inventories

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GDP and Housing: Better and Worse

More mixed messages. Today’s release of the revised GDP figures for the third quarter was better than expected, whereas the report on sales of existing homes continued to disappoint. Add in yesterday’s hints that the Fed is in the process of downgrading its views for growth in 2011 and we end up with a decidedly murky view of what’s going on. Evidently we are stuck somewhere in the mire of slow to middling growth with chunks of the economy acting as anchors preventing much acceleration.

First GDP.

GDP grew at an annualized rate of 2.5% in the third quarter. This compares with an original estimate of 2.0%, and 1.7% in the second quarter. The fourth quarter of 2009, and the first quarter of 2010 were 5.0% and 3.7% respectively. So, after fading sharply at the beginning of the year, growth has been restored at a moderate pace. Not enough to cut into unemployment, but enough to fend off any concerns of further contraction.

The key facts to consider in the report is that growth is fairly wide spread. Personal consumption grew at its best pace for several years, with services picking up well and sales of autos particularly strong. Investment is slowing down after the normal early recovery spurt. Residential investment plummeted back tom earth after the false dawn of growth in the second quarter. And government spending was decent, with the notable feature of positive spending at the state level, so the states were not a drag on the Federal level stimulus efforts.

Frankly growth was better than I expected. For the last twelve months we have seen GDP grow by 3.2%, which is steady rather than great coming out of a recession. It is more than I predicted, but still not enough. The early predictions for 2011 are all in the 3.0% range, but rumors abound that the Fed is downscaling its own view: they had been at the more optimistic end of the spectrum. I think the reason for the new caution is the realization that the growth we have, and the growth we are likely to see, is not sufficient to tackle unemployment. There is a growing realization that our problems are more deeply rooted than some analysts originally thought. Personally I put this realization down to the result of a revision in the basic theories used to drive analytical thinking. The re-emergence of Keynes and his followers, especially Minsky, coupled with all the new research on post banking crisis recoveries has dampened even the most ardent neoclassical zealot’s views. I hope this realism persists and informs policy.

Meanwhile unemployment appears intractable to anything other than direct government intervention. Since we are not going to see that, it will last. The latest Fed thinking is that we will have an unemployment rate in excess of 8.0% well into 2013.

Second, Real Estate.

Sales of existing homes took yet another beating, dropping 2.2% in October. They are now down 25.9% year on year. There seems to be no end in sight for the malaise in housing. All the factors playing into the market are working against sellers. The glut of foreclosures hangs heavily on prices; this induces huge uncertainty as to what a good price should be, thus deterring buyers; credit is very tight as banks over react to their own stupidity; and unemployment is making many people fearful of big ticket commitments. None of these are likely to change for a while, and with the fall selling season now behind us a recovery will have to wait until spring. Whether things will change even then is highly disputable. I don’t see anything on the horizon to suggest a radical improvement. The aftermath of the bubble will linger well into late 2011 and early 2012. Only then will we see increases on a regular basis, and they will be from a very low base of activity.

So: even though GDP looks to be in better shape than I predicted, I think the economy is still more lurching along than sprinting. While growth seems well established across the board, nowhere is it truly good. The best characterization is still one of steady, insufficient, and halting growth. GDP will expand in the 2.5% to 3.0% range from here on out. That is not enough. Meanwhile we all have to be concerned about continued disinflation and its impact next year.

Are we out of the woods yet?

No.

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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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GDP Revised Sideways; Jobs Edge Up

Todays has seen a little flurry of news, so lets’ just take a look:

The latests revision of GDP was released, and showed practically no change. At 1.7%, GDP growth was mediocre in the second quarter to say the least. The details are worth looking at because they give us insight into the probable course of the third quarter.

  • Personal Consumption contributed +1.5%
  • Investment contributed 2.9% [Fixed Investment being +2.1%; Inventories being +0.8%]
  • Net Trade contributed -3.5% [Exports grew 1.1%; offset by Imports growing 4.6%]
  • Government Expenditures contributed +0.8% [Federal growth being +0.7%; State growth being +0.1%]

The clear story here is that consumption is growing slowly, certainly not enough to push the economy out of the doldrums, but enough to prevent the onset of renewed recession. Add in the growth in investment, particularly in fixed investment, and the basic private sector is chugging along at a slow but decent pace. One spot of concern is that we have reached the end of the inventory cycle, so the addition to growth from that activity is declining quite sharply from the levels we saw at the end on 2009. That’s fine as long as fixed investment takes up the slack as it appears to have done in the second quarter, but we need to keep close watch on this in the coming months.

The other big news was the big shift in trade. Exports ticked up moderately which reflects the recovery going on around the world. Unfortunately there was a very large growth in imports that swamped exports and took a lot of the steam out of GDP overall. A couple of things seem to be going on there. One is that importers of finished goods appear to have brought in an unusually large amount of goods, possibly to re-stock shelves in anticipation of growth, all at once. Another is that the pick up in GDP generally always has the effect of sucking in things like oil: as the economy moves up a notch, so too do such imports. I doubt that the surge in imports will be repeated in the third quarter, so that alone will tend to boost GDP beyond its second quarter level.

The last factor to note is that government spending at the state level shifted into a positive gear, albeit at very low levels. One thing I try to point out relentlessly is that government spending at the Federal level is stimulative – its adds growth – but at the state level it has been negative as states try to balance their budgets. So much of the stimulus that attracts the eye of voters and media alike has been offset or neutralized by this state level contraction. In effect the states have worked against the Federal government and its effort to get the economy going. This is one reason that I have advocated allowing states to run deficits and have the Feds write checks to pay for them. That way local services and jobs are not sacrificed, and the national stimulus is not neutralized. I doubt that the positive shift at the state level can be maintained for long and thus expect the local drag on the economy to re-assert itself either this quarter or next.

Overall, this report is a sideways revision from the last release of data. We learned very little we didn’t know already. The economy is not declining, nor is it brimming with health. Most importantly there is no sign of sufficient health to get job creation out of its cellar dwelling existence.

Speaking of which:

Today’s release of the weekly numbers on new claims for unemployment assistance was a modest pleasant surprise. New claims declined by 16,000 to 453,000. While the absolute level is still way too high for this point in a recovery, we should acknowledge the modest progress. This is the third week of very slight improvement, which is better, obviously, than the alternative.

Nonetheless, businesses are now reporting weaker sales forecasts and are reacting by downgrading their hiring expectations. This is just awful news.

The entire outlook hinges on business expectations. As long as the prospect of weak demand lingers, so too will the prospect of a poor job market. Eventually the two interplay with each other and the poor job market creates the conditions in which businesses see poor sales. The economy is operating well below its potential, which is based upon the amount that could be produced were we at full employment and businesses were producing at or near full capacity. The gap between where we are and where we could be is now between 6% and 8% of GDP. That’s almost $1 trillion in lost wealth this year alone. Assuming that it will take us a while to get back to close to potential, this recession will end up costing us more than $6 trillion in lost wealth. We should be willing to spend, and borrow if need be, in order to reduce that lost wealth total. That’s one reason why people who wring their hands about the cost of the stimulus are wrong: they are looking only at the cost. They ignore the payback from that debt. The payback being the decrease in wealth lost as we recover.

The social benefit of stimulus far exceeds the social cost. We should think of it as an investment in our future. As long as the job market stays in its current funk we should be willing to endorse any plan to get it moving. If that means borrowing, so be it. The benefits outweigh the costs. By a lot.

I am tired of saying this: we need more stimulus.

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GDP: Crawl, But No Stop

Today’s much hyped release of the revised GDP figures for the second quarter delivered as promised: the economy is moving at a snails pace, but it hasn’t yet stopped.

The revision shows growth of a paltry 1.6%, which is down both from the original estimate of 2.4%, and the now final number for the first quarter of 3.7%. Our fears that the underlying economy is weak without the support of the stimulus have been completely vindicated. Likewise fears of a double dip recession have grown, but we are still not there. Just.

The numbers don’t need much analysis:

Consumption contributed +1.4%

Investment contributed +2.1%

Inventory Adjustments contributed +0.6%

Trade deducted -3.4%

Government Spending contributed 0.9%

These raw figures mask some interesting details.

Private investment, particularly in machinery and equipment surged by 19.5% during the quarter. Even residential investment picked up, admittedly from a very low base, and grew 27.2%. This latter number seems enormous but we should remember that residential investment has collapsed over the last few years, so this rate of increase cannot be sustained and merely reflects the extraordinary depths of the recession, rather than reflecting a renewed vigor.

Consumption had a decent, but not great, quarter. Durable goods expenditures were the key, growing 6.9%. This makes it two quarters in a row of solid gains for durable goods, which is usually a sign of gathering strength for the economy as a whole.

The big shocker in the quarter was the radical change in the trade figures. Exports grew 9.1%, but were swamped by a 32.4% surge in imports. This truly horrible performance was driven the increase in consumer demand for electronics and other ‘hard’ goods, as well as a recovery in the demand for autos. The size of the shift in imports was so large that I cannot see it being repeated, so we should expect the third quarter to show a much lower negative impact from trade.

The government spending numbers are also interesting for what they don’t show: the steady reduction of spending at the state level abated temporarily and actually reversed slightly. So the 9.1% increase in Federal expenditures were not offset by a local government contraction as has been the case recently.

So what?

The economy is obviously going through a very weak period. We should be extremely cautious in our expectations for the next few months. Growth of around this same level is what I think is a reasonable projection, absent any major shocks. More to the point: I think there is sufficient strength – only just – for us to avoid a further slowdown into recession. Final demand is healthy at around 4.1%, and as long as the trade figures for the second quarter are an aberration rather than a new norm, we should eke out growth over the rest of this year.

The problem is that growth at these meager levels doesn’t feel healthy and will not generate an improvement in the job outlook. As a rough rule of thumb we need around 2.5% GDP growth for unemployment to stop growing, and about 3.5% for it to start to drop. We are nowhere near those levels and so there is a distinct chance that unemployment could tick up as the year progresses.

It is that possibility that undermines everything else. Higher unemployment could tip consumption back down and ruin business prospects. That would bring a halt to the current increase in investment and thus throw us into contraction.

So the entire focus of policy makers should be on jobs. That means spending government money.

The chances of that remain poor as the GOP obstructs and the Administration dithers.

Instead of action on jobs we hear far too much discussion in policy making circles about the need for a tightening in monetary policy. One Federal Reserve bank president – Kocherlakota from Minneapolis – has attracted the scorn of some economists by arguing that we need to raise interest rates in order to fend off deflation. But low interest rates are not a cause of deflation, but they may be a symptom of an ongoing disinflationary process. It is true that long term rates are lower now, and that a possible reason for that is the reduction of the so-called inflation premium embedded in them. But the causality runs the other way around. We raise short term interest rates in order to alter the economy’s path by slowing the demand for credit, and to signal an outlook for acceptable inflation at all levels of GDOP activity. In a period of high inflation this has the effect of reducing expected inflation and, thus, long term rates decline. So lower long term interest rates reflect, rather than cause, reduced inflation. That Kocherlakota got his Ph.D. from Chicago, hotbed of monetarist economics, merely adds to the confusion and merriment.

Meanwhile millions of Americans continue to struggle needlessly because our elites – political, business, and academic – are too embroiled in re-hashing discussions first held during the 1930’s. Keynes was right then and is right now. That some classical economists don’t like that, or that some Republicans want to score short term election points, is not a reason to keep people unemployed.

We could do better than this.

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It’s The Demand, Stupid

Things are not looking very good. When we have luminaries such as Greenspan and Rubin agreeing that the economy is weak, but that it will get through this minor lull in good shape, we have to worry. Neither of them has much credibility any more, so I take their unanimity on the positive outlook as a bad sign: the economy must be getting weaker.

In any case the data seems to suggest we have hit a tough patch. How tough is all we are debating.

The problem is that I don’t think there’s any way to tell exactly where this slide will end up. It is easy to make the case that GDP could continue to drop back into negative territory. It is also easy to argue that we will pull put of the dive before we hit the ground. My own view is that the evidence suggests a rocky second half with very low growth, but growth nonetheless. This is small comfort to the unemployed: it would be no surprise at all were unemployment to creep up as the swoon continues.

It is remarkable how quickly the discussion has turned to towards trying to size up the decline. Only a few months ago those of us who warned of a tough road ahead were being called unduly pessimistic. After all profits were rebounding, manufacturing was on the up, productivity was rising, and even housing had a semblance of life. Only profits remain healthy. Everything else has hit the proverbial bump in the road.

If you recall my view of 2010 was conditioned by the oddity or imbalance of the spurt in activity that generated all that hope. There was a genuine rebound from the depths of 2007/2008, especially later last and early this year. My issue was with the froth over and above that base rebound. A big inventory cycle reversal and the benefits of the stimulus, neither of which were permanent features of the ongoing economy, made it very difficult to determine just how robust the recovery was.

We are now finding out.

Which brings us to the question of what policy should be going forward.

The main line of attack should be supportive. Of that there is no doubt. Now is far too early to start any tightening. In fact, while I have argued against tightening throughout the past few months, that position is even more important now.

The Fed acknowledged as much yesterday with its begrudging approach to the money supply. As I predicted, the Fed basically avoided making any move in either direction, it stayed pat. It accomplished this by announcing that it would reinvest the proceeds of any maturities in its portfolio back into more investments. This means that it is not reducing its level of support for the economy. Nor is it adding anything.

Meanwhile the war amongst various policy camps rages on.

There are those who argue we should reduce or simply get rid of the stimulus since it has not achieved a total reversal of the crisis. This is, of course, nonsense. I agree that the stimulus failed to turn the unemployment situation around. But that was entirely predictable. It was too small to begin with. What the stimulus achieved was a far more limited goal: it stopped us falling into depression. So far anyway. The notion that we should look to investment activity and business to lead the way is totally without credibility. Yet this is the alternative being pressed by those who opposed the stimulus. Their line of attack is that we should reduce regulation and other ‘encumbrances’ on business. We should reduce the uncertainty in the business environment. We should subsidize investment. We should throw tax breaks to businesses. And, most of all, we should get rid of any silly notions of government interference in the ‘natural’ workings of the economy. Once this is all done, the sun will rise again, the birds will sing and we will emerge into a re-run of the good old days. Oh and there will be plenty of jobs in this rediscovered capitalist nirvana.

This sort of reasoning is the time honored approach adopted by all right of center thinkers. It can be summed up as: ‘get government out of the way and we’ll be fine’.

The problem I have with this is that all the evidence contradicts it.

Profits are strong. Companies have cash to spend. Interest rates are very low, which means that borrowing is cheap, and that even marginal investments will make a profit. Project hurdle rates are minimal. The economy is awash with cash – if it isn’t why are people concerned about the inflationary impact of the money supply?

Yet despite all this, business is still retrenching or standing still. The investment environment is strong. Why aren’t we seeing a surge of construction, development or expansion?

It’s the demand stupid!

Demand is weak.

That reduces the prospect for sales and so offsets the low cost of capital. This weak sales outlook cripples business expectations. And as any Keynesian will tell you: the most volatile component of the economy is business investment based upon those expectations. Until demand picks up even ridiculously low interest rates and the total elimination of regulation will not be sufficient to spur investment.

Which also undermines the parallel argument we hear from the same analysts that all that government debt implied by the stimulus soaks up the available savings and so ‘crowds out’ private investors from the credit markets. This is specious for the same reasoning. We are suffering from excess savings not insufficient savings. There has been a remarkable collapse in business investment. So there is no demand for capital coming from that quarter. In any case profits have recovered, so businesses are generating capital from internal cash flows. They don’t need, necessarily, to borrow. That represents a problem for the capital markets: where does the cash all go, if not into private investment? Into government. All that is happening at the moment is that the government is borrowing instead of the private sector, and spending, instead of the private sector, because the private sector has no intention of doing so.

Were the government deficits crowding out the private sector we should be seeing interest rates rising in response to the capital squeeze. But they are falling, not rising. If the prospect of government debt inundating the market was as awful as the deficit hawks tell us it is, those fears would be translated into higher rates, not lower rates.

The point is simple: all the signs are that the credit market fears continued decline more than it fears the bloating of government debt. This makes perfect sense when we look at the cost of lost wealth from recession/depression versus the cost of debt accumulation. The cost of carrying debt is far less than the cost of all that lost wealth from our failure to reignite the economy. The tradeoff is simple and the credit market is voting with its feet for more stimulus and more debt. Despite all the bleak words flowing from the denizens of the market. Plus, once we get GDP rising at reasonable rates we can run deficits for long periods and still lighten the debt load. This is because of basic math: as long as the increase in GDP outpaces the increase in debt, the debt load and its cost as a percentage of GDP goes down.

The goal has to be getting GDP going at decent rates. Not managing the debt downwards.

To put this in perspective: the rate on inflation proofed government five year bonds fell below zero this week. Think about that. There are sufficient investors, with enough cash, who are so concerned about the economy’s prospects that they will pay the government to keep their cash safe rather than look for an opportunity to invest it at higher rates. That’s what a negative rate implies.In other words business expectations are so bleak that the government could borrow almost endlessly at almost zero cost and still not absorb all the money looking for a safe home.

There is a savings glut.

We are in a liquidity trap.

The only exit is through more expansive government activity.

There is only one target for policy:

It’s the demand stupid!

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