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US House Prices Slip Again

There was considerable doom and gloom this morning after the monthly Case-Shiller index report showed further slippage in home prices in the top twenty cities of the US. The latest figures are for October since gathering this data takes a while, and show a national dip of 1.3%, which represents a small acceleration of decline from September’s 0.8%.

Looking at the details it is immediately apparent that the downturn is national and not local. Every single one of the top twenty cities saw a decline with the least decline being in Las Vegas and Washington DC, where prices dropped only -0.2%; and the largest drop being in Atlanta at -2.9% and Detroit at -2.5%. Further, the only reason the index bounced back from its 2009 lows to the extent that it did, appears to have been a temporary recovery in the worst hit housing markets, and where the temporary first time buyer tax credit had most impact. Several other markets, such as Atlanta, Charlotte, Seattle, and Portland [Oregon], never had a break in their declines and are now at new low points.

Clearly housing remains in very weak condition. Prices will remain under pressure, with the usual local exceptions, until normal inventory levels are reached. Year over year sales are well down, by about 25%, while unsold inventories have ballooned by upwards of 50%. Throw in the turmoil surrounding foreclosures and delinquency rates on mortgages and the picture remains ugly. It is no wonder that housing starts are at thirty year lows and show little sign of recovery.

All this adds up to a continuing grim outlook. Whether the breathless talk of a threat to overall economic growth is justified is questionable. Such talk depends on an interpretation of the central role of housing in the consumer market. If a resumption of a decline in home prices puts more stress on household expenditure, as some claim, then it could undermine the general recovery. As we have just seen, consumers came out in force during the holiday selling season and pushed retail sales up at a rate not seen for years. Depressed home prices could – only could – cause this uptick in consumption to stall. It all revolves around whether the average household has now factored in a lower home price as part of its overall financial situation. If so, then as long as further price declines are not too severe, the damage will be contained. But if prices drop by a larger amount, say another 10% or so, then the depressing effect could be large enough to drain demand from an already demand deficient economy and undo much of the good work done hitherto.

I tend toward caution at the moment. I continue to argue that real estate is still overpriced. In some markets prices are still way inflated above their 2000 levels and look ripe for more decline depending on local income and other conditions. For instance, one reason New York prices declined less dramatically, and are still at 171% of their 2000 levels is, obviously, the impact of all that banker bonus money flooding the area. Whether it stays that way over the next few years depends on attitudes towards those bonuses.

In general a good rule of thumb, and that’s all it is, is that a home is worth about what it would have cost in 2003. That still leaves the bubble based inflation between 2001 and 2003 vulnerable to decline. Having said that, what wage growth we have seen since then supports some sort of price increase, but with the excessive inventory built during the bubble still looming in the background it is hard to tell where the bottom of the decline ‘should’ be. So if you are buying beware of overpaying. No one is quite sure where prices are based upon “normal” relationships like rent equivalency and wage to price ratios, or even whether such ratios have meaning at the moment. Clearly they didn’t during the run up in prices, and so the question is how long it takes for those relationships to re-assert themselves on the downside. I would expect some typical “overshoot”, meaning that prices drop more than “normal” ratios suggest they should because of adverse psychology and localized oddities like large unsold inventories. So the unwinding of the bubble continues apace, in fact it looks as if the downward pressure has been restored for a while longer. And if you are selling, be aware that any price you have in mind that includes gains since 2003 is a stretch.

As for the impact on the general economy: I agree home price declines might slow things down, but I doubt enough to offset buoyancy elsewhere. Most likely it adds a little drag and undoes a bit of the gain from the recent tax deal passed through Congress. I still think we will see GDP growth close to or a little beyond 3% next year. It’s 2012 we need to worry about.

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Lost Balance: Were Is The Anger?

With the steady increase in activity that seems to be characterizing the US economy currently the early frenzy of placing the blame for our crisis is ebbing. Already we are being treated to “year end” articles calling people such as myself, those who view things a little more skeptically, unnecessary naysayers. The improvement in the general economic numbers now being reported is being used as a vehicle to justify yet another round of optimism and good news stories. The market, we are told, is poised for a banner year. With profits on the up, and Wall Street back on its feet, 2011 has all the makings of a good year. So, apparently the skeptics were wrong, and their mediocre forecasts failed to take into sufficient account the remarkable resiliency of the great American money machine. Our problems, we are told, are now more those of mopping up the mess, rather than worrying about sinking under its weight.

Well, I don’t care much about profits. Not unless they are put to good use. Corporate profits have seen banner times in America for over a decade. Shareholders may have been buffeted in the downdraft of 2008, but they have either been bailed out directly by the government or they have benefitted from benign government policies ever since. They can have no gripes at all. Cash is piling up in corporate coffers. Profits are back with a vengeance.

So what?

I care about the general economy, and about rusty boring details like wage and job growth. I care about opportunity. I care about balance. In that context the economy is still festering. Indeed without endless government support there is little evidence that it would yet have recovered much at all. But above all else I fear that the great recession will simply reinforce the pre-existing trends dividing the country between those who have an advantage and those who are left behind. That divide shows up in the enormous income and wealth inequalities that now bedevil society, and the huge discrepancies in expectations now reasonable for the mass of middle and lower class families, and those of the privileged above them.

To this extent I think that the generalized numbers are masking something important. Something we should be angry about, but aren’t. The steady separation of the economy into two distinct economies, one of the rentiers and capitalists and the other of the average workers, is getting more stark every year, and the gap may well have opened even wider with this crisis. Which is really infuriating, to me at least, because it was the folly of financiers that brought the crisis upon us.

I am struck by the constant marginalization of anyone who dares talk about inequality as a core subject for economic discussion. Orthodox economists, or at least the less thoughtful, simply treat inequality as a side product, or after effect, of the workings of capitalism. Periodically the media produces an article or two talking about the income gap that yawns wide nowadays, but they quickly move onto more acceptable mainstream topics like inflation or interest rates, as if the only grown up subjects to discuss are what ails the market.

The New York Times produced such an article recently talking about the pay of “super stars” and how it distorts incentives. Buried in the article, and treated as a minor rather than the main fact, was a revealing statistic. America is less upwardly mobile, in terms of wage earning opportunity, than any other large industrial nation.

Think about that for a moment.

This is the self promoted “land of opportunity”. A very large component of the “American dream” rests squarely on the notion that the US is the place to be if you want to profit from hard work and industrial innovation. Old Europe, in particular, is derided as sclerotic and inept at providing such opportunities. So why is it that a lower wage earning European has a much higher chance of moving upwards than a similarly placed American?

Capitalism.

The more naked the capitalism the more unequal the income. This we all know. What we have ignored is the social corollary: the more naked the capitalism the more rigid the society. Let’s set aside the failed alternatives: we could debate endlessly the merits and demerits of either socialism or communism. I do not intend to, I have a natural distaste for all solutions to problems that rely upon idealistic assumptions about human behavior. There is too much contrary evidence to allow me to view them with anything other than deep mistrust. Capitalism, by contrast has no such flaw: it works exactly the way it comes advertised. It is divisive, abusive, prone to manipulation, and encourages inequality. There is no magic to it: that’s what it is. Unleash capitalism, and that’s what you end up with. Every time.

But human beings may be less rational and messy than utopian economists of either left or right would like to pretend. They, after all, are simply trying to justify their ideologically preferred social arrangement. We, in the middle, know better. We know that there are ways to mitigate capitalism without killing off its energy and wealth production. Our primary weapon is democracy.

As in income redistribution. As in progressive taxation. As in the provision of safety nets. As in affirmative action. As in women’s rights. And so on. We have a whole armory to stop the wealthy from building citadels and extending privilege only to themselves and their kind.

It’s called balance.

All utopian economic systems, from genuine Marxism through to neoclassical economics, make self serving and unreal assumptions about human beings and their behavior. Thus they all produce solutions that need to be enforced against the flow of that behavior. Because they are not based upon real humanity, but upon an idealized version of it – because they are Platonic and not Aristotelian – they also force their advocates to bend society to their wills. Thus they become authoritarian, often despite their advance intentions.

This is the great weakness now breaking the American dream apart.

The dream, such as it was, assumed a balance. It assumed that the lessons of the 1920’s and 1930’s would not be forgotten and that the economy would be managed for the benefit of all. For two or three post-war decades it was. But after the onset of the Reagan illusion and the triumph of neoclassical economic thought, balance was tossed aside as an impediment. Complacency prevented the newly minted middle class from identifying the error in Reaganism and its advocacy of naked capitalism. After all if we can read, as we do, in the introduction to basic economic textbooks that Americans are wealthy because their economy is “market based”, then spotting the error is hard for anyone not grounded in alternative economics to do.

The average American is wealthy not because of free markets, but because those markets were strongly monitored and regulated for decades. Once that monitoring and regulation was re-interpreted as the “dead hand” of government and removed, the path to wealth for the masses dried up.

So why are we not angry about this?

Because we still live within the illusion. We conflate capitalism and democracy. They might both depend on similar core principles, but they are antithetical. The one concentrates power and wealth, the other seeks to diffuse them. They may be symbiotic, but only when we have a clear understanding of their conflict.

It is only when a society enforces itself against the results of naked capitalism, when it makes sure that the elite does not rent seek, and that people like the bankers of 2007/2008 actually pay for their errors, that it can benefit from that capitalism. Every other time, as in the post Reagan decades, including the Clinton years, society will fracture along the lines we are now so aware of. The lower and middle will ossify and lose traction. The upper will scarf up ever more of the rewards.

In this context the contemporary and persistent attack on our safety net seems to me to be an attack on opportunity, and as an attack on the democratic bulwark against the pernicious effects of inequality. So every attempt top enforce austerity in order to assuage markets pains me. The benefit of austerity flows only to the elite while the cost is borne by the less privileged majority. Early industrial nations abandoned classical economics for a reason: it was designed to justify the actions of the new industrial class. In Britain, first Smith then Ricardo attacked the old world in order to foster capitalist growth. A hundred and fifty or so years later Keynes sought to save capitalism from itself by injecting the government into the heart of activity. In between the two, the severity of inequality made it evident that naked capitalism imperiled itself. It was doomed if left unattended. Yet all our current attempts at austerity cut away at what is left of the boundaries of capitalist behavior. Instead of re-estabkishing balance we are deliberately veering further away.

A long time ago I came across models of the economy built by Kaldor. One explicitly encompasses the impact of balance. The more wages take of the fruits of growth the less incentive there is for capitalist innovation, and thus growth slows to everyone’s disadvantage. And, in contrast, when profits take too much, workers become discouraged, unable to maintain advancement, and ultimately impose themselves on capital. In other words society becomes politically unstable at either extreme.

Are we there yet?

I do not know.

But I do know we are headed that way, and that textbook economics is culpable for spreading market myths far enough to help destroy the opportunity it was designed to justify. It ignores balance. It ignores reality.

Let me change my mind. I do care about profits after all. We need less, so that wages can flourish again. We need to get back into balance. Only then will the economic engine hum again.

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Economic Growth Disappoints

The latest revision to the third quarter GDP numbers produced a disappointing report. While most analysts had been looking for growth to be about 3.0%, which would have meant another slight upward adjustment, the final tally was only 2.6% and thus quite a bit short of expectations. The hope had been that growth would be picking up as we head into 2011, and that the new stimulus hidden within the recent tax deal would then catapult us higher into the mid 3.% to 4% range. Now such a spurt looks much more difficult unless the fourth quarter comes in unexpectedly strong.

The second revision to the third quarter figures released last month had shown growth at 2.5%, and with some sectors of the economy performing better than expected – sales of autos especially – many people had stared to believe the economy was in much better shape. Indeed there were rumblings that too much more stimulus would only show up as inflation rather than as real growth. Such thoughts are now to be banished. The economy is growing, but it is nowhere near growing fast enough either to tackle unemployment quickly, or to raise inflationary concerns. Instead we appear to be still stuck in a sideways crawl, like a crab on the beach not going anywhere in particular.

Indeed the pessimists might get support from the numbers. Much of the jump in growth from the second quarter, which saw GDP rise only 1.7%, was due to factors such as a drop in imports and a rise in inventories, both of which can have very ambiguous causes. Imports typically rise when the US is growing quickly as demand for finished goods and raw materials takes off. That imports fell could be an early sign of renewed stagnation. Likewise the fact the inventories continued to rise can also be interpreted as a weak sign: perhaps businesses overestimated sales and will have to cut production in order to get sales to inventory ratios back in line.

Of course there are more optimistic interpretations too. Especially for inventories. During the recession firms cut back drastically on inventories as they reduced their sales forecasts and generally hunkered down to weather the storm. As the recovery gained steam the need to rebuild inventories re-asserted itself and we saw a long and steady climb back towards more normal levels. Sales forecasts were raised, albeit only slightly, and production rose accordingly.

Obviously the key will be the holiday selling season. Early indications are that it is fine but not great. Steady as she goes seems to be the way to characterize the state of the economy.

And therein lies our problem.

We need much more rapid growth to work off the huge slack that still hampers the employment market. The longer we go without such a burst of activity the worse the situation becomes for those workers who have been unemployed for a long time. Their skills and enthusiasm will ebb, and with a hostile Congress their chances of getting more help is receding. Unusually for the US we are now, apparently, facing a very European like sclerosis in our vaunted job market. Flexibility used to be the watchword during our business cycles, with rapid increases and decreases in unemployment. The last two recessions should have warned us that our job market was getting very “sticky”, by which I mean the decrease in jobs took longer to reach bottom, and the recovery took much longer to re-absorb the unemployed. This cycle has been even worse. It truth it has been awful, not just in its severity, but in its stubborn lack of improvement. This more Euro style cycle is unnerving for America where the Euro style safety net does not exist, and old fashioned puritanical attitudes toward the unemployed resurface very easily. This comparative weakness in our safety net programs was all well and good when we had a youthful and dominant economy. Clearly the economy has moved on. Unfortunately our political thinking has not. It may take a few years of suffering for us to realize that this was not just another cycle, but was the end of a long term decline that we now need to arrest and address.

Which leads me to this:

I have said it many times, but it bears repeating, healthy economies and healthy societies do not privilege one part over another for long. They seek and try to maintain balance. During the 1950’s and 1960’s the US managed to locate a mother lode of wealth by staying in such a balance. Profits, wages, productivity, and wealth moved in a harmonic trend together. Neither wages nor profits soared at the expense of the other. Higher wages fed sales which created higher profits and so it rolled on. After the Reagan illusion set in and the economy shifted towards debt based growth and short term profit gain at all costs, the balance was lost. Or rather it was deliberately thrown overboard. The new generation of managers and politicians, steeped in Friedman and Hayek, tossed away any notion of social cohesion whilst in the misguided thrall of free market dogma. The result has been the steady rise in inequality, profits reaching record levels while wages stagnate, and the substitution of debt for equity at both the household and business level as the cost of keeping decent growth in living standards became ever more difficult. Our post 1980’s leaders formed an educated elite who drove home the advantage their education wrought. The bulk of the rest were left way behind.

This asymmetry eventually eroded the economy’s ability to self generate wealth in a steady even stream. Instead it became susceptible to Minsky like financial cycles and thus inevitably to implode. Bank caused bubbles are the new norm. The rentiers cling to their privilege by offloading the cost of recovery to the taxpayers who are now underrepresented within the halls of power. To belabor the blame due Friedman and Hayek: we were indeed “free to choose”, but we were led along the “road to serfdom”. A populist reaction was inevitable, and the Tea Party seems to be its first manifestation. People will lash out even if they lash out in the wrong direction, as they have done this time.

Free markets just don’t work in complicated societies reliant upon complex production to meet its needs. The market needs to be augmented by strong government intervention to prevent rent seeking imbalances from creating an uncontrollable yaw. When we fell for the free market illusion we condemned ourselves to exactly the kind of cycle we are now suffering through. And it looks as if the denouement is years of unsatisfactory GDP growth and prolonged unemployment. We hurtled back in time to the pre-Keynesian world of classical economics and a highly bifurcated society. We embraced red blooded capitalism in an age when global reach and rapid technological advances exposed us as easy prey to those with capital or lower costs, and those in control of the vast bureaucracies able to move resources around at will to seek profit from that capital or those lower costs.

How many times during this cycle have we been told that we need to swallow unpleasant medicine in order that the “system” be saved? Did we ever ask in sufficient depth who this system benefitted? If the market is so magical how come the system broke? Should those who benefitted not pay for its repair? If there is one lesson that history should have taught the average citizen: there is nor “fair” in laissez faire. When we start to be told about rising tides lifting all boats we should question who is on the biggest boat. When we are told that something trickles down, we should question whether a trickle is enough. Yet we fell for the illusion, and soldiered on getting ever more into debt in order to stay afloat.

We shut our eyes to history. That’s never a good thing.

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Incomes Falter …

Financiers and farmers. Agriculture and banking. Somewhere we have heard this story.

I don’t usually pass along the personal income data from the Bureau of Economic Analysis, but today I will because it has some revealing detail. Overall state level personal income growth slowed to 0.7% in the third quarter, down from 1.4% in the second quarter. Obviously this does not augur well for future consumption trends, especially as households are still looking to stabilize their balance sheets in the aftermath of the post-bubble crisis.

What is more interesting is the variance within the data.

Those states whose income is tied to farming or mining, notably those in the Great Plains or the Southwest, saw much better income growth. Texas, for instance, has seen incomes rise at an above average rate all year, and had third quarter growth of 1.0%. Even better was the growth in the farm states such as Nebraska, at 1.5%, South Dakota, at 1.8%, and Iowa at 1.4%. Indeed only Missouri of the Plain states saw income growth below 1.0%. Contrast those rates with New York and Connecticut both of which saw zero growth, or California with its modest 0.5%, and we see that the coastal regions are undergoing much less robust overall income growth than the central states where commodity prices are driving a healthy recovery.

Even more interesting is the variability showing up at the industry level. The reason both New York and Connecticut fared so badly in the third quarter was the sudden reversal in personal incomes in the financial sector. But I am not sure this means much. Even though New York saw finance sector incomes drop by 0.71% in the third quarter they still were 8.0% higher than the beginning of the year. Clearly banking incomes are highly sensitive to the timing of those toxic bonuses, and are such a large part of the overall picture in both New York and Connecticut that we need to look at those states on an annual, not quarterly, basis.

Besides farming and banking, two other industries are worth mentioning: construction is still tanking in most states, and contributed -0.02% t0 overall income growth; and manufacturing, especially in the durable goods sector saw the healthiest growth of all, even better than farming, contributing 0.08%. Lastly those of us who focus on shifts between white collar and blue collar workers will also note that incomes in the “professional and technical” sector outshone everything else, contributing 0.09% to overall growth, and doing especially well in New York and New Jersey. I suspect that consultants, accountants and lawyers who litter Wall Street are hanging in there very well despite all the moaning I hear!

Another cut through the data reveals the enormous differences between small business in non-agricultural activities and those in farming. The numbers for “proprietor’s” income in New York showed income growth of just 0.5%. In Texas it was 0.12% and in California it was 0.4%. Clearly small businesses are being squeezed. But in the farming states the equivalent income group was experiencing a healthy revival: with South Dakota and Nebraska leading the way with 0.82% and 0.75% respectively. These are good times for self employed farmers.

One last observation: rental and dividend incomes are also weak. This is the only aspect of the income report that is common to the entire nation. To put that in context: of the aggregate increase in incomes of 0.7%, 0.51% came from net earnings such as wages and small business income; 0.24% came from transfer payments such as government programs and retirement income; whilst the category including dividends, interest, and rent contributed a negative amount, -0.07%.

This is a little arcane but speaks to the patchy nature of our recovery. It also may help explain some of our politics. There are areas of the country where a recovery is well under way, at least at the personal income level, while other areas are lingering either in very low growth or highly divergent growth. The recent run up in commodity prices is clearly providing a boost to the center of the country. While on the coasts only the professional class is doing well, the rest not so much. Meantime small business is stuck firmly in a rut everywhere. Finally those numbers for dividend and rental incomes mean that our rentier class is not doing too well. No wonder the Tea Party thinks capitalism is under attack. Quite why the farmers are joining them I don’t know.

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The Tax Deal

We knew that there had to be some kind of deal on those Bush tax increases. Nobody wanted to be responsible for the planned tax hike going into effect, especially while the economy is still sluggish. So, despite all the silly posturing, a deal was always the most likely outcome. The question now becomes: is this particular deal any good?

As usual the answer is muddled.

I find it sad that we cannot legislate transparently sensible things such as extended unemployment assistance without a behind the scenes political brawl over making sure the wealthy folks get some benefits as well. Quite what our horde of unemployed fellow citizens and Wall Street bankers have in common I am not sure. Nonetheless it became necessary to lavish gifts on the rich in order to secure their support for the needy. We are incapable of doing the right thing for its own sake. We have to bargain away at everything. Oh well.

So the Bush tax increase was averted for a couple of years. Big deal. According to the Congressional Budget Office that will pump up GDP growth by all of 0.1% in 2001 and 2012. OK, let me be honest: the CBO gave a range of 0.1% to 0.3% for the boost to GDP. Frankly that’s not much of a boost at all, especially considering all the huffing and puffing needed to acquire it. Then again, as I have said many times here, tax cuts are not very good at generating economic growth. Especially when people are still paying down debt. I have a suspicion that the average family will not notice any change. Why not? Because there isn’t any. We seem to forget that this entire discussion has been about avoiding a tax increase, not about getting an actual tax cut. That’s why the terminology was wrong. The projected boost to GDP is more theoretical than actual. Since analytical models had to take into account the existing law, which had the Bush tax increase coming into effect, the postponement of that increase alters the models more than it alters actual cash flows in the economy.

Thus far: no big deal.

However, the compromise worked out does have some real stimulative content. It includes three such components: a modest change in business tax deductions for investment; an extension of unemployment payments; and a temporary 2% cut in employee payroll taxes.

The first of these, the business investment tax credit, will have minimal effect. At least I don’t see how it can. With businesses awash with profits and cash, this $40 billion or so credit will hardly encourage investment. Besides, the economy is knee deep in excess capacity making additional investment foolhardy at best.

The other two pieces of the deal make more sense and are truly stimulative. Keeping a flow of cash into unemployed worker’s pockets will be expansionary. They need the cash and are likely to spend it. So the economy benefits from this. Similarly, the cut in payroll taxes gets extra money into worker paychecks and is also likely to get spent. While most right wing politicians want to deny it, money given to the average or below average household is much more likely to be spent than the same money given to the more affluent. This is not only intuitive it is proven. So these two parts of the deal will provide a boost to growth next year. Depending on your view of the “multiplier” or knock-on effect, this boost will be between 0.5% and 0.7% of GDP. Not a whole lot, but better than nothing.

So overall the deal will have a modest benefit next year before tapering off during 2012. Which is odd, since this implies the boost declines just as we are cranking up for yet another election. By the way, that increase in GDP will lower unemployment only by a small amount. A good rule of thumb is to look for a reduction in the unemployment rate of about half the addition to the GDP growth rate. So, taking the entire deal as a whole, we can expect extra growth of between 0.6% and 1.0% next year, thus cutting unemployment down by about 0.5% at best. Not a huge return on such a vast output of political effort.

One last thing. Nowhere in the brouhaha about this deal have I seen anyone ask what it means for the deficit of the debt. I can only wonder why this is. Up until now we have been bombarded by right wing stories of gloom and doom based upon apocalyptic visions of the wave of debt supposedly about to wash away the republic. Apparently maintaining the tax reductions that caused over 50% of our current deficit is not a problem to the deficit hawks. Which makes them either liars or hypocrites. Maybe both. It’s easy to see where this is now headed. With the tax cuts for the rich safely protected we will all be asked to sacrifice the safety net in order to balance the books.

But that’s after the New Year. When the hawks will be hawks once more.

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