from CBO's and the Fed's.
What I had was a close-to-skipping recession waning in the first half of 2013 as the inventory control kind of evened out, and very slow growth thereafter. But the payroll tax increase is going to have a negative effect, and if not offset by wage gains, it will be cumulative over this year. The effect will build and be quite evident by August.
The other factor that could offset some of the payroll tax increase would be a drop in prices, but the Fed is trying to ensure that it doesn't occur.
The other negative effect pulling down growth in the second half of 2013 is Obamacare implementation. Right now a range of lower-paying retail, restaurant and other service establishments are cutting hours of employees to limit their costs under Obamacare in 2014. They have to do it now, because the way you figure out whether the employee is "full-time" is retrospective to 2013. You don't have to use a full-year period, but establishments with seasonal hour variations might really want to do so. If businesses wait to cut hours until next year, they would be in the bag for fines for their part-time employees if they had averaged 30 hours this year.
So what I am forecasting is that many working people with low-to-moderate incomes will see a drop of 40-60% in their actual discretionary incomes, and the effect on their pocketbooks is accumulative over the year. This is between 20-30% of the population, and it is the lower-spending part of the population, In the first two to three months, they'll just be behind a utility bill or two. By the end of the third quarter, they'll be missing a rent or mortgage payment.
And that generates the very unpleasant probability that default rates on consumer loans are due to rise throughout the year barring very strong creditor control of risks.
Right now I think the Fed's actions will keep the flow of subprime auto loans going. Mortgages get a lot dicier toward the end of the year.
In 2014, we take on an additional load as Obamacare kicks in, and that's where it begins to bite.
Anyway, by the end of February I'll have a much better feel for our potential this year.
However by the end of 2015, the federal deficit is going to start going through the roof. The costs of Obamacare are going to be much higher than predicted, and raising taxes as high as we just did on capital gains is going to probably generate a net drop in federal capital gains receipts.
So everything is unstable. I expect the fiscal pressures to force cutting SS and DI benefits in 2015. There are two ways to do this - cut benefits now but in a small way, or cut benefits in the future hugely. If we do that, we are pretty much dooming ourselves to a recession that will look more like a depression in the future.
The window for holding Treasuries without large capital losses is getting smaller. Sometime this year the future trajectory will shift.
PS: Even the Fed knows it is playing with fire.
Monday, January 14, 2013
A Lesson On How It Could End
Japan's balance of trade is no longer the source of great stability that it used to be, and in part that will not be redressed but worsened by a cheaper yen. Since shutting down the reactors, Japan is locked into importing more energy, and the more the yen drops, the more expensive the energy component will be.
It is true that all the foreign money that is repatriated will gain, but that makes it even more profitable to shut down Japanese manufacturing ops and move them elsewhere.
As soon as any real trickle of money out begins, this gets potentially unstable. It's all about money flows now.
Saturday, January 12, 2013
And Frankly, We're Embarrassed To Have To Address This
Friday, January 11, 2013
Excellent, Excellent Plosser Speech
I'm just reproducing the whole thing below as released, because I'm afraid that you might not click through and read it. This is a formidable note of realism amid a sea of nonsense, and it is probable that this speech today will cause a momentary pause in the irrational exuberance:
(Note: If you are not in the mood for this type of thing, may I recommend Ann Althouse's hilariously scatological yet safe-for-work riff on the trillion dollar coin?
Charles Plosser throws a bomb:
Good morning and thank you for inviting me to address the New Jersey Economic Leadership Forum. Last year, my colleague Bill Dudley, president of the New York Fed, addressed your group. As you may know, the northern part of New Jersey lies within the New York Fed’s District, and the southern part lies within the Philadelphia Fed’s District. I am sometimes asked why it was set up this way, with District boundaries that don’t always follow state boundaries. The answer is I don’t know. But if the political nature of decision-making in 1914 was anything like it is today, I am not sure any of us would find the rationales offered at the time particularly enlightening.
Nevertheless, President Dudley and I each lead one of 12 Federal Reserve Banks across our nation. Together with the Board of Governors in Washington, this decentralized structure of the Federal Reserve System helps ensure that monetary policy decisions are based on the full breadth of economic conditions across our diverse country.
The goals of monetary policy are set by Congress in the Federal Reserve Act, which states that the Fed should conduct monetary policy to "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." I have long believed that the most effective way monetary policy can contribute to maximum employment and moderate long-term interest rates is by ensuring price stability over the longer term. Price stability is also critical in promoting financial stability.
The Fed seeks to promote these objectives by influencing the cost and availability of credit through its decisions about interest rates and the supply of money. These decisions are the primary responsibility of the FOMC — the Federal Open Market Committee — the group within the Fed charged with setting monetary policy.
By design, policy is set by 12 voting members on the FOMC — the seven members of the Board of Governors in Washington always have a vote, as does the president of the New York Fed. The remaining four votes come from among the other 11 Reserve Bank presidents, who serve one-year terms on a rotating basis.
Whether or not we vote, all Reserve Bank presidents contribute to the discussion. Though we may, at times, disagree on how to promote the best outcome, we share the same goals and objectives prescribed by the Federal Reserve Act. This process ensures that the Committee considers a wide range of independent assessments of the economy and of the policy options available to pursue.
Before I continue, I must note today that my views are my own and not necessarily those of the Federal Reserve Board or my colleagues on the FOMC.
Economic OutlookLet me begin with an overview of the economy as we enter 2013. We are now in the fourth year of an economic expansion that officially began in mid-2009. Yet economic growth has come in fits and starts, taking two steps forward, only to then stall or take one step back. The general path has continued to be forward, but we’ve made far slower progress than anyone would like. A year ago, many economists were forecasting that economic growth would be closer to 3 percent for 2012. Instead, when the year-end data are released later this month, we are likely to see that growth in 2012 was near 2 percent.
I anticipate that the pace of growth will pick up somewhat, to about 3 percent in 2013 and 2014 — a pace that is slightly above trend. In December’s projections by FOMC participants, the central tendency showed real GDP growth of 2.3 to 3 percent in 2013 and 3 to 3.5 percent in 2014. So my outlook places me at the high end of the central tendency for 2013 and at the low end for 2014.
This level of growth should allow for continued improvements in labor market conditions, including a gradual decline in the unemployment rate, similar to the improvements we have seen over the past two years.
In the fourth quarter of 2010, the unemployment rate averaged 9.5 percent. By the fourth quarter of 2011, the average rate had fallen to 8.7 percent. We now know that the unemployment rate for the fourth quarter of 2012 came in at 7.8 percent. Thus, over the last two years, we have seen unemployment fall by 1.7 percentage points. I believe we will see the rate continue this downward trend at a similar pace, falling to near 7 percent by the end of 2013.
Part of the challenge with this recovery has been the modest number of net jobs added to the economy. In 2012, employment growth averaged 153,000 jobs per month, on par with the average monthly gain in 2011. We are simply not adding jobs at a pace that will rapidly reduce the unemployment rate.
The economy lost 8.8 million jobs from the peak of employment in January 2008 to the employment trough in February 2010. We have regained just over half of these jobs. Progress has been particularly challenging here in New Jersey. As of the latest employment numbers from November, New Jersey had regained under a quarter of the 260,000 jobs lost in the recession. The state’s unemployment rate stood at 9.6 percent, compared to 7.8 percent in Pennsylvania and 6.7 percent in Delaware, and the rate is higher than its level at the start of last year.
Many people are understandably frustrated by the modest pace of the recovery, especially when it is compared with the recovery from the 1981-82 recession, which was also a severe downturn. In 1982, the unemployment rate peaked at 10.8 percent — notably above the 10 percent peak of this recession. Yet by the end of 1985, three years after the peak, the rate had fallen 3.8 percentage points, to 7 percent. In contrast, today, about three years after the unemployment rate peaked in October 2009, the rate has fallen only about 2.2 percentage points. But recessions are not all alike, and to understand the dynamics of recovery, including why this one has been relatively sluggish, we must understand the size and nature of the shocks that sent the economy into recession in the first place.
We entered this recession over-invested in the housing and financial sectors. The adjustment in the housing market as a result of this boom and bust has been painful for the housing sector and the financial markets. Those sectors have shrunk as a share of the economy, and labor and capital must be reallocated to other uses. Indeed, it would not be particularly wise to seek to return those sectors to their pre-crisis highs, which we learned the hard way were not sustainable. Moreover, the labor force needs to be at least partially retooled to match the skills employers demand. Even within sectors such as manufacturing, the skills of workers now being hired are different from those who were let go. Employers are seeking generally higher skilled workers who are more technology savvy, and thus better able to deliver the increases in efficiency that firms have sought to achieve. This adjustment takes time. It is painful to be sure, but it will lead to a healthier economy in the long run.
The housing collapse also significantly reduced consumer spending, which accounts for about 70 percent of the nation’s GDP. The sharp decline in housing values destroyed a lot of the equity that families had built up in their homes. Thus, a huge chunk of their savings vanished. Many households had been counting on that equity to help send their children to college or to help fund their retirement. With that wealth gone, it is only natural, and rational, for consumers to want to rebuild savings. Consequently, private savings rates have risen substantially and consumption by households has been restrained.
I believe these adjustments are unlikely to be significantly accelerated through traditional government policies that seek to stimulate aggregate demand. This is especially true in the case of ever more aggressive monetary policy accommodation.
The conventional view is that by lowering interest rates, monetary policy lowers the price of consuming today relative to consuming in the future, thereby encouraging households to reduce savings and bring consumption forward. However, as I’ve noted, in the current circumstances, consumers have strong incentives to save. They are trying to restore the health of their balance sheets so they will be able to retire or put their children through college. They are behaving wisely and in a perfectly rational and prudent way in the face of the reduction in wealth. In fact, low interest rates and large budget deficits can frustrate those efforts to save. For example, low interest rates encourage households to save even more because the return on their savings is very small. And large budget deficits suggest that they are likely to face higher taxes in the future, which also encourages more saving. Thus, efforts to drive real rates more negative or promises to keep rates low for a long time may have frustrated households’ efforts to rebuild their balance sheets without stimulating aggregate demand or consumption. In my view, until household balance sheets are restored to a level that consumers and households find comfortable, consumption will remain sluggish. This is likely to take some time, and attempts to increase economic "stimulus" may not help speed up the process and may actually prolong it.
Manufacturing activity has also shown sluggish growth. The Philadelphia Fed’s monthly Business Outlook Survey of regional manufacturers has been a useful barometer of national trends in manufacturing over many years. The survey’s general activity index posted negative numbers over the summer, recovered briefly in September and October, and then posted declines in November in the wake of Hurricane Sandy. In December, the index returned to positive territory. The good news is that the survey’s future activity index suggests that firms expect growth to continue over the first six months of 2013. Yet that growth may be restrained compared to other recoveries.
Even though the balance sheets of most corporations are in pretty good shape, we continue to hear of weak demand and a great deal of uncertainty. Domestic demand has slowed as U.S. consumers save more, as I have just described. Yet, global demand has also slowed, due in large part to the economic turmoil in Europe, which is hovering near recession. This slowdown has restrained world trade. U.S. exports have slackened and, with it, so has our manufacturing sector.
Uncertainty is the other factor restraining hiring and investment by businesses. The fiscal issues in Europe remain unresolved. While leaders in Europe have, at least so far, avoided the financial implosion that some have feared, they are far from resolving the underlying fiscal issues they confront.
Of course, uncertainty is not limited to Europe. Many U.S. firms have taken a wait-and-see attitude with respect to hiring and investing as businesses and consumers wait to see how our own fiscal problems will be resolved. How much will tax rates rise? How much will government spending be cut? U.S. fiscal policy is clearly on an unsustainable path that must be corrected. Yet, there remains significant uncertainty about the choices that will be made. And that uncertainty has been a drag on near-term growth. Although recent efforts by Congress have reduced some of the near-term uncertainty over personal tax rates, the long-term fiscal issues have not been fully addressed. However, we will have to wait and see if the somewhat greater clarity on near-term tax rates reduces some of the drag on business spending going forward.
Here, too, in my view, monetary policy accommodation that lowers interest rates is unlikely to stimulate firms to hire and invest until a significant amount of the uncertainty has been resolved. Firms have the resources to invest and hire, but they are uncertain as to how to put those resources to their highest valued use.
So to sum up, there are good reasons to expect that the recovery will continue but at a moderate pace over the next couple of years.
Turning to inflation, it has been running near our longer-term goal of 2 percent. Although the drought in the Midwest and higher gasoline prices during the summer pushed inflation up slightly, these effects are waning. Thus, I do not see a risk of higher inflation, or deflation, in the near term. Indeed, over the medium to longer term, I expect inflation to be near our 2 percent target. But this expectation is based on my assessment that the appropriate monetary policy is likely to tighten more quickly than the Committee anticipated in its latest statement. Thus, I do see some risks to inflation in the medium to longer run, given the current stance and anticipated path of monetary policy.
Long-Term Growth ProspectsThe shocks we have experienced are large and likely to impact the economy for some time. During this period, the economy’s level of output has been significantly reduced, and it is unlikely we will ever fully recoup those losses. This is a painful and disruptive consequence of the imbalances and shocks that have hit the economy. But what are the longer-term consequences of the Great Recession? Has the economy’s longer-term trend rate of growth been permanently impaired? This is much harder to determine, and the answer will depend, in part, on the economic policy choices we make.
A simple way to assess the long-term trend rate of growth is to think of it as the sum of labor productivity growth, which is typically measured as the growth of real output per worker or real output per hours worked, and labor force growth. If an economy is averaging 1.5 percent labor productivity growth and labor force growth of 1 percent, you can anticipate that its trend growth will be about 2.5 percent per year. Over the long term, labor force growth is mostly a demographic phenomenon, although economic policy can affect it as well. Japan is an interesting example, as its labor force is declining at a pace of about 1 percent per year. This is due in part to an aging population, low birth rates, and fairly stringent immigration policies. Thus, if Japan were experiencing 1.5 percent productivity growth, its long-term trend growth rate would only be 0.5 percent per year.
Over the long run, productivity growth is the primary determinant of rising living standards, or per capita income. Over the shorter run, variation in labor force participation rates and the share of income going to labor vs. capital are also factors. But over the longer run, these latter factors tend to be more stable, leaving productivity growth as the main determinant of per capita income growth. Without productivity growth, economies would stagnate and living standards would fall as the population increased. Thus, productivity growth is the essential ingredient for continued improvements in economic prosperity.
Most economists view productivity growth as being determined over the long run by education and the quality of the labor force, innovation, and enterprise. Of course, many factors can influence these drivers. Various government policies can support productivity growth; others can dampen it. In this sense, societies face trade-offs and make choices. One way that I like to describe these choices is in a risk-reward framework. Investors, for example, can choose strategies that are risky, with asset prices or returns that can be quite volatile. Yet, the expected rewards for tolerating that volatility are higher over the longer term than those from adopting the safe or risk-free strategy.
A society can do the same thing. It can choose policies that potentially increase productivity over the longer run, but those choices may result in more volatility in economic outcomes over time or across citizens. Alternatively, a society can choose policies that are safe and that reduce economic volatility, but such choices could dampen expected growth.
So what effects will the Great Recession have on long-term economic growth or productivity? I think our policy choices and how they affect incentives will matter. Establishing training programs, investing in education, and adopting immigration reforms can increase the quality of our work force and enhance future productivity growth. But policies that reduce labor and capital mobility could harm longer-run growth. Attempting to eliminate volatility by creating an expanded safety net, if you will, for both individuals and institutions could stifle innovation and distort risk-taking. This would likely be costly in terms of longer-run productivity growth. On the other hand, adopting policies that enhance the opportunity for all citizens to reap the rewards of their efforts could enhance productivity growth.
Of course, tax policies and spending priorities, as well as financial regulation and trade policy, will also play a role. For example, most economists see our tax code as almost byzantine, with its inefficient complexity, loopholes, and special interest provisions that distort incentives and the allocation of resources. Simplifying and enhancing the efficiency of our tax system by lowering tax rates, closing loopholes, and broadening the base could enhance productivity growth. Tax and government spending policies that put our fiscal affairs back on a sustainable path and increase incentives for private capital investment, R&D, and education and training would be very beneficial as well.
Financial regulations that work to ensure that markets are transparent can improve efficiency and enhance productivity. For example, investors are attracted to our financial markets when they know that the rules provide a level playing field rather than favoring one set of participants over another. Similarly, regulatory reforms that penalize excessive risk-taking and create incentives for the appropriate level of risk-taking in our financial markets could also improve longer-run growth prospects. But regulations and supervisory steps that dramatically reduce the risks of failure by financial or industrial firms are likely to reduce long-term growth. In my view, government regulation should seek to enhance the effectiveness and incentives of market participants to discipline the firm’s risk-taking — not try to totally supplant it. That is, regulations should work to enhance market discipline. I would add that excessive compliance costs in either the tax system or the regulatory system can be sources of inefficiency and reduce productivity.
Thus, the choices that we make in response to the Great Recession can be a major factor in determining whether long-term productivity growth and the potential growth rate of the U.S. economy declines or not. This is not meant to be a pessimistic story. Indeed, I am generally an optimist and a strong believer in the resiliency of our market economy. But we must choose wisely. Crises sometimes can lead to an over-reaction by policymakers and the public; we must seek to achieve an appropriate balance.
ConclusionIn summary, the U.S. economy is continuing to grow at a moderate pace. I expect annual growth of around 3 percent in 2013 and 2014.
Prospects for labor markets will continue to improve only gradually, but I believe we may see rates near 7 percent by the end of this year. I believe inflation expectations will be relatively stable and inflation will remain at moderate levels in the near term. However, with the very accommodative stance of monetary policy in place for more than four years now, we must guard against the medium- and longer-term risks of inflation. How the economy and the standard of living of our citizens ultimately fare over the longer run will be determined by the policy choices we make in the aftermath of the Great Recession. Some of these policies could increase the quality of the country’s labor force and make us more competitive; others, while they may reduce volatility, might also reduce our long-term growth prospects. It behooves us to choose wisely.
- The views expressed today are my own and not necessarily those of the Federal Reserve System or the FOMC.