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Jobs and Trade: News, But Not New

Neither the trade deficit news, nor the report on new claims for unemployment assistance should surprise us. They shouldn’t upset us too much either.

The trade deficit widened 15.1% in January, the latest month for which we have data. The gap between imports and exports rose to a near record $46.3 billion, up from $40.3 billion in December. This was despite a record level of exports. The problem stems from two different sources. First: importers appear to be stockpiling goods and raw materials in anticipation of the economy’s faster growth later this year. Clearly they don’t want to miss out on that higher activity due to lack of inventory. Second, and perhaps more obvious: the recent run up in oil prices and driven the value of petroleum imports up way beyond expectations. Plus, anytime the economy accelerates we draw in more oil. So both prices and volumes rose.

Should we be concerned? A little. But not yet too much. An improvement in our net trade position – the deficit dropped – during the last quarter of 2010 was a major contributory factor to the jump we saw in GDP. So, to the extent that we see a repeat of January’s reversal during the rest of the first quarter this year, we will also see a corresponding drag on GDP. Indeed since oil prices have jumped around since January we can almost guarantee trade will be a lot more negative than it was late last year. Like many things in economics a deterioration in trade is a useful sign of an otherwise healthy economy. We tend to import more as we grow. So rising imports suggest that businesses are preparing to sell more, and this is a good omen. Of course we would like to export more as well to keep the imbalance to a minimum, but boosting exports is a longer term project and is not a primary solution to our economy’s ills anyway.

On the jobs front today’s news was also a mixed bag. On the surface the 26,000 increase in new claims for unemployment assistance is not good, but the total stayed below 400,000 and there were mitigating circumstances that suggest this is more a statistical blip than a reversal of the recent improving trend. That 400,000 barrier is important because we need to keep new claims trending down towards a much more healthy 325,000 – 350,000. But the bigger news is that this week’s claims number is distorted by the oddities of spring break holidays in New England, where large numbers of people with jobs in education were able to make a claim for the one week covered by that break. The biggest jump in claims were all centered in the New England states and will most likely be reversed next week. Without this aberration the data was much more benign, which suggests that the all-too-slow upturn in the jobs market is still on track. Let me repeat myself: that improvement is incredibly slow moving and weak by historic standards and continues to cast a long shadow over the economy. The current attempts to cut government jobs threatens to throw what forward momentum we have into reverse, so we have to pay particular attention to this data over the next few months.

One last thing: household debt continues to decline across the US economy, although the latest data shows that the decline is now slowing considerably. US households have been cutting debt for eleven straight quarters, but the fourth quarter’s annualized decline of 0.6% is the slowest drop since the third quarter of 2008. One thing to note was that the decline was driven almost entirely by a 1.3% drop in mortgage debt. In contrast, consumer credit returned to a growth path by increasing 2.0% at the same time. The same government report shows household net worth to have grown $2.1 trillion, back up to $56.8 trillion. This is still below the all time peak of 65.9 trillion set back in early 2007, with rising stock prices offsetting some of the drop in home values since then. It bears repeating that these figures don’t serve us well when we look at the entire economy simply because that wealth is so concentrated. That a small number of people have witnessed a solid recovery in their balance sheets does not automatically extend to a generalized feeling of well-being. The massive inequality of incomes and wealth now built into our economy inhibits growth by marginalizing the lower end consumer who is likely to spend a greater portion of their income, while privileging the higher end consumer who is likely to save more at a time when the economy is already awash with cash for investment. Yet that cash sits under deployed. This is why my view on policy remains that we focus on getting demand pumped up. I seem to be, once more, in the minority though, so look for the economy to underperform for a while yet.

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Quick Comment: Trade

Today’s report tells us that the US trade balance worsened 5.9% in December to $40.6 billion, which ends a period of improvement and could potentially slow down overall growth early next year. The biggest shift came in oil, where imports and price increases drove the imbalance to its highest since October 2008. Overall for the entire year 2010 the trade deficit totaled $497.8 billion which is an increase of 32.8%. Exports rose well, by 16.6%; but imports also rose strongly, by 19.7%.

A great deal of focus has been on prices of commodities and raw materials, but we should all recall that the portion of finished goods prices that these things represent is actually quite small. Labor costs are much more significant. So, even though rising oil prices will act to increase the deficit it isn’t clear that those increases will translate into a sudden surge in inflation. There just isn’t any sign of such a surge in the one component capable of driving inflation quickly higher: wages. This is for obvious reasons, while unemployment remains as high as it is.

Meanwhile the trade gap widening will act as a drag on GDP. Don’t forget that trade added a major portion of the fourth quarter’s overall growth, so a wider than forecast gap in December may imply a lower GDP number when the next revision is announced.

Lastly: as US growth continues to maintain its current pace retailers and manufacturers will be impelled to restock supplies and inventories at higher levels. This suggests that imports will continue to outpace exports in the near term. In turn this tells us that trade will continue to dampen GDP growth throughout the next phase of the recovery.

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GDP: Good or Fair?

The initial reaction to today’s GDP report has to be positive. The economy grew at an annual rate of 3.2% in the fourth quarter of 2010, up from a revised 2.6% during the third quarter. So the recovery seems secure and well on track. Here is my usual breakdown of the parts of the economy and how much they all contributed to the total:

  • Consumption: added +3.0%
  • Private Investment: subtracted -3.2%
  • Trade: added +3.5%
  • Government Spending: subtracted -0.1%

The interesting number here is that consumption figure. Personal spending rose at the sharpest pace for four years, driven particularly by a strong showing in durable goods. This is encouraging because these ‘big ticket’ items are normally easily postponed when households are adjusting their balance sheets and when fears of unemployment prevent people making long term financial commitments. So this gain may be a sign that consumers are feeling better bout the future and might suggest the economy will move ahead well during 2011. Notice all those words like ‘might’ etc. We need to wait and see whether the numbers are not revised downward as better information is analyzed. And we need to see this momentum, if it turns out to be real, maintained throughout the year. Even with all these caveats, the news is good. Sales of services seem stuck in a bit more of a rut and grew at pretty much the same pace as they did all through last year. There has been no acceleration in that sector. So we could easily construct a more negative narrative: consumers postponed their big ticket purchases as long as they could but eventually they were forced to buy – things wear out after all – and the underlying rate of household consumption is closer to the growth rate of services than that of durable goods. Hence the need to wait and see. Incidentally durable goods sales jumped 21.6% from the third to the fourth quarters, hence my mild skepticism about the sustainability of that pace.

The picture in investment was also very distorted. Here it was the run down in inventories that muddled things. Non-farm inventories suddenly shifted into reverse as businesses ran down their stocks during the holiday sales, so after several quarters of helping keep GDP rising, inventories actually knocked a big hole in growth. This change masked a very mild recovery in residential investment which managed to record only its third gain in the last nineteen quarters. Having said that the gain was negligible, but that it existed at all is noteworthy.

Trade too was subject to a big shift. Exports have been recovering quite well for several quarters and continued to rise at a decent rate. But imports suddenly dropped which is why the total impact of trade was so beneficial. Given that worldwide demand for commodities is putting a great deal of pressure on prices I suspect that the trend in imports will turn negative again during the summer. Plus there seems to have been a modest amount of stockpiling of imports during the late summer and early fall which meant importers could reduce their activities subsequently. This too probably shifted the numbers around a bit and so the sharp turn in today’s report may not be representative of a ling term trend.

Lastly, the government spending line is something of a warning. The effects of the stimulus are now well worn down, which leaves us with the increasing drag on GDP caused by the continued, and increasing, austerity at the state government level. This is something to watch. As the austerity hawks gain more control we can expect government spending to taper off somewhat. This will press down on growth and harm our prospects during 2011 and beyond. Today’s report could simply be the beginning of that downward trend.

So, overall, the report is good. Remember it is preliminary and subject to revision. Typically those revisions can be quite large. So keep a large asterisk against this data. Having said that it is good to see GDP running at a rate above 3.0%.

One last thing though: even at this pace we will not work unemployment down very quickly. We lost an enormous amount of GDP activity during the downturn. Had we not had a recession the economy would be about 7% larger than it is today. That’s a lot of jobs. Moreover, at a steady 3.0% rate of growth we would need years – maybe a full decade – to get catch up to where we would have been. So although this is a good report, it isn’t really good enough to get too excited over. We need more rapid growth for a while to make that catch up period more tolerable. There’s not much evidence we will see such an acceleration.

Which means we are in for a long, steady climb, rather than a rapid ascent.

Translation: good, but not quite good enough.

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House Prices Drop Slightly

Getting hold of hard economic data right now is difficult. Worse: when we find some it is ambivalent. Today’s Case-Shiller Index report bucks that trend somewhat, home prices dropped 0.7% in October. That’s not ambivalent, it’s just bad.

The problem with housing is not just that it seems difficult to identify the bottom in prices, but that so many unknowns impinge on that calculation. The Case-Shiller Index measures resales of houses in 20 of the country’s top housing markets, so it gives us an excellent reading on the movement of values through time. After picking up a little earlier in the year we are now facing the likelihood that prices will continue to ebb for a few months more. My guess is well into the early summer of next year.

Why?

Because of all the reasons that undid the bubble to begin with plus the pressure of a “shadow” inventory hanging heavily in the background. This latter effect is the great unknown: no one really has a proper notion of its impact, yet we all know that there is such an impact. The shadow inventory consists of all the homes with mortgages in arrears, in foreclosure, or simply in the hands of owners who would dearly love to sell but cannot for a variety of reasons, negative equity being primary among them.

So the openly discussed inventory of unsold homes, which is still large by historic standards, but is down from the peak reached in the immediate aftermath of the crisis, is just the tip of a very large and depressing iceberg. Even if it never transmutes into actual activity to the extent that its shadow suggests, that inventory is choking off any solid recovery in housing. Couple this continued loss of wealth implied by lower home values with the poor income outlook into 2011 and 2012, and it is very hard to see a dramatic upturn in aggregate demand.

Without that we won’t get back to our historic growth pattern any time soon. And the longer we remain below that long termtrend, the more prone we are to reversals and dissatisfaction all round.

Don’t forget that real estate played a disproportionate role in generating jobs over the last decade. Construction is just not going to be a big factor in the near to medium term. Which leaves the great question unanswered: where will the jobs come from?

Who knows?

And that is why we all are stumbling with our forecasts. If we subtract construction from the equation, the US economy has a weak record for job creation for a very long time. So we keep coming back to the same solutions. Devalue the dollar to get jobs from export trade; and boost domestic demand as best we can through reflationary policy actions. Looking beyond that old bag of tricks requires an imagination singularly lacking in our policy and business leadership at the moment.

Meanwhile today’s home price report suggests we are still stuck in a low gear. Unfortunately.

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More GDP Muddle

We have been waiting for a while for today’s first look at third quarter GDP. We should have known better. At an annualized rate of 2.0% it was neither good nor bad. Frankly this concerns me more than either of those results would have. Muddling through is fast becoming the American way. That cannot be good for our ong term health or wealth.

First let’s look at the numbers:

  • Consumption added +1.79% to the total
  • Private investment added +1.54%
  • Trade deducted -2.01%
  • Government Spending added +0.68%

As usual it’s more interesting to get behind some of these numbers.

The consumption figure is encouraging. It is the fastest rate of personal spending since the end of 2006, and is the third straight steady improvement. Households appear to be coming out of the depths of their funk. But they are nowhere near back to sufficient activity to drive the economy forward without help from other sectors. Within consumption the big pick up over the last few quarters has come from services. The recovery in sales of services has been both stronger and more sustained than the recovery in the sales of goods. This suggests to me that people are out and about more frequently than they were back in the depths of the recession, but that they are also still postponing commitment to the purchase of expensive durable goods. That does not auger well for manufacturing, and may show up as a slow down in our factory activity early next year.

In fact the private sector investment figure includes hints that manufacturers are already scaling back a little. While investment grew quite well it is well down from the pace earlier in the year, and, more worrying, the majority of investment came in the form of inventory build up. I have been saying that the shift in inventories during the end of last year and the beginning of this was a temporary phenomenon and would dissipate as the economy recovered. That is the normal trajectory we should expect. And that was the pattern we saw during the first six months of the year. So to have that normal path reverse itself is a a concern. We don’t know exactly what the cause of the shift is – was it voluntary in advance of expected higher sales; or was it involuntary because sales fell short of projection? Plus inventory numbers are one of the least reliable of all the statistics in the GDP calculation, so it could change as the numbers are refined. Nonetheless, that inventories figured so prominently in the investment data is pause for thought.

As for trade: after the huge hit that imports dealt to GDP in the second quarter the trade number was bound to improve. Even so, at -2.01 it is still a big drag on the economy. The good news is that imports did indeed fall back from the awful record of the second quarter. The bad news is that exports also fell back. We need the dollar to fall quite a bit further is we want to get trade under control. Unfortunately it is not easy to have the dollar fall without other nations trying to make offsetting adjustments. Obviously a decline in the dollar implies an increase in the value of other currencies, which, in turn, implies rising prices and so on elsewhere. As the world struggles to rebalance the very unbalanced nature of trade and capital flows we should expect a very bumpy trade number in our own GDP calculation. This is not the place to opine on trade wars, but they remain a distinct possibility, especially if the Fed’s QE2 efforts flood the world with cash rather than inflating the US economy alone.

Lastly, government spending. The key here is that while spending at the Fed level remains a strong positive for the economy, state level spending went into reverse last quarter and undid some of that good work. This is a constant problem in the US, and one we quickly overlook. State level cutbacks offset and undo some of the stimulus effect of the Federal deficit, which means that the expansionary impact of the stimulus is reduced. This is why I have always advocated that the states maintain deficits and have the Federal government underwrite them. That way services are not reduced and the stimulus is not muted. That would be too easy for us however and some states, especially those run by Republican governors have steadfastly cut back and added to the malaise by so doing.

So what do we make of GDP?

It simply is too slow growing.

For an economy ostensibly recovering from a very deep slump, GDP growth is very disappointing. As I have said repeatedly, however, this is entirely normal for a recovery caused by a banking crisis. Both the depth and length of the problem was underestimated by our leadership. That meant the response was inadequate. As a result we are headed for a very weak and potentially long lasting period of poor performance. There is nothing in today’s data to change my opinion: the economy is growing far too slowly for unemployment to come down at an acceptable pace. We are likely stuck with high unemployment, disinflation, and high risks for a long time. The Fed will no doubt use today’s figures to justify the launch of QE2 next week. I have my doubts as to the value of monetary policy at the moment. We need more Federal level fiscal stimulus. We won’t get it. So the malaise will linger. Get used to it.

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