DID THE STIMULUS WORK?
The rationale for the $787 billion stimulus legislation enacted in February 2009 is that government spending is necessary for juicing economic activity that would otherwise lie fallow. The idea comes from The General Theory of Employment, Interest and Money, the 1936 tome by Keynes that put macroeconomics on the map and launched a debate about the role of the state in managing the business cycle.
Economics being economics, definitive answers are forever lacking. We have only one run of history to analyze and so it's never clear what might have transpired if we tried x vs. y. Such is life in the dismal science, leaving mere mortals to argue over the scraps of evidence dispensed in the numbers. With that in mind, we offer the following statistical crumbs, fully aware that there are a billion or so other perspectives one might conjure from the sea of data.
Let's recognize that any stimulus plan worthy of the name should focus on raising consumption, which arguably leads to an expansion in the labor market. But first things first. For our purposes here, let's define consumption by three metrics:
1) personal consumption expenditures, a broad measure of consumer spending
2) retail sales, a somewhat more granular gauge of Joe Sixpack's spending habits
3) new orders for durable goods, which measures the business sector's consumption appetite.
Collectively, this trio represents a broad measure of the spending trend in the U.S. The following chart indexes these three metrics to 100 for November 2007, a month before the Great Recession began, according to NBER. It's clear from our chart below that the contraction in spending in the consumer and business sectors ended in January 2009. (Well, almost. Durable goods slipped again in March 2009, although the general trend for all three has otherwise been rising since the start of 2009.) We can debate if the consumption rebound has legs, but it's clear that the retreat hit bottom as this year opened. That brings us to the question: Was the bounce that began in January due to the fiscal stimulus?
The answer is an emphatic "no," for reasons that require only a calendar and a news archive. The stimulus package was enacted in February, a month after the consumption rebound began. And as of October 30, only a fraction of the stimulus funds had been spent or "awarded"—roughly 20% of the total, according to Recovery.gov.
One can, of course, argue that the fiscal package has helped strengthen the recovery. But the recovery was arguably underway before the fiscal dollars hit the street.
If any aspect of government intervention deserves praise for ending the Great Recession, monetary policy is the leading candidate. The smoking guns are the explosion in the Federal Reserve's balance sheet and a Fed funds target rate of 0% to 0.25%.
But we should be cautious in congratulating the central bank. For one thing, the Fed's near-zero policy rate didn't arrive until September 2008, when the financial crisis metastasized into a far deeper problem. Some argue that had the Fed acted earlier, the worst of the fallout in late-2008 could have been avoided. Economist Scott Sumner, for instance, argues that the Fed "misdiagnosed" the economic challenge and thereby allowed the crisis to fester and build momentum.
Whether or not you agree with Sumner's thesis, there's still reason to wonder how much of the January 2009 bounce is due to monetary policy. Many economists argue that even under the best of circumstances, the influence of monetary policy has a 12-to-24-month lag. By that standard, an optimistic view of the Fed's influence on the January 2009 bounce means that policy choices in early 2008 are responsible for the revival. Yet that view is suspect, considering that the effective Fed funds rate was 4%-plus when 2008 opened. As late as September 1, 2008, the effective Fed funds was still roughly 2%. The Great Stimulus, in other words, arrived too late to influence the January bounce.
What about all the extracurricular quantitative easing engineered by the Fed? That too is debatable as a cause for the January 2009 revival depicted in our chart above. In the final months of 2008, most if not all of the Fed's monetary stimulus came from traditional policy adjustments, i.e., cutting interest rates, according to James Bullard, president of the St. Louis Fed.
What, then, accounts for January 2009 bounce back? Perhaps the answer is simply that the natural forces of the business cycle brought on the revival. Have the liquidity injections by the Fed been worthless? No, not at all. Indeed, there are other measures of economic activity beyond the trio noted above. That includes the risk of deflation, which is almost surely lower these days thanks to central bank policy decisions in the fall of 2008. But deciding on how much is too much is certainly a valid topic. Alas, we'll never know for sure. We can't rerun economic history with an alternative policy.
What we do know is the consumption in U.S. stopped contracting in January 2009. A portion of the rebound, perhaps most of it, is due to the natural forces of the business cycle.
Deciding if the fiscal stimulus is productive, a wash or a drag on economic activity has inspired a furious debate in economic circles this year. Some of the analysis is wickedly complex. In the interest of brevity (and clarity), Professor Eugene Fama has boiled down the key issues as follows:
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
The debate necessarily focuses on #3. That is, will the government’s stimulus spending end up in more productive investments relative to what the private sector would do with the money? History suggests we should be skeptical in answering “yes” in anything close to absolute terms. Of course, some government spending is productive, particularly when it goes into projects that are unlikely to find financing otherwise. The development of highways, for instance, to cite the standard example.
It’s not obvious that there are enough productive opportunities to satisfy billions of stimulus dollars. Even under the most optimistic assumptions about stimulus spending, the biggest bang for the buck comes early on. Eventually, the odds decline for producing a net gain (i.e., a positive multiplier effect) associated with the stimulus.
In fact, the hangover effect of stimulus is lurking. No less a proponent of fiscal stimulus than Paul Krugman is warning that the post-stimulus economy may be in for a fresh round of headwinds. Arnold Kling writes that "that the concept of a multiplier has completely disappeared." Duncan Davidson observes, without a multiplier effect "we would have to keep increasing stimulus to keep the economy alive until we cannot fathom funding it anymore."
Kling spells out the problem succinctly:
The more you spend this quarter, the more people are employed this quarter, the more they spend next quarter, and so on. If you do not believe in a multiplier, then any time you slow the rate of government spending growth you slow the rate of overall GDP growth.
If there is no multiplier, and we follow the Krugman logic, then we have no choice but to keep increasing government spending until...what point? when it is 100 percent of GDP?
On the other hand, if there is no multiplier, then I think we should question the whole concept of stimulus. With no multiplier, its benefits are almost entirely transitory and artificial.
The year ahead, particularly the second half of 2010, may look quite a bit different than 2009. A double-dip recession isn't inevitable, although the odds for a slowdown in GDP's expansion, such as it is, look higher than 50/50. Given the precarious state of the "recovery," combined with a labor market that's still a long way from expansion, the possibility of even a mild downshift in economic activity in 2010's second half will put a lid on what the bulls can accomplish next year in the capital markets.
REFLECTING ON 2009
We’ve had the Great Recession and the Great Liquidity. Next comes the Great Unknown.
Central banks have averted the Great Depression 2.0 courtesy of liquidity injections on an unprecedented scale over the past 18 months. In essence, the Federal Reserve and its counterparts around the world have eased the economic and financial pain relative to what would have occurred in the absence of government intervention. If you give the patient enough morphine, he feels better. But what happens when the nurse visits cease? Or will they cease?
The first phase of the Great Intervention has generally drawn cheers and high marks. Certainly the capital and commodity markets in 2009 have registered their approval by way of higher prices. The risk of deflation has been materially reduced. Meanwhile, economic growth has returned. News that that U.S. GDP expanded in the third quarter, for instance, is widely celebrated as proof that the monetary and fiscal stimulus have been a success.
But having scored a victory in the first round, the question arises: At what price?
It’s asking too much to assume that the intervention of the past year is cost free. Economic logic tells us that for every action there’s a counter action. Maybe not immediately, or in obvious ways. But it comes. You can control prices or quantity, but not both. The notion that governments can intervene in the global economy without repercussions requires ignoring history.
To some extent, the market correction of 2008 and early 2009 was a reaction to excess that had been allowed to build in the prior years. As it turns out, the government aided and abetted the excess in a variety of forms, including keeping interest rates too low for too long and promoting market-distorting incentives for owning real estate. The private sector, responding to what amounted to a state-financed boom, exacerbated the excess, which ultimately led to the correction of 2008.
Now we have what amounts to a government-engineered rally in markets and economies. The rebound is certainly welcome, but it comes with caveats and lots of questions. First and foremost is deciding how much of the apparent recovery is self-sustaining. If the government intervention of the past 18 months deserves credit for buoying the global economy and financial markets, reason suggests that taking away some or all of the stimulus creates a new obstacle in the months and years ahead.
The devil’s in the details of the exit strategy that awaits. There are many ways to remove the liquidity that minimizes the negative repercussions. But make no mistake: We are in unprecedented times. Governments have embraced Keynesian economics like never before, particularly on the monetary front. The immediate results include higher asset prices, growing economies and a sharp increase in government debt.
We know how this relationship has fared in 2009. It’s not obvious what it’ll bring in 2010 and beyond. The Great Experiment has only just begun.
WILL A NEW YEAR BRING NEW JOBS?
The great economic question in the year ahead will center on job growth: Will there be any?
The answer will almost certainly be “yes,” but that invokes the inevitable follow-up: How much? In turn, that inspires the equally burning inquiry: “How soon?”
The latter two are the primary unknowns at the moment, and the stakes are high. Much of economic fate now depends on the outcome of job growth, or the lack thereof. We can be reasonably sure that 2010 will witness job creation, but there's still an unusually high degree of uncertainty as to when this glorious moment will come, how quickly the upward momentum will kick in and how many jobs the trend produces in the business cycle ahead.
What we know so far is that the momentum of job destruction has just about burned out. The ongoing decline in initial jobless claims since March has been hinting at no less. Or as we wrote earlier this month: The bleeding has stopped…almost. But if the labor market's decline is over, as it seems to be, it's not yet clear that job creation worthy of the name has arrived. With the jobless rate at 10%, what this country needs is a good five-cent cigar and an unprecedented boom in employment growth. Alas, neither appears imminent.
The more likely scenario is a labor market that crawls back into the black in the months ahead to a degree that’s welcome, given recent history, but far below the pace required to repair the damage wrought since the recession's start in December 2007. With nonfarm payrolls lighter by more than 7 million over the past two years, replacing those positions over, say, the next 24 months requires job creation in excess of 300,000 every 30 days. By that standard, a hefty dose of optimism is required to see the glass half full. At least we can argue persuasively that the glass has water in it.
Nonetheless, there's no getting around the fact that the clues in the here and now are flashing mixed messages, at best. That includes the tea leaves from the world of small businesses, the workhorse of job creation in recent history. As BCA Research reminds, small companies are responsible for minting 60% of the new jobs over the past decade. That's a discouraging statistic if we combine it with the news that the percentage of small firms with job openings continues to bump around at recession lows of 8% this month, unchanged since August, according to a December survey of small firms by the National Federation of Independent Business.
The availability of credit is a critical piece of the hiring pie for small businesses. The ability to expand depends on access to capital, which in turn contributes to the cause of expanding payrolls. But as we recently reported, lending is weak, although the nascent signs of change may be underway. Nonetheless, a revival in lending has yet to make an appearance in the NFIB surveys. Small businesses continue to report that credit conditions in December were virtually unchanged from earlier in the year, which is to say that loan availability is at its lowest in a generation.
Even so, loans by themselves may pack less of a punch this time around, assuming small businesses can tap new lines of capital. As one observer of the small business scene advises, the problem is less about access to credit and more about dim prospects for sales and the heavy hand of government. "Small businesses need the government to think less about lending and more about taxes and regulations," writes Peter Crabb, a professor of finance and economics at Northwest Nazarene University.
Despite the incentives to think otherwise, a return to labor market growth, if only weakly, may be in the offing. ''There is still a lot of ground to make up in the labor market, but the overall increase in hiring intentions is clearly a positive,'' according to Jeff Joerres, chairman and chief executive officer of Manpower, an employment services firm. ''The first quarter is a seasonally slow hiring quarter. To see an increase over the fourth quarter is unusual and seems to indicate increased confidence levels from employers," he said in a press release from earlier this month.
Which statistics are most likely to give us clues about things to come in the labor market? The average workweek and small business job openings, according to Jason Buol, chief economist/research analyst for the San Diego-based Private Asset Management. In an essay from earlier this month, he explains that the average workweek, which tracks the average number of hours worked by U.S. employees and reported by the U.S. Labor Department, "is an important indicator to watch as we believe employers will first increase the number of hours worked for existing staff before they meaningfully increase the number of workers."
As we write, it's not yet clear that the process of expansion in payrolls is here, or that the magnitude and timing of the anticipated recovery will suffice. But hope springs eternal and with the arrival of a new year comes a fresh round of optimism. Massive government stimulus hasn't turned the labor market tide, at least not yet. Maybe turning the calendar page to 2010 will do the trick. The next installment on an answer arrives on January 8, when the government releases the December employment report.
December 24, 2009
MERRY & HAPPY!
Posting will be light to nonexistent as the Capital Spectator winds down the final days of the year. We'll be returning to our usual schedule on Monday, January 4.
Meantime, best wishes to all our readers. Thank you for your support. If we can survive 2008/2009, we can do anything. Bring on 2010!
December 23, 2009
WASHINGTON’S NEW MATH, PART II
Last month we voiced some skepticism over the idea that higher government spending just shy of a trillion dollars for a redo on healthcare would reduce the budget deficit. A month later, this particular strain of our apprehension remains alive and well.
The devil, of course, is always in the details when it comes to complex pieces of new legislation of a certain magnitude and there's no reason this evening to think that Mephistopheles has changed his stripes when it comes to the latest round of economic logic in the healthcare debate. In particular, James Pethokoukis at Reuters is reporting that the problem of double counting Medicare tax hikes is painting a misleading picture of how much healthcare "reform" will reduce red ink in Washington. The Congressional Budget Office has been dragged into the argument over who's spending what and how often. To quote the CBO analysis:
To describe the full amount of [hospital insurance] trust fund savings as both improving the government’s ability to pay future Medicare benefits and financing new spending outside of Medicare would essentially double-count a large share of those savings and thus overstate the improvement in the government’s fiscal position.
Apparently the pols in the capitol are playing fast and loose with the budgetary projections. Shocking, shocking. Yes, Virginia, there may be savings when all the healthcare reform dust clears, but you can continue to count us as skeptical.
LOOKING FOR THE ESCAPE HATCH
Is there no way, said I, of escaping Charybdis, and at the same time keeping Scylla off when she is trying to harm my men?
We can argue if today’s encouraging numbers on consumer spending and personal income for November are skewed because it’s the holiday season (a.k.a. an excuse-to-spend season). We can also debate if yesterday’s downward revision in third-quarter GDP implies that the recovery will be unusually sluggish. And we can go back and forth over yesterday’s sharp rise in November sales of existing homes on whether that’s due a first-time buyer’s tax credit that expired last month. Of course, we can also throw around some ideas about how much if any of the government's stimulus deserves credit for keeping the country out of the black hole of economics. But for now, the recovery trend in post-apocalyptic America is intact.
Deciding if it’ll remain intact is the great unknown. More than likely this will be a debate over the degree of the recovery’s magnitude and duration. Never say never, but short of a new and unexpected negative of some consequence arriving on the economic scene in the weeks and months ahead, the U.S. recovery has legs. Exactly how wobbly those legs prove to be is the question. But if we step back and look at the broader trend in the statistical front line for economic fate—spending and income—there’s no denying the upward bias, as our chart below shows.
There’s still plenty to worry about, but most of the anxiety is related to how the growth in 2010 plays out. Yes, there's an expansion building, but it's not yet clear it'll suffice for the challenge ahead.
"I think we'll be 'driving sideways' in both the California economy and the U.S. economy," UC Berkeley economist Barry Eichengreen opines today. Meanwhile, Brian Bethune, an economist with IHS Global Insight, predicts the U.S. economy will expand by a modest 2.0% to 2.5% next year. "It's a half-speed recovery."
In other words, there’s some debate about how quickly the labor market will recover. The jobless rate remains at a lofty 10%, the highest in 30 years. In past cycles, the peak in the jobless rate was followed by a sharp and swift decline. Will history repeat? There’s some skepticism this time.
One reason it may stay weak is the growing propensity to save. We should be cautious in assuming too much when it comes to Joe Sixpack’s inclination to renounce his spendthrift ways. Indeed, today’s income and spending report for November is hardly compelling evidence for thinking that the urge to consume has evaporated. But spending habits can and do change, although there’s no reason to think that change will come quickly. Consider the second chart below. Consumers are clearly saving more these days than they were when the Great Recession was just building a head of steam. Last month, personal saving as a percent of income was 4.7%, up sharply from the previous nadir of 0.8% in April 2008.
Saving is neither inherently bad nor good, although it does have economic ramifications depending on the time and context. The paradox of the moment is that America needs more saving to fund its mounting liabilities. Yet the same economy, which is overwhelmingly dependent on consumption, needs spending to bounce back and stay high to keep the rebound rolling and unemployment falling. There are no easy solutions for navigating the tight space between the economic Scylla and Charybdis that awaits. Even worse, evidence of success or failure will come slowly. It’s going to be a long 2010.
But, heck, Christmas is just two days away and it’s already been a long year. For the moment, we’re going to focus on Chart 1 and dream of sugar plums. There’ll be plenty of time to sober up in January.
THE ASSET ALLOCATION CHALLENGE SPRINGS ETERNAL
The 2000s have been the worst decade for U.S. stocks in 200 years, reports yesterday's Wall Street Journal. Meanwhile, it’s been a somewhat better decade for the Global Market Index, a passively weighted mix of all the major asset classes that's the benchmark for our sister publication, The Beta Investment Report.
There are still two weeks left to 2009 and the decade and so it's not over until it’s over. But barring a massive change in prices in the days ahead, the mystery is fading quickly for year- and decade-end numbers. Using performance through the end of last month, the 10-year annualized total returns for the major asset classes and GMI stack up as follows:
U.S stocks were dead last, returning a trifling 0.1% on an annualized basis for the past 10 years. By contrast, the best performer among the major asset classes has been emerging market bonds, which soared by an 11.5% annualized total return. As for our Global Market Index, it returned 4.2% over the past decade.
GMI’s more or less middling performance isn’t surprising. As a market-weighted asset allocation of all the major asset classes, our index embraces the world’s assets as they are. It is a naïve benchmark of everything, presuming nothing other than the idea that there’s some degree of embedded wisdom in the valuation of assets as collectively assigned by investors.
Did some of us do better? Yes, although some of us did worse. Although this is just a guess, it wouldn’t surprise this observer to learn that more than half of the planet’s efforts to "beat the market" trailed GMI. So it goes. A robust definition of "the market" is a competitive beast over the medium and long term.
Should we give up hope of engineering a better outcome than GMI over time? No, not necessarily. As GMO’s Jeremy Grantham notes in today’s Journal article, "We came into this decade horribly overpriced" in terms of stocks. The message: prospective equity returns a decade ago looked unattractive if not horrible, a point that Grantham and a few other contrarians made at the time.
We can argue if various market clues (dividend yield, volatility trends, yield curves, etc.) about future performance are a sign of market inefficiency or evidence of time-varying expected returns in a reasonably efficient marketplace. The better question: Should we act on this information? If so, when? And under what conditions? Sometimes—sometimes—these clues provide compelling reasons to adjust Mr. Market’s asset allocation.
Unfortunately, the clues aren’t always as clear and potent as they were at the end of the 1990s for stocks, when expected return for equities--U.S. equities in particular--looked unusually low. Peering into the future isn't always so investor friendly. Sometimes, arguably most of the time, the outlook is murky. That's one reason why besting an expansive definition of the market (i.e., GMI) is so difficult for so many of the world's investors over time. Yes, some beat the odds, although not so many as conventional wisdom suggests after adjusting for risk.
The good news is that different asset classes dispense different messages at different times. In other words, a relatively potent signal about future risk and return may be reflected in one or more asset classes at any point in time, which provides a basis for adjusting the passive asset allocation. That was certainly true at the end of 2008 and early this year. The problem is that the outlook for most asset classes is usually a gray area, as it is now. That suggests holding something approximating the passive allocation for that asset class until better information comes along.
Meanwhile, forecasting risk premiums for the major asset classes, GMI and our trio of model portfolios on a monthly basis is the raison d’etre of our monthly subscriber-based newsletter, The Beta Investment Report. Our current forecast for GMI’s risk premium is roughly 2.5%, well above the 0.4% delivered over the past 10 years. (Risk premiums are returns in excess of the risk-free rate, such as the return on a 3-month Treasury bill.) Not surprisingly, our modeling tells us that the component asset classes offer an array of prospective returns above and below our expectation for GMI. Par for the course.
Figuring out which asset class looks compelling, or not, keeps the midnight oil burning in the offices of The Beta Investment Report. Coming up with robust forecasts isn’t easy, nor is it foolproof. Suffering all the usual caveats that bedevil mortal efforts at divining the future, we assume a fair degree of error in our predictions. That said, the road to strategic insight is smoother if we routinely assess the outlook for risk and return cautiously, do so for all the major asset classes through a variety of techniques, and generally remain humble in deviating from GMI's mix until the numbers strongly sugggest otherwise.
Accordingly, the fact that U.S. stocks dispensed an dreadful 10-year run is but one piece of a larger strategic puzzle. The more valuable perspective begins by recognizing that a passive allocation to everything is likely to continue dispensing middling levels of return and risk in the years ahead. That’s hardly a silver bullet, but it’s a solid foundation for analyzing markets, developing some intuition about future risk premiums and deciding what looks compelling, and not so compelling, for second-guessing Mr. Market’s asset allocation.
LOOKING FOR LOANS
There are many things to worry about for the economy in 2010, but perhaps the leading cause of anxiety is bank lending, or the diminishing state thereof.
Commercial and industrial loans made by U.S. commercial banks fell in November to the $1.36 trillion, the lowest since September 2007, reports the Federal Reserve. This isn't surprising after the large negative economic shock over the past two years, but it's troubling nonetheless.
The Federal Reserve can print all the money it wants, but if the liquidity isn't finding its way into the coffers of businesses, the recovery will suffer. Financial institutions, of course, are only too happy to accept the central bank's monetary gifts of late. Nothing makes a banker smile more than a world where he can borrow short and lend long. But while there's a whole lot of borrowing short going on, there's a dearth of lending. What are they doing with the money? For reasons that need no explanation at this point, banks have been focused on rebuilding their balance sheets.
The four largest banks in the U.S., for instance, reduced loans by 15%, or $100 billion since April, according to analysis of government data released earlier this week, reports The Huffington Post.
Bank lending is a lagging indicator and so we should expect to see lending levels decline at this point in the business cycle, or so history suggests. Richard Yamarone's The Trader's Guide to Key Economic Indicators notes that C&I loans tend to "bottom out more than a year after the end of a recession."
If we're optimistic and assume that the recession ended sometime in the summer, that implies that bank lending will continue to fall through the first half of 2010. That's a long time to wait for an economy that's struggling to mount a recovery in the wake of the deepest economic retreat since the Great Depression. Bank loans are critical for juicing business growth, which in turn helps the labor market expand. The latter is essential for an economy that's lost more than 7 million jobs over the last two years and continues to shed workers (of last month).
The good news is that there appear to be signs that the descent of C&I loans is slowing. As our second chart below illustrates, last month's 1.2% drop in lending was roughly half as deep as the 2%-plus pace that prevailed in each of the previous three months.
It's too early to say if C&I loans have hit bottom, but for the moment there's at least reason to hope. That's doesn't mean that lending will quickly soar. The ranks of qualified corporate borrowers have thinned. Meanwhile, banks continue to look for any excuse to hold on to their cash. Lending has remained frozen to the point that the President earlier this week asked bankers to consider "every responsible way" to boost loans.
Talk is cheap, of course, and so are loans. But for the moment, talk is all we have, and some hope that the trend has finally turned.
“In light of ongoing improvements in the functioning of financial markets,” the Fed advised this afternoon, “the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010...” It's a start.
Actually, it's a continuum. Ben Bernanke, chairman of the Fed and part-time op-ed columnist, wrote in The Wall Street Journal this past July that, yes, there is an exit strategy lurking somewhere in the future. What's more, the Fed has the means and the will to pull the trigger at some point on the Great Liquidity. Or as the chairman wrote in the summer, "the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so."
The Fed has been telling us all along that its various forms of quantitative easing will be a fleeting presence. But the emphasis has turned decidedly rigid today, if only partially, by reminding us that there’s a hard date ahead for the inglorious moment when the party ends, or begins to end. The numerous taps weren't all turned on at once and so they won't all close together. But close they will.
Back in June, the FOMC statement stressed that it was "extending" its monetary lifelines through "early 2010." In a subtle but notable shift, we're now told of an end. Extension is now being replaced by termination dates.
It’s not clear if all the various monetary denouements will be telegraphed so clearly by way of advance warning wrapped in calendrical precision. But whether the news of future finales come like a thief in the night or with full clarity days or weeks ahead of the act, a reckoning awaits.
If you absolutely, positively need an optimistic outlook on the economy, Alan Blinder's your man.
Today’s update on consumer prices looks less threatening than yesterday’s news on producer prices for November. Whereas wholesale inflation last month was up for both headline and core readings (i.e., less food and energy), this morning’s CPI is a mixed bag. Headline CPI rose 0.4% in November (the highest since June), but core CPI was flat, on a seasonally adjusted basis. This gentle statistical profile all but assures that the Fed won't raise interest rates at this afternoon's FOMC announce, assuming they needed another reason to remain dovish.
“Inflation is not a problem and we do not expect it to become one anytime soon,” Brian Bethune, chief financial economist at IHS Global Insight told Bloomberg News before the CPI update. He also noted that “deflation risks have greatly diminished.” In short, we can continue to celebrate…with one eye open.
But, heck, even if this morning's CPI report was awful, Fed Chairman Ben Bernanke couldn't raise interest rates on a day when he was named Time magazine's Man—make that Person of the Year, a.k.a. as "the most powerful nerd on the planet."
December 15, 2009
THE FINAL DAYS OF THE GREAT LIQUIDITY?
Time may be running out for the policy of embracing the Great Liquidity without paying an inflationary price. A hint of things to come is buried in today’s producer price report for November.
Wholesale prices jumped 1.8% last month, the Bureau of Labor Statistics reported this morning. That's near the upper range for monthly changes in recent years. The surge last month is easily dismissed, however, considering that much of the rise is due to energy prices. On the assumption that energy prices won't keep rising, one could soft pedal the headline PPI number for November.
It's harder to dismiss last month's core PPI change, which excludes the volatile food and energy sectors. As our chart below shows, core PPI gained a hefty 0.5% in November, the highest monthly change in more than a year.
Is simply a case of statistical noise? Or is pricing pressure finally starting to rebubble as the financial crisis of 2008 continues to fade into history? Another clue arrives in tomorrow's consumer price report.
Meantime, the Federal Reserve's FOMC meeting begins today, with a fresh monetary policy announcement scheduled for tomorrow afternoon. Presumably the Fed heads will factor the latest wholesale and consumer price reports into their decision tomorrow.
The Fed funds futures market doesn't expect that Bernanke and company will change policy tomorrow. As we write this morning, futures are priced in anticipation that Fed funds will remain as is, targeting the zero-to-0.25% range.
Certainly there's no imminent threat of inflation. Indeed, a fresh bout of deflation can't be ruled out entirely, at least not yet. There are still weaknesses in the global economy, and some of them are bubbling here in the U.S. The ongoing contraction in the labor market is one example. But as we discussed earlier this month, the bleeding is poised to cease quite soon. That doesn't mean the labor market will start expanding robustly. But marginal changes at this stage can have an unexpectedly large impact on pricing trends, perhaps suprising the market along the way.
The factors that have allowed central banks to keep nominal interest rates at zero retreating, one by one. At some point, and perhaps sooner than the crowd expects, the Fed will begin raising interest rates. Slowly, to be sure. But even that change won't arrive until next year. Tomorrow's FOMC confab will offer no surprises, or so markets are predicting.
The clock is ticking, however. The good news is that it's still ticking slowly. The 10-year outlook for inflation in the Treasury market, for instance, calls for price changes of around 2.2% a year for the decade ahead. That's still low by recent standards, as our second chart below shows.
In short, the inflation outlook isn't very threatening at the moment, as suggested by the Treasury forecast. But let's also recognize that the inflation forecast isn't falling either.
NOVEMBER: A STRONG MONTH FOR RETAIL SALES
Say what you will about household debt and the blowback from recession, but Joe Sixpack and his spendthrift ways won’t go quietly into the night, recession or no recession.
This morning’s update on retail sales for November was a reminder that ours is a consumer economy and old habits die hard. U.S. retail and food services sales for November rose 1.3% on a seasonally adjusted basis, the Census Bureau reports. A monthly rise above 1% for this series is impressive and should soothe worries that the danger of an imminent double-dip recession is lurking. Even after excluding volatile auto sales last month, retail sales climbed 1.2%. In addition, the advance was broad based, with only a few sectors posting declines.
One month a trend does not make, of course. But as our chart below suggests, the general bias appears to be looking up. There's still a long way to go to close the gap between retail sales pre-recession and what prevails today. But for the moment, the most important issue at this stage is that a recovery is in progress, or so one can say with a bit more confidence today.
The encouraging retail sales news may be short lived, of course. Indeed, the holiday shopping season is upon us and so the temptation to buy is potent. It remains to be seen if it endures once the dreary winter months of 2010 arrive. And there's the nagging problem with the labor market, which is still very much an open question, at best. But for a day, at least, there's reason to breathe another sigh of relief if only to acknowledge that the risk of a deeper crisis than what's already passed faded by another notch.
And not a moment too soon. In the December 2009 issue of The Beta Investment Report, we noted that our proprietary economic index had stumbled in October, dropping 0.4% for the month—the first since March 2009. Confirming the weakness was an even bigger fall in the BIR Leading Economic Index, which tumbled 1% (see chart below).
The question is whether this was merely a temporary blip or a sign of fresh weakness in the economic rebound? The true answer won't be known for months, but today's report on retail sales offers one more reason to vote in favor of the temporary blip explanation.
But rest assured, we'll need to see improving signs in the labor market before we're convinced that retail sales are on a sustained rebound. There's reason to think that the economy will soon be creating jobs on a net basis, as suggested by the trend in nonfarm payrolls. Even then, there's some doubt about the magnitude and duration of the expected recovery in the labor market.
Yes, we're only a few steps into the thousand mile journey, but beggars can't be choosy.
December 10, 2009
A SETBACK IN JOBLESS CLAIMS, BUT THE TREND IS STILL DOWN
Today's update on new jobless claims for last week shows a gain in the number of freshly minted unemployed, but that doesn't mean the general decline is over.
New filings for unemployment benefits jumped last week by 17,000 to 474,000, the Labor Department reports. But as you can see from the chart below, the overall trend has is down, albeit interrupted at times by temporary setbacks. Last week dispensed another one of those setbacks.
But barring some dramatic new and unexpected event with hefty negative consequences, weekly jobless claims are likely to drift lower in the months ahead. The economy is recovering, albeit slowly and in fits and starts, but the recovery rolls on. It remains to be seen just how durable this expansion will be, but for the moment the growth, light and tenuous as it is, has legs.
Indeed, the positive momentum continues to show up in continuing claims for unemployment too. This metric, which tallies those who've been collecting jobless benefits for some time, dipped to 5.157 million for the week of November 28, the latest data available. That's more than 300,000 fewer than the week before and the lowest since February.
Meanwhile, we have a government committed to throwing everything but the kitchen sink at the forces of contraction. And politicians and policy makers aren't shy about saying so. Perhaps the most striking example came in President Obama's comment this week. As he said at the Brookings Institute on Tuesday, the nation will "spend our way out of this recession." Given the ambitious embrace of liquidity injections on the monetary and fiscal side of the table, no one should doubt the President's intentions. Evaluating the results is something else.
There are good and bad consequences to such a strategy. We're seeing some of the good side, i.e., the Great Recession is over and Great Depression II has been averted. Much of this, of course, can be attributed to extraordinary stimulus via the Federal Reserve. The natural buoyancy of the U.S. economy deserves credit as well, perhaps most of the credit. Unfortunately, teasing out what was critical in reviving the economy (or preventing deeper problems, if you prefer) and what was superfluous is destined to remain a guessing game. So it goes in macroeconomics.
Having sampled some of the positive results of government spending in recent months, the future may bring some of the negative consequences. There are no free lunches in macroeconomics, but there are risks. Determining if recent policy decisions were wise or not has yet to be determined, but judgment day is coming. Meantime, the recovery is still running, albeit with more than a few caveats.
Are there other risks floating about? Absolutely. And there'll be new ones tomorrow. The good news is that risk is also the source of return over and above the proverbial risk-free rate that’s available in short-term Treasury bills and the like. A managed, intelligent exposure to risk is the goal. But we can never forget that risk has the power to take as well as give. Fortunately, there are some basic strategies for minimizing risk’s potential for pain and maximizing its capacity for minting profits. One possibility is owning an investment portfolio resembling our Global Market Index. This portfolio will never be the top performer, but neither is it likely to be last. Some risks, at least, are manageable with minimal effort and cost.
THE TROUBLE WITH A GOLD STANDARD
The bull market in gold, now in its ninth straight year, is more than one more commodity trading at higher levels—around $1,160 an ounce, as of Friday’s close. Gold being gold, it carries a range of emotional, financial and economic baggage.
That includes the embedded warning that the risk of instability, including future inflation and banking default, is still bubbling around the world as more than a distant threat. The biggest gold bull market in modern history is also stirring arguments anew in favor of returning monetary policy to a gold standard. As alluring as that might be in concept, in practice it would be unworkable in the long run.
The first problem is that there’s not enough gold in official reserves to back the paper money supply. The U.S. gold reserves held at the Federal Reserve—the world’s largest for any central bank—are worth roughly $312 billion, assuming gold prices of $1,200 an ounce, based on Fed holdings totaling 8,133.5 tons of the metal, according to the World Gold Council. That’s less than one-fifth the value of M1 money supply currently in circulation.
The implication: the supply of currency now in circulation would have to fall dramatically, the price of gold would have to rise dramatically, or some combination of both. The net result would likely be a massive overnight surge in interest rates.
Gold bugs would, of course, be in favor of something on that order. And to some extent there’s logic in them thar hills. Interest rates are certainly too low and the U.S. is printing too many dollars. But attempting to fix years of monetary mismanagement overnight is like trying to correct for 20 years of no exercise and deciding one morning to run 20 miles a day. The goal is admirable but implementing the plan would be lethal.
Even if the U.S. could devise a gradual return to the gold standard that doesn’t kill us, there’s still a problem. Indeed, there’s a reason why the gold standard of yore, in all its various forms, was abandoned. It doesn’t work.
Oh, sure, most of the time, when the business cycle is calm, the gold standard is a charm. Tying the supply of currency to a hard asset—real money, so to speak—has merit. But the problem comes in those rare but inevitable moments when the business cycle goes insane. And let’s be honest: that’s never going to change. There’s always going to be a crisis lurking in the future. The underlying catalysts will change, but the economy will invariably hit a wall at times. At such times, a rigid gold standard is unworkable in political terms and perhaps economically as well.
The problem is that there are times when a central bank must step in as lender of last resort and inject liquidity into the system. That’s not possible under a gold standard. As such, the gold standard’s appeal is also its weakness.
You can’t snap your fingers and create gold out of thin air. That’s a valuable tool for preventing central bankers from debasing the currency, as they tend to do over time. But in that rare moment when all hell’s breaking loose and the economy may be poised to implode, a gold standard would almost surely exacerbate the danger. Maintaining the integrity of a currency is the goal 99% of the time, but it’s the 1% that’s the problem for a gold standard.
This is old news, of course. That’s a reason why the gold standard has been abandoned. In fact, there are no silver bullets for monetary policy, at least if we’re trying to design the perfect system. No matter what you come up with, it’s going to have some flaws. Pick your poison. The basic choice: live with inflation, preferably a small but consistent amount, vs. a currency that’s as good as gold but at the risk of one day courting economic disaster.
Of course, central bankers aren’t immune from making mistakes and turning mild problems into much bigger ones. Indeed, we're not shy about pointing out what we perceive to be policy mistakes or the potential for human error that routinely shadows the oversight of paper money. But that doesn’t change the fact that the gold standard could possibly make central banking errors far worse during a crisis.
Yes, there are serious problems with a fiat currency system too, starting with the gray area of deciding how much money to print. A gold standard solves this problem, but ultimately at a dramatic if not obvious or immediate cost. No wonder that the gold standard has been deserted. It’s simply implausible to expect a government to say it’s helpless to intervene in a financial crisis because the gold supply is fixed.
The good news is that anyone can buy gold and hedge their personal wealth. But what’s practical in some degree for individuals and private institutions isn’t a slam dunk for central banks.
THE BLEEDING HAS STOPPED...ALMOST
All hail the arrival of zero! It’s been a long time coming—nearly two years. But better late than never.
Technically, nonfarm payrolls slipped last month by 11,000, the Labor Department reports. But in a labor force of nearly 131 million, that’s effectively no change if we consider the potential for statistical noise and the prospects for an upward revision down the line.
Today’s news is, of course, encouraging. Indeed, the November employment report is the most optimistic since the recession began in terms of trend and magnitude. The return to zero, or thereabouts, isn't a complete surprise, however. As we noted yesterday, the continued drop in new filings for unemployment benefits suggests that the wave of layoffs that has burdened the economy is rapidly fading. That doesn't necessarily mean that a new era of robust job growth is set to begin. But at least half of the problem seems to be history, or so one might assume.
The recession, for all intents and purposes, is over. That statement doesn't minimize the massive job loss that's taken place over the past two years, but it does reflect the mounting evidence that broad economic contraction is probably behind us. Indeed, reach this point in the business cycle was always the first priority: Stop the bleeding. That included keeping deflation at bay. Both objectives have been accomplished, although it took longer than usual.
But let's not forget that failure on those twin fronts—ending the broad economic retreat and keeping prices stable—surely would have created another Great Depression instead of the Great Recession. On that point, we can be grateful, and much of the congratulations go to the Fed and its counterparts around the world. Aggressive monetary policy has intervened and, for the moment at least, to our advantage.
But having slayed the ghost of the 1930s, we must now confront the bigger challenge: growing the economy on a sustainable level that lifts the labor market. The hard work is about to begin. As difficult as it's been to return the economy to a state of treading water, that will pale next to the business of promoting non-inflationary growth on a meaningful scale in the years ahead. Simply expanding the labor market to its pre-recession level—roughly 7 million jobs more than we currently have—will require an unusually lengthy and potent expansion. As if that wasn't enough, there's the threat of high inflation, rising interest rates and a hefty debt load on governments and consumers lurking. This isn't going to be easy.
And just to keep our perspective firmly grounded in reality, let's not forget that even today's relatively rosy employment report is still technically showing job destruction. If it wasn't for the buoyant services sector, the slight 11,000 retreat in nonfarm payrolls would be worse by nearly 60,000.
December 3, 2009
HALFWAY HOME & A THOUSAND MILES BEHIND
Today’s update on jobless claims strengthens the case for arguing that the Great Recession is over.
New filings for unemployment benefits dipped 5,000 to a seasonally adjusted 457,000 for the week through November 28--the lowest since September 2008, the Department of Labor reports. The obvious caveat is that last week's number is skewed to the downside because of the Thanksgiving holiday, which undoubtedly delayed and otherwise deterred the newly unemployed from paying a call to the local unemployment office.
But while should be suspicious of last week's data point, there's no uncertainty about the broader trend. As our chart below shows, jobless claims have been in decline since peaking in March. That alone doesn't tell us that the economic contraction is fading, but it drops a rather large clue for thinking so when considered with a range of other economic indicators.
Anticipating the end of the recession based on looking at a general retreat in new jobless claims is a familiar notion on these digital pages. In the spring we argued that a peak in jobless claims would send a potent signal that the end of the recession was near. Calling peaks in real time is, of course, the stuff of guesswork. But now we can look back with confidence and say that new filings did indeed top out in late March of this year. That and a number of other encouraging macro signals, including the rally in the stock market, all but confirms that the recession has ended.
To the extent that corporate America is laying off fewer workers, the trend is good news, of course. Nonetheless, weekly losses in the upper-400,000 range are still too high. Consider that in the halcyon days before 2008, new claims were running in the low-300,000 range. By that standard, there's still a long way to go.
Even if claims fall further in the weeks and months ahead, as we expect they will, this is only half the battle in the all-important task of repairing the labor market, which has been blindsided by the events of late. In short, the second part of the recovery is one that requires job growth. Alas, on this front we should keep our expectations in check. What's more, the prospects for a quick recovery continue to look dim on ending the job destruction.
As we reported yesterday, ADP's estimate of the employment trend for November is firmly in the red to the tune of a 169,000 loss. That's a lesser retreat compared with October and well below the levels from earlier this year. But at this point—two years after the recession officially began—another slumping employment report feeds the fear that the American jobs machine is deeply wounded and can't get up.
Perhaps that's hasty. Given the magnitude of the recession, it's not beyond the pale to think that the labor market is destined to recover s-l-o-w-l-y. But the hints that job creation has been fading for some time precedes the Great Recession. For the past generation, every post-recession period has witnessed a lesser pace of job growth (in absolute and relative terms). The economic contraction over the past two years is sure to exacerbate that trend. Indeed, it already has. You have to go back to the 1930s to find a slower recovery in the job market.
In short, we're not expecting much in the way of a positive surprise in tomorrow's employment report from the Labor Department. The recovery glass is still only half full.
GOLD, JOBS & LOTS OF UNCERTAINTY
The gold market’s worried about inflation, but there are few signs of it in the official numbers. Nor is there likely to be much pricing pressure anytime soon if we consider the latest estimates from ADP.
Nonfarm payrolls for November are expected to be lighter by 169,000 over the previous month, according to the ADP National Employment Report, which attempts to provide an advance estimate of the official data from the government, which will be released on Friday. If we take the ADP report at face value, the labor market is still bleeding jobs, albeit at a lower level than October's 190,000 loss. But no one should mistake a 169,000 reversal as good news at this late date in the economic cycle.
The danger here is that the labor market continues to contract at a brisk pace. The fact that jobs are evaporating at well below the rate from earlier in the year is cold comfort at this point—two years after the recession began and more than 7 million jobs down the rat hole. At some point job growth will return, but it's unclear if that glorious day is anywhere near.
As for inflation, the ongoing weakness in the labor market sends a rather large clue that inflationary pressures will stay muted, at least as officially calculated. That hasn't stopped the gold market from rising above the $1,200 market today for the first time in history. Anxiety over rising debt and a weaker dollar are the immediate concerns driving the metal higher. Eventually that will bring higher inflation, argue the goldbugs.
In the meantime, the Treasury market's inflation outlook remains marginally higher relative to the depressed levels from earlier this year, as our chart below shows. But the market's inflation forecast of a bit over 2% for the next decade is well short of a future of bubbling prices envisioned by the gold market.
One of these markets is wrong. Or perhaps inflation will run at a rate that's midway between the two extremes anticipated. Nonetheless, it's hard to ignore the fact that there's a fair amount of conflicting signals about 2010 and beyond. Inflation is just the tip of the iceberg.
With all the major asset classes rallying sharply this year, as we noted yesterday, the possibility for disappointment is alive and kicking. The fact that the crowd thinks otherwise only strengthens the case for thinking that a fresh round of volatility may be coming.
December 1, 2009
NOVEMBER WAS NO TURKEY
Reflation was alive and well in the financial and commodity markets last month. Although November’s rally was well short of the best months this year, no one’s complaining. After nine consecutive months of upward momentum, interrupted only briefly among the major asset classes, 2009 is shaping up as one of the best calendar years on record.
As our chart below reminds, the year-to-date tallies are impressive. By any standard, it’s been a stellar year. Barring a wave of selling this month, risk premiums are on track for results that seemed impossible as 2009 opened.
The trend has definitely been our friend in the cause of rewarding risk. Momentum is king, at least for the moment. The big winner so far is emerging market stocks, which have surged by nearly 70% this year through November 30. Junk bonds are also posting unusually large returns. The laggard, of course, is cash, which is just about unchanged on the year.
The connection between return-less cash and outsized gains in risky assets is proceeding according to plan. The Federal Reserve has engineered the party and so far everyone’s enjoying themselves. The powers of easy money are feted the world over as we write. And that’s what worries us. No, we’re not expecting any sudden change of sentiment in the crowd. In fact, we’d be surprised if the upward momentum doesn’t roll on into the new year.
For now, however, the party's swinging. Enjoy. But don’t become too distracted. Expected returns fluctuate, which reminds that the midnight chime may yet turn our gilded carriage into a pumpkin.