A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Sunday, July 31, 2011

Transcript 451: Extreme Economic Weather

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The whole Lancelot v. the Black Knight debt ceiling production ran into trouble last week. You have to wonder what they’re making of the news in Washington and on Wall Street. All this orchestration, set design, sound design, lighting, costumes, staging. It was up and running to record audiences, if not rave reviews, and then the lights go out. Yikes.

People spill out of the theater into the real world and find extreme economic weather. Unemployment at 9.2, and the heat index is now 16.2 (the all-in U6 measure). Then the revised drought reading comes in. GDP is worse – far worse – than has been reported. Real GDP was 1.3 for Q2, but it was a miserable 0.4 for Q1, AND it was revised downward for the past fifteen quarters. So if you thought it was worse than advertised, you were right. The shape of the curve after revisions to GDP now tracks almost perfectly the public works and state support portions of the stimulus. That irrigation project was all that was supporting a meager crop. Now its gone, piped off to freshen the pools of the corporate elite.

A troubling change in the barometric pressure has occurred that may have been overlooked with the other bad news. PCE, personal consumption expenditures, is now below the Real GDP line. By which I mean growth in PCE is now below growth in Real GDP. During the faux recovery period it was above. This is a tornado warning. A little dry lightning and we’ll have a serious wildfire. Bad news for preparedness: Not only has the water gone off to the pools of the oligarchy, but Congress is selling the fire trucks for scrap to pay for the renovations on their mansions.

Is Demand Side rushing in with fresh fears of catastrophe? No. We’ve been here all along. It may be that we want to keep leverage on the rest of the field, making sure nobody is more gloomy than us. Nobody in the business, that is. Obviously a great number of real people have been aware of the real economy. But if you think our alarm is new, please review past episodes. By the way, if the PCE slash Real GDP cross needs clarification, there is a chart online, and another descriptive chart from the blog Worthwhile Canadian Initiative describing the downward revisions to GDP.

It might amuse you to check out the Big Guys’ forecasts over the past seven months. Their attempts to finesse their upside Q1 misses, when they said 3.5 percent and it turned out to be 1.9, now look a little like the toga dropped, since the latest number is a fraction of that at 0.4. Don’t miss the confidence in their voices a couple of months ago when they assured us that the second half is sure to be better than the first.

Not going to happen. The economy operates from the demand side, and they’re in the process of dismantling demand with austerity and threats to social insurance.

Meanwhile, back at the theater, the politicians and Wall Street forecasters are filing out the stage door and beginning to work out how they’ll play in the park, outside, no special effects.

This is not really where we intended to go today, which was into commodity and financial markets, but in tangent to this let’s indulge a return to another question, one we posed earlier in the year, a political question:

What happens to the Reactionary Right if a second leg down in the Great Recession occurs just as they are flexing their obstructionist muscle? Not exactly the best political time to be caught on camera in your robes and torches. Do we really have to endure another verse of “Cut Spending, Lower Taxes and Re-Deregulate?” Won’t that be a little much even for the Fox News junkies? Maybe not. Maybe the Democrats’ rush to the Right will put them in the same frame. And maybe it’s all Obama’s fault for not doing more to stop them. At least THAT would bring everyone up on the same page. Demand Side would be on that page.

On the other hand, maybe the Democrats get a 1932 election. Obama comes out in new costume. No longer Herbert Hoover, now FDR. Maybe we get started on a real recovery. The climate change war is in the wings waiting to appear as World War II magnitude societal mobilization.

Okay. Enough theater. Now casino. What we wanted to talk about today was commodity and financial markets.

One of the things we expected to see when we came out of the woods last week was an oil price in the 80s, if not lower. We had argued that 2011 was a repeat of 2008. The first part of the year would see a commodities bubble that would collapse in the second half. True, cheap credit – an essential ingredient for a bubble – would continue to be available for market players, courtesy of the Fed. But the capacity of a reeling economy to pay, and thus to validate the increasing pressure, was more limited than in 2008. Oil and commodity prices would peak and fall and continue to fall, we said. But the trigger of a second leg down would have already been tripped. What we found was the drop had been halted.

A second market mystery to us: Why no reaction in bond and stock markets to the hysteria dome that has engulfed D.C.? The fundamentalist zealots are hell bent to fulfill their prophesy that government is the problem. Every other segment of the society forced to watch this has come away shaken and fearful. Somebody said on Bloomberg that a downgrade from one of the Cleuceau-like ratings agencies would cost U.S. taxpayers more than $100 billion. But the segment that has most to lose, the bond investors, has reacted with a suppressed yawn. Or so it seems.

Why are these two markets behaving like this?

Oh yeah, we forgot to mention, commodity speculation kills. According to José Graziano da Silva, new director of the UN’s Food and Agriculture Organization, the major cause of suffering in the world is hunger and the major cause of hunger is high food prices. Those high prices are fueled in the short term by speculation. In the long term it is the inability of Third World farmers to compete against the massive agriculture subsidies endemic to the U.S. and Europe. AND investment in commodities is speculation. Commodities are the products of legitimate investment and business activity. They are not investment vehicles.

Commodity prices have long since left the realm of supply and demand and legitimate hedging. Our current hypothesis is that when the smoke clears, you’ll see ETF’s and the Wall Street trading algorithms directly in the middle of the mess. The initial peak in prices fell as it should have in a bubble. We suspect prices have hit this strangely rhythmic choppiness, on account of lots of money needing a place to find a return and lots of players are ready and able to try new strategies. At a minimum, it is the error of believing real things like commodities are going to hold value.

Now quickly on to the bond markets. What does it mean that the bond vigilantes punish Italy and Greece and the like and don’t punish the U.S.? The price signal for fiscal profligacy is clear in Greece, but in the U.S. there is no price signal for absurd governance. If your school says markets are rational and efficient, you need to answer this question before you pass.

To us it is the same reason you make your ransom payment in any country in the world in one hundred dollar bills. The dollar is liquid. All the paper gains around the world are running to the dollar. Liquidity. It is an aspect of the liquidity trap. In this case, like the trap under your sink.

Real assets are deflating -- strip malls, office towers, warehouses, older manufacturing or assembly facilities. It may be that the CPI is above zero – prices for consumer goods. But prices for capital goods must be falling. The value of these is a function of the expected return from the stream of their product. Demand and sales are down. The expected return from sales is down. The price of the capital good must be down. Corporations don’t hire people and expand to make stuff these days. They keep their cash on their balance sheets, or use it to nudge up the dividend and hopefully the stock price.

Short form.

Commodity markets are now tables for speculation. You can’t get yield by investing. You have to speculate. Treasury bonds are stable because they are close substitutes for hundred dollar bills and you get a little interest. Investors won’t use the price signal. To get their message out, they’ll have to depend on the whining talking heads they have in such abundant supply.

Sunday, July 24, 2011

Transcript 450: Real Recession Continues as Political Theater Distracts

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Returning from our three and a half week retreat we expected to see more difference in the economic landscape than actually met our eye. Unfortunately, the political theater is in summer reruns, and nothing of substance has really changed, which means things are getting worse.

The debt ceiling debate has everyone else focused, and I suppose it is possible that disaster might be allowed to happen. After all, it is real fire they are playing with up there on the stage. Many otherwise intelligent people are absorbed in the show. To us the time for fiscal responsibility was when we were making our purchases, not now when the credit card bills come in the mail.

The great crime to us is the madness of austerity, which has overtaken both sides, it seems. So high drama or not, the current game of chicken is not very interesting. It’s like we have become fascinated with a schoolyard shouting match and failed to notice we are standing in the path of a runaway bus.

What is most the same is that we are still claiming to be in a recovery. Once again, as an economic recovery denier, Demand Side has the shorter story to tell. Disaster was delayed, but not necessarily avoided, by a tremendous government intervention in financial markets and by huge federal deficits. Now we are bouncing along the bottom with big and growing downside risks.

NBER, the National Bureau of Economic Research, made the longer story necessary for others by officially calling an end to recession and the start of recovery now more than two years ago. At a minimum, the phrase, “but it doesn’t feel like a recovery,” must accompany any comment or analysis for it to be taken seriously. A fuller and more honest version includes the interesting fact that the recession continues in employment, where we are leveling out at five percent below the peak nearly three and a half years ago. Employment is two-thirds of the economy. This is a level of loss unseen except for one quarter in 1949 when we were transitioning from wartime to peacetime. Construction and housing continue in recession, another footnote sometimes omitted, never mind that housing has led every single recovery – other than this one – in the postwar period.

No. the only recovery in sight has occurred on Wall Street and on corporate balance sheets. It’s a curious thing that markets continue strong in spite of the bad economic news, and perhaps odd that they don’t seem worked up like the rest of us by the preposterous debt ceiling play inside the beltway. But if you think corporate profits, stock and bond prices are the definition of a recovery, then I have a trillion dollars worth of mortgage backed securities you might be interested in. Actually, the Fed and Ben Bernanke already bought them. But I have a good used bridge.

Summarizing the data, courtesy Calculated Risk’s chart gallery.

• More months of jobs have been lost in this great recession than in all other postwar recessions combined. Absolute. Even in percentage terms, we are sure to achieve that amazing mark before we’re through. More months of jobs will be lost in this … downturn … than from all other recessions – all ten others – combined.
• The official unemployment rate has been above 9 percent except briefly since spring 2009. Only the Reagan-Volcker Recession of 1981 produced higher unemployment numbers, and then for a shorter period of time.
• The employment-to-population ratio is four points off the start of the recession and is not recovering.
• The average duration of employment is astronomically high. Over six million people, more than double the number ever before, have been unemployed for more than 26 weeks.
• New home sales have been at all-time lows for more than a year and in depression for more than three.
• Housing starts, of course, same story.
• Mortgage equity withdrawal added 8 percent to demand in the boom years 2003-06. Now it subtracts nearly 4%. That’s a 12% change to the downside.
• Percentage of equity in homes? Used to be 60%, now below 40% and falling
• Multi-family starts bounced off historic lows. Completions continue to fall.
• Ah, good news, apartment vacancy rates falling, market tightening.
• Private construction spending on non-residential projects, in the tank.
• Architecture Billings Index, in contraction mode and falling. Never recovered from 2008.
• Commercial Real Estate prices have fallen further faster, but also somewhat later, than residential prices.
• Office vacancy rates, no surprise, stuck near the historic highs of the early 1990s.
• Mall vacancy – both strip and regional malls – historic highs and rising.
• Investment in offices, hotels and shopping facilities – quelle surprise – low and falling.
• Manufacturing: Capacity utilization below 75%
• Industrial production at 2004 levels, still 6 percent below the previous peak.
• Small businesses: Optimism, low and falling
• Hiring plans low
• Poor sales as the biggest problem, still well above any pre-recession number.
• GDP: 1.8% for Q1. Stagnant at a low level. Demand Side forecasts GDP falling to negative in the second half.
• Ah, more good news, equipment and software investment is up, as corporations take advantage of tax concessions to automate their operations.
• PCE, personal consumption expenditures, inflated by high oil and food prices (cutting into stagnant incomes), but now falling.
• Real personal income now well below the pre-recession levels.
• Real GDP barely back to the pre-recession level of 2007, per capita GDP down down down, as four years more of people are splitting up the same GDP.

But how can you tell for sure we’re not in recovery? The deficit. It is huge and rising. Not a recovery story. We need jobs as in direct jobs programs. We need a recovery in housing and household balance sheets as in renegotiation of principle on mortgages. We need stabilization of government services as in direct aid to state and local governments and remediation of infrastructure.

Maybe we’ll remember the debt ceiling fight as the cause of our hospitalization, but our physician might point to collapsing aggregate demand. As Robert Reich said recently,

For thirty years now we've been hearing from Supply Side economists who say that if we reduce tax rates on the rich and on corporations and keep the cost of capital low, we'll get more jobs and growth, and the benefits will "trickle down" to everyone else. Well, we've tried the theory out, and little or nothing has trickled down.

Tax revenues are now 15 percent of the national economy. That's the lowest in sixty years, and capital is cheaper than ever. But the economy is going nowhere.

Can I be blunt? It's the demand side, stupid.