consumer confidence

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Consumers Swoon; Inflation Flat; Weak Weekend

The flow of weak data continued this morning and leaves us all with plenty to ponder over the weekend: the economy may well be headed out of recession as inventories are adjusted, but beyond that the horizon is murky to say the least.

The theme all week has been the abrupt ebbing of forward momentum and today’s news that consumer confidence fell in July – the index dropped to 63.2 from 66.0 – merely reinforces a worrying trend. The consensus prediction among analysts had been that the index would rise to 69.0, so obviously plenty of people have been carried away by the hoopla over recovery rather than getting a solid read on the underlying factors affecting consumers.

Wall Street analysts are perennially optimistic and tend to see a bright future on the basis of the slightest break in the clouds. This is what has happened over the past two months. As all the data started to suggest that the economy was no longer in free fall Wall Street immediately rushed to the conclusion that it would adjust back to normal quite quickly. Hence the run up in stock prices that seem to be based upon profit projections unrelated to where business is today.

I would urge caution.

While it is very clear that the economy has started to level off and is no longer imploding at the rate it was last year, we remain very far from a sustainable recovery. On the contrary the turn around has all the makings of being a ‘technicality’ rather than a ‘reality’.

Consumers seem to agree.

Dark clouds are hanging heavily over consumers: unemployment is the leading issue, and there seems to be no prospect of job generation in the next few months. Home prices are devastated which has destroyed many people’s savings – home equity is a false measure of ‘savings’ but many families fell into the trap of believing it was secure. And even those who are still employed are facing shorter work weeks, lost benefits, and reduced wages. This is not a recipe for rapid recovery. Indeed it may not support recovery at all.

Prices reflect this weak activity.

The Consumer Price Index was flat month on month in July, which was about what everyone had expected. Food and energy prices fell sufficiently to offset increases elsewhere, especially in health care costs. Unfortunately the CPI has now fallen 2.1% since this time last year, which, while not unusual in a recession, is not a trend we want sustained for long: the threat of prolonged deflation is too damaging to be viewed without alarm.

The enormous slack in the economy provides businesses with no room for price increases; commodities are generally in good supply relative to the now low levels of demand and so their prices are not under great pressure; and labor costs are still falling. All of which suggests that prices will be quiescent for a while longer.

Overall I doubt inflation is a concern any time soon – until well into next year. This is despite the huge flood of money that the Fed has pumped into the economy over the past year. Most of that extra cash is now sitting as excess reserves held by banks at the Fed – it hasn’t found its way into the economy by way of credit growth. As long as that cash sits in the vault it represents no threat of inflation. But nor does it help us re-ignite growth. The Fed’s dilemma next year, or maybe in 2011, will be how to suck that cash out of the economy so as to prevent sudden uptick in prices.

You will read plenty of panicky stories in the financial press about the risk of inflation stemming from the enormously lax Fed monetary policies of the last year – pay them little or no heed. The people who are now worried about inflationary expectations driving up long term interest rates are ‘fiscal hawks’ – they are not focused on the depth to which the economy has plunged and the gap that has now opened up between actual activity and potential activity. My advice is to focus on that gap: until we have worked off the slack in the economy, that is until factories are humming, jobs are abundant, and workers are hard to find because they are all employed, inflation will be a theoretical rather than actual threat. Over a five year horizon I see rising inflation along with rising taxes to rein in fiscal deficits. Over the next two years though I don’t see inflation as much of an issue – not yet anyway.

So the week ends on a weak note. The optimists still cling to a vision of a recovery sufficiently robust that it self-sustains and thence accelerates. My view is that the recovery is less secure: until consumers are a firm footing with debts well covered, jobs safe, and wages growing, the economic engine will continue to sputter. As I reported yesterday: the entire GDP growth later this year can be attributed to the effects of the stimulus and an inventory correction. This means that the private sector is falling well short of the kinds of activity we need for a sustainable recovery to emerge.

This really does have all the makings of a jobless recoveryso we may well need more stimulus this fall.

The prospect for that is not good. Let’s hope that the next few weeks brings a turn about in consumer sentiment. Then we can look forward to 2010 with more optimism.

Addendum:

A brighter note:

Today’s release of real incomes shows a slight uptick in weekly wages from June to July. The growth came entirely from longer work hours as factories increased output to restore inventories. This is exactly the kind of impetus that the more optimistic analysts use when they forecast a self-sustaining recovery taking hold later this year. This evidence supports their case, let’s hope it continues.

More interesting in today’s report is the fact that wages increased 0.1% from July 2008 to July 2009. This looks very poor until we factor in the drop in CPI I mentioned above. Take the two together in order to arrive at inflation adjusted incomes, and real wages – which in theory are the measure we should be looking at – rose a decent 3.5% [ don’t add the CPI to the wage growth number: there is a separate CPI-W for wages, which deflated a little more than the overall number!] . This provides some extra hope that consumers will start to feel better about the future.

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Today’s News: Home Prices and [Lack of] Confidence

Two pieces of news were released today: the Case Schiller Index of home prices, and the Conference Board’s consumer confidence survey. The message: very mixed.

The good news is that for the first time since 2006 there was a slight increase in home prices across the country. Prices in the twenty city index rose 0.5% in May, the latest month covered, compared with a 0.6% drop in April. This slight pick up had the effect of slowing the annual decline: for the year ending in May the same index shows a decline of 17.1%, whereas the decline for the year ending in April was 18.1%.

The message here seems to be that the bottom of the housing price cycle may not be too far away. Whether there are one-time effects at work distorting the figures we will have to wait and see next month: for instance, the activity created by recent tax credit for first time home buyers may have produced a slight firming in prices. Nonetheless when we add this data point to the decent new home sales figures yesterday the overall tone of the real estate sector does seem to be improving. This is a long way from a recovery – and there are plenty of reasons to hope we don’t get back to the way we were a few years back – but at least the dizzying descent appears to be drawing to a close.

That is not the message we get from consumer confidence which dropped unexpectedly last month. The index now stands at 46.6, whereas it had been 49.3 in June and 54.8 in May. So clearly there has been a significant souring in the public’s mood over the past two months. The importance of this is clearly linked to consumption: as long as consumers feel less confident they will tend to spend less. That will undermine any incipient recovery.

In all likelihood we will see the end of the recession later this year for the simple reason that inventories will need replenishing and that drives GDP upwards – just as any investment does. Whether there is enough activity to maintain growth into next year is now the question. The optimists are still calling for overall GDP growth in the 2% range during 2010, a series offadingconsumer confidence figures and we have to question that optimism. With real estate investment unlikely to recover much strength, and with businesses still waiting for stronger signs of consumer activity before the commit to re-hiring the best guess for GDP next year is slow – perhaps closer to 1% than to 2%. That will have all the hallmarks of stagnation: a poor employment market along with very low growth.

We really need the employment picture to change quickly if we are to avoid such a stagnation. It is very hard to see why consumers would suddenly start to spend much again without a decent job outlook.

Anecdotally the stimulus is now kicking in by stemming job losses, and we are getting the first proper analyses supporting that view. If that turns out to be a true trend then the hope is for the rising tide of job loses to taper off later tis year. Unemployment will still keep rising, but the damage to consumers will abate as they realize they have weathered the storm. Once the tide turns in the job market the rest of the economy can fall into place.

We will get a better handle on that later this week with the weekly initial claims data. Then on Friday we will get our first look at second quarter GDP, which should come in around at a decline of 1.5% – the first quarter saw a decline of 5.5%. If that is the case then this will be a rare four quarters in a row of decline, but it will also give us hope that the third or fourth quarter will see a return to growth.

Stay tuned.

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Weekend Round-Up

What did we learn this week?

  • That unemployment is going to be an intractable and long term problem. The free-fall phase of job losses seems to be ending, but the outlook for re-creating the lost jobs is very bleak. Frankly the sources of new jobs are still shrouded in mystery: the two strongest employers of recent years were construction and finance, neither of which appear likely to be generating huge demand for employees over the next few years. As long as employment lingers in the doldrums there is no way a recovery could be sustained. A ‘jobless’ recovery would be a very difficult problem to resolve because the political will to stimulate growth may be absent, yet the discontent amongst voters would be high.
  • Banking profits were generally stronger, but the details revealed near term difficulties. The administration has taken a very passive approach towards dealing with our banking problems. Yes they has spent a fortune on bailouts, but they have done very little to prevent a recurrence of the problems – just look at the Goldman Sachs bonus pool and you can see the source of our next bubble: the traders are on the loose again stacking up private gain knowing that the taxpayer will bail them out. Worse: buried in those bank earnings reports were the first signs of the commercial real estate debacle about to unfold. Our banks are not fixed yet by any means.
  • Ben Bernanke went to Congress to report on his ‘exit strategy’ from the extraordinary monetary stimulus the Fed has been providing. The bond market appears to have been soothed by his words. But he promptly ran into a political ambush: the Republicans all wanted to question him about the fiscal stimulus. They obviously were trying to get him to say it wasn’t working, and he was forced to be obscure in his responses, which, of course satisfied no one. As if that wasn’t bad enough his own position comes up for renewal next year so the rumor mongers are hard at it talking up possible replacements. Which has the effect of undermining his credibility right when we need him to be viewed as safe for the long term – those bond markets like continuity. He also managed to get into an open spat with Tim Geithner over financial reform: Geithner wants to be a little more aggressive and wants a new regulator to oversee consumer finance. Since such a new regulator would imply the Fed screwed up on mortgage oversight, Bernanke pushed back saying we didn’t need such a thing. Hey guys: there’s an economy to fix, just stop the bureaucratic infighting. Oh, and by the way: Geithner is right on this one.
  • Real estate perked up slightly. But it was a very ‘iffy’ report that suggested there was an improvement. The weight of foreclosures still hangs over home prices and will exert downward pressure for a while. The upward blip in sales reported this week can be explained by first time buyers exploiting one-off tax credits and ‘bottom feeders’ snapping up foreclosed houses at bargain prices. The vast middle and upper prices market is still in the tank and will remain there while sellers refuse to adjust to the new reality of lower prices. Plus, as I have mentioned, unemployment will keep many buyers off the market while they wait for more secure times to return.
  • To reinforce this point: consumer confidence slipped last month after having shown improvement in both of the prior two months. Clearly the notion that this is a long slog is beginning to settle in. Consumers are, at last, getting the message that there is no ‘silver bullet’ to resolve our crisis. The media reporting of ‘green shoots’ may have created an illusion that we were about to burst back sprinting: the bank crisis had faded from the front pages and the stimulus had been passed, so there was an expectation that a recovery and thus the ‘good times’ were just around the corner. No one viewing the data with a sobriety would have thought that, but the media has a short term focus. My fear is that the wrongheaded upbeat tone of May and June is not supplanted by an equally unnecessarily gloomy tone in July and August. This was always going to be a long fight. And its only just started.
  • Finally: it was a very bad week for economists. The internal fighting over the future of economic theory has burst onto the front pages. Several influential articles were printed this week, e.g. in the Economist and the Financial Times, over the collapse of consensus in economic theory. Some of us have been saying for years that there was no consensus, but now the ‘free marketeers’ have taken it on the chin even their friends in the media are chiming in and saying that free market theory sucks. From my point of view this is a welcome turn of events. But from a policy makers point of view the timing couldn’t be worse: with the ‘free market’ extremists of neo-classical economics now exposed as ideologically motivated and theoretically flawed the source of sound economic policy advice seems to be Keynesian. That incites the neo-classicists into apoplectic fits and forces them to write ridiculous op-ed pieces as a form of rebuttal. All of which causes even more confusion for both the public and politicians. But it’s great fun for those of us in the discussion.

Meanwhile the health care debate chugs on. I will leave you with a reference to today’s Financial Times, hardly a bastion of left wing or socialist thought, which argues that reform is not just necessary but vital. I couldn’t agree more. There are two issues that could cause the collapse of the economy in the medium term:

  1. The financial industry’s power and lack of control; and
  2. The huge cost and massive inefficiency of health care.

Ultimately we will be forced to reform both, because the status quo is simply unaffordable. Neither sector is serving us well. Both are making excessive profits and therefore extracting economic ‘rents’ which burden us all. Neither is remotely efficient. And either could destroy us.

To me health care is both a moral problem to be solved: I find it an abomination that the world’s richest country blithely ignores the health care issues of its poor; and a practical problem to be solved: we simply cannot afford the current system.

Either way reform is an imperative.

From where I sit any opposition to reform has to be based on a self-interest that is willing to jeopardize the economic welfare of the country. Those who oppose on the grounds of cost have yet to justify their support of the Bush tax cuts which cost us a lot more. Or they have to explain why every other country can afford something we cannot – are those foreigners simply better managers than we are? Or they have to justify why society should bear the costs of an immense and duplicative bureaucracy, one which offers, apparently, no offsetting advantage in terms of output.

It is a simple fact that our system is in the process of failing – wages are much lower, and the cost is out of control as a result of it.

It is also a simple fact that the free market cannot fix this problem. For the ‘market’ to work the incentive structure has to be transparent and obvious to all. This is not the case with our health care system: consumers of services do not bear the cost, so they have no incentive to demand better or cheaper service. So the producers of the service have no incentive to improve. On the contrary producers have every incentive to extract excessive profits by over-charging and over-prescribing, safe in the knowledge that their customers are not bearing the true costs of the service. Nor is there any pressure to improve outcomes or incentive to link costs with those outcomes.

In short health care in this country is a textbook example of the failure of a market.

For those of you who are aghast at the notion of a government run system, look at it this way: if you truly believe in free markets then pay the full cost of your care. All of it. Not a tax affected rate. Nor a subsidized rate. Pay the full cost. Right now that’s in the range of $15,000 per person per year. That’s before any service of course. Buy the insurance the way you buy car insurance: directly, not through an employer who masks the cost from you because they get a tax deduction [ By the way that tax deduction costs the taxpayers about $1.3 trillion a year or more than the cost of public health care for all]. Plus: accept the full consequences of a free market style insurance regime that will necessarily, for purely and sensible, profit motivated reasons, exclude anyone with a known illness or the aging since both those groups are loss makers for the profit system. Plus: accept that a free market system rations the sale of goods via a price mechanism, so there will always be some people who are too poor to afford coverage. Plus ask yourselves why it is that we as a nation do not ‘care’ about those who could not access a free market system.

Ultimately we have to learn that health care, like fresh air and clean water, are a ‘public’ good not a ‘private’ good. We all need to know that our fellow citizens are healthy so that we are not exposed to risk of disease from the uninsured. A sick person can impose a cost on you, so you may be forced to bear the cost of that fact that sick person had no health care. That disconnect between cause and effect is what makes health care a public good. The economic theories of the free market cannot deal with such public goods: they call things where the cost of something is borne by someone other than those consuming the goods or services ‘externalities’. The free market system is known to fail for externalities. Which is why the government has to step in.

But that’s enough for one week!

Enjoy the weekend everyone.

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Mixed News

This morning brings more data to support the notion that the worst is behind us. But along with it is evidence of the long road ahead. In other words a typical day for this point in a recession.

  1. First the good news: consumer confidence, as measured by the Conference Board,jumped quite strongly last month and is now back roughly where it was in September last year. So the glum despondency of the winter months has been lifted. Maybe it’s the prospect of summer? The rise in the confidence index, from 40.8 in April to 54.9 in May, caught most people by surprise and is the fourth largest one month jump in the index’s thirty-two year history. Notably respondents told the survey compilers that they thought jobs were easier to come by than last month. That seems to be more aspirational than factual, nonetheless sentiment will play a key role in resolving our economic ills, so even this will help if it causes people to spend more freely. Still, we should remember that, at 54.9, the index is still very low by normal standards. Readings in the 70’s are more healthy, so we obviously have a very long way to go in order to find consumers truly breathing easily.
  2. Second: today’s release of the Case-Schiller home price index confirms that house prices are still falling across the country. The index measures home prices throughout the nation and particularly in the top twenty metropolitan districts. All of those twenty districts saw price declines in March, which is the latest available data, with Minneapolis showing a 6.1% drop, the largest ever in any area. The month-to-month price decline was 2.2% nationally, more than anyone expected and shows just how difficult unwinding the housing bubble is proving to be. In fact the year-on-year decline was 19.1%, a record. Sellers are still hoping that the vast inflationary windfall profits the bubble brought them are not going to evaporate entirely, so there remains substantial downward ‘stickiness’ in pricing. It seems difficult for property owners to realize that their gains were on paper and a product of inflation only: selling for ‘less than the home is worth’ is still a common mantra amongst disgruntled sellers. Cities like New York are still experiencing rapid declines – last month’s decline was the largest ever for New York and Detroit – and the backlog of unsold homes will only contribute to the continuance of that trend. Even with mortgage rates at historic lows activity is very poor, with most of that action on distressed properties.

So the news is very mixed. The consumer confidence data points to a possible uptick in spending later in the year. But the housing data is miserable and will cast a long shadow for a while yet. Couple this with the facts that unemployment is still rising, albeit less rapidly, and that foreclosures are still rising as more and more people experience difficulties after a job loss, and the prognosis is still guarded.

All the evidence suggests that the recession will end later this year, but the outlook for next is very weak. The optimists look for things to snap back to normal levels of growth – somewhere between 2.5% to 3% for 2010 as a whole. I think that is too high. The combination of stubborn unemployment levels above 9% next year, and the continued need by most families to reduce their debt levels, doesn’t leave much room for a strong recovery in spending. Add in the weak outlook for business investment and exports and a more likely prospect is for to grow only a little over 1.5%. Given that the population will grow more than that, the implication is that wealth per person will actually fall next year.

That’s not a strong recovery by any means.

We will have to wait until 2011 for strength to re-appear across the board.

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