inventories

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Signs of Life? Part 2

Yesterday’s reports of economic strength have been followed by a couple of similar reports today. We are spoiled by good news. Well sort of.

The headline grabber will be the news that GDP grew 3.6% in the third quarter. If you recall, the first estimate had growth at a much lower 2.8%. This level of growth is the highest we have seen for a while and would, on the surface, suggest things have taken a turn for the better.

But, of course, that’s just on the surface. Before we get to the enigma inside the news let’s run down the basic facts:

  • Personal Consumption rose by 1.4%, which added +0.96% to that 3.6% total
  • Private Investment grew by 16.7%, which added +2.49% to the total
  • Exports grew 3.7%, while imports only grew 2.7%, which means that net trade added +0.07% to the total
  • Federal government spending declined 1.4%, but State government spending rose 1.7%, so overall government spending added +0.09% to the total

So what’s the enigma?

First, personal consumption, which accounts for around two-thrids of the entire economy, had its slowest rate of growth for a while. In fact you have to go all the way back to 2009 to find weaker growth. This does not auger well for the economy. Clearly households are still holding back. Or, which is more likely, they are being constrained by weak employment and wage growth. All those arguments about inequality and our incredibly skewed distribution of wealth are relevant to this part of the economy: there may be a lot of cash sloshing around the economy, but if it doesn’t end up in the average household where it is more likely to get spent, then the economy doesn’t benefit.

Second, and this may well follow from the prior point, the big jump in private investment was ruled by a second quarter of huge inventory accumulation. Indeed almost half of all growth in the third quarter can be accounted for by inventory build up. This, to put it bluntly, is not a good thing. There are always two interpretations of inventory accumulation. The positive spin is that businesses are sensing an imminent burst to consumption and so stock shelves in anticipation of strong sales. The negative spin is that businesses stocked shelves but the sales didn’t materialize and so production will have to be cut in order to allow stocks to run off. I think there is more of that second explanation than the first in last quarter’s numbers. Demand looks weak. Inventories are too high. Production will have to be adjusted downwards. This implies a weaker economy in the next quarter or two.

We ought not to leave GDP without commenting on the continued shrinkage of Federal spending. In ten of the last twelve quarters Federal spending has declined. This puts a dampener on overall growth, which is the exact opposite of what we need. There is a time and place for budget cuts, the last few years was not such a time. We have, due to wrongheaded austerity policies, prolonged and worsened the economy’s weakness.

There’s no news in that. But we ought to resist further austerity moves as determinedly as we can.

The other report released today was the weekly summary of new claims for unemployment assistance. This was also unexpectedly good. Claims fell by 23,000 to 298,000. This is only the second time claims have been below the 300,000 mark since the recession, and, under normal circumstances would be very good news. There is a problem however. The report is seasonally adjusted, and such adjustments are always a little tricky during holidays like Thanksgiving, when newly unemployed people may delay making their first application for help. So, rather than get too excited, we all need to wait a week or two to see if future numbers reinforce or contradict today’s apparently upbeat message. Besides, as I have mentioned many times before, we all ought to focus on the four week moving average of claims because it is a more reliable statistic. That number also dropped nicely, by 10,750, to 322,250. So clearly there is positive momentum in the labor market. How much remains to be seen.

So there you have it, two good but flawed pieces of news.

The economy is still growing, employment is still improving, but neither is as strong as today’s reports suggest.

Which means we are still stuck in relative stagnation and still need help rather than hindrance from Congress. Good luck with that.

 

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US Economy Grows 2.8%

Don’t get too carried away by today’s report on the economy. Growth of 2.8% in the third quarter is nothing to be happy about because it falls right in that range of ho-hum figures that neither excite nor disappoint. It isn’t sufficient to break the back of unemployment, but it is enough for do-nothing politicians to use as a reason to do nothing.

We are stuck., but at least inflation is nonexistent. I wish that were a good thing, but it isn’t. A little inflation, say around 3% per year, would help us enormously by easing the pressure on borrowers, and by introducing some elbow room into credit markets so that Fed policy would have more purchase against our problems.

When I think about it more I fear that 2.8% is almost exactly the kind of number we don’t want. Especially as the great conference in Congress is kicking off and exploring the possibilities of a grand bargain on the deficit. Had growth slumped it might have energized those few in Washington who actually care about our workers into action to end the lunacy of the sequester and the damage that austerity is doing to each and every one of us. Had growth been much higher it might have ben sufficient to reduce the deficit even more rapidly than it is reducing now and thus have relieved pressure on the need for further reduction.

But no. We are stuck in no man’s land still.

The colossal failure of recent economic policy is now so manifest I have to wonder whether anyone – anyone – down in Washington understands just how  poor their collective record is. The one thing we can be sure of is that they are so absorbed in ideological infighting that they no longer have any contact with reality. I have used the metaphor of trench warfare many times these past few years and I still cannot think of a better one. Just as the generals failed to think beyond the trenches and the stalemate they imposed on them, our current leadership cannot think beyond their fixation on the deficit, the debt, and the stalemate they impose on policy.

Boy are we stuck.

In any case the numbers today are not that good even if you accept 2.8% as being par for our rotten policy set. Too much of third quarter growth comes from an increase in business inventories. The problem with inventories is that an accumulation can be either good or bad. Good if it signals business is optimistic about future growth and is ramping up production ahead of sales. Bad if it signals that business missed a downturn in sales and will have to reduce future production to downsize and fit demand. Given the rest of today’s report I suspect it the negative message we should hear, not the positive.

True, trade improved, but with the shadow cast by the antics of the Republicans in Congress, the world economy can catch cold at any moment. So trade is no guarantee of a rosy future. Besides, no matter what you hear, trade is just not a large enough component of our economy to drive us to the promised land. Our issues are all domestic, which given the impasse in Washington, means we won’t resolve them any time soon. As case in point: today’s report tells us that consumer spending, the true engine of our economy, sputtered along at 1.5% in the third quarter. That’s down from a poor 1.8% in the second. Business investment, another key engine for growth, also fell – from 4.7% to 1.4% – so the private sector is not looking good.

Then there’s the continuing cut in government spending. Federal spending alone fell 1.7%, and has now fallen for four straight quarters. That’s what austerity look like. Those cuts mean fewer jobs and less cash flowing into the myriad of businesses that rely on government contracts to keep afloat.

Not that you would think the deficit is melting away were you to listen to the Republicans. Paul Ryan remains adamant that we need a “down payment” on deficit reduction – especially cuts in entitlement programs like Social Security – in order for the great conference to have any meaning. As if the recent precipitous decline in government spending was not a;ready a large – too large – a down payment.

I apologize if this all sounds repetitive or downbeat, but I think we all need to realize just how awful policy has been and how much damage is self-inflicted rather than “natural”. We have well and truly shot ourselves in the foot, and our politicians continue to relish the chance to shoot again. That is plainly stupid and antisocial. Especially when we have the policies, if we would use them, to stop the rot and build a brighter fixture for us all.

As I said, don’t get too excited over today’s report.

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More Sideways Than Up

The economy just can’t get on a roll. We managed to get passed the slow down of late last year only to run full square into a self-inflicted slow down this year. Ugh. That’s a technical term for ‘I told you so’. The economy, as measured by Gross Domestic Product (GDP) grew at a 2.5% rate in the first quarter this year. The good news is that the economy gained speed – the last quarter of last year had seen anemic 0.4% growth. The bad news is that this acceleration is too slow to clear up all our excess capacity, especially our severe long term unemployment problem. It is also too slow to get us anywhere near back to our potential. Every day we slop about like this we leave wealth on the table unearned. And that matters to us all. Or at least it ought matter to us all. A lot.

Here’s the breakdown, as usual I show the contributions of each major part of the economy:

  • Personal Consumption grew at a 3.2% pace, contributing 2.24% to the total
  • Private Investment grew at a 12.3% pace, adding 1.56% to the total – of which 1.03% was in the form of inventory accumulation
  • Net exports reduced the total by 0.50% because the growth in exports was more than offset by growth in imports
  • Government spending continued to shrink and reduced the total by 0.80%

This is a really mixed bag.

As you can see, the biggest impetus to overall growth came from personal consumption, but no one expects this pace to carry forward much. Disposable incomes dropped 5.3% in the quarter due primarily to the rollback of the payroll tax holiday. Couple this with the continued decline in savings and it becomes very difficult to forecast strong personal consumption for the remainder of the year.

Then there’s the increasing negative effect of the decline in government spending. A large number of people, some in the media as well, seem not to realize that US government spending has been in decline for a while now. Right after the crisis hit, state and local governments around the country began to retrench in order to balance their books in the face of a collapse in revenues. The 2009 Federal stimulus meant that Federal level spending grew for a couple of years, but with that now fully worked through the system, and with the sequester cuts coming on line,  even Fed level spending is now declining. Add the two together and total governments spending is acting a strong brake on growth. Which is exactly not what we need to see. But Congress in its wisdom has decided to slash away at the economy. This is despite all the rapidly accumulating evidence that austerity doesn’t, can’t, and won’t work.

Let’s look at two charts:

Here’s GDP growth over the last few years …

Yes that dip was enormous.

Here’s how the total accumulation looks when we express it as a percentage the peak reached jut before the crisis …

As you can see we’ve managed to get back above the pre-crisis peak. But not by much. That’s because we are running well under a rate of growth enough to get us back to our potential. Here’s the gap between potential and actual …

 

And, last of all, here’s a look at the level of government spending as a percent of that potential GDP …

I think it correct to look at government spending in terms of potential, and not actual, GDP because the result gives us an idea of what that spending looks like were the economy in good shape and not impaired as it is now. Two points ought to leap out at you when you look at the last chart:

  1. Both the Reagan and Bush II years show sharper increases in government spending than the intervening Clinton years. Indeed if you look closely you can see that the Clinton era was one of good control over government spending.
  2. It is very clear that the leap in government spending associated with the crisis has not continued and that the Obama administration is overseeing the only non-recession caused contraction is such spending anywhere on the chart. In fact Obama is pursuing a tighter fiscal policy than any president of the past forty years.
  3. This Obama austerity movement is not something to applaud. Draining government spending from the economy before the private sector is back to full health makes matters worse, not better.

What does all this mean?

That the economy is not fully healed. That growth is more likely to slow than to accelerate. And that government fiscal policy is working in exactly the wrong direction.

This is not a good message. The first quarter’s 2.5% growth may well be the high water mark for the year. It’s most likely down hill from here.

Unless, of course, Congress decides not to be so stupid. That’s not happening though, is it?

 

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Growth, But Barely?

Today’s headline is that the economy grew, just, in the fourth quarter last year. GDP rose at an annual rate of 0.1%, down from 3.1% in the third quarter and at the slowest pace in almost two years.

But things aren’t that bad. On the contrary the report is quite encouraging. this is one of those occasions when we need to dig a little deeper into the numbers.

Here are  the basics, broken out by primary economic sector:

  • Personal consumption grew at a 2.1% rate; this contributed 1.47% to the total
  • Private investment slumped, declining at a -1.5% annual rate; this reduced the total by -0.2%
  • Exports and Imports both declined, at annual rates of -3.9% and -4.5% respectively; this added 0.24% to the total
  • Government spending declined sharply, at an annual rate of -6.9%; this subtracted 1.38% from the total

Now here’s the good news:

There are some major quirks inside those numbers.

Private investment looks rotten on the surface until we realize that the entire decline can be attributed to a major inventory adjustment. Without inventories investment actually grew at its fastest pace in over  year. That big shift in inventories is typical. Businesses periodically realize they have overstocked and try to compensate in the next period. There is nothing particularly abnormal about the swing in the fourth quarter, and it has little bearing on the sustainable rate of growth we have carried forward into 2013.

The other real oddity in the figures is in defense spending which dropped a remarkable -22.0% in the fourth quarter after having jumped up 12.9% in the third. Obviously the data needs to be smoothed out to accommodate such shifts, and even with a tighter budget there is no way that we will see a repeat of the fourth quarter any time soon. Setting aside defense, spending at the federal level rose 1.8% which was mostly offset by a continued decline – of -1.3% – at the state and local level. So without defense total government spending was a nearly neutral factor for the economy late last year.

In terms of looking forward into this year it is encouraging to see personal consumption continuing to contribute a healthy amount to activity. That 2.1% growth rate is vital as we seek to keep the recovery on track. Consumption has grown steadily, but not outrageously, in every quarter for three straight years, the last decline coming in the third quarter of 2009.

Without the quirks I noted above the economy would have grown at a healthy 3.0%, virtually identical to the 3.1% of the third quarter, so it safe to say that the recovery remains on a decent trajectory.

That, however, may end soon as the sequester eats into government spending. My original thought for 2013 growth was in the range of 2.0% to 2.5%. With the upcoming budget cuts that has to be reduced by at least 3/4%, so instead of a decent year in 2013 we will get minimal growth and thus will prolong the rotten employment outlook much further than we ought.

I find it strange that Congress actually is proposing a slower economy, one that might even totter on the edge of recession, but that’s exactly what the House seems to want. The dominant thought in the House is that cutting government spending will magically release a surge of confidence in the private sector and thus more than offset the negative effects of the cuts. It won’t. It never has. It never will. Private sector confidence is a function of a pragmatic assessment of the future. The outlook for demand is the largest single contributor to that assessment. Government tax policy and spending is a much lesser component. So even if businesses and households perk up at the thought of lower future tax bills – which is what right wing theory says happens – that extra optimism will be overwhelmed by the simultaneous realization that demand will ebb as government spending is cut. It is, after all, entirely rational to take into account all the effects of austerity and not just those the right wing prefers us to focus on.

If you disagree take a look at Europe. They tried the austerity-leads-to-growth idea. It has produced nothing but longer deeper recessions, and now is producing a populist backlash. It is an unequivocal failure. But we are about to follow.

That’s just stupid. It’s also where the House wants to go. I haven’t a clue as to why.

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A Mixed Week Ends Well

There was a flurry of economic news this week, most of which was encouraging. The economy is in decent shape. Not great, just decent.

We began, on Monday, with a strong showing from durable goods, which grew 4.6% in December. The problem with this is that the growth was skewed by aircraft orders which are notoriously volatile. Even without them, however, orders were – you guessed it decent. The other Monday report was also a bit misleading. Pending homes sales dropped 4.3% in December, but the problem appears to be a lack of inventory of houses for sale in key areas rather than a lack of demand. This weakness may continue until the spring when home owners usually start the selling process. This would ease the inventory blockage and allow demand to be met more closely.

Then Tuesday produced evidence to support that interpretation of the pending homes sales decline: the Case-Shiller index of home prices showed a solid year on year price gain of 5.5%. Nineteen of the twenty cities comprising the index showed a year on year gain, with only New York City showing a decline. So the real estate market continued its recovery throughout the year and enters 2013 in much better health. We ought to remember, though, that even after 2012’s recovery home prices are still about 30% below the absurdity of their bubble peaks and practically every index of activity in housing is well below those peak levels as well.

Tuesday also brought us a shocking consumer sentiment number. The Conference Board measure of sentiment dropped to 58.6 in January, its lowest level since November 2011. Not only was the decline sharp – the index had been 66.7 in December – but it was more than expected and through the market into some confusion. The thinking had been that the horror show in Washington had eroded consumer confidence a tad, but no one expected anything to this degree. It turns out that the decline was less to do with legislative lunacy and the ongoing farce that is our political system, but was driven largely by a reaction to the sudden loss of wages due to the hike in payroll taxes. Not only does that hike scrunch worker pay packets, but it reminds people that their wages haven’t been growing much anyway. Score another negative for the forces of austerity.

Next: Wednesday brought us the bad news that the economy actually shrank 0.1% in the fourth quarter. This turns out to be an illusion when we adjust for two major quirks. First, inventories dropped sharply. Second, there was a huge spike down in defense spending. Remove these two oddities and the economy was chugging along at its recent 2.0% pace. there is no reason to believe that either inventories or military spending will repeat that fourth quarter gyration. So we can safely ignore them when we try to project the trajectory of growth this year. That dull, but decent, 2.0% rate seems a safe bet.

On Thursday there were one or two more strange numbers to think about. Personal incomes rose in December at the fastest rate for eight years. Was this the end of wage stagnation? Unfortunately not. The 2.6% jump came almost entirely because of a 34.3% increase in divided income. A very large number of businesses shifted their dividend payout from early 2013 to late 2012 in order to avoid potential tax increases. So what appears top be a great number turns out to be a total dud. The increase will simply be offset by a decline in 2013 as things settle back to normal. And that flood of cash it unlikely to turn up as spending. Typically people who receive much of their income as dividends are more wealthy and tend to spend a smaller percentage of their overall income.

Thursday’s weekly new claims for unemployment assistance data was also a jolt. Claims shot up 38,000 in a single week. Under normal circumstances this kind of change would make us all worry about the labor market, but this week’s figures elicited a big yawn. The reason being that it seems to be simply an unwinding of a major seasonal shift. The prior few weeks had been unusually strong, so much so that no one really believed the figures, and so this week’s weakness has been interpreted as a return to normal.

That this is the case is supported by today’s employment data. The economy added 157,000 new jobs in January which belies any thoughts of weakness. The number of new jobs was less than many had predicted based upon the very healthy 192,000 new private sector jobs reported by ADP earlier in the week. One of the key differences between the government report and the ADP date is that the government includes public sector jobs as well. Since government at all levels has been shedding jobs steadily the relatively good data for the private sector is being masked by the layoffs by government. Don’t forget that the majority of government jobs fall into three categories: teachers, police, and fire personnel. So the attrition of government jobs means we have of those people. Indeed most of the loss is in teaching – the country is employing about 300,000 fewer teachers than before the onset of crisis.

The good news on the jobs front was that there were some major revisions to the data for the end of 2012 with the result that the economy added an average of close to 180,000 jobs a month last year. This is the best sustained rate of job creation we have seen for a decade, and speaks well to the underlying strength of the economy. It still isn’t good enough, though, to prevent the unemployment rate from ticking up slightly to 7.9%. The reason being that we are seeing a greater influx of workers into the workforce. With opportunities more abundant some of the discouraged workers who dropped out completely during the bad years are now starting to look for work again and this has the perverse effect of making the data look worse.

Lastly, also today, we had the monthly glimpse into manufacturing provided by the Institute for Supply Management’s index and we had a different look at consumer sentiment.

The ISM index rose to 53.1% from 50.2%, which was a slightly stronger improvement than expected. Any reading over the magic 50.0% mark means that the manufacturing sector is expanding rather than contracting so this months number is encouraging. It also reverses the slight reversal that had set in during late summer and early fall. At the same time it is a not a very strong statement about the economy. Clearly thing could be a lot better.

Then there was the University of Michigan’s monthly look at consumer confidence which showed an increase from 72.9 in December to 73.8 in January. Yes, I know. This contrasts rather starkly with the other index – from the Conference Board  – I mentioned earlier. One fell, the other rose. The common features are these: the ending of the payroll tax ‘holiday’ hit consumers hard; neither index is very strong by historic standards; and both were depressed  by what people see as dampened current conditions. Those aspects of sentiment dealing with the future were more buoyant. Whether consumers are right about the future we will have to wait and see.

Right now we have navigated a very full week of information only to end up pretty much where we started. The economy is decent,not great. It could be a whole lot better, but won’t be until we get policies aimed at getting demand moving. Since the entire focus is on austerity, which is a policy disaster, we cannot expect an improvement.

Nothing this week changes my mind: look for growth to hover between 1.5% and 2.0% this year. Better than nothing. Not good at all.

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