wages

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Looking Ahead: Leading Indicators Give Us Hope

This week promises little by the way of new data on the economy, instead most eyes will be on Ben Bernanke as he gives his regular testimony before Congress. The key issue we will all be focusing on in his comments is his strategy for unwinding the extraordinary monetary policy of the past few months before it turns malevolent by pumping up inflation.

Other than that we only have today’s leading indicators from the Conference Board, retail sales for June on Thursday and the weekly claims for unemployment insurance. A light week indeed.

Well what about those leading indicators?

Sad to say not much.

The message being delivered by the index is very much a confirmation of what we already know: the economy is slowly turning the corner from free-fall to tentative recovery. For instance, the index has now risen for three straight months. That rules out any aberration: there is a clear trend emerging – as you can see from the graph in the press release I linked through to. Over the past six months the index has risen about 2%, which is a sharp contrast with the previous six months when it fell 3.1%. So the turn around is now significant enough for us to rely on as a true indication of the economy’s performance.

The leading indicators index is a composite. The idea is to take a view of several data sources and then combine them into one statistic. As its name suggests the index is compiled from various data sources that have been shown in the past to change course, either up or down, ahead of the economy as a whole.

The problem – and as usual there are problems – comes from the components of the index that are not improving. There are three very important data sources: real money supply, manufacturers orders of capital goods, and consumer expectations that are not improving. And these three carry a lot of weight in our analysis of the shape and speed of recovery.

Just to illustrate my point:

One of the positives in the index is the length of the manufacturing work week. All the signs are that manufacturers are very slightly operating more hours as they start to replenish depleted inventories. This is a sure sign that the much anticipated fall re-stocking is a reality. Consequently we can expect a lift to GDP from increased inventories – perhaps sufficient to bring the decline of the economy to an end. But all the signs are that such a turn of events will have an empty feel to it. The recession will have ended on a technical basis, since GDP will no longer be contracting, but that isn’t exactly what we want: we need GDP growth in order to re-generate jobs and to keep up with population growth.

Put it another way: GDP may start to grow in total, but it may still be declining per capita.

One of the reasons we should be wary of the potential speed of the recovery is within today’s index. Consumer sentiment remains in the tank. I hate to sound like a broken record, but consumer spending is still the lifeblood of the economy. As long as consumers remain cautious the economy may grow, but it will not grow quickly.

And an economy that doesn’t grow quickly will not create many jobs. Nor will it provide wage increases.

Surveys of businesses show that they may not be shedding jobs as quickly as they were in the winter, but they are certainly not re-hiring either. In fact the emphasis remains on cost cutting, with downward pressure on wages increasing. So while the leading indicators include a positive report of longer work hours, other reports, not included in the index, show a much more pessimistic view of working conditions.

So the long awaited recovery has all the early signs of a ‘jobless’ recovery. In which case we are heading into a prolonged and turbulent period. The economic outcome I most dread is where GDP meanders at a slow and steady rate of growth, but not sufficiently to spur job creation. The past eight years were an example of what happens in such an episode: wages stagnate because there is no labor shortage, profits bulge because productivity expands but employers are not forced to ‘share the wealth’, and income inequality inexorably creeps up. Ultimately that kind of economy ends up in social turmoil: the social contract of the 1950’s and 1960’s was built on very different premisses: strong wage growth, moderate profits, and the entrenchment of the New Deal. For the record: those two decades saw the fastest accumulation of national wealth in American history. We should be very wary of extending the mistakes of the Reagan/Bush era much longer.

Meanwhile: the leading indicators give us mild cause for hope that we will end this recession soon. It’s what happens beyond then that we should all be thinking very hard about.

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Production, Inflation and Wages: More of the Same?

The data so far this week has simply added to the feeling that while things are getting worse less slowly, they are still a fair way off actual improvement. The data is sparse, so I won’t spend much time on it.

Industrial production continues to decline, it fell another 0.4% in June. The decline is widespread across the economy and is the seventeenth month out of the last eighteen that we have experienced a fall. The rate of decline is slowly getting better though: the rate of decline in the second quarter was a ‘mere’ 11.6%, compared with the first quarter’s 19.1%. Obviously none of these figures can be construed as being ‘good’, except in our extraordinary times. The level of capacity utilized by industry dropped to a record low of 68%. That means business investment will not be a major driver of GDP growth for the foreseeable future.

This industrial perspective paints a very ugly picture for unemployment over the next few months. There isn’t any strength in manufacturing on the horizon to spur a surge in hiring.

As for inflation: the bumping around in energy prices meant that the Consumer Price Index rose in June by 0.9%, bringing the annual rate of inflation over the last year to -1.4%. The news here is that there was no real news. Pretty much everyone anticipated that energy costs would distort the data, which it did. There seems to be little or no inflationary pressure on the economy at the moment other than the arbitrary way in which oil prices are moving – and they have backed off considerably lately.

From a thematic point of view I think the threat is still on the side of deflation rather than inflation.

Why?

Because wages are now starting to suffer. The important factor to notice in today’s report on wages is that real wages, i.e. wages adjusted for inflation, dropped 1.2% last month. That wasn’t simply due to inflation rising because it was also affected by the loss of hours being worked. As wages are constrained by continuing unemployment and by business cost cutting efforts, more and more buying power is being sucked out of the economy. That means less consumption and a risk of deflation. Here’s where the message gets difficult to interpret: nominal wages, i.e. wages not adjusted for inflation, actually have fallen over the past twelve months – average weekly wages were $609.37 in June compared with$613.80 a year earlier – but that drop was eliminated by deflation, remember that the CPI fell over the past year. The result was that real wages actually rose 2.6%. This means that employer efforts to cut wages have been to naught – deflation ran more quickly – so effective business wage costs rose even though wages fell. That conundrum implies even more efforts to cut costs in the near term. So look for wages to continue to fall.

None of this is good news. Nor is it really bad news. The data all seems to be reinforcing a simple message: more of the same. The recovery is somewhere out there. But it’s not here yet.

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Green Shoots Update: Not Good

Well we didn’t have to wait too long before we were doused with some cold water: this morning’s release of April’s retail sales was a distinct downer. No only did sales fall by an unexpectedly large 0.4% in April, but March’s decline was widened to 1.3% form its original 1.2%. That April drop was about four times as large as the ‘street’ was looking for, and is a very sharp reminder to us all that the rays of hope we have been talking about are very very fragile.

The fall was fueled by continued consumer reticence to ante up for anything other than the necessities of life. There had been plenty of anecdotal and industry information recently that consumers were coming back to stores and buying more ‘discretionary’ items. Sales earlier in the year, in January in particular, fed into this stream of thinking and was one of the biggest factors underlying the sighs of relief emanating from the White House and from the Federal Reserve Board.

In this light the March and April fall back is especially disappointing. We should remain very cautious about the year as a whole. If the data in May or June isn’t any better then we will have to think again about our expectations for an end to the recession later this year.

Let me demonstrate this point by reference to the first quarter. From January to March GDP fell 6.1%. But it would have fallen much more had it not been for the rise in consumption of 2.2% over that same time. I realize that retail sales data and GDP level data do not match one for one, but they do track quite well. As we go through this second quarter the recent fall in retail sales suggests that consumption is unlikely to repeat its 2.2% first quarter gain, a number of less than 1.0% seems far more probable. Since consumption is 70% of GDP that small decrease becomes magnified and GDP itself suffers. So the end of the recession is pushed off further into the future.

Unemployment and wages are still the key. As long as jobs are being cut and wages trimmed we cannot reasonably expect a recovery. Just yesterday the government released grim data on what it calls ‘mass layoffs’ – a mass layoff is where a company accounts for 50 or more unemployment claims in a short period of time – and estimates that there were 3,489 such events in the first quarter alone. These large scale events are the ones that catch the headlines are thus play a big role in setting the tone of consumer psychology.

“Unemployment and wages are still the key”

Meanwhile there is rapidly accumulating evidence that wages are under unusually strong downward pressure. That cannot be good news for the economy as a whole. The specter of deflation clearly still lingers, even after all the hard work done by the Fed, and provides even more reason to hesitate before we call the recession near and end.

This morning’s report also hints at more reason for concern: commodity prices have begun to turn.

All last year we benefitted from a worldwide drop in commodity prices. This was reflected in our trade balance. Not only were import volumes down, but prices were too, so the total cost of imports fell strongly. The early signs of economic recovery have now started to push commodity prices back up: the price of oil in particular has risen quite sharply and is now back over $60 a barrel. This means the data has mixed messages in it that we need to interpret carefully: even though oil prices jumped 15.4% in April, they were still over 50% lower than a year ago.

This means that the gains we saw throughout the end of 2008 and into early this year in terms of GDP resulting from lower import prices is ending. Lower imports totals from here on out will result entirely from low domestic demand, not lower prices.

Plus, the ‘disinflationary’ or deflationary pressure lower commodity prices exerted in that period is now waning. We cannot expect future prices to be as quiescent as those in the immediate past.

Add all this together and the message is a little worrying.

The reduction in disinflationary price pressure due to the shift in commodity prices will hurt us as long as wages are falling: it will further cramp consumers ability to go out and spend. So consumption will be reduced. That cuts into GDP and so slows the recovery.

Likewise as long as commodity prices now turn back upward, any benefit flowing to GDP from reduced import prices is also gone. This also could, potentially, slow the recovery.

This is one of those moments when the data tells many different stories at once. The plus we had from import prices last year isnow be ending. That part of the deflation threat therefore is noweasing. Except wages remain under pressure. So the ebbing of the deflationary threat heightens the damage to consumption that weak the wage outlook represents. Either way GDP growth will likely take a hit from both consumption and imports in the second quarter.

Buckle up. This thing is a long way from being over.

Addendum:

Also released today, and also in the ‘cold water’ category was the news that inventories are stuck. One of the key factors many of us expected to help lift the economy out of recession later this year was the ratio of inventories to sales. A high amount of inventory is always bad, and especially if sales are slow or declining. The widely held presumption was that sales to inventory ratios were bound to fall below normal levels this year because production has been cut severely. Eventually businesses will be forced to increase production, even if sales are still weak, because there is not enough inventory available. So today’s news that inventory to sales ratios remain stubbornly higher than they were a year ago is not something we want to hear. Yes inventories fell. But sales fell even more quickly.

At this rate the recovery is unlikely this year.

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Unemployment: The End in Sight?

This morning’s unemployment released from the Bureau of Labor Statistics makes for grim reading: businesses shed another 563,000 jobs bringing the total of people out of work to 13.7 million, and pushing the unemployment rate up to 8.9%, its highest in about 26 years. Overall in the past twelve months the unemployment rate has risen 3.9% with the number of jobless going up 6 million in the same period.

So why is everyone treating this news with optimism?

The economy seems to reached the bottom in terms of the rate of decline. Things are still getting worse, but now the pace of change has moderated. The employment figures, while awful at any other time represent a step in the right direction: losses are piling up more slowly than in the last few months.

The key point, as I always remind you, is not to get too carried away with this one data point. We can feel much better in the early summer when this month’s apparent change in direction has been confirmed by two or three more months.

Meanwhile, clearly the tone of the economy is shifting. Those green shoots Bernanke referred to a few weeks ago are now looking a lot more robust. So there’s hope the worst is over.

But.

No one should get too excited. Buried in the same report is the news that wages are virtually stagnant. This is supported by local and anecdotal information that indicates wages may even be falling. This is really bad news for the recovery.

Getting the economy to stop falling was the first task. That goal is now within sight. Our next task is to develop the shape or nature of the recovery. My view is that we have to acccomplish a few things in order to establish strong growth over the next few years.

  1. We need to reduce debt loads: both for families and for companies. This will be hard to do if wages and profits remain weak. It will be impossible if wages or profits actually fall. I have written about the problems of deflation before,and at the moment I don’t think it is a significant issue because of the enormous amount of monetary stimulus the Federal Reserve Boards has used to stave off depression. Nonetheless while we may avoid deflation proper we must also be careful to avoid stagnation. My preference would be a return to a healthy 2% – 3% annual inflation rate that helps lift wages and erodes the value of debt without undermining it [as would be the case at a higher inflation rate.]
  2. We need to establish a more robust savings culture. Savings have jumped recently from practically zero to about 4.5%. But I imagine that is a result of a temporary hoarding of cash rather than a permanent shift. Savings will allow investment to flourish since the financial system funnels savings into business via lending. The US has been the end point for much of the world’s ‘surplus’ savings for decades: the flood of foreign money into America provided the grist for the sub-prime mill. We need to wean ourselves off of foreign capital … why?
  3. Because we also need to reduce our trade deficit. A trade deficit has to be financed. The way this is done is by sucking in money from abroad. If we end up buying more foreign goods than we sell abroad we inevitably end up financing it by selling more assets – bonds, stocks, buildings, businesses – to foreigners. We then recycle the cash we receive for those assets in order to pay for the excess goods we buy from them. This closely linked cycle is why the US and China are inextricably linked in trade: we need each other at the moment. The trade balance needs to be reduced … why?
  4. Because we have to ensure the dollar doesn’t fall too fast in value. We have huge government deficits to finance for the next few years as we crawl out of the hole we built for ourselves in the years of indulgence. Much, though not all by a long shot, of that debt will have to sold abroad. In order to attract investors we will need to maintain a stable currency and attractive interest rates. If our savings rate is sufficiently high we can channel some of those savings into government debt to avoid reliance on foreign investment. But that might reduce the amount available for business to use to build new factories and so on. So we simultaneously need to …
  5. Run a tight fiscal policy. That’s code for raising taxes. I am an avid supporter of fiscal stimulus as a short term expediency. If we have a great credit rating for our debt we should use it to acquire funds to spend our way from the edge of depression. But, we also need to ensure we get our books back in balance quickly so that the deficits don’t become permanent. Cyclical deficits are OK. Structural deficits are not. Our government’s books were in dire straits before the crisis because of decades of failed economic thinking and partisan bickering. That has to stop. Of course we can avoid heavy taxation by …
  6. Making sure growth is both steady and strong. One of the failures of the Reagan era was that fiscal policy focused exclusively on reducing taxes. Unfortunately there was no ‘trickle down’ effect and the lower tax regime failed to ignite growth sufficiently to ‘pay for themselves’. That whole policy regime, along with the economic theories that underly it, is now thoroughly discredited. So in order to mitigate the negative effects of higher taxation wages have to grow strongly so as to allow consumers to buy things, save, and still afford the taxes. So wages have to return to their more normal share of GDP at the expense of profits. Remember: profits were the only major factor in the economy to show above normal growth during the past eight years. Wages have been virtually flat.
  7. Finally: we need a financial system that focuses on the careful expansion of credit – loans to families and businesses – rather than on the yahoo wild west nonsense that we have seen since the early 1980’s. This implies heavy re-regulation and possibly the use of anti-trust laws to carve down the size of the ‘too big to fail’ banks that ruined our economy and started this crisis off. Remember the mantra: ‘too big to fail’ means ‘too big to exist’.

That’s a heady agenda. But as you can see it is all intertwined. Wages must be growing well for us to accomplish our goal of strong GDP growth. We need a better balance between thrift and consumption. We need a more conservative fiscal policy – and yes I mean conservative. And we need to eliminate the excesses and excessive behaviors that caved the roof in the last time.

Which brings me back to today’s release: that wage data tells me that a strong recovery is far off still. We may be growing slightly by year end, but the pace of that growth will be very poor.

Our efforts should all now be on acceleration. There are huge policy debates ahead that will determine our success. Most importantly re-shaping banking, and getting a better sense of fairness into our economy should top the agenda.

Wages over profits for the near term. And make banking dull.

They’re the two thrusts needed to get this place humming again. This morning’s data shows we have a long way to go.

But at least we have started.

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Economic Stagnation

I hate it when the headline writers try to be upbeat when the whole gist of the subsequent story is downbeat. The New York Times falls into that trap with today’s story about personal incomes: Census Reports Slight Increase in 2005 Incomes – New York Times

Now if you look quickly at the headline you’d think there is a pretty good story to tell. Not great, but definitely upbeat. The trouble is that’s not the case. The only reason that incomes rose at all in 2005 was the fact that people were working more and thus getting more hours worth of pay. Wages per hour actually fell.

This is just the kind of gloss that the Bush regime likes to put on its dismal record. After years of growth, productivity improvements, and profits, the average family in America is worse off than before Bush arrived on the scene. The distribution of incomes is increasingly skewed away from wage earners towards stockholders and towrads the very few at the top of the heap.

The Republican squeeze on the middle class is showing just the kind of results you would expect, and the middle class response is to work longer hours to try to keep up. It is not a triumph that incomes rose because we worked more hours. Those hours are lost to family time, to leisure, to community activities and to keeping informed. The American public already overworks. It has notoriously few holidays, and works ridiculous weekly hours.

No wonder no one has time to keep up with the news and to remain fully informed about the Republicans failure at economic management.

Then again maybe that’s part of the plan too!

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