stimulus

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Manufacturing Signals a Slowdown?

The data this week so far has been sparse, and in the context of our fragile economy it can be worrisome not to see a constant flow of statistics confirming our growth path. People like me tend to get concerned about downside risks and so fret in the absence of rosy information.

Take today’s Manufacturing ISM report.

This is a measure of activity in our factories and has been in a growth pattern for a few months. But it stalled in November. It dropped from October’s 55.7% to 53.6%. Not a huge drop I admit, but a worrying one. Ant reading on this index over the 50% mark indicates that the economy is growing, so November’s figure still supports the view we are out of recession. The problem is that the pace of recovery seems to be slipping already.Worse yet is the labor component of the overall index: it slipped to just 50.8% which is barely expansionary.

Clearly we are not out of the woods yet.

I realize this is repetitious, but the issue is that most of the recovery has been fueled by the combination of inventory correction and the government stimulus. It was the inventory re-stocking that spurred the original uptick in manufacturing. What today’s news suggests is that the adjustment has been completed and that any further growth in factory activity will have to come from an increase in demand.

And there is little or no evidence of such an increase.

So, with the impact of the stimulus also beginning to fade – in growth terms it has already had its biggest impact – we are all now waiting for the basic economy to show signs of life. Those signs are there, but are weak. Today’s news makes me wonder whether they will get weaker still. Given how close we remain to the edge, any further weakening could be sufficient to push us back into recession.

Few people are forecasting a ‘double dip’ recession, but the odds are increasing not diminishing.

And that has me worried.

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Are We That Dumb?

Apparently.

The growing consensus in the media and commentariat is that a recovery has begun, that the economy is therefore OK, and so we need to shift our attention to setting the stage for tightening both fiscal and monetary policy. And this tightening had better come soon since there is a tsunami of problems ready to destroy the civilized world if we don’t act now. Or even sooner.

The problem I have with this train of thought is that nothing in the data suggests it’s true.

Nothing.

I have just read Paul Krugman’s blog where he notes the same thing. His conclusion is that we have entered one of those all too familiar periods of US history where the facts and the consensus opinion our not in step. What makes things worse is that, inevitably, it is the facts that lose in such a confrontation. The last time we were like this was during the run up to the Iraq war when no amount of fact checking could persuade the media that an invasion was the wrong course of action.

I just hope this current disconnect does less damage, and that we do not have to be subjected to a string of mea culpas over the next few years as the economy flounders deep in depression.

Because that’s where we will be if this herd mentality infects policy too much.

I fear it may be too late anyway.

The simple fact is that our economy is very weak. The recovery is more technical than real. Jobs are horrendously scarce and the employment outlook is still grim. Don’t just listen to me: the general consensus of economic forecasters is that we will still have an unemployment rate in excess of 8% deep into 2012. Think about that. Nearly three years from now our unemployment rate will be higher than it was when Bill Clinton used a poor economic record to wrest the White House from Bush Senior.

This nugget of information is not exactly top secret, so I would have thought that the current administration would be pulling out all the stops to get unemployment down as rapidly as it can. Winning elections usually focuses political attention on inconvenient things like a lack of jobs.

But no. The Obama folks have fallen under the same spell as the media. All the talk now is of tough action to be taken soon to tighten the Federal budget. Just in case those nasty bond people decide to pull the rug out from underneath us.

Here’s another interesting nugget: PIMCO our largest domestic bond fund, and one of our most successful, just bought up a huge pile of US bonds. That does not sound like an imminent panic. On the contrary it sounds like a vote of confidence.

The only way I can explain the disconnect between the facts and the curious fiction found in the media is that we live in an era of attention deficit disordered reporting. No matter what the crisis is, no matter how deep, nor how difficult it might be to cure, it must not last long. We need new angles and new stories to keep the front page fresh. So, after due time, we must shift our attention to the aftermath of the crisis rather than on its continued existence. After all the fact that we have a crisis is soooo yesterday.

We have reached the Age of Immaturity.

To some degree this explosion of stupidity is being fed by the counter-revolutionaries of the free market brigade. They have manned the intellectual barricades in order to salvage what reputation they can from the chaos their ideas have wrought. This resistance to honest re-appraisal of theory and its concomitant embrace of delusion pervades the entire fabric of all institutions who were fully invested in the free market deregulatory era. Don’t forget that our society became obsessed with stock market watching over the last few years. We gorged on spurious economic and financial data and were spoon fed market based ideology by endless cable TV talking heads all who seem to have grown up in the post Reagan era. Not one seems to have heard of Keynes. And few seem bothered by the prospects of depression. Since nothing lasts long in this fast paced world, the assumption is that the recession cannot last long either. Every news station and cable TV channel pours out daily minutia about the economy and therefore the competition to be on the leading edge of the next story trumps [sorry about the pun] any need to dwell on the current story.

This is why risk management failed us so miserably over the last few years: it got in the way of a good, positive, message.

The funny thing is that, as I reflect on my years in banking, the same problem existed back then. The difference between the two eras is that nowadays the stupidity is magnified by the vast array of news outlets. Back then the damage was confined to the banks whose managers fell prey to the good time stories. And there were plenty of them even then.

So here we are rushing full tilt into a group think disaster. The economy is great. The stock market is flying again – that’s all that really matters – and the only hiccup between here and nirvana is the potential threat from the bond market and the falling dollar.

Therefore all serious people will surely act early and firmly to demonstrate our commitment to defending the dollar and balancing the budget. [Does anyone care that the dollar dropped like a stone during the Bush years and that none of these same commentators mentioned it?]

Damn the consequences.

Apparently it far better to sink on a neatly run ship than to float on a messy one. It shows our commitment.

How else do I explain tepid financial reform? Weak stimulus? Dithering on jobs programs? Ridiculous commentary about bond rates?or hysteria about debt levels?

Are we that dumb?

Yes we are.

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GDP: When Is Growth Not A Recovery?

Today’s revised GDP numbers for the Third Quarter are disappointing. You may recall that the original estimate last month was that we saw the economy grow about 3.5% in those three months. As better data has been accumulated, that growth is now estimated to have been smaller, at 2.8%.

While any growth is good, especially after the crisis of the past year or so, this level of activity is scarcely sufficient o keep us treading water on the one big issue we have to fix: jobs.

First let me show you the numbers:

  • Personal Consumption added 2.07% to GDP in the third quarter, compared to a negative 0.62% the prior quarter
  • Private Non-Residential investment reduced GDP by 0.4%; which was better then the second quarter’s -1.01%
  • Residential Investment bounced back a bit, adding 0.45%; it had been-0.67% in the second quarter
  • Inventories showed a big swing, adding 0.87% in the third after having reduced the second quarter by -1.42%
  • Trade was a problem: exports added 1.71% to GDP in the third quarter after being a -0.45% drag in the second; but imports grew rapidly as well to offset that export improvement, imports reduced GDP 2.53% in the third after having added 2.09% in the second quarter
  • Government Spending was positive both quarters: Federal expenditures added 0.65% in the third quarter slightly down from the 0.85% contribution of the second; State spending fell rapidly and has become a drag on growth, it reduced GDP by -0.02% in the third quarter after having added 0.48% in the second.

If you add all these figures together you arrive at the -0.74 reported for the second quarter and the 2.79% announced this morning.

So here’s the problem:

This is just not strong enough to make a goodly dent in our enormous overhang of spare capacity. I was very disappointed to see that both personal consumption and private non-residential investment were both adjusted down from the initial announcement. Even a cursory review of the results makes it obvious that all our talk about an inventory and stimulus led recovery was spot on. The basic economy is still quite weak and shows no real sign of gathering much momentum. The pick up in exports was easily offset by the acceleration in imports as the economy began to suck in more oil and manufactured goods. Plus there seems to be a problem developing in the level of state expenditure: as states struggle to balance their books they will reduce spending which will act a significant drag on the economy. Already the Federal level spending burst is beginning to dissipate, so when we add in the movement in trade and in state spending activity, the burden for the next few quarters shifts decisively to the private sector, which while not dormant is not exactly humming along either.

The big problem is that capacity gap. This is the difference between what GDP would be if we were utilizing all our resources, and its level given the percentage of our resources we are actually using. Currently this gap is huge. We have the capacity to be generating a GDP several points higher than that we are actually producing. Such is the collapse in private sector activity that this gap will take years to close if we meander about at the pace of growth we achieved in the third quarter.

It is this enormous overhang of spare capacity – most of it in the form of unemployment – that makes the economy feel as if it were still in recession, even though the data says it is growing again.

We are simply mired in fear. Consumers are afraid to spend as they struggle with debt loads that now seem out of whack with income and wealth prospects, and business keeps moderating its expectations for the future and refuses to ramp up employment. This is beggar thy neighbor writ very large. Until the fear subsides we will wallow about in mediocrity.

Oddly the one hope we had is the government and that now seems to be getting ready to step aside. All the talk in Washington and in the financial media is now fear driven too. Fear of the Chinese bailing out on our debt; fear of the bond market; fear of the dollar sliding some more; fear of a burst of inflation resulting from the money supply binge needed to prop up the banks; and fear of just about anything else you can imagine that could cost money. Except defense of course. Always except defense. These fears are all unfounded, but are easy to exploit politically in the absence of strong leadership.

Compound this fear by adding in a political system that has become totally unresponsive and easily ground to a halt, and we look set of a long period of frustrating and sub-optimal economic behavior.

No one wants to fix the problem.

I think this gridlock is a natural outcome of the crisis in economic thinking itself – where the free market ideology is being uprooted at long last – and in politics where the basic tenets of right wing economic policy beliefs have been overcome by reality.

So we are undergoing a sea change. A shift in worldview away from the Reaganite free market, free wheeling, laissez-faire system towards something that has yet to emerge. The rearguard from the free market crowd is fierce at all levels – in Washington as well as in academia – and it is this rearguard action that is stalling our progress: as an example, it prevents us from moving quickly to implement jobs programs because the free market folks object to more government spending.

Couple this with the health care reform ‘debate’ which has surfaced deep ideological divisions even in the Democratic Party and nothing much gets done. What legislation is passed comes at an increasing cost in terms of time and pent up emnity.

Our political system is teetering on the brink of failure. In particular the gentlemanly rules of engagement in the Senate are breaking under the strain of an increasingly entrenched ideological separation between the parties. The GOP has moved sharply rightward over the last few years and actively uses arcane rules to reduce the Senate to a standstill. The threat of filibuster essentially ends any chance of major legislation by either party. Unless the rules are changed neither will get a coherent program through and the Senate will deteriorate into a farcical debating chamber incapable of addressing big issues. Perhaps this is what the GOP wants. It certainly acts to their advantage currently. But in politics what goes around …. at some point the Republicans will suffer the same. Much of this will go away with time as the old time methods of reaching across party lines evaporate and legislation becomes more party line oriented. For this to happen we need to rid ourselves of the centrists who like to wheel and deal: they trade their votes for bundles of pork barrel spending in their home states. They also like the attention and power they get from being able to hold up action.

This clubbiness is a major deficiency of the American system as long as the nation is deeply divided along cultural or ideological lines. Those divisions are now so deep that reaching across party lines to form consensus on anything significant is just not possible. This slide towards dysfunction has been going on for a while. The American system was never designed to handle or reflect ideological divisions as deep as we now have. It was designed to operate best on a middle ground where there was general agreement on national goals and characteristics. Yes of course horse trading took place, but once that was done most major votes were very lopsided. Now the very notion of horse trading is limited to those few centrists. The Republican central committee has even banned cooperation, saying that it will not support candidates who reach out across the ideological divide.

I don’t know if this is good or bad. I come from a very confrontational style of politics with deeply rooted ideologies, so I am empathic with anything that simplifies party lines. At the same time the American system, which is unique and very parochial in its mechanics, has served well. It is only in the light of the culture wars and social changes of the past thirty years that it has been under strain.

What I do know is that unless the political fog clears and allows us to eliminate anyone’s ability to exploit fear, we are more likely than not to stay mired in the mess we just created for ourselves.

That could result in a ‘lost decade’. Which would be tragic.

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More Debt Hysteria

I have often wondered how easy it would be to write a completely silly article and still get it published. Now I know. Emund Andrews did it this morning. You can read his foolery on the front page of the New York Times.

Yet more debt hysteria I am afraid.

This is getting a little monotonous, but as in any epidemic, we must not let our guard down. We must confront this hysteria front on wherever we come across it. I just didn’t expect to find it on the NYT front page.

What really annoys me most is the amazing lack of analytical thought going into these articles. They simply seem to be a re-hashing of the same tired, and by now thoroughly debunked story. This is, of course, familiar territory: there is a school of thought out there supporting the notion that repetition can convert a falsehood into a truth. So we are bombarded with ever increasing frequency about the impending perils of America’s debt crisis.

It would nice were there some facts to document this crisis. Apparently I am asking too much.

But a crisis is assuredly is because Mr. Andrews breezily asserts so. Or more to the point he simply wonders aloud about the consequences of said crisis, presumably taking its existence as a given.

So allow me to be boring. Let me talk facts. I realize it’s less inflammatory and makes for a dull headline, but, given the enormous consequences of incorrect policy actions, I think we need to be quite sober when we discuss our national debt.

So without the hyperbole here goes.

Taking a look at the way in which our budget has fallen afoul of the recession we need to pick apart the causes of the rising Federal deficit. That is to say we need to know why we are in debt. To do this we should compare budgets, one put together before the crisis, and one that includes all the actions and expenses of the crisis. Given that we are supposed to be facing a tsunami of debt we need to look out a few years so we can identify when we get swamped. So lets look at our forecast budget out ten years. The ‘before crisis’ budget was about $8.3 trillion better off than the ‘after crisis’ budget. So the hysteria is over that addition of $8.3 trillion to the debt. As a proportion of GDP this addition drives the US debt ratio from about 40% up to around 70% over the ten years – a significant jump. Significant enough to cause all this panic.

Now let’s look at the books:

  1. First we see that projected discretionary spending does indeed increase. Somewhere in the region of $1.3 trillion over that period. This is the category that covers stuff like bail outs and stimulus packages. So this is where Obama’s fiscal folly would be accounted for.
  2. Second we see that debt servicing – the cost of paying interest on all that debt – also goes up. In this case by about $1.5 trillion also. Now let’s be clear here: much of this cost is baked into the numbers because the debt already exists. The Treasury has been active in extending maturities lately to take advantage of low interest rates. But there is also a huge amount of short term debt that needs constant refinancing and so could be re-priced at higher rates. Given that short term rate are practically zero currently any move would be up. But the budget allows for that. So let’s go with the budget figure.
  3. Next comes mandatory spending on things the law says the government has to do. That goes up about $0.8 trillion.
  4. So, thus far we have accounted for a big chunk of the deterioration between the ‘before’ and ‘after’ crisis deficits: $1.3 + $1.5 + $0.8 = $3.6. Hmmmm. The total dent in our finances is $8.3. We have not accounted for over half the problem, and yet we have accounted for all the changes in spending. I wonder what could create that other chunk? We need to find another $4.7 trillion.
  5. Well its the recession stupid. By far the biggest reason our budget appears in the hole right now is because there’s a recession going on. Whoops we forgot about that. Revenues have imploded. Tax intake has dropped like a stone. That’s the big issue here. Revenue decline accounts for over 50% of the debt bulge everyone is getting panicked about. Sorry everyone but we don’t have a spending issue we have an income issue. And a temporary one at that.
  6. Even more: the after crisis budget has a much reduced number for GDP in 2018. That means any ratio of that figure is going to be higher than it would have been had GDP not been reduced. This phenomenon is called arithmetic. So naturally the debt looks a lot worse – that 70% number – when the debt is expressed as a ration of a recession hit and therefore shrunken GDP.

This is why I get annoyed. The tsunami becomes a normal wave when you look at it clearly.

Obama’s reckless budgets are not our problem. The recession is. I thought we knew that by now.

Apparently not.

Once the economy starts to grow much of the deficit melts away of its own accord because Federal revenues will recover. This is not including any tax increases, or even the elimination of the infamous Bush tax cuts that created a far larger deficit issue than all the bail outs and stimulus added together.

This is what we call a ‘cyclical’ debt problem. Bush created a ‘structural’ debt problem by cutting revenues and getting no increases in GDP or cuts in expenditure to offset that loss. The Bush deficits are the permanent bit of our problem.

In contrast the bail outs and stimulus spending is temporary. Yes they added to our debt. But the deficit won’t stay that way. It will shrink as soon as we get going. Leaving us the Bush debacle to fix. If we have a debt problem it’s that one, not the one caused by recession.

I hate having to belabor all this, but it is vital we separate the issues so we can deal with them sensibly.

The US has long term fiscal problems. It has Social Security and Health care costs that need controlling. More importantly, ever since Reagan began to use the Social Security surplus to offset the regular budget deficit we have managed to avoid looking at the true gap in our everyday spending. Reagan was the first president to use a combined budget. Up until then we saw two budgets: one for the everyday stuff, and one for Social Security. So for thirty years we have been bamboozled into thinking our budget was in better shape than it is. That way we could avoid having to cut or control costs. This was vital to Reagan because he wanted to inflate defense costs and hide the impact – basically he used debt and Social Security income to fund defense. The key he wanted to get around was having to raise taxes to pay for that defense build up. His great twin legacies were the loss of truthful accounting and the illusion that borrowing could go on interminably.

The irony now is that it is his ideological successors who are raising the panic about deficits and debt – these are the very folks who looked away during the Reagan and Bush debt frenzies.

So there you have it.

Yes our debt ratio will get worse. We’ve just been hit by a horrendous recession. Duh. And, yes we can pay for it – it is all very manageable – as long as we get our economy humming again. It will take a few years for the debt levels to fall back to more ‘normal’ levels, but frankly we haven’t had ‘normal’ levels for three decades anyway, and we might not get back there for three more decades.

The key is to remember why the debt ballooned, and to keep our focus on the really big job at hand. That is to get the economy growing sustainably. That means jobs. It might even require more debt. The number one task right now is still recession fighting. We can begin the switch to fiscal rectitude afterwards.

Let them eat cake is not a particularly palatable economic policy, but it is the logical outcome of this bout of debt hysteria. If we get our priorities backwards and look to balance budgets and reduce debt loads before the economy is safely back on track then we run the risk of repeating the 1930’s. Allowing the bond market – or rather the supposed bond market since the actual one doesn’t seem too worried at the moment – to take priority over things like jobs programs is dooming us to a decade of horrendous human cost. That road is known to us. It is an ugly one.

Which is why we need to defang this hysteria before it sweeps us in the wrong direction.

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Are We Already Slowing Down Again?

The data from the last couple of days has me wondering whether the growth in the third quarter – which increasingly looks likely to be reduced from the first estimate in next week’s revision – is something of a tease. Indeed the questions about next year are gathering more ominously and require both thought and action.

Here’s the problem:

Politics.

The so-called centrist Democrats, who are looking remarkably Republican at the moment, are fixated on the size of the budget deficit … in about 2030. That’s when the proverbial hits the fan big time and our ridiculous health care system will bankrupt the country. So these centrists are freezing all talk of taking immediate action to jump start the economy. They are afraid of adding to the deficit twenty years from now.

Likewise the Republicans, who are becoming both more obstructionist and more extreme every day, argue that a 10% unemployment rate is ‘proof’ that the stimulus didn’t work and therefore we should throw the economy to the free market wolves. This is a modern form of the immortal ‘let them eat cake’ sentiment. And we all remember how that went.

Thus, just as it is becoming apparent that the economy is only sputtering to life, and barely at that, we appear to be paralyzed by a combination of timidity and ideology.

The numbers are weaker than I hoped for:

  • Retail sales rose, but only because there was a modest growth in car sales. Back that out and the growth is extremely small. This raises a question about the upcoming selling season which now has a more ‘make or break’ feel to it than I first imagined. As long as unemployment persists, and even continues to grow, it is highly improbable that we will see much by way of consumption growth. I keep looking around for a sector of consumption that is lively – something that augurs well for the new year – and all I find is a hint here and there. Those vaunted green shoots of a few months ago have produced a very weak crop, one unlikely to withstand much of a storm.
  • Likewise the housing market took a decided turn for the worse: housing starts dropped by over 10% in the latest month of data. This after a few months of steadiness. There are all sorts of explanations floating about as to why this drop occurred, but none can hide the fact that residential construction is deeply in the doldrums. This can be no surprise given the horrendous over-supply of housing that now exists, but we need the industry to stabilize so as to stop its drag on the economy. Construction provided the strongest job growth during the years of illusion and is now a major contributor to unemployment. If it doesn’t reverse course soon it will continue to shed jobs, and thus make matters more difficult for the rest of the economy.
  • Real incomes are up about 2.8% on the year, but actually dropped last month because inflation was a tad higher than wage growth. The reason real wages have shown any growth at all is that inflation has been so low for a while now. It isn’t because wages have taken off. Indeed one of the great characteristics of the years of illusion was the general weakness in wages: that weakness drove many families to rely more and more on debt as a source for current consumption.
  • The withering of the American Myth Dream is perhaps the defining outcome of the last three decades. By any standard America is now a highly stratified society. Wealth concentration is back to its 1920’s worst, before the re-distributive efforts of the New Deal created the current middle class. It is an irony most of us miss that the statistic used by the CIA to predict an unstable political system abroad – it is fairly accurate – would now predict such instability here. As the illusion is kicked away the body politic gets angry and thrashes about for someone of something to blame. How else can we understand the rise of Sarah Palin?

Which returns me to my lead in.

Politics are now in the way of our success.

The combination of Democratic timidity and Republican ‘let them eat cake’ will block the prospects of corrective action on jobs. We will see some ‘jobs legislation’, but our ability to get the kind of scale aid we need is made remote by the lack of courage in Washington.

No one seems to understand the epic scale of our situation: we came very close to depression. We avoided it, but barely. We are not healed. By analogy we are in the early 1930’s, not out of the woods by any means. A wrong step, or a step not taken, could condemn us to a massive implosion.

That we are even arguing about what to do is disappointing. That some of the blockage is on the Democratic side is desperately so. I can understand the resistance from the free market advocates: their very worldview is under threat, but anyone purporting to be ‘progressive’ or ‘liberal’ – however modest – must surely see through the utopian dream of the free market dogma. The big point to keep firmly in mind is that the free market dream can never exist in reality. That’s why I call it an illusion. It reads well in a textbook. Beautifully well. But in practice it falls prey to the venal habits of regular people. It just doesn’t work. It never has. And never will. Instead it allows the powerful to accumulate more wealth and power to the detriment of those less fortunate. Hence the current concentration of wealth. Hence the ability of banks to pay enormous bonuses even while ‘main street’ continues to suffer.

The scramble for wealth, and the relentless distortion of the system so that wealth can be retained, always dominates the supposed allocative power of a free economy. That’s why we regulate. That’s why we make certain kinds of actions illegal. Free markets are far closer to Thomas Hobbes’ vision of ‘nasty, brutish, and short’ or Schumpeter’s ‘creative destruction’ than they are to Adam Smith’s more benign enlightened ‘invisible hand’.

The relevance of this?

That we are hemmed in by people who truly believe the myth. And they are abetted by people who are scared of a problem that we won’t even face for another twenty to thirty years.

At our current rate of progress – or the lack thereof – those remote problems will be dwarfed by what happens when the economy slides backwards next year.

The chances of depression are small because of the extraordinary stimulus and bail out actions taken so far. But if those actions are all we can do, either because we become complacent, return to illusory ideologies, or simply because we afraid, then those odds start to grow.

Paul Krugman describes this dilemma as our having to choose the third best plan. Politics has removed the first and second best plans: a bout of inflation, or a second stimulus. So we are left to introduce a set of ‘jobs programs’. Even these are being attacked by the free market apologists.

The data suggests we are still on thin ice. The ideologues defending the illusion have big feet. Lets all hope they don’t jump up and down too hard. It’s very cold down there.

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