December 30, 2010
A YEAR-END DIP IN JOBLESS CLAIMS. CAN WE BELIEVE IT?
The year’s economic news is ending on a high note, or at least a relatively encouraging note. Initial jobless claims declined by a hefty 34,000 last week to a seasonally adjusted total of 388,000. That’s the first reading under 400,000 since the summer of 2008. Is it real? Maybe, although the timing raises some doubts.
Does Christmas week provide a robust sampling of new jobless claims? No, probably not, although the fact that new claims have been trending down in recent months suggests there’s a favorable wind blowing here, even if last week’s data point is skewed.
Last week's tumble in new claims raises hope that next week's employment report for December (scheduled for release on Friday, January 7) will offer some confirmation that the job market is improving. If you're an optimist, you can argue that the outlook is moderately favorable at the moment. The consensus forecast among economists calls for a rise in private nonfarm payrolls of 101,000 for December. But even assuming that's an accurate forecast, it still falls well short of what's needed to bring the elevated 9.8% unemployment rate down by something more than a trivial degree.
Of course, a 101,000 gain in private payrolls would be a step in the right direction compared with November's dismal 50,000 net rise. Yes, we've been here before and so one looks ahead cautiously these days when it comes to reviewing the prospects for the job market. But, heck, it's the end of the year and so it's a time for hope, misguided or not. Today's jobless claims update soars majestically on those terms. Next week may tell us different, but a round of thinking positively fits nicely with the New Year's weekend ahead.
On that note, this is our last post for 2010. To all our loyal readers, here's wishing everyone a healthy and prosperous new year! See you in 2011. As John Lennon once sang, "Let's hope it's a good one."
PEAK OIL & CRUDE WAGERS
Peak oil is back in the news, mostly for its apparent failure. The story starts with a five-year-old wager.
In 2005, John Tierney of The New York Times bet $5,000 with peak-oil supporter Matt Simmons (the late energy investment banker and author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy) on the future price of oil. Simmons predicted that the average price of oil this year would be $200 or higher; Tierney bet it would fall short. As Tierney wrote earlier this week:
The past year the price has rebounded, but the average for 2010 has been just under $80, which is the equivalent of about $71 in 2005 dollars — a little higher than the $65 at the time of our bet, but far below the $200 threshold set by Mr. Simmons.
What lesson do we draw from this? I’d hoped to let Mr. Simmons give his view, but I’m very sorry to report that he died in August, at the age of 67. The colleagues handling his affairs reviewed the numbers last week and declared that Mr. Simmons’s $5,000 should be awarded to me and to Rita Simon [she shared in Tierney's side of the bet] on Jan. 1, but Mr. Simmons still had his defenders.
One of his friends and fellow peak-oil theorists, Steve Andrews, said that while Mr. Simmons had made “a bet too far,” he was still correct in foreseeing more expensive oil. “The era of cheap oil has ended,” Mr. Andrews said, and predicted problems ahead as production levels off.
It’s true that the real price of oil is slightly higher now than it was in 2005, and it’s always possible that oil prices will spike again in the future. But the overall energy situation today looks a lot like a Cornucopian feast, as my colleagues Matt Wald and Cliff Krauss have recently reported. Giant new oil fields have been discovered off the coasts of Africa and Brazil. The new oil sands projects in Canada now supply more oil to the United States than Saudi Arabia does. Oil production in the United States increased last year, and the Department of Energy projects further increases over the next two decades.
Is the peak oil debate really dead? Maybe, but the front line on this topic is, of course, oil production. No one really knows what production will look like in the years ahead, but the past is relatively clear. Consider the last 15 years of global oil production on a monthly basis, courtesy of data from the U.S. Energy Information Administration:
For the moment, oil production has peaked—twice. The first crest came in July 2008, just as the price of crude oil was also peaking. Global production that month was a bit more than 86.7 million barrels per day, according to EIA. Production subsequently fell, no doubt in sympathy with the sharp drop in oil prices, thanks to the Great Recession and the financial implosion in late-2008. But oil prices have recently rebounded, reaching more than $90 a barrel this week--the highest in over two years.
Earlier this year, global oil production also rallied, although the surge came up short of the July 2008 output high. Close, but no cigars. This past July, global crude output nearly reached 86.5 million barrels per day, or slightly below the all-time peak set in July 2008.
Will the old peak hold? Or are we headed for a new all-time high in production levels? Maybe it's time for a new five-year bet: $200 by 2015? Was Simmons wrong—or just early?
December 29, 2010
The year is coming to a close, which inspires looking at recent history for some perspective on the year ahead. The past is hardly a flawless window into the future, but it's a good place to start for considering the possibilities for 2011. The following charts, courtesy of the economics database at the St. Louis Fed, summarize some of the key macro trends over the past year.
The basic message in the graphs below: the economy is on the mend, but it's a precarious rebound. The main challenges: job growth is still tepid and the housing market continues to suffer. Elsewhere, the economy is showing signs of improvement. But the struggle between growth and contraction rolls on. The forces of expansion have the upper hand these days, but only marginally so. More of the same is expected for 2011.
The broadest measure of U.S. economic activity is real (inflation adjusted), seasonally adjusted annualized gross domestic product (GDP). The latest estimate runs through this year's third quarter and pegs GDP at $13.3 trillion, or 3.2% higher than the year-earlier total. That's just below the all-time high of $13.4 trillion reached in 2008's second quarter. Given what we know about the recent uptick in economic activity in recent months, the odds look modestly favorable for expecting GDP to reach a new high in 2011.
A new high in GDP would be welcome news, but it will ring hollow until job growth picks up. For the moment, the labor market recovery remains weak, but at least there's a recovery to speak of. The manufacturing sector was hit hardest during the Great Recession (red line in chart below), but its 0.8% year-over-year rise as of last month is now in line with the annual rate of increase for job growth in the services sector (+0.7%, green line) and private sector employment overall (+1.0%, blue line), as of November 2010.
Weekly hours worked and average hourly earnings
The aggregate weekly hours worked index has rebounded sharply over the past year. The annual pace has recently jumped to a 2%-plus rate (red line in chart below). That's roughly in line with the annual change in average hourly earnings (blue line), although it's clear that the pace of wage growth continues to trend down, offering another reminder that the forces of disinflation are taking a toll in some corners.
Meantime, there's still no sign of improvement in the jobless rate, which remains elevated despite the formal end of the recession in June 2009.
Industrial production and commercial & industrial loans
Industrial production has rebounded sharply (red line in chart below), although the pace of commercial lending is still contracting (blue line), albeit at a lesser rate these days. Banks are still reluctant to lend, which only creates another headwind for growth.
The annual rate of change in various measures of the nation's money stock turned higher recently (again), thanks to the Federal Reserve's renewed focus on monetary stimulus.
Spending & Income
Real personal consumption expenditures (red line in chart below) and disposable personal income (blue line) have rebounded too. Both are now rising at an annual pace of well over 2%, as of last month.
But the housing market remains weak. New housing starts (blue line in chart below) and new single-family home sold (red line) remain depressed.
No wonder that housing prices have trended down.
Unsurprisingly, consumers are still wary.
December 28, 2010
JOBS & INFLATION: THE CRITICAL VARIABLES IN THE FED'S EXIT STRATEGY
Inflation is still low and so the Fed is in no rush to raise interest rates. The market is expecting no less. Fed fund futures expiring next November are priced for only a slight rise in Fed funds—roughly 38 basis points vs. the current target rate of zero to 25 basis points. Cheap money won't last forever, but almost no one thinks higher rates are imminent. Still, it's not too soon to consider the future, including the possible triggers that launch the Fed's exit strategy.
The leading influence on the Fed's monetary policy is probably the labor market. But with the unemployment rate at 9.8% as of last month—only slightly below the 10% peak reached in the wake of the Great Recession—there's little chance that the central bank is set to hike rates any time soon.
The weak growth in nonfarm payrolls lately certainly doesn't inspire thinking the trend's set to change soon. Private job growth on a net basis was a scant 50,000 last month—down sharply from October's gain of 160,000.
Will the December update on payrolls (scheduled for release on January 7) offer better news? Yes, according to the consensus forecast, which predicts an improvement in private nonfarm payroll growth for December—a gain of 100,000, according to Briefing.com. That's still slight, but if it's accurate it would at least mark an improvement over November's disappointing report.
Inflation is also a factor in the Fed's monetary policy, of course, but here too the outlook is relatively tame. Consumer prices overall are barely rising on a monthly basis, according to the government's official calculation. Measured at an annual pace, CPI rose by 1.1% for the year through last month, well down from the 2.7% rate at the start of this year. Disinflation, it seems, is still the path of least resistance.
Market expectations, however, are inching higher when it comes to inflation forecasts. Based on the yield spread between the nominal and inflation-indexed 10-year Treasuries, the market anticipates inflation of 2.3% for the decade ahead, up from around 1.5% in late-August.
The question, of course, is whether the market's outlook for inflation keeps rising or remains stable. By some accounts, this is a critical variable for second-guessing the timing of the Fed's exit strategy. Former Fed governor Lyle Gramley (currently a consultant for the Potomac Research Group) explains via The New York Times that if the market sees inflation rising over the Fed's unofficial 2% target rate for an extended period, that could inspire a tighter monetary policy.
For the moment, the market's low-2% inflation forecast is more or less in line with the Fed's long-range target. But one unexpectedly strong employment report, or a sharp jump in monthly consumer price inflation, could dramatically alter perceptions.
What are the odds for an outlook adjustment? Low, but not necessarily zero. "2011 is going to look a lot like this year did in the sense of, we'll see growth, but it is going to be sluggish, it's going to be stop-and-go," says economist Heidi Shierholz of the Economic Policy Institute via The Nightly Business Report. "It's not going to be fast enough to start bringing the unemployment rate down substantially."
That's probably a rough estimate of the consensus outlook. The crowd's expecting sluggish improvement, which implies little or no change in monetary policy. At some point, that forecast will be wrong, however. As Hyman Minsky famously warned, stability in economics is unstable.
December 27, 2010
THE GREAT DIVERGENCE
Faster economic growth in emerging markets compared with mature countries has been celebrated as a rare bright spot in the global economy in recent years. Without the robust expansion rates of China, India and other emerging nations, the fallout from the Great Recession surely would have been deeper and linger longer.
And the divergence is a gift that keeps giving. China's economy is expected to grow by more than 10% this year, vs. 2.8% for the U.S., according to The Economist. India is on track to expand by nearly 9% this year, while the Euro economies are will advance by less than 2%.
Clearly, the world economy is better off thanks to the emerging markets. For the most part, analysts have focused on the positive aspects of the bifurcated state of global macro. But there will be costs as well, even though they've been minimized in recent years.
A world of relatively wide differences in growth is a world subject to economic tension. An early test of this strain can be found in the rising inflation pressures in China, which increased interest rates last week for the second time since October. The inflation rate in China is 5.1%, the highest in more than two years, Bloomberg reports. By contrast, the U.S. inflation rate is 1.1%, as of last month, or less than half the rate in this year's first quarter.
The economic contrast between the emerging world and mature economies is nothing new, of course. But the differences may be pushed to extremes in the years ahead, with unknown outcomes. The worst-case scenario would be a future where the U.S., Europe and Japan suffer an extended period of sluggish growth and unusually low inflation while the emerging markets continue to expand at a rapid pace, which triggers rising pricing pressures.
In a globalized economy that's closely linked, it's unclear how a two-track world in the extreme will fare. Meantime, there are lots of questions. What, for instance, is the relevance for the developed world that's struggling with debt and disinflation while emerging markets are focused on keeping strong growth from unleashing inflation? Does China's tightening imply stronger headwinds for America's recovery?
In many ways, the U.S.-China relationship is the world's most important, for good or ill. The fact that both nations are currently at opposite ends of the spectrum in terms of monetary policy suggests that the year ahead may be volatile for the global economy.
There is little precedent in the modern era for the economic extremes that currently prevail. Economic stimulus is still needed in the developed world while monetary tightening is required for emerging markets. In the past, the two realms were relatively separate, with success and failure contained and isolated. But globalization continues, and the economic linkages are broader and deeper than even just a few years ago.
Meanwhile, the interest rate hikes in China are expected to continue in the year ahead. "We expect more to come in 2011, forecasting another 75 basis points of rate hikes by the end of next year,” says Brian Jackson of RBC Emerging Markets via the Financial Times. “Policymakers have work to do to, not only in China, but across the region, with more rate hikes also likely from India and Korea in the new year.”
In the U.S., on the other hand, almost no one expects the Federal Reserve to start raising interest rates any time soon. The labor market is still too weak to even consider a new round of monetary tightening.
For the moment, it's easy to downplay the divergent state of monetary policies in the world's two biggest economies. But this too shall pass.
December 25, 2010
Buone Feste Natalizie
December 24, 2010
READING ROOM FOR FRIDAY: 12.24.2010
►Economy brightens as consumers spend and layoffs slow
Christopher S. Rugaber/Associated Press/Dec 24
Economic reports Thursday suggested that employers are laying off fewer workers, businesses are ordering more computers and appliances, more people are buying new homes, and consumers are spending more confidently. Combined, the latest data confirm that the economy is improving, though the job market remains a problem with unemployment at a stubbornly high 9.8 percent. "The recovery is moving into higher gear," said Jim O'Sullivan, global chief economist at MF Global Ltd., of New York.
►Consumers Lift Economy
Justin Lahart/Wall Street Journal/Dec 24
"It looks like we've transitioned into a period of solid consumer spending," said Barclays Capital economist Dean Maki. "That makes it hard not to be optimistic about economic growth."
►New home sales climb - but recovery is sluggish
Laurie Segall/CNNMoney/Dec 23
New home sales edged higher in November, but the recovery remains sluggish. Sales of new homes rose 5.5% to an annual rate of 290,000 in November, the Commerce Department reported Friday. And while that shows improvement, sales are still off 21.2% from a year ago.
Although the numbers indicate a slight improvement, little has changed, according to IHS Global Insight economist Patrick Newport.
"It's just another bad report. There's some improvement but it's fiscally insignificant," he said. "It means that we're basically still stuck at the bottom - that the situation for builders is as bad its ever been." Newport says he expects the numbers to improve in 2011, but at a slow pace.
►US durable orders ex-transportation surge in Nov
Lucia Mutikani/Reuters/Dec 23
New orders for U.S. manufactured goods excluding transportation rose more than expected in November, to record their largest gain in eight months, according to a government report on Thursday that pointed to continued strength in the manufacturing sector.
►Has the recession permanently changed Americans' holiday shopping habits?
Annie Lowrey/Dec 23/Slate
It is the third recession-era holiday season. And although the economy has picked back up in recent months, Americans are clearly still adjusting to the new normal of high unemployment, sagging wages, increased poverty, and general economic malaise. Tear-jerking Santa stories aside, how have the bad economic times changed the way Americans treat—and shop for—the holidays? And what might be the effect going forward?
For one, Americans are certainly spending less on gifts due to the persistent hangover of the recession. Overall holiday spending looks as if it will tick up this year but will probably remain lower than it was in 2004, 2005, 2006, or 2007. And about half of Americans say they'll spend less on gifts this year than the last. But they don't seem to be lamenting the cutbacks, becoming frugal both out of necessity and out of choice. According to a Strayer University poll, 77 percent of Americans say the economy "gives them a chance to focus on what is truly important."
►Consumer Spending Above Pre-Recession Level
Mark J. Perry/Carpe Diem/Dec 23
Real personal consumption expenditures increased by 2.77% in November from a year earlier, to $9.432 billion, according to today's BEA report. This was the largest increase in spending since a 2.96% yearly gain in January 2007, and lifted consumption spending above the pre-recession peak of $9.355 billion in December of 2007, when the recession officially started. The U.S. consumer is back.
►Oil Consumers Wary as Some in OPEC Target $100 Crude Before Cairo Meeting
Ola Galal and Lananh Nguyen/Bloomber/Dec 24
Oil importers are growing wary of the impact of prices near two-year highs as some OPEC members foresee a further rally to the $100-a-barrel level and Arab oil ministers gather for a meeting in Cairo...“An issue for OPEC will obviously be prices edging higher,” said Bill Farren-Price, chief executive officer of Winchester, U.K.-based consultants Petroleum Policy Intelligence. “The issue is whether we’re in a new rally and for now the jury’s out on that. And I don’t think anyone in OPEC would disagree with that.”
December 23, 2010
HAS SPENDING & INCOME HIT A CEILING?
Personal income and spending continued rising at a moderate pace last month, the U.S. Bureau of Economic Analysis reports. Disposable personal income rose by 0.3% for the second consecutive month and personal consumption expenditures gained 0.4%, logging the fifth straight month of higher spending. The revival in economic growth that the bond and stock markets have been anticipating in recent months was confirmed once more with a fresh batch of data. Good news, to be sure, but is there also a glimpse of the new normal in the data?
As always, there’s value in stepping back and looking at the rolling 12-month percentage change. By that benchmark, the spending and income renaissance in the wake of the recession’s end in June 2009 seems to have hit a ceiling at roughly 4% annual growth. That’s hardly fatal, although it falls well short of the rate of increase for the preceding period of economic expansion, offering another sign of how things have changed after the crisis of 2008.
It’s possible, of course, that we’ll see higher rates of growth in the months and years to come. But given what we know about the heavy debt load weighing on household balance sheets, it’s reasonable to wonder if the 4% ceiling will hold for the foreseeable future.
Again, a 3%-to-4% rate of growth in spending and income is far from the end of the world, but keep in mind that we’re talking here of nominal rates of growth. Fortunately, inflation is minimal these days, but that’s not a permanent state of macro affairs. One day, pricing pressure will return. Let's hope that higher rates of income do as well.
Meantime, inflation worries aren’t a priority, nor are the likely to become an imminent threat in the near term. Alas, there’s always something to worry about, and that includes the uncertainty over wages, which are a critical part of assessing the future for the consumer-dependent U.S. economy.
Today’s spending and income report shows that private-sector wage growth posted an advance in November, but the 0.1% rise was the slowest since June’s slight decline. The rolling 12-month percentage change for wages also turned down. For the first time last month in more than a year, the 12-month rate of change was lower than the previous month’s annual pace, as the second chart below shows.
Let’s not make too much of this...yet. Private-sector wages, after all, are still higher by 3.8% vs. a year ago. But once again, the possibility of a 4% ceiling lurks.
Unsurprisingly, the slowdown in wage growth is primarily in the goods-producing sector of the economy, which accounts for around 20% of private-sector wages on an aggregate dollar basis. Last month, goods-producing wages retreated slightly. On a 12-month rolling basis, wage growth is still positive for the goods-producing sector, but it’s weakening. Wages for the much-larger services sector, fortunately, appear to be in better shape in terms of the trend.
It’s hardly news that manufacturing is no longer a robust source of employment for U.S. The question is whether the slow decline in manufacturing employment will infect wage growth. If so, how much trouble that will cause for an economic recovery that generally quite sluggish vs. the historical record?
Part of the answer, or perhaps all of it, lies (still) in the big picture for the labor market. An economy that’s minting new jobs at a healthy clip can smooth over the rough edges of a secular decline in manufacturing wages and employment. That's certainly been true in the past. But the outlook remains mixed on job growth overall.
On the one hand, the falling trend in new jobless claims is encouraging. Indeed, today’s weekly update brings word of another decline in new fillings for unemployment benefits to near the lowest levels in more than two years. That suggests the labor market will continue to recover.
Unfortunately, there was little sign of recovery in the disappointing news in the November employment update. Maybe the December update will bring beter news. Perhaps, although the consensus forecast for December payrolls (scheduled for release on January 7) calls for a modest gain of 100,000, according to Briefing.com. That would be a step up from November's paltry gains, but no one will confuse a 100,000 net rise in payrolls as a game changer.
It’s still all about jobs, and it’s still all about wondering if there’s a dependable recovery underway in the labor market. There are enough clues in recent months to think positively, but it’s not enough to dismiss the potential for expecting trouble. It’s been more or less the same all year, and 2011 is likely to continue the tradition.
December 22, 2010
MACRO SURVEILLANCE FOR WEDNESDAY: 12.22.2010
What IHS predicts for global economy in 2011
The U.S. recovery will pick up steam as the year progresses. In 2011, the U.S. economy is likely to be firing on more cylinders. Housing investment will begin to recover and the United States will enjoy export-led growth. Additional fiscal stimulus will add 0.6 percent to growth in 2011 and push the unemployment rate below 9 percent by year's end.
International Business Times, Dec. 22
Economic outlook: GDP growth expected
Analysts expect US third-quarter GDP to be revised higher to show annualised growth of 2.8 per cent, up from the previously reported 2.5 per cent.
Financial Times, Dec 19
Fannie Mae sees brighter 2011, raises GDP growth estimate to 3.4%
Fannie Mae raised its estimates for 2011 based on improving consumer spending and consumer confidence, increased demand for goods and services, and expected drops in unemployment claims. The government-sponsored enterprise now expects GDP growth of 3.4% next year up from a prior estimate of 2.9%, but warned a weaker-than-expected November jobs report, the continuing economic turmoil in Europe, and potential inflation problems in China pose downside risk.
HousingWire.com, Dec. 21
Sales of U.S. Previously Owned Homes Probably Rose in November
Sales of existing homes probably rose in November as the industry that triggered the worst recession in seven decades struggled to recover, economists said before a report today. Purchases increased to a 4.75 million annual rate, up 7.1 percent from October, according to the median of 70 estimates in a Bloomberg News survey. Another report may show the U.S. economy expanded at a faster pace in the third quarter than previously estimated.
Bloomberg, Dec. 22
RE/MAX November Existing Home Sales Continue Decline
In what could be a prelude of the national monthly existing home sales report to be released by the National Association of Realtor (NAR) on Wednesday, December 22nd, a report released on December 17th by realty giant RE/MAX revealed that home prices declined for the fifth consecutive month.RE/MAX reported in its news release that existing home sales fell 4.9 percent in November compared to October and nearly 25.9 percent from a year ago in the 54 metropolitan areas that it tracks.
Loan Rate Update, Dec. 21
Expect More Defaults and Foreclosures Over the Next Year
Although the housing sector has often led the economy out of downturns in the past, it is very unlikely to do so in this episode given the still-significant degree of oversupply in the market. The vacancy rate for owner-occupied housing, at 2.5 percent, remains a full percentage point above the pre-crisis norm. In addition to the softness in construction, a big concern for the housing market is the possible future path of home prices. For the most part, it appeared home prices stabilized after their plunge between mid-2006 and early 2009. But recent readings from a variety of sources, including a release by Corelogic Thursday, point to modest declines in prices in recent months. This is a somewhat troubling trend for home prices, and one that could possibly get worse before it gets better.
Fiscal Times, Dec 17
Durable-goods report could show weakening
Economists surveyed by MarketWatch expect durable-goods orders to fall 0.5% in November.
A decline in aircraft orders may be the culprit for the November decline and as a result, economists will be paying more attention to orders excluding transportation goods. Analysts expect a partial rebound in orders excluding transportation after a sharp 4.3% decline in October.
MarketWatch, Dec 19
ABC News Consumer Comfort Index
The ABC News Consumer Comfort Index, produced for ABC News by Langer Research Associates, has risen 4 points in the last two weeks to -41 on its scale of +100 to -100, 5 points above its 2010 average and 9 points above its low for the year, last seen in early August. Nonetheless, the CCI’s still far below its 25-year average, -14. And previous rallies have faltered: The index hasn’t risen above -40 since April 2008.
ABC News, Dec 21
Consumer spending is up: Are Americans enjoying a post-recession holiday?
Spending is up in all retail categories compared with last year, according to MasterCard Advisors’ SpendingPulse, which tracks spending on all transactions including cash. Analysts say the increase in personal savings and a decline in consumer debt are giving consumers more confidence than they had in recent years to spend on others and even themselves. “There is tremendous pent-up demand as consumers are tired of being afraid. So they’re seeing a little sunlight and a few more bucks in their pockets,” says Robin Lewis, an independent retail consultant based in New York City. “They’re willing to go out there and find a little treat for themselves.”
Christian Science Monitor, Dec 20
NRF Revises Holiday Forecast Up to 3.3 Percent
After a solid start to the holiday season, the National Retail Federation announced today that it is revising its forecast to 3.3 percent, up from 2.3 percent. The upward revision is due to improvement in a variety of economic indicators including stock market gains, recent income growth, savings built up during the recession - all giving consumers the capacity to spend.
National Retail Federation, Dec 14
December 21, 2010
THE TREND VS. THE NEW NORMAL
The third and final estimate for third-quarter U.S. GDP that's scheduled for release tomorrow is expected to report a rise of 2.7%, economists predict, according to the consensus forecast via Briefing.com. If accurate, the gain represents a slight improvement over the previously reported 2.5% increase. That's still modest, but the trend at least looks friendly.
The case for thinking that the economy will continue growing in the months ahead rests partly on momentum, which has been positive recently, particularly in recent months. Should we expect more of the same? In search of an answer, or at least some perspective, a few pictures are worth several thousand words.
Indeed, the trend is clear if we survey rolling 12-month percentage changes in the economic indicators. For example, consider the chart below, which shows the annual pace for three key measures of economic activity: private sector employment, real retail sales, and total weekly hours logged by workers. In all three cases, there's been a sea change for the better in the trend. Retail sales turned higher initially, followed by improvement on the employment front.
The dramatic change for the better is good news, of course, although the magnitude of the revival in relative terms is somewhat misleading as a window into the future. The recession of 2007-2009 was unusually deep, which led to a recovery that was equally stark in relative terms. As the trend settles into something approximating normality, the true nature of the expansion is revealed. That inspires a closer analysis of the trend. For instance, the second chart below shows the monthly percentage change in private employment through November. By this measure, there's reason to wonder if the economy's capacity for creating jobs is stumbling.
As long as consumer spending holds up, it's reasonable to reserve judgment on the next phase in the labor market. Employment, after all, is a lagging indicator. One clue for expecting that job growth will accelerate comes from looking at the trend in real disposable personal income, a key factor for personal consumption expenditures. The American economy is heavily dependent on consumption. That may change in the yeas ahead, but for now it's still the 800-pound gorilla for macro analysis. Looking at the year-over-year change for both of these measures suggests the economic growth still has the upper hand, which implies that the revival in the labor market will continue.
There's also a glimmer of hope that initial jobless claims are finally starting to drop after treading water in the first half of the year. If the decline continues, the odds improve that the economic expansion will roll on.
Nonetheless, the year ahead will be a rocky ride, as suggested by last week's update on labor markets within states. State unemployment rates were generally unchanged in November, the Bureau of Labor Statistics advised. The national jobless rate inched upward by 0.2% in November to 9.8 percent, which works out to a stagnant trend from a year ago.
“There is a fundamental change under way in the hiring habits of companies, who are not very sure about the strength of final demand and the strength of the economy,” John Silvia, chief economist at Wells Fargo Securities, tells Bloomberg.
Changing the general level of uncertainty and caution about the future isn't going to be easy. The risk of recession has receded, but the odds for robust growth remain low in the near term. The economy, it seems, is struggling to break free of the new normal. It's going to be a long struggle.
Update: The third GDP update is scheduled for Wed, Dec. 22--not Tues., Dec 21 as originally reported. Sorry for the confusion.
December 20, 2010
READING THE YIELD CURVE
The Treasury yield curve is at its steepest since February. That's a widely recognized sign that the economy is set to strengthen. Researchers have recognized for years that the slope of the yield curve has proven itself a worthy leading indicator.
That suggests we should take comfort in the wider spread. As Bloomberg reported over the weekend, "the difference in yield between 10- and 2-year notes increased for a third week, rising to 272 basis points yesterday, or 2.72 percentage points, from 268 basis points on Dec. 10, according to Bloomberg data. The spread touched 289 basis points on Dec. 15, the widest since Feb. 23."
But here's a reason for wondering how much good news is really embedded in the spread these days. The Cleveland Fed advises that the yield curve predicts "real GDP will grow at about a 1.0 percent rate over the next year, the same projection as in October and September."
Growth is good, of course, but 1.0% is dangerously close to stall speed. One percent is also well below the 2.5% pace in this year's third quarter. In fact, that's set to rise in Wednesday's scheduled release of the government's third and final Q3 GDP report. The consensus forecast calls for a slight uptick to 2.7%, according to Briefing.com. But is it downhill from here? Yes, according to the Cleveland Fed's interpretation of the yield curve tea leaves.
A forecast is just a forecast, of course, and even a yield curve prediction isn't fate. But if you're going to consider these numbers as something more than noise, the main message is clear: the recovery is going to remain wobbly for the foreseeable future.
Update: The third GDP update is scheduled for Wed, Dec. 22--not Tues., Dec 21 as originally reported. Sorry for the confusion.
MARKETS MAY FAIL, BUT THAT'S (THANKFULLY) THE EXCEPTION
Paul Krugman dispatches a new broadside against free market theory today in his New York Times column. The attack is anything but subtle. "Free-market fundamentalists have been wrong about everything…" Everything? Call me crazy, but I can think of one or two things that's productive about free markets. I suspect that I'm not alone.
Extremism is hard to defend, of course—from any angle. Arguing that free markets are an across-the-board failure is every bit as misleading as saying that, well, free markets flawlessly deliver optimal results now and forever.
Krugman's condemnation was focused on politics, and so it's fair to give him some leeway. There are lots of free market fundamentalists out there, and so one needs to be specific. This is hardly a unified bloc. Surely he's not making a grand argument against competitive markets generally. No one will confuse Krugman as a free-market ideologue, but he's no Marxist either. Like most economists and students of the dismal science, his views fall somewhere in the middle. Granted, the middle is a big place, as defined by the debates in America over the last generation. If you spend enough time in this middle realm, disagreements over policy prescriptions can look radical, even fanatical. But if Krugman truly finds no value in free market economics, it's not obvious in surveying the broad spectrum of his writings over the last several decades.
Of course, one can argue that certain politicians these days are abusing notions of free markets. Well, that's what politicians do sometimes--exaggerate reality for political ends. Shocking.
Still, free markets have taken a beating in recent years. Some of it was justified, but perspective is important. Free markets aren't perfect, but neither are the alternatives. In fact, most if not all of the competing frameworks for organizing economies are quite a bit worse, if not disastrous. That's hardly an extremist statement. Indeed, most economists argue as much.
The broader point is that attacking free markets as fatally flawed because the theory isn't perfect is like going on a hunger strike because the supermarket doesn't sell your favorite foods. You'll score points for embracing your ideals, but it's a contest with a dead end.
It'd be nice if there was an alternative to free markets that delivered economic triumph flawlessly. In that case, we could simply abandon capitalism and switch over to brand X. But perfection doesn't exist in economics. Ditto for the various choices for managing free markets. Rather, the best we can hope for is a system that produces the best results for the greatest number of people with minimal defects most of the time. Which system is that? The empirical record is pretty clear on how to answer the question.
But that still leaves plenty of room for debate on implementation. One could make a 30,000-foot argument that China and America both embrace free-market economics of a kind, but that's a far cry from arguing that the two systems are synonymous. The details matter. In fact, the closer you look at the two countries, the more you realize that the differences dominate. But, hey, it's common to talk about how China become a capitalist nation in recent years. Yes, but...
It's also topical to point out that free markets stumble at times. But even the critics are reluctant to throw this baby out with the bathwater. If you read some of the recent books that analyzed the limits of markets—John Cassidy's How Markets Fail: The Logic of Economic Calamities and Robert Barbera's The Cost of Capitalism: Understanding Market Mayhem and Stabilizing our Economic Future, for instance—you'll note that the authors stop short of abandoning free markets. Sure, the market's flawed, which means that it has a tendency to go haywire at times. Exactly why markets fail, to use Cassidy's term, is a subject of much debate. Suffice to say, no one's really sure of the answer, which is why recessions are a recurring problem.
But markets work most of the time, and quite a bit better than the alternatives. The real debate is how to optimize markets so that society can maximize the benefits, minimize the failures, and do so in a framework that doesn't end up killing the golden goose. That's been devilishly hard to pull off. Finding the sweet spot between creative destruction and a social safety net has been an epic question over the last century, but the solution still isn't clear without going too far in one direction or the other.
Yes, there are lots of good reasons to keep looking for answers and for thinking that progress on the margins awaits. But there are lots of risks too. In the long run, and quite often in the medium run and even the short runs, it's tough to beat markets. It's tempting to call markets irrational when they produce volatile results. And perhaps markets are irrational, although defining that is tricky.
In any case, it's still hard to generate superior results that exceed the collective choices of the crowd. That's patently obvious with investing strategies, a world where indexing—piggybacking on the market—tends to produce moderately above-average results over time. It's also true in macroeconomics. The national success stories that represent alternatives to free markets are in short supply.
That's no argument for blindly accepting free market theory as flawless. But let's recognize that markets are still the only game in town--warts and all. The bottom line: Beggars can't be choosy when it comes to economic paradigms.
December 18, 2010
BOOK BITS FOR SATURDAY: 12.18.2010
● The Gold Standard at the Turn of the Twentieth Century: Rising Powers, Global Money, and the Age of Empire
By Steven Bryan
Review via Economic Principles
A historian working for the moment in Tokyo as an attorney (Columbia Ph.D, Harvard Law J.D.), Bryan exemplifies a new generation of historians who cast a jaundiced eye on the market triumphalism of the 1990s. In The Gold Standard at the Turn of the Nineteenth Century: Rising Powers, Global Money and the Age of Empire, he argues that Argentina, Japan, Germany and other countries rose to power in the years before World War I following currency policies not all that dissimilar to China’s today. By adopting the gold standard, they were looking to lock in the most depreciated currency possible in order to promote industry and exports.
● Your Money and Your Life: A Lifetime Approach to Money Management
By Robert Z. Aliber
Summary via publisher, Stanford University Press
Your financial health is more than a mere collection of debits and credits on a balance sheet. In fact, the numbers on a financial statement represent a series of decisions that, if made strategically, can ensure that each of us maintains our desired standard of living at every age and stage of life. Many people think that key financial choices are too complicated to make on their own. However, with the right information and guidance, we can all secure our own financial future.
Your Money and Your Life is more than your average guide to financial planning and retirement. Acclaimed author and speaker Robert Z. Aliber helps readers to make efficient and effective financial decisions at key moments throughout their lives, such as where to go to college; if and when to buy a home; how much insurance, if any, to buy; how to manage savings and retirement; when the time is right to approach a professional advisor; and how to proceed with estate planning. With an eye toward the issues that are most pressing in today's economy, Aliber clearly explains the sophisticated concepts that underpin everyday money management—with the goal of making this guide the go-to reference in your financial planning library, regardless of your age or wealth.
● Don't Count on It!: Reflections on Investment Illusions, Capitalism, "Mutual" Funds, Indexing, Entrepreneurship, Idealism, and Heroes
By John C. Bogle
Excerpt via publisher, John Wiley & Sons
Mysterious, seemingly random, events shape our lives, and it is no exaggeration to say that without Princeton University, Vanguard never would have come into existence. And had it not, it seems altogether possible that no one else would have invented it. I ’ m not saying that our existence matters, for in the grand scheme of human events Vanguard would not even be a footnote. But our contributions to the world of fi nance — not only our unique mutual structure,
but the index mutual fund, the three - tier bond fund, our simple investment philosophy, and our overweening focus on low costs — have in fact made a difference to investors. And it all began when I took my first nervous steps on the Princeton campus back in September 1947.
● Money Smart: How to Spend, Save, Eliminate Debt, and Achieve Financial Freedom
By Ted Hunter
Press release for book
“The world is full of people who want to ‘help’ you get rich,” says Hunter. “Translation: They want to get their hands on your money.” Consumers can protect themselves by looking out for certain words and phrases that can be warnings, Hunter suggests. Some of the most common “magic words” used to describe an investment opportunity are: free, secret, sure-fire, anyone can do it, always, no-risk, foolproof, insider, confidential, the smart money, nothing down, easy money, magic, not a get-rich-quick scheme, become a millionaire, just a few hours of your spare time, almost nothing to do, and makes-you-money-while-you-sleep. Every one of these words or phrases should be taken as a red flag warning the consumer to walk away and refuse the offer—whatever it may be.
● Capital Offense: How Washington's Wise Men Turned America's Future Over to Wall Street
By Michael Hirsh
Review via New York Times
In fact, the main reason the financial crisis of 2008 occurred, the journalist Michael Hirsh argues in his provocative new book, “Capital Offense,” is that “the people in charge of our economy, otherwise intelligent and capable men like Greenspan, Rubin and Summers — and later Hank Paulson and Tim Geithner — permitted themselves to believe, in the face of a rising tide of contrary evidence, that markets are for the most part efficient and work well on their own.”
● Twenty Years of Inflation Targeting: Lessons Learned and Future Prospects
Edited by David Cobham, Øyvind Eitrheim, Stefan Gerlach, and Jan F. Qvigstad
Summary via publisher, Cambridge University Press
There is now a remarkably strong consensus among academics and professional economists that central banks should adopt explicit inflation targets and that all key monetary policy decisions, especially those concerning interest rates, should be made with a view to ensuring that these targets are achieved. This book provides a comprehensive review of the experience of inflation targeting since its introduction in New Zealand in 1989 and looks in detail at what we can learn from the past twenty years and what challenges we may face in the future. Written by a distinguished team of academics and professional economists from central banks around the world, the book covers a wide range of issues including many that have arisen as a result of the recent financial crisis. It should be read by anyone concerned with better understanding inflation targeting and its past, present and future role within monetary policy.
December 17, 2010
ANALYZING FINANCIAL ADVICE
The possibility that financial advice can sometimes be worse than nothing needs no explanation these days. Think Bernie Madoff. That was extreme, of course, but how wary should investors be when it comes to more prosaic counsel from, say, the local financial planner? As with everything else in finance, the answer boils down to a gray area. In short, it depends.
It’s a given that in the grand scheme of financial advisory, most of it will end up as mediocre; a small slice of it will bring stellar gains; and a bit of it will be a disaster. That’s simply a twist on what Professor Bill Sharpe described as The Arithmetic of Active Management. Returns, in other words, are a zero sum game and the winning hands are financed by the losers. In the end, most invetsment decisions end up in the middle. That's not necessarily bad news. For most investors, sound advice that delivers reasonable if middling results will suffice. And compared with what happens with many portfolios, middling represents progress. But expectations are still important.
Sharpe's law of active investing has been demonstrated many times, and it has a habit of explaining the ebb and flow of performance in a single asset class as well as the rules for asset allocation. In a recent issue of The Beta Investment Report, for instance, I looked at how a passive mix of all major asset classes fared relative to 900-plus actively managed multi-asset class mutual funds over the past 10 years, courtesy of data crunching with Morningstar’s Principia software. The result wasn’t terribly surprising: the passive mix delivered a modestly above-average return.
Is it reasonable to expect something similar when it comes to hiring a financial advisor? Perhaps. Everyone can’t be above average. But can they at least do no harm? Not necessarily, or so a recent study of financial advisory suggests.
A paper penned by two researchers at Goethe University Frankfurt (“Financial Advice: An Improvement for Worse?) asks three key questions:
1. Does the consultation of financial advisors improve portfolio performance?
2. Do financial advisors ameliorate their clients investment mistakes?
3. Do advisor recommendations improve asset allocation?
The answers aren’t encouraging, according to the paper, which explains:
Firstly, involving financial advisors results in lower portfolio returns, higher risk, and thus, in lower risk-adjusted returns. Second, advisors correct for some but not all investment mistakes. Third, advisors do not generally improve the asset allocation in client portfolios. Overall, our analysis provides evidence that the advice offered by the sample bank lacks quality in some tangible dimensions. This implies that conventional types of financial advice may not be the best remedy for the widespread financial illiteracy of households.
Critics will rightly point out that the study examines one large German financial institution, and so it can be said that this unnamed “German universal bank” is the problem rather than financial advice per se. In addition, one could take issue with the paper’s methodology, which draws on the traditional mean-variance optimization process for reaching conclusions. There are other assumptions that could conceivably skew results, such as that deciding that all transactions take place in the middle of the month.
The study, which analyzes "10,434 randomly selected customers for the 34-month period from January 2003 to October 2005," is hardly definitive, and so reasonable minds can differ about its relevance. But at the very least this research is a timely reminder that investors who hire advisors to manage money and/or dispense financial recommendations need to have a clear idea of what they’re paying for and who they're dealing with.
Suffice to say, different advisors offer different services and come with different skills. When it comes to straight investment advisory, it’s crucial to develop reasonable expectations and decide if you’re paying a fair price. That’s a complicated subject, of course, although no investor can afford to dismiss the necessary work to gain a reaosnable comfort level with a hired financial gun. The details, in short, can get messy when it comes to weighing the pros and cons of advisors.
Meantime, some of the usual caveats still apply. That starts with the recognition that the odds that any one advisor is going to deliver stellar performance results is probably expecting too much. Of course, everyone likes to focus on the outliers. The difference between Bernie Madoff’s results vs. Warren Buffett’s are the proverbial night-and-day outcomes. But for most investors, the middle ground is probably destiny.
Impressive investment returns are still dependent on three factors: skill, luck and asset/factor allocation. Quite often, a mix of all three is often relevant when analyzing results. For obvious reasons, advisors and money managers prefer to emphasize one of these variables over the other two.
There are no short cuts for intelligently choosing a financial planner, but you can start by asking prudent questions. The Certified Financial Planner Board of Standards, for instance, recommends 10 Questions to Ask When Choosing a Financial Planner. The Financial Planning Association publishes useful resources on the topic as well, including this primer.
Ultimately, many of the hazards that infect investing choices apply to choosing an advisor. Indeed, the decision may be as much art as it is science.
Even if you do everything right and choose a great planner, you’ll still need to monitor and assess through time. Expecting to fully transfer responsibility to an advisor and assuming that everything he or she recommends is exactly correct is asking for trouble. Yes, minding assets is time consuming and requires hard work. But you’re going to be involved one way or another. After all, it’s still your money.
THE TWO-YEAR TAX SOLUTION
The House of Representatives passed the tax-cut extension bill last night and sent it over to the White House for President Obama to sign it into law. The legislation prevents the Bush tax cuts from expiring on December 31, offering what some say is a stimulus for the economy at a critical point in the recovery.
"This legislation is good for growth, good for jobs, good for working and middle class families, and good for businesses looking to invest and expand their work force," Treasury Secretary Timothy Geithner says via AP. Why, then, is there so much opposition? "There probably is nobody on this floor who likes this bill," House Majority Leader Steny Hoyer, D-Md, complains. "The judgment is, is it better than doing nothing? Some of the business groups believe it will help. I hope they're right."
This much, at least, is clear. Tax cuts are sure to be front and center in the 2012 presidential race, courtesy of kicking the extension two years down the road. Another deadline looms. Presumably the economy will be in better shape by then. Meanwhile, there's debate about the value of extending tax cuts for 24 months vs. making them permanent. Some critics complain about the uncertainty that surrounds a short-term temporary extension.
"Taxpayers now know that their taxes will once again become a political football in 2012," writes Scott Hodge, president of the Tax Foundation "Stability is one of the guiding principles of sound tax policy, but lawmakers have traded some near-term certainty for further long-term unpredictability. Taxpayers will not know how to plan their affairs beyond 2012."
At least the uncertainty has been banished for two years, runs counter argument. Is that enough? As many supporters of the bill rationalize, it's better than letting the tax cuts expire. The incoming Republican speaker of the House, John Boehner, advises in a new statement:
With nearly one in 10 Americans out of work, acting to ensure no American’s taxes go up on January 1st was critically important. Failing to stop all the tax hikes would have destroyed more jobs and deepened the uncertainty in our economy. Stopping all the tax hikes is a good first step in our efforts to reduce the uncertainty family-owned small businesses are facing, but much more needs to be done, including cutting spending, permanently eliminating the threat of job-killing tax hikes, and repealing the job-killing health care law. These are critical priorities the new majority has pledged to act on in the next Congress, and I hope President Obama will listen to the American people and work with us to stop Washington’s job-killing policies.
The challenge of cutting spending and maintaining the tax cuts promises isn't going to be easy. Some pols worry that the tax cut legislation only makes the job of pursuing fiscal rectitude that much more difficult. And there's a range of policy implications to ponder as well. Time's Curious Capitalist blog provocatively asks: Will the Tax Deal Kill Social Security?
At the center of it all is the question of how much boost the economy will receive in exchange for elevating the government's debt. Indeed, extending tax cuts is easy; curtailing spending is something else.
Extending the tax cuts is no free lunch in the long run, as the Congressional Budget Office has warned all this year. Then again, no one expects a lame-duck session of Congress to tackle such issues.
“Republicans are talking a lot about certainty,” Matthew Mitchell, a research fellow and tax policy expert at George Mason University, says via The New York Times. “But even if they had won some sort of a victory where they got the current tax rates written in stone, spending is on such an unsustainable path in terms of entitlements, it really isn’t certain at all.”
But for now it's all about politics."The fact that President Obama has moved toward recognizing that a pro-growth economic policy has direct ties to the level of taxation…is a positive sign," Rep. David Dreier (R., Calif.), a member of the House GOP leadership, tells The Wall Street Journal. "I believe that moves him in the direction of being a better president."
It remains to be seen if the voters will agree in two years.
December 16, 2010
THE SLOW DECLINE IN JOBLESS CLAIMS
The favorable trend in weekly updates for initial jobless claims over the past two months remains intact with today’s release. New filings for unemployment benefits in the U.S. on a seasonally adjusted basis dipped by 3,000 last week to 420,000, the Labor Department reports. That’s hardly a definitive sign that all’s well, but the modest decline of late appears to be alive still, giving hope to the notion that the trendless trend for this series that prevailed earlier this year is now history. Such is the diminished definition of progress these days when it comes to the labor market.
The sluggish decline in new jobless claims arrived late and remains tentative. That’s in keeping with this installment of the economic recovery generally. If this was a statistic without corroboration, it would be highly suspect. But the mild thaw that seems to be unfolding in the labor market draws support from a variety of economic trends elsewhere in the economy.
Retail sales, for instance, continue to look perky, as we noted earlier this week. And yesterday’s news that industrial production posted its biggest gain last month since July, while inflation remains tame, only strengthens the case for thinking that the economy is on the mend.
“The manufacturing sector continues to heal itself,” John Herrmann, a fixed-income strategist at State Street Global Markets, tells Bloomberg. “The outlook for business spending on equipment and software remains very positive.”
Even the battered housing market showed signs of life last month. Housing starts in November rose 3.9%, the Census Bureau reports today—the first gain since July.
It’s still too early to break out the champagne, and that's not likely to change any time soon. There’s not going to be a conspicuous turning point this time. Barring an unexpected shock, the economic recovery is going to proceed in the year ahead, but slowly, tentatively and suffering period setbacks that shake the faith. It's going to be just as easy to raise doubts as it is to look on the bright side for many months to come. Of course, economic pundits are old hands at this game by now.
Meantime, it’s still all about the labor market, and even the optimists recognize that this is the weak link in the recovery and it’ll remain so for the foreseeable future. The job-creation machine is tepid, as the latest payrolls report reminds. Expecting a substantial change for the better in the months ahead is probably asking for too much. But growth is still intact, and it’s likely to roll on.
In the grand scheme of the business cycle, one could say that not much has changed since we surveyed the year ahead back in January. Our conclusion then is no less valid today. As we opined 11 months ago: “No one should doubt that an economic recovery is underway. But no one should assume that the rebound is robust or destined to quickly bring economic healing on a broad scale. It's different this time.”
DATA CHECK: EMERGING MARKETS
A new article in the IMF's Finance & Development journal brings some fresh analysis and numbers to an old theme: emerging markets are hot and they're reshaping the global economy. We've heard the story before, but the details are no less no impressive.
"The superlative performance of emerging market economies, a group of middle-income countries that have become rapidly integrated into global markets since the mid-1980s, has been the growth story of the past decade," write M. Ayhan Kose (assistant to the director in the IMF’s research department) and Eswar S. Prasad (professor of trade policy at Cornell University). "After being beset by various crises during the 1980s and 1990s, emerging markets came into their own during the 2000s, recording remarkable growth rates while keeping inflation and other potential problems largely under control."
There is a wide variety of economic statistics that illustrate the powerful rise and evolution of emerging markets. One of the more impressive set of numbers is the strength these countries demonstrated in the Great Recession. In fact, there was no recession in emerging markets, as a chart from the Finance & Development illustrates:
No wonder that the emerging nations of the world are grabbing a larger share of global GDP in relative and absolute terms. "During 1960–85, advanced economies on average accounted for about three-quarters of global GDP measured in current dollars adjusted for differences in purchasing power parity across countries," Kose and Prasad report. They go on to advise:
This share has declined gradually over time—by 2008–09, it was down to 57 percent. In contrast, emerging markets’ share has risen steadily from just about 17 percent in the 1960s to an average of 31 percent during the period of rapid global trade and financial integration that started in the mid-1980s. By 2008–09, it was close to 40 percent.
Even so, broad macro trends don’t dictate the ebb and flow of capital markets in the short term. As this year's investment returns show, the emerging markets theme isn't a monolith of above-average performance:
One year-to-date period doesn't tell you much, of course, although it does remind that variety is a constant, with an evolving set of leaders and laggards. It's one thing to recognize the influence of broad macro trends. It's quite another to assume that there's easy money associated with the theme, or that today's winners will remain written in stone.
The American consumer was the dominant story over the past half century. Recognizing that economic force was critical, but it was hardly a short cut to big profits in every short-term period. No less will be true for the ongoing rise of emerging markets. Meantime, there's the old problem of uncertainty, which is constantly lurking. Two decades ago there was an army of analysts forecasting that Japan would take over the world and deliver the premiere economic model. How's that prediction working out for 'ya these days?
Sure, the emerging market outlook is different, and probably a lot more durable. But no one should be the farm on one prediction, one region, one asset class--one anything. Even in 2010, when emerging markets generally have performed quite well, there's been a fair amount of variation in year-to-date returns through December 15. Expect more of the same in the months and years ahead.
There will be winners and losers in emerging markets, just as there will be among mature economies. Same old, same. Some trends are forever.
December 15, 2010
MORE MARKET GAINS IN 2011, ACCORDING TO MANAGER SURVEY
Russell Investment's new quarterly survey of investment managers reports a fair degree of confidence in the performance outlook for the global economy and capital markets next year.
A few highlights from the survey:
INFLATION STAYS TAME IN NOVEMBER
Today’s update on consumer prices for November provides no cover for analysts expecting higher inflation to burst out any day now. Consumer inflation rose a mere 0.1% last month on a seasonally adjusted basis, the Labor Department reports. That's down from 0.2% in October. Core inflation—price changes less the volatile food and energy sectors—is also quiescent, inching higher last month by only 0.1%. If there's an imminent threat of inflation trouble, it's not obvious in today's CPI report.
Pricing trends look equally tame on an annual basis. For the 12 months through November, headline CPI advanced by 1.1%. Core inflation is even lower, rising by just 0.7% over the past year. By the looks of the trend this year, the path of least resistance is down, as the chart below suggests.
“Inflation is a non-threat right now, there’s a lot of slack in the economy,” Ryan Sweet, a senior economist at Moody’s Analytics Inc., tells Bloomberg. “Inflation will remain very subdued and tepid over the next several months.”
WHAT'S THE DEAL WITH HIGHER RATES?
The Federal Reserve is forging ahead with its quantitative easing strategy for monetary policy. Although there's a sea of critics who think the central bank should rethink QE2, there was no mention of the debate in yesterday's FOMC statement, which explained: "To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November."
Inflation is, in fact, holding steady, or at least expectations of inflation are stable, as measured by the yield spread between the nominal and inflation-indexed 10-year Treasuries. By this benchmark, the outlook for inflation is roughly 2.2%, based on yesterday's Treasury yields. That's more or less unchanged vs. the tight range of the last two months.
But while the market's outlook for inflation is relatively calm, the yield on the 10-year Note is climbing, reaching nearly 3.5% yesterday. That's up sharply from 2.4% in early October. The debate has shifted to whether this is a sign that the Fed's QE2 is a failure or success.
Economist Jeremy Siegel is firmly in the camp that higher rates are a sign of triumph. In yesterday's Wall Street Journal he writes:
The Fed's QE2 program has raised expectations of growth and inflation, sending long-term Treasury rates up. It has also lowered risk aversion, which implies rising long-term rates. The evidence for a decline in risk aversion among investors is the shrinkage in the spreads between Treasury and other fixed-income securities, the strong performance of the stock market, and the decline in VIX, the indicator of future stock-market volatility. This means that expectations of accelerating economic growth—and a reduction in the fear of a double-dip recession—are the driving forces behind the rise in rates.
But there are plenty of analysts who disagree. For instance, the New York Times today reports that some economists are "skeptical, saying the rise in interest rates demonstrated the limited effectiveness of the Fed’s program to buy bonds in a bid to lower long-term interest rates and spur growth." That includes Chris Rupkey, chief financial economist at the Bank of Tokyo-Mitsubishi UFJ, who penned a note to clients yesterday that advises: "All the king’s horses and all the king’s men can’t push bond yields back below 3 percent again…There must be some disappointment at the F.O.M.C. that the purchases have not kept 10-year yields from rising so much, let alone decline."
Bernard Baumohl, chief global economist of the Economic Outlook Group, poses the operative question via today's Washington Post: "Did these rates move higher because the economy is getting stronger - or because bond investors fear the Fed is about to err by continuing to pump too much money into an economy that is in the midst of accelerating? Our concern . . . is that it's the latter."
Earlier this week, CNBC.com reporter Jeff Cox wrote that "rising interest rates for now are generating views that the economic glass is half-full, even though the trend would seem to counteract aggressive monetary policy from the Federal Reserve."
Is optimism unfounded at this juncture? No, according to economist David Beckworth, who argues forcefully that higher rates at this point are a good thing:
Though it too soon to know for sure, the data seem to support the recovery interpretation of the rising nominal yields. Below is a figure showing the 10-year expected inflation rate and the 10-year real interest rate from the TIPs market. This figure shows that inflation expectations pick up first and eventually the real interest rate does too:
Ultimately, the debate will be settled by the numbers. The key variables are inflation, economic growth and interest rates. Inflation expectations are currently stable and relatively tame. So far, so good. That can change, of course, but for the moment this is the lesser threat in this trio.
The main focus has moved to interest rates and economic growth. Higher rates that are accompanied by an improving macro picture is a winning combination. The latest sign that the mending process is moving forward comes in yesterday's encouraging retail sales report. The labor market, however, is still sluggish and so there's plenty of incentive to wonder what comes next. If we don't see a stronger trend in job growth in the months ahead, higher interest rates will be a problem and there will be hell to pay.
For now, you can make a case for almost any scenario. But one side in this debate will be wrong. The only issue is deciding when the truth will out.
December 14, 2010
NOVEMBER RETAIL SALES RISE FOR 5th STRAIGHT MONTH
Retail sales rose again in November—the fifth consecutive monthly gain, the U.S. Census Bureau reports. Last month’s 0.8% increase brings seasonally adjusted retail sales to just under the all-time high set back in November 2007, which was the last month before the start of the Great Recession. It’s getting harder to argue that consumer spending is headed for a new normal of self-imposed saving and austerity. It's too early to dismiss that possibility, but it looks like a lesser risk at the moment.
Holiday shopping undoubtedly is a factor, combined with the fact that the economy has stabilizied, albeit at a relatively weak level compared with post-recession periods in recent history. Nonetheless, the trend is unmistakable. “Consumers are on fire relative to expectations in the last three months,” Brian Jones, an economist at Societe Generale, tells Bloomberg.
That’s good news for the economic outlook. "Consumption is likely to post a solid rise in the fourth quarter. For the first time since the recession ended, consumers are contributing to growth in a real way," FTN Financial’s chief economist Chris Low says via Reuters.
The trend in retail sales is also strong on a year-over-year basis. In fact, the 7%-to-8% annual pace of growth in recent months is well above the rate during boom years before the recession started in December 2007.
It all looks encouraging…until you remember that the job growth is still weak. That’s a sore point that inspires caution among some dismal scientists. Until the labor market moves beyond a tepid recovery, the retail sales trend may be destined for a slower pace next year. "This tentative consumer revival may not be the start of a prolonged period in which households become the engine of the economy once again," warns Paul Dales, senior U.S. economist at Capital Economics, via AP. He argues that sluggish job growth will keep a lid on wage growth, which in turn will create headwinds for spending.
The warning is underscored by the latest payrolls report, which shows that job growth was weak last month, even by the deflated standards of the new normal. But all’s not lost. The hope is that the recent and long-awaited drop in initial jobless claims marks the start of better days for the labor market.
The next update on new weekly filings for unemployment benefits arrives on Thursday. The consensus forecast calls for a rise of 425,000 new claims (seasonally adjusted), or just slightly above the previous week’s 421,000, according to Briefing.com. The low-400,000 level is still painfully high, although that's the lowest range since the start of the recession three years ago. If it holds, chalk up one more statistic in favor for thinking positively for retail sales and the economy overall.
The broad recovery is weak, subject to change, and vulnerable on a number of levels. But the good news is that there is a recovery. That's still better than the alternative.
READING ROOM FOR TUESDAY: 12.14.2010
►Senate vote sets stage for approval of tax-cut bill
Shailagh Murray and Lori Montgomery/Washington Post/Dec 14
Republicans and Democrats joined forces in the Senate on Monday to deliver the most significant bipartisan vote since President Obama took office, advancing a plan to extend tax cuts for virtually every American and to boost the economic recovery…The package would add $858 billion to deficits over the next decade, according to congressional estimates. The bulk of the cost - about $545 billion - would come from a two-year extension of income tax reductions enacted in 2001, as well as provisions to adjust the alternative minimum tax for inflation through 2011, sparing more than 20 million mostly middle-income taxpayers from sharply higher tax payments in the spring.
►Summers Warns Against Permanent Tax Cuts
Damian Paletta/Wall Street Journal/Dec 13
Top Obama economic adviser Lawrence Summers praised the White House's tax-cut compromise with Republicans, but issued a defiant warning to Congress to not make some cuts permanent when major elements expire in two years.
►Tax bill passes Senate test
John Fritze/USA Today/Dec 13
If the measure is approved this week, it heads to the House, where its path is murkier. Top Democrats predicted the extensions will pass, but would not say in what form. House Majority Leader Steny Hoyer, D-Md., said he is hopeful the measure will move by the end of the week. "We're going to have a vote on the Senate bill, and with possible changes," he said. "The legislative process is a process of give-and-take."
Democrats are particularly anxious about changes to the estate tax that would permit a couple to pass $10 million on to heirs tax-free and would tax inheritance beyond that amount at 35%. The provision, which Hoyer said "a number of us would like to change," would cost $68 billion over the next decade.
►Darrell Issa uncomfortable with tax deal
Jake Sherman/Politico/Dec 14
Count a future GOP committee chair as one of those icy on President Barack Obama's tax compromise with Republicans.
California Rep. Darrell Issa, the future chair of the House Oversight and Government Reform committee, said the tax bill that passed a key procedural hurdle Monday is "an incomplete effort that fails to create a permanent tax structure giving businesses the kind of long-term predictability needed to support investment, economic growth and job creation."
►The Tax Deal and the Apocalypse
Dean Baker/Huffington Post/Dec 13
As I have noted before, the major risk of this deal is that it would undermine Social Security. The deal temporarily lowers the Social Security tax by 2 percentage points. In principle, the tax rate will go back to its current rate after the end of next year.
►A Fiscal Non-Event, and a Stimulus Non-Event, Too
Douglas Holtz-Eakin/National Review/Dec 13
The discussion surrounding the tax bill — especially its contribution to deficits and debt and its “stimulus” effects — is hopelessly muddled. By and large, the bill is a continuation of current policy, which is to run massive deficits. And doing more of the same is not stimulus.
►Responding to Conservative Critics of the Tax Deal
Keith Hennessey/ KeithHennessey.com/Dec 13
I agree that the bill would be much better if the 2010 tax rates were made permanent. But if there’s no deal, we’ll have the current law rates for only another 18 days. Two years is better than 18 days.
►Will the Tax Deal Hurt Housing?
Stephen Gandel/The Curious Capitalist/Dec 13
So the recent rise in interest rates has John Mauldin on the Big Picture blog fretting that the Federal Reserve's plan to buy Treasury bonds, called QE2, and presumably the tax deal as well, will make the struggling housing market that much worse...
So will the tax deal and QE2 sink the housing market? Probably not. Here's the problem with Mauldin's and others' logic: Interest rates don't really have that much effect on housing prices. Consider what has gone on in the past two years. Up until recently, the Fed has been driving down the rate on the 10-year Treasury bond. But has that boosted housing prices or sales? Nope. What's more, housing price continued to rise in the mid-2000s even when interest rates were rising. The real thing that drives housing prices is jobs and access to credit. People buy houses when they get a new job and can get a loan. They don't buy houses when they think there is a shot they will lose their current job. So if the tax deal is able to boost the job market, housing prices should rise. If not, prices will fall. The tax deal's effect on interest rates doesn't matter nearly as much, at least when it comes to housing.
►Video: Stockman Says Tax-Cut Deal Is Bad Policy
Simon Constable/Wall Street Journal/Dec 13
Former Reagan White House budget director David Stockman says the tax deal emerging in Washington is “Keynesian flimflam” that won’t help stimulate the economy.
December 13, 2010
OUT WITH THE OLD, IN WITH THE NEW (YEAR-END PREDICTIONS)
'Tis the season of predictions. Although there's never a shortage of forecasts, the calendar year's finale typically shifts the prognosticating into overdrive. This year is no different. You can hardly swing a cat these days without hitting a fresh batch of prophesies for the year ahead. The trick, as always, is figuring out which forecasts have a decent chance of correctly describing the months and years ahead.
More is actually better when it comes to predictions. There's an intriguing line of economic research that stretches back to the 1960s that demonstrates how combining forecasts is more reliable than focusing on the lone guess. Common sense, perhaps, but formally vindicated too. In any case, the insight inspires a broad look at what the pundits and analysts expect for 2011 and beyond, an art form that's unusually fertile at the moment.
What follows is a random review of recent crystal-ball gazing in no particular order from a variety of people and institutions. A few of the specifics are arbitrarily highlighted, although you can read the unedited source material by clicking on the link. Meanwhile, hope springs eternal. So too do the usual caveats, including the warning that some of the forecasts that follow may actually prove to be accurate.
Mercer predicts top investment trends for 2011
Mercer Wealth/Dec 13
• As developed nations struggle with debt and credit remains tight, global growth will be driven by emerging economies. Considered too risky or difficult to access in the past, markets such as China and India now offer economic strength, positive demographic forces, improved governance, political stability and expanding capital market access – making them increasingly attractive to investors…
• Asset allocation and portfolio structuring will evolve and result in the creation of more robust portfolios… Sophisticated investors have responded by using more nuanced models, and supplementing the traditional ‘asset-class’ approach with one based on risk factors…
• More investors will exploit capital market deviations through medium-term asset allocation ‘tilts.' The financial crisis emphasised that asset allocation is the key driver of returns, and in 2011, investors will continue to move from a static, long-term strategic asset allocation approach, to processes which adjust allocations according to their medium-term outlook.
Eleven Themes for 2011
Richard Bernstein (Richard Bernstein Advisors)/Dec 7
• The US Dollar Continues to Appreciate. Despite all the talk about debasing the dollar, the DXY Index has actually risen about 2% so far in 2010. In addition, most investors remain unaware that the dollar troughed in April… 2008! We expect the dollar to continue to appreciate in 2011…
• We expect stocks to outperform bonds in 2011 as the US economy continues to expand and as normal upward pressure on longer-term interest rates becomes more apparent.
• Gold Produces a Negative Return. Gold seems to be in a pure momentum market these days. Momentum markets are exciting, and the media love them, but they have a nasty tendency to fall faster than they rose.
Schwab Market Perspective: Cutting Through the Noise
Charles Schwab/Dec 3
• Economic data is rarely clear-cut, but we believe the weight of the evidence indicates a strengthening US economy, which should help to support stock-market performance in the coming year.
• The negative rhetoric surrounding the Federal Reserve's recent decision reached a crescendo, but while we were among the first to voice our belief that it wasn't necessary, we believe the dire warnings of potential consequences from a second round of quantitative easing (QE2) are overblown.
• The European debt crisis continues to plague world markets. We believe the European Central Bank (ECB) needs to be more proactive instead of continually reactive.
UBS global outlook: Key investment views
• Global economy divided in 2011
The global economy is becoming more fractured – not down the traditional lines of West versus East or Developed versus Developing, but the strong versus the weak. Record deficit levels, previously unheard of stimulus measures and uneven levels of economic growth will force many countries to make hard political choices to shape the investment environment in 2011.
• Equities our preferred investment
Equities are well-positioned for a year of accommodative central banks, are able to weather the risks of inflation better than most, and offer attractive value going into 2011. Companies that sell products or services, generate cash and have profit margins are unlikely to go out of fashion soon. We favor equities in the larger emerging markets (BRICs) and Core Europe, such as Germany.
• New rules: No major currency should be considered safe
“It’s the economy stupid” was once a popular slogan during the US presidential campaign in 1992, and is the economic reality for currency investors. The traditional Big Four currencies (USD, EUR, GBP and JPY) will be challenged in 2011. We recommend diversification, and many investors may wish to consider the currencies of commodity
producers and emerging markets.
U.S. Economic Perspective: Recent Rate Rise Reflects Growth Hopes, Not Sovereign Fears
Alan Levenson (chief economist, T. Rowe Price)/Dec 10
• Prospects for additional tax relief bolster our expectation of a gradual quickening of growth. If enacted, the proposed measures would add roughly 0.5 percentage points to real GDP growth next year.
• Against this backdrop, we view the recent rise in Treasury interest rates as a reflection of firming growth expectations, rather than as an aversion to the debt of a profligate sovereign borrower. As such, the backup in risk-free rates is not a threat to near-term economic prospects.
• At the same time, we are mindful of the intermediate-term risks associated with the wider fiscal shortfall that this policy choice entails, and reiterate that fiscal stresses cannot be viewed safely as only a long-term threat.
Investment Ideas for 2011
Morgan Stanley Smith Barney/Dec 2010
We believe high yield corporate bonds offer one of the more attractive risk/reward profiles in fixed income. A recovering economy, coupled with declining default rates, should improve the credit profile of the asset class over the coming year. To be sure, the high yield spread over Treasuries has come down a long way from the record-setting levels seen in late 2008 during the depths of the financial crisis. However, the current high yield spread of roughly 600 basis points remains attractive relative to its long-term average.
CFOs More Optimistic About Hiring in Annual Bank of America Merrill Lynch Outlook
Bank of America Merrill Lynch/Dec 9
Financial executives at U.S. companies expressed more optimism that their businesses will hire employees and see revenue growth in 2011, according to a recent Bank of America Merrill Lynch survey.
Of the 801 executives surveyed in the bank's annual CFO Outlook, 47 percent said they expect their companies to hire additional employees next year, up from 28 percent who forecast hiring last year. Only 6 percent said they expect layoffs, compared with 9 percent last year. In addition, 64 percent of CFOs expect revenue growth in 2011, up from 61 percent last year...
Other notable findings in the survey:
• When asked what will have the biggest impact on the economy in 2011, CFOs ranked healthcare reform No. 1 at 54 percent, followed by the budget deficit at 52 percent and the housing market at 43 percent.
• Related to the above, CFOs' top financial concern by far is health care costs, followed by revenue growth and cash flow. The top concern last year was revenue growth.
• Only 27 percent of CFOs expect the cost of capital to increase, compared to last year when nearly half of CFOs expected a higher cost of capital.
Predictions 2011: Michael Farr On Treasuries And Home Prices
Michael K. Farr (Farr, Miller & Washington via CNBC)/ Dec 1
• Interest rates on Treasuries rise. Interest rates on longer-dated Treasuries begin to rise as 1) deficits remain high due to tax cut extensions; 2) investors lose confidence in the government's ability to address structural deficits (entitlement spending); and 3) commodity prices continue to rise. Central banks across the developing world will increasingly tighten to avoid runaway inflation. The Fed may attempt QE3 but will find that it has lost control of the Treasury market…
• Home prices will fall again. Housing prices will fall an additional 5-15 percent as mortgage rates rise moderately and foreclosure backlogs work through the system. Further home price declines will trigger more defaults and foreclosures as the percentage of underwater mortgages rises from the current level of about 25 percent. The government will be forced to address the deteriorating housing market through initiatives designed to support prices.
Top 10 economic predictions for 2011
Nariman Behravesh (IHS Global Insight) via ThisIsMoney/Dec 6
A two-speed recovery is likely to remain a salient feature of the global economy throughout 2011. The deceleration in growth that manifested itself in the latter half of 2010 will extend into the first half of 2011—for nearly every region and country in the world.
However, the global recovery should pick up steam in the second half of the year, as some of the worst-hit sectors (housing and autos) rebound and as consumer and business confidence improves.
Economists Predict Growth in 2011
The Wall Street Journal/Dec 13
Economists have grown more optimistic about the outlook for U.S. growth next year, predicting the expansion will accelerate as 2011 progresses, according to the latest Wall Street Journal forecasting survey...On average, the economists now predict GDP will grow 2.6% in the current quarter at a seasonally adjusted annual rate, up from the 2.4% growth they projected in last month's survey. The economy grew 2.5% in the third quarter. The economists now see stronger expansion in the first half of 2011, with growth picking up speed as the year progresses. For the year, they expect GDP will rise 3%. Meanwhile, they have reduced the odds of a double-dip recession to 15%, the lowest average forecast of the year, from 22% in September survey.
Pimco Raises US Growth Forecast After Tax Deal
Pacific Investment Management Co, manager of the world's largest bond fund, raised its growth forecast for the U.S. economy to between 3 percent and 3.5 percent for 2011 from its earlier estimate of 2 percent to 2.5 percent, Chief Executive Mohamed El-Erian told CNBC late Thursday.
Stock forecasters predict market gains in 2011
USA Today/Dec 10
The most bullish of the eight 2011 forecasts reviewed by USA TODAY comes from Barclays Capital strategist Barry Knapp. His base case for the Standard & Poor's 500 index, a broad market gauge, is for it to hit 1420 by the end of 2011, which equates to a gain of 15% from Thursday's close of 1233. He did not, however, rule out pullbacks along the way. "We are more optimistic than we have been at this time in each of the last two years," Knapp wrote in his "Outlook 2011."
His optimism stems from his belief that the economy will continue to improve, corporate earnings will keep growing and the Federal Reserve will stick to its ultra-easy interest rate policy. "We are optimistic about U.S. corporate profits," Knapp wrote. He expects S&P 500 earnings to grow at a 9% clip next year.
"Before You Uncork The Champagne": David Rosenberg's 10 Themes For 2011
Business Insider/Dec 11
People are overbullish on U.S. equity. Consensus views of 1,350 on the S&P 500 and 4% real GDP growth are far too high. Not one strategist polled by Bloomberg is bearish on equities. So we have a complacency problem on our hands, the exact opposite of what we experienced at the March 2009 and the July 2010 lows. For that reason, the outlook for at least the first half of 2011 is less than positive.
Mark Zandi (chief economist of Moody's Analytics) talks with Bloomberg News about the Fed and the outlook for the U.S. in 2011...
December 11, 2010
BOOK BITS FOR SATURDAY: 12.11.2010
● Uprising: Will Emerging Markets Shape or Shake the World Economy?
By George Magnus
Review via Financial Times
It is not often these days that an investment banker takes a sceptical view of emerging markets. Such has been the rush to put money into China, India, Brazil and the rest that caution has often been thrown to the wind...Magnus rightly warns that financial instability and financial euphoria often go together, with disastrous results.
● Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis
By Anatole Kaletsky
Summary via publisher, Public Affairs
In this provocative book, Anatole Kaletsky re-interprets the financial crisis as part of an evolutionary process inherent to the nature of democratic capitalism. Capitalism, he argues, is resilient. Its first form, Capitalism 1.0, was the classical laissez-faire capitalism that lasted from 1776 until 1930. Next was Capitalism 2.0, New Deal Keynesian social capitalism created in the 1930s and extinguished in the 1970s. Its last mutation, Reagan-Thatcher market fundamentalism, culminated in the financially-dominated globalization of the past decade and triggered the recession of 2009-10. The self-destruction of Capitalism 3.0 leaves the field open for the next phase of capitalism's evolution. Capitalism is likely to transform in the coming decades into something different both from the totally deregulated market fundamentalism of Reagan/Thatcher and from the Roosevelt-Kennedy era. This is Capitalism 4.0.
● Beyond the Crash: Overcoming the First Crisis of Globalization
By Gordon Brown
Review via Marco Trade News
The international financial crisis that has held our global economy in its grip for too long still seems to be in full stride. Former British Prime Minister and Chancellor of the Exchequer Gordon Brown believes the crisis can be reversed, but that the world’s leaders must work together if we are to avoid a decade of lost jobs and low growth.
Brown speaks both as someone who was in the room driving discussions that led to some crucial decisions and as an expert renowned for his remarkable financial acumen. No one who had Brown’s access has written about the crisis yet, and no one has written so convincingly about what the global community must do next in order to climb out of this abyss. Brown outlines the shocking recklessness and irresponsibility of the banks that he believes contributed to the depth and breadth of the crisis. As he sees it, the crisis was brought on not simply by technical failings, but by ethical failings too. Brown argues that markets need morals and suggests that the only way to truly ensure that the world economy does not flounder so badly again is to institute a banking constitution and a global growth plan for jobs and justice.
● See No Evil: Uncovering The Truth Behind The Financial Crisis
By Erik Banks
Summary via publisher, Palgrave Macmillan
The story of the recent global economic crisis is told in the words of the main players in the drama. Including quotes from bankers, rating agencies, housing agencies, regulators, politicians and media figures. Erik Banks' latest book shows why we are doomed to experience further financial crises in the future.
● China After the Subprime Crisis: Opportunities in The New Economic Landscape
By Chi Lo
Summary via publisher, Palgrave Macmillan
This book analyzes the post-subprime crisis world from the global, Asian and Chinese perspectives. It dispels some of the myths about the crisis's effects on Asia and China; and exposes the ugly truth of bailout policies and their distortion and hindering of the world's economic rebalancing effort in the post-subprime era.
December 10, 2010
READING ROOM FOR FRIDAY: 12.10.2010
►Obama 'Confident' Congress Will Pass Tax Deal
Scott Horsley/NPR/Dec 10
In the face of strong opposition from members of his own party, President Obama says that he's confident lawmakers will eventually approve a tax cut deal he negotiated with congressional Republicans.
►Liberal Democrats: We won't support tax deal without changes
Todd Spangler and staff/Detriot Free Press/Dec 10
Liberal Democrats in the U.S. House delivered a sharp rebuke to the deal between President Barack Obama and Senate Republicans to extend unemployment benefits and keep tax rates stable, saying Thursday that they wouldn't accept the agreement without change.
►Angry House Democrats vow to block tax package
Lori Montgomery and Paul Kane/Washington Post/Dec 10
As the Senate steamed toward a Monday afternoon vote on the far-reaching package, House Democrats were in open revolt. Amid chants of "Just say no," they agreed overwhelmingly during a private meeting Thursday to block the measure from going to the House floor, a symbolic move that underscored the depth of their anger...
"House Democrats share the president's commitment to providing the middle class with a tax cut to grow the economy and create jobs" but "reject the Senate Republican tax provisions as currently written," House Speaker Nancy Pelosi (D-Calif.) said in a statement. "We will continue discussions with the president and our Democratic and Republican colleagues in the days ahead to improve the proposal before it comes to the House floor for a vote."
►Anger at tax cut proposal: strange political bedfellows
Jessica Yellin and Kevin Bohn/CNN Political Ticker/Dec 9
It is strange political bedfellows. Some on the right are joining their usual adversaries on the left in their anger at the proposed tax cut deal.
Of course, the reasons for their dismay are different. While liberals wail at the extension of the Bush-era tax cuts for those making more than $250,000 per year and other items, many are particularly upset that the measure would add hundreds of billions of dollars to the deficit.
►Senate to Consider Tax-Cut Bill That Would Add $857 Billion to U.S. Debt
Ryan J. Donmoyer and Richard Rubin/Bloomberg/Dec 10
Senate leaders released an agreement crafted by the White House and Republicans to sustain Bush-era tax rates through 2012, set the estate tax at the lowest rate in 80 years, extend jobless aid and cut payroll taxes by 2 percentage points.
The legislation would add $857 billion to the federal debt over 10 years, government analysts said.
Senate Majority Leader Harry Reid introduced the legislation late yesterday after three days of lobbying by Democrats to include measures excluded from the framework announced Dec. 6 by President Barack Obama.
►The Payroll Tax Cut: Effective Stimulus, Phony Accounting
Charles Blahous/e21/Dec 8
It’s good news that President Obama and Congressional leaders have reached agreement on a deal to prevent a near-term tax increase on individuals and small businesses. As a public trustee for the Social Security Trust Funds I feel, however, obliged to sound an alarm about one component of the deal: specifically, a double-dose of new government debt, via a proposed accounting maneuver to disguise the effects of the agreement’s payroll tax cut provision...
Understand, my point here is not to critique the idea of payroll tax relief itself. Economists on both sides of the aisle believe that payroll taxes are a drag on job creation; indeed, one reason that we need Social Security reform is to prevent future payroll tax increases from hindering economic growth. Relative to other forms of stimulus, payroll tax relief introduces a minimum of both bureaucracy and economic distortions.
The problem is not with the tax relief but with an accompanying accounting gimmick: as described, the provision would also issue $120 billion in additional debt (from general revenues) to the Social Security Trust Fund – in other words, changing the government’s accounting to make it appear as though the $120 billion had been collected even though it hadn’t.
This is more than a harmless accounting entry; because Social Security spending is statutorily limited to the amount of assets in the Trust Fund, the accounting maneuver increases the government’s spending authority by $120 billion plus interest to be accumulated over decades to come...
Let’s make this simple: Social Security benefits are funded by payroll taxes. If we want higher Social Security benefits, then we need to collect more payroll taxes. If we want to relieve payroll taxes, then we can finance less in Social Security benefits. Either policy is a valid choice. What is not valid is to refund the payroll tax while still pretending that we are successfully financing higher future Social Security benefits with money we haven’t collected.
December 9, 2010
JOBLESS CLAIMS CONTINUE TO TREND LOWER, BUT WITH A NEW CAVEAT
Last week we pushed the case for thinking that the recent decline in new jobless claims was more than a statistical glitch. That was a slightly harder sell after looking at the numbers through November 27, a week that suffered a hefty gain. But the broader trend still pointed down, we opined, a view that returned to the good graces of the statistical goods with this morning’s update. Yes, there’s encouraging news in the latest tally of initial jobless claims, which fell a solid 17,000 last week. But while the widely cited seasonally adjusted number offers fresh encouragement today, a new front in the war on job growth may be opening up once we consider last week’s seasonally unadjusted jobless claims total.
But first the good news. Seasonally adjusted jobless claims dipped to 421,000 last week. As the chart below shows, that’s near the lowest level in more than two years. Indeed, other than the week through this past November 20, the latest reading is the lowest level in more than two years. It's been a long time coming. After nearly a year of treading water in this series, the trend seems to have broken through the glass floor. That suggests the labor market will continue to recover, if only mildly.
Surprising? Not really. The economy was either headed into a new recession or the bias was set to tip toward growth on the margins. As we’ve been discussing in recent months, the evidence has been building in favor of the growth argument on multiple economic fronts. It’s no shock, then, to see initial jobless claims trend lower...eventually. Eventually seems to have arrived. Better late than never.
So far, so good. But then we stumbled across a rather frightening surge in the unadjusted claims numbers for last week. This raw measure of new filings for jobless claims soared by more than 169,000 for the week through December 4—the biggest weekly gain by far since January 2010. Yes, the unadjusted trend in jobless claims is a wild statistical pony and therefore it's subject to volatility levels that can make even battle-scarred statisticians dizzy. In that case, the usual caveat about ignoring any one number goes double here. By definition, the unadjusted numbers are subject to a wide range of seasonal quirks that can and do mislead us in deciphering the true trend. Nonetheless, no one needs an excuse to wonder about what could go wrong these days, and so the reversal of fortunes in unadjusted initial claims speaks for itself, as the second chart below reminds.
It’ll take another week or two to figure out if the unadjusted claims are just statistical noise on steroids. For the moment, we’re assuming just that. There’s too much contrary evidence swirling about to give in to fears tied to any one negative number, albeit a rather large negative number. But forgive us for being a little paranoid. We’ll sleep better after seeing the unadjusted trend fall back to earth. But while we're waiting, the guessing game just got a little more challenging.
WILL DEMOCRATS DERAIL THE TAX CUT EXTENSION?
Is the agreement to extend the Bush tax cuts in trouble? There are new reasons to wonder today, which means that there are new questions about the outlook for any economic stimulus effect that the markets are expecting since the tax deal news hit the wires earlier this week.
On Tuesday, the White House and Republicans agreed in principle to maintain the tax breaks enacted a decade ago. Without a new vote, that legislation is due to expire at the end of the year, effectively delivering a tax hike at a time when economic growth is sluggish. But what was blessed by the President and the Republicans in theory must now navigate the realities of congressional politics, a realm where Democrats are reportedly fuming that Obama signed off on the deal that extends cuts to all Americans, including the wealthy.
“I’m not sure this bill can pass in this form in the House of Representatives,” Rep. Chris Van Hollen (D-Md.), told MSNBC yesterday via The Hill. Van Hollen is a liaison between House Democrats, the White House and the Senate. According to The Hill: "Van Hollen said Democrats were stunned that Obama agreed to set the estate tax at 35 percent and apply it only to inheritances over $5 million." Van Hollen confessed that "This provision makes it very, very difficult for me to support it in its current form."
Van Hollen is hardly the only Democrat to voice frustration with the idea of extending the Bush tax across the board. “There is a substantial amount of dissatisfaction with the deal that was cut,” Rep. Jim McDermott (D-Wa.) said yesterday, the New York Times reports. “The Democratic caucus put itself on notice that it would not vote for tax cuts for the wealthy because we can’t afford them and because they are not needed, and that’s the point one Democrat after another is making.”
Another headwind for the tax deal is the news that the co-chairmen of the President's deficit commission will reportedly warn the White House that an extension of the Bush tax cuts doesn't raise the national debt. "I am deeply disappointed that we have this short-term deal and it's not linked," co-chairman Bowles said yesterday. "It must be absolutely linked to long-term fiscal restraint."
Worrying about the tax cuts' impact on the nation's finances goes far beyond Simpson and Bowles. As the AP reports:
The worry in the markets, echoed by the credit-ratings agency Moody's Investor Services, is that the tax-cut extension could add about $4 trillion to the U.S. deficit over the next 10 years. Bond investors see no credible plan to get a grip on that deficit - especially since the government will be split for the next two years, with Republicans in control of the House and Democrats in control of the Senate and the White House.
"The world in which investors took solace in lowly yields on account of sovereign debt crises in the eurozone and fears over the health of global recovery has suddenly changed after agreement to keep tax cuts in place," said Andrew Wilkinson, senior market analyst at Interactive Brokers.
The White House is fighting back with its own pointed rhetoric. The President's economic adviser Larry Summers warned that "if they don't pass this bill in the next couple of weeks, it would materially increase the risk the economy would stall out and we would have a double dip."
But one vocal Democrat—Rep. Barney Frank, chairman of the House Financial Services Committee—announced: "No, I won't vote for it. I don't think that I should be coerced." Is Frank worried that the risk of a new recession is higher if the tax cuts aren't extended. Nope. "I do not believe that raising the marginal rate from 36 to 39 percent on hundreds-of-thousands of dollars is going to affect their spending patterns," he said. Frank did predict, however, that the bill would pass, despite his opposition.
The irony in the Democratic opposition, as LA Times's columnist Andrew Malcom opines, is that "if keeping more of their own money [by way of extending the tax cuts] does prompt American consumers to feel better and spend more, then the Republican tax plan will have saved not only the lagging economy but the Democrats' bacon come 2012."
But if there's confusion about the politics of the proposed tax cuts, some of the blame must go to the President, who seems to be of two minds about the deal that he supports…sort of. “I’m as opposed to the high-end tax cuts today as I’ve been for years,” Obama said yesterday. “In the long run, we simply can’t afford them. And when they expire in two years, I will fight to end them.” The President, it seems, was against his own tax cut deal before he was for it.
Indeed, Obama has also been the strongest advocate for extending the tax cuts, even if he argues against it. Letting the tax cuts expire for the middle class would "cost our economy nearly a million jobs," the President explained. “All of this would have been damaging to those individual families. It would have been profoundly damaging to the economy, as well, at a time when, frankly, the economy is growing but we still have very high unemployment."
On that point, at least, there is no disagreement.
December 8, 2010
TALKING UP INTEREST RATES & INFLATION FORECASTS
In his "60 Minutes" TV interview on Sunday, Federal Reserve chairman Ben Bernanke reminded the world that the central bank can raise interest rates in 15 minutes. The bond market is similarly endowed with the power to move the prices, and therefore yields, of fixed-income instruments in more than gradual increments, as this week's trading reminds.
The benchmark 10-year Treasury Note's yield rose to 3.15% yesterday—the highest since June. The market's forecast for inflation is also rising. Yesterday's implied prediction for inflation rose to a 7-month high of 2.23%, based on the yield spread between the nominal and inflation-indexed 10-year Treasuries.
In looking for reasons why interest rates and inflation forecasts are moving higher this week, the list of possibilities starts with the news that the Bush tax cuts will be extended. The New York Times labels the tax deal a "back-door stimulus plan." The bond market apparently agrees.
Indeed, some critics worry about the cost of the tax cut deal. The price tag could be as high as $1 trillion, according to Moody's Analytics via USA Today. There's hope that the the tax cut proposal will bring higher economic growth, but there's also concern about what that will mean for inflation. As USA Today advises:
Bond traders worried that the Treasury would have to increase its borrowing to finance the government's operations — and that the extra borrowing could lead to added inflation in the future. The yield on the benchmark 10-year Treasury note, for example, soared to 3.13% Tuesday — from 2.93% Monday— its highest level since June...
If the inflation rate moves beyond the Federal Reserve's target of about 2%, the Fed could be prompted to raise interest rates sooner rather than later to keep inflation in check, says Anthony Valeri, fixed-income investment strategist for LPL Financial. "Short-term futures are showing a slight possibility of a rate hike in November of next year," Valeri says. He thinks that's unlikely, however, given the economy's weakness.
Meanwhile, Barron's reports:
Economists reckon the tax package will add one-half to a full percentage point to real growth in 2011, with estimates now falling in the 3%-4% range. The better growth prospects from the fiscal proposals reduce the chances the Federal Reserve will purchase more than the $600 billion in Treasuries it currently plans; indeed, the central bank could buy less if the economy picks up.
None of this is surprising in the wake of big changes for the macro environment. Expected returns and risk fluctuate, and sometimes they fluctuate more than usual when the catalysts are supersized. "The tax cuts have changed the market's landscape," Arihiro Nagata, fixed income manager at Sumitomo Mitsui Banking, tells Reuters. "A lot of people are now changing their scenarios. Many economists are saying the tax cuts will push up U.S. growth by 0.5 to 1.0 percentage point."
December 7, 2010
DECIPHERING THE TAX CUTS
The Bush tax cuts will be extended for two years, with a bonus: a one-year cut in the payroll tax for a year. Harvard economics professor Greg Mankiw writes of being "generally pleased with the compromise over taxes the President and Republicans struck yesterday." But a random survey of reactions near and far suggests something other than pleasure as the common denominator.
Anxiety, for instance. As the LA Times reports…
The bond market is suffering a brutal sell-off Tuesday, driving yields up sharply, as investors react to the deal between President Obama and Republican leaders to extend the 2001 and 2003 tax cuts. The 10-year Treasury note yield, a benchmark for mortgage rates, has soared to a five-month high of 3.16% from 2.94% on Monday. Shorter-term yields also are rocketing.
There's also political intrigue to consider…
The president’s agreement to this deal is an implicit admission that voters aren’t buying what the Democrats have been selling on the budget for the past year. The primary argument Democrats pushed throughout 2010 was that the country simply could not afford to “spend” anything more on tax cuts for the wealthy. The president went so far as to say he could find much better uses for the hundreds of billions of dollars that would be “spent” by extending the top Bush tax rate at 35 percent.
The hope is that the tax cuts add up to something more than an accounting change. Art Hogan, chief market strategist at Jefferies & Co., sees the bright side in the possibilities. "It's something that clearly is going to put some confidence back in corporate America," he says of the tax cut proposal.
But there's no shortage of critics picking over reported flaws. "Obama's proposed payroll tax holiday botches an idea of truly Singaporean cleverness," writes Bryan Caplan. "Instead of giving the tax cut to employers, where it would do the maximum good, or splitting it evenly, where it would do intermediate good, he's giving all of it to employees, where it does the minimum good."
The Center for American Progress argues otherwise: "Our analysis of the framework tax agreement that President Barack Obama announced yesterday, including additional tax cuts and an extension of unemployment insurance, finds that 2.2 million jobs will be the end result. In this time of economic distress, millions of new jobs are, of course, very welcome." But there's a catch, or so we're told: "It is, however, unfortunate that these jobs have to come from an agreement that is a balance between large, unneeded, bonus tax breaks for the wealthiest Americans and the needed continuation of unemployment benefits, middle-class tax relief, and additional help for the economy for the rest of us."
A little class warfare is always lurking in any discussion about changing the tax code...or keeping it as is.
What does the stock market think? After an early rally, the S&P 500 ended flat on the day, edging up a scant 0.05%. Why so tenuous? Maybe it has something to do with questions of how to "pay" for the tax cuts. As Bloomberg advises,
Extending all income-tax rates for two years, along with renewal of business tax breaks, relief from the alternative minimum tax and other moves such as expanded unemployment insurance could add about $750 billion to the deficit over the next decade, about $300 billion of which is beyond the deficit- expansion which the “pay-as-you-go” law would allow.
WILL POLAND RETHINK THE EURO?
Dropping out of the gold standard to adjust monetary policy in the face of a macroeconomic shock is no longer possible. The gold standard, after all, is long gone. But the next-best thing is still visible in Poland, albeit in relative and pre-emptive terms. Indeed, it's striking how the country is growing while its neighbors are having a rough time. The comparisons of Poland with Ireland and Greece are especially striking. Why is Poland faring so much better? There's no one answer, but for the moment there's a connection between Poland's relatively favorable trend and the fact that it hasn't (yet) adopted the euro.
Poland retains its own currency, the zloty. Although the country has plans to jump on the euro train, it continues a quaint tradition on the Continent: running its own monetary policy. That’s an advantage in the blowback of the Great Recession. As The New York Times reports, “The floating zloty, which has fallen about 18 percent against the euro since early 2009, acted as a pressure release valve, helping to keep Polish products competitive on world markets and insulating Poland from the effects of the sovereign debt crisis.” The country, we’re told, is the lone case of a EU member state that’s sidestepped economic contraction and that scourge of the developed world these days: bank bailouts.
“Output is expected to rise 4 percent or more in 2011, after an estimated 3.6 percent this year,” according to the Times. “Commercial real estate prices in Warsaw are rising at a 10 percent annual clip. Foreign direct investment is expected to be up 28 percent this year, drawn by the country’s status as one of the few growth stories in Europe. And hardly anybody is complaining about the influx of foreign money.”
Poland obviously didn’t abandon the gold standard. You can’t give up what you don’t have. But the zloty devaluation relative to the euro can be thought of as something akin to dumping gold...in advance. The euro is effectively a gold standard for those countries that use adopt the currency. The Wall Street Journal drew a parallel earlier this year explained:
Though it may not have been evident to politicians or populations at the time, governments joining the euro were tying themselves to the modern equivalent of the gold standard, the monetary link to the yellow metal which guided the international financial system for more than a century.
In what may be a depressing parallel for the euro zone, that arrangement was ended by the Great Depression of the 1930s. And the lesson that many economic historians have drawn from that era was that sticking to the gold standard was a hugely painful and ultimately unsuccessful strategy.
"The historical record seems very clear," says Nicholas Crafts, an economics history professor at Warwick University. "In the 1930s, the countries that left the gold standard early did better on average than those who left it later."
Indeed, the historical record doesn't lie, as I discussed last month. Tempting as a gold standard appears, the details remind that it comes with a fair amount of baggage.
As for Poland, well, it has its troubles, of course. But it seems to have one less problem compared with Greece and Ireland.
"The creation of the euro imitated the gold standard, or perhaps, the gold-exchange standard with the German mark imitating gold," Raymond Richman wrote in March when he was analyzing the troubles in Greece—the crisis du jour at the time.
December 6, 2010
A DECADE OF GAINS & LOSSES. SO WHAT ELSE IS NEW?
The year and the decade are nearly over. This calendrical conclusion inspires looking back and considering what might have been vs. what actually happened. Some are already calling the last 10 years a lost decade. But that’s misleading. Only investors who made big, risky bets suffered a lost decade. Despite what you may read elsewhere, broad asset allocation across the major asset classes delivered a modest gain. It wasn’t stellar, even by broadly diversified investing’s standards. But a lost decade? Hardly.
True, U.S. stocks didn’t have a good run over the past 10 years. The Russell 3000 Index, for instance, gained a mere 1.6% a year for the decade through the end of last month. That’s an usually poor performance by historical standards. It wasn’t much better for equities in the developed world either. The MSCI EAFE Index gained 3.1% a year.
Meantime, owning a broad portfolio of asset classes did much better. As I'll discuss in more detail in an upcoming issue of The Beta Investment Report, a passively allocated mix of all the major asset classes earned an annualized 5.1% total return for the decade through November 30, 2010, based on my proprietary Global Market Index (GMI). If you mechanically rebalanced GMI every December 31, the return rose to 6.0% a year.
Surprising? No, not really. The range of annualized returns for the major asset classes—as usual—is all over the map for the trailing 10 years, ranging from the slightly negative result for U.S. stocks up to 18% for equities in emerging markets. That's not going to change for the next 10 years, although figuring out which asset classes will win vs. lose isn't going to be any easier. That's one reason for not sticking your financial neck out too far and betting the ranch on one or two asset classes.
This isn’t rocket science. Rather, it’s prudent risk management. Owning a broad array of asset classes and opportunistically rebalancing the pieces from time to time are the first line of defense in a world where uncertainty reigns supreme and forecasting suffers the usual failure rates.
Update: The original version of this post reported the Russell 3000 as losing 1.6% a year for the past 10 years. We should have wrote that it gained 1.6% a year. Also, MSCI EAFE did a bit better than we originally reported, posting a 3.1% annualize total return for the past 10 years. Sorry for any confusion.
December 4, 2010
BOOK BITS FOR SATURDAY: 12.4.2010
● The Power of Passive Investing: More Wealth with Less Work
By Richard A. Ferri
Video of author discussing book, and a summary via publisher, John Wiley & Sons.
Time and again, individual investors discover, all too late, that actively picking stocks is a loser's game. The alternative lies with index funds. This passive form of investing allows you to participate in the markets relatively cheaply while prospering all the more because the money saved on investment expenses stays in your pocket.
In his latest book, investment expert Richard Ferri shows you how easy and accessible index investing is. Along the way, he highlights how successful you can be by using this passive approach to allocate funds to stocks, bonds, and other prudent asset classes.
● Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence: Revised and Updated for the 21st Century
By Robert Z. Aliber
Summary via publisher, Stanford University Press
Your Money and Your Life is more than your average guide to financial planning and retirement. Acclaimed author and speaker Robert Z. Aliber helps readers to make efficient and effective financial decisions at key moments throughout their lives, such as where to go to college; if and when to buy a home; how much insurance, if any, to buy; how to manage savings and retirement; when the time is right to approach a professional advisor; and how to proceed with estate planning. With an eye toward the issues that are most pressing in today's economy, Aliber clearly explains the sophisticated concepts that underpin everyday money management—with the goal of making this guide the go-to reference in your financial planning library, regardless of your age or wealth. Readers of this book will come away with the sense that Aliber is their own financial planner, offering strategies that will help to guide them toward security in the present and the future. Your Money and Your Life is filled with examples to which readers will be able to relate, as well as checklists of "actionables" to help make their plans realities. Robert Z. Aliber is Professor Emeritus of International Economics and Finance at the University of Chicago Booth School of Business.
● Living Richly: Seizing the Potential of Inherited Wealth
By Myra Salzer with Greg I. Hamilton
Review via Wills, Trusts & Estates Prof Blog
Living Richly provides guidance to any person coming into a large amount of wealth, emphasizing the idea that personal potential is more important than financial net worth. Salzer discusses how the financial aspects of managing an inheritance are easy; the hard part is the one-of-a-kind challenge faced by each of us, inheritor or not, to achieve our maximum potential. An excerpt from chapter 1 is below:
Much of my professional journey has turned out to be a very personal one. In assisting my inheritor clients through the stages of wealth and working with them toward a position of empowerment, I’ve almost always found myself caught up in the personal dynamics of life, family, passion, history, and vision.
Working with inheritors is not just about the material aspects of money or the mechanical details of a portfolio, a life spending plan, or even a legacy that will outlast a lifespan. On the contrary, it is a surprisingly complex and sometimes agonizingly introspective process. I say “agonizing” with the sort of affection normally reserved for the freakish masochistic set. That’s because, in my life, soul searching is such a painfully beautiful process that it makes me want to burst. Sort of like the enigmatic Ricky Fitts in American Beauty when he said: “Sometimes there’s so much beauty in the world I feel like I can’t take it, like my heart’s going to cave in.”
● The Economics of Ego Surplus: A Novel of Economic Terrorism
By Paul McDonnold
Interview with author via MV=PQ: A Resource for Economic Educators
I learned from teaching that economics is one of those subjects where a subset of the population likes it very, very much, while outside of that group many view it with confusion, suspicion or even hostility. In trying to make problem sets more palatable to my principles students, I incorporated a fictional scenario involving a terrorist attack on the U.S. economy. The reaction I got was very positive, and writing was already a big hobby of mine, so I thought a full-out novel teaching economics would be a great thing to attempt.
● The Powers That Be: Global Energy for the Twenty-first Century and Beyond
By Scott L. Montgomery
Excerpt via publisher, University of Chicago Press
The basic concept of limits is a healthy one. It teaches modesty, control of appetite, evaluation of actual need—old-time virtues with a stoic but sensible appeal. The idea also lies at the heart of a sustainable society, one able to use its Earth-born resources with intelligent self-interest, in a manner that encourages progress without degrading the planet, and allowing future generations to do the same. Feeling there are inevitable constraints on growth seems like common sense; no society, under any scenario, can expand indefinitely unless it takes into account the finitude of commodities.
Clear enough. But then again, perhaps not. Not everyone, it turns out, agrees. In fact, there are two fundamental worldviews at issue here, deeply opposed in their longstanding contribution to Western self-analysis. One sees growth as bearing the seeds both of advance and destruction; the other sees only progress, unmitigated. Neo-Malthusian is the title sometimes given the first position, after the nineteenth-century British philosopher Thomas Malthus, whose followers have often proclaimed coming exhaustion and deep decay of la condition humain. On the other side are the Cornucopians, who find in the last 200 years an unbroken rise in abundance and benefit, such that, in the words of a most ardent proponent, Julian Simon, “the more [resources] we use, the better off we become—and there's no practical limit to improving our lot forever.” Here is good news indeed, if we choose to believe it. And, until recently, the facts, viewed from an appropriate altitude, seemed to bear it out, if we ignore such wrinkles as world wars, genocides, religious fundamentalism, and the like. Of course, the tale is not yet fully told. Human history hasn’t yet ended, despite a few rumors to the contrary.
The battle between Neo-Malthusian and Cornucopian beliefs is thus a war of faith, fear, and perception, and since the Great Depression, Western nations have shifted between dilute versions of these two positions. In the postwar era, the 1950s seemed to many the opening of an “endless frontier,” impelled by science, but by the 1960s and ‘70s, this came to look naïve in the wake of environmental damage and oil crises. Beginning in the 1980s, pro-growth and laissez-faire attitudes once again took over and ruled for a generation, but climate change, a new oil shock, and global economic crisis have, in the late 2000s, brought a shift back toward worries over limits. There are again deep doubts about where humanity is headed and how long its resources may last. In the lands of energy, this notion has found a specific embodiment in the idea of “peak oil”—and its lieutenant, “peak gas”—defined as the moment in history when global production reaches a halfway point, having used up 50% of all the recoverable resource, and then begins to fall. According to this hypothesis, no matter how many new wells may be drilled, no matter what techniques or new technologies are applied, production will decline; not enough new oil can be found to replace what is being consumed. At this moment, therefore, terminal depletion begins, and the era of “cheap oil,” on which so much depends, is over. But before we talk about the peak concept itself, a bit of background is very much in order.
December 3, 2010
ON THE ROAD AGAIN...
I'm speaking at the Superbowl of Indexing conference in Phoenix that starts on Sunday, which means that blogging will be light to nonexistent for a few days...
NOVEMBER PAYROLLS EDGE HIGHER, BUT SO DOES UNEMPLOYMENT
The labor market expanded last month, but the net gain in private nonfarm payrolls was disappointing, even by the deflated standards of late.
The private sector added a net 50,000 jobs in November, the Labor Department reports. That’s far below what many economists were predicting. November’s meager gain is also a sharp slowdown from the 160,000 rise in October. No wonder, then, that the unemployment inched higher last month to 9.8% vs. October’s 9.6%.
Today’s report is a stark reminder that job growth by itself isn’t necessarily a cure for the macro ills weighing on the U.S. economy. The real solution is robust job growth, and that was nowhere in sight last month.
The slight progress in private payrolls overall masks the deterioration last month in manufacturing. Save for a small uptick in in mining and logging employment, goods-producing industries generally shed workers in November. The services sector, as usual, came to the rescue, but even here there was only modest improvement of 65,000 positions.
If today’s jobs report muddies the outlook for the economy, it sharpens the clarity for the debate over extending the Bush tax cuts, which are due to expire at the end of this month. As USA Today reports,
Ten minutes after the latest report from the U.S. Labor Department, Republican Eric Cantor of Virginia -- the incoming House Majority Leader -- said the rising jobless rate shows the need for new GOP leadership.
"The new Republican majority will be committed to changing the culture in Washington by cutting spending and stopping government overreach so our businesses can do what they do best – innovate, compete, and lead," Cantor said in a statement.
Republicans also used the bad economic news to push their case that George W. Bush-era tax cuts should be extended for all Americans, including wealthy ones who can create jobs.
"The last thing our economy needs right now is a job-killing tax hike," said incoming House Speaker John Boehner, R-Ohio.
Today’s news on the labor front also brings additional perspective on the Federal Reserve’s efforts to stimulate the economy. David Semmens, a U.S. economist at Standard Chartered Bank, explains: “The labor market is not turning around, and that’s key to the overall recovery. Anyone who feels that the Fed perhaps acted too prematurely is definitely going to have to eat their words.”
READING ROOM FOR FRIDAY: 12.3.2010
►Gauging the Odds of a Double-Dip Recession Amid Signals and Slowdowns
Harvey Rosenblum and Tyler Atkinson/Dallas Fed/December
The yield curve’s steep upward slope suggests a low probability of a recession in the coming year. Nonetheless, many economists are reluctant to rely on this indicator because the curve’s shape and slope have been distorted by the Federal Reserve’s unconventional monetary policy: a near-zero federal funds rate and a quantitative-easing program that damped intermediate- and longer-term Treasury rates. With near-zero short-term rates, it is almost impossible for a yield curve inversion, that is, short-term rates exceeding longer-term ones.
There is some reason to believe the unemployment rate could climb again. Claims for jobless benefits remain at a level usually associated with an increasing unemployment. Even if the rate does not increase, it remains elevated, straining the overall recovery.
While the current real price of oil does not fit the criterion of a shock, it sits at levels only seen in the early 1980s and 2006–08. An oil supply shock would be especially damaging to the already weak recovery.
Most forecasters project growth at 2 to 3 percent over the next year, but not gaining sufficient momentum to advance safely above stall speed. Until this situation is resolved, policymakers will continue facing pressure to pursue fiscal and monetary measures to guide the economy toward full employment and more robust growth.
►The Euro at Mid-Crisis
Kenneth Rogoff/Project Syndicate/Dec 2
Now that the European Union and the International Monetary Fund have committed €67.5 billion to rescue Ireland’s troubled banks, is the eurozone’s debt crisis finally nearing a conclusion?
Unfortunately, no. In fact, we are probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s.
►Trichet Keeps Pressure on EU as Bond Program Buys Time
Simon Kennedy and Simone Meier/Bloomberg/Dec 3
Jean-Claude Trichet is keeping the onus on governments to fix the debt crisis as the European Central Bank buys bonds to win politicians time to ax deficits.
Warning European Union leaders that they can’t rely on “benign neglect” to quell market turmoil, Trichet, the ECB’s president, is deploying a two-pronged strategy to ease roiled markets. The bank snapped up Portuguese and Irish bonds again today after Trichet yesterday assured investors that policy makers will delay the withdrawal of emergency liquidity...
“Trichet doesn’t see a quick and easy fix,” said Axel Merk, president and chief investment officer of Merk Investments LLC in Paolo Alto, California. “The ECB is most reluctant to intervene too heavily in the markets as that would take the pressure off policy makers to follow through with reform.”
The ECB’s purchases, which were stepped up during Trichet’s press conference in Frankfurt yesterday, have triggered a surge in bonds across the euro region’s periphery.
►China 'set to tighten monetary policy'
BBC News/Dec 3
China is to tighten its monetary policy next year, the Communist Party's top body has said, in a sign that interest rate rises may be on the way.
The country has recently tightened lending rules by telling banks to keep more cash in reserve,
Now the Communist Party's Politburo has said China will shift its monetary policy from "relatively loose" to "prudent", the Xinhua news agency said.
►Chinese exports to become a lot dearer
Natasha Bita and Michael Sainsbury/The Australian/Nov 27
Cheap imports of electronics, toys and textiles are at tipping-point...After two decades of exporting deflation by cutting the cost of everyday items for consumers around the world, the tables have turned in Asia's industrial powerhouse...Wages, raw materials and other manufacturing costs in China are on the rise, forcing up prices for companies and consumers long accustomed to cheap clothing that costs less to buy new than to dry-clean.
►Currency imbroglio: Estrangement problems of strange bedfellows?
Debojyoti Dey and Venkatachalam Shunmugam/VOX/Dec 3
The current spate of emerging market currency appreciation may appear to be another chapter in the “trade wars” between the US and China. It may appear that an undervalued renminbi enables the flooding of US markets with cheap Chinese goods, while a frustrated US battles hard to kick-start its domestic economy. But as our discussion...shows, China’s huge trade surplus has facilitated its continued investment in the US and enabled the continuation of a low interest rate regime that the latter wanted to maintain in its effort to steer the economy out of the woods. A low interest rate regime in the US led to most of its investors chasing the emerging market returns, thereby pressurising currency fundamentals. Though these two economies may be putting on public posture against each other, they are quietly playing a tango that neither can step out of. The same messy equilibrium contributed to the Great Depression and is now causing the current consternation in world currency markets. But it is an equilibrium, nonetheless.
►The Federal Reserve comes (almost) clean about all the crazy stuff it did in 2008
Annie Lowrey/Slate/Dec 2
The Federal Reserve has made public an enormous trove of data about the emergency measures it took during the worst of the credit crunch and the ensuing recession. It's confusing stuff: arcane spreadsheets showing more than 21,000 transactions totaling more than $3.3 trillion via an alphabet soup of programs. (Gratuitous example: the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or, well, ABCPMMMFLF.) Still, the revelations provide a fascinating glimpse into the workings of the Fed in the apocalyptic days of 2008, when the world economy was on the verge of collapse...
The trove shows which firms used what facilities, when, for how much, and on what terms. (The Wall Street Journal has a handy tool so that the curious don't need to wade through spreadsheets.)
December 2, 2010
JOBLESS CLAIMS RISE, BUT THE TREND STILL LOOKS ENCOURAGING
We were so close. Last week’s initial jobless claims report tempted optimistic expectations with a notable decline in new filings to the lowest level since July 2008. It looked like salvation had arrived at long last. But a large chunk of that drop evaporated in today’s update from the Labor Department. Claims rose 26,000 to a seasonally adjusted 436,000 last week. Were we hornswoggled again? Not necessarily, at least not yet.
Never say never these days. Yet Jobless claims are highly volatile from week to week and so it’s the trend that’s critical rather than any one number. The good news is that the trend is finally starting to break lower, or so it appears. After 10 months or so of generally treading water, initial jobless claims have been showing signs of punching downward in recent months, albeit in fits and starts...as always. You can see that in the chart below and in the latest four-week moving average, which is now at 431,000, the lowest since August 2008.
Support for thinking that the dip is more than a statistical glitch can be found in continuing claims for jobless benefits, which also appear to be slipping of late.
There's also a modestly brighter trend in private-sector payrolls for November, according to ADP, which further boosts the case for cautious optimism. Indeed, it’s a bit easier to argue that the icy trend in job growth is beginning to thaw. No one should expect a full-out spring melt, but the winter freeze in the labor market may be headed for warmer days.
Even so, don’t expect too much heat in job creation. It’s still hard to anticipate much more than a modest, precarious recovery, and so the jobless rate is likely to remain static or dip slowly. And it's still a risky world overall, thanks primarily to large quantities of debt weighing on developed economies. In short, more of the same. In fact, there's a new hazard brewing. The housing market continues to struggle, and it may get worse before it gets better. New home sales and housing starts are weakening again after bouncing higher earlier in the year. Home prices are also stumbling anew.
Perhaps the critical issue now is deciding if residential real estate will nip the labor market's rebound in the bud just as job growth is starting to pick up.
A STRONG YEAR FOR CONSUMER STOCKS
Betting on consumption has been a winning investment strategy in 2010. The S&P 500's top sector this year through December 1 is consumer discretionary, posting a 23.4% total return. That's more than double the broad market's year-to-date gain, as measured by the S&P 500's 10.2% rise through yesterday.
At the opposite end of the sector spectrum is the so-called safe haven of health care stocks, a sector that's retreated by 1.7% in 2010 through December 1.
"It seems as though just about everyone has been down on the US economy, in general, and the US consumer, in particular," Yardeni Research advised in a note to clients on Monday. Mr. Market has been advising otherwise. "The stock market is telling us that the US economy, in general, and the U.S. consumer, in particular, are in better shape than widely perceived."
Is that view gaining traction in consumer sentiment readings? Yes, or so the Conference Board advises. Consumer confidence rose to its highest level in five months, the consultancy reports in Tuesday's update of its consumer confidence index. "Consumers’ assessment of the current state of the economy and job market, while only slightly better than last month, suggests the economy is still expanding, albeit slowly," the Conference Board said in a press release. "Expectations, the main driver of this month’s increase in confidence, are now at the highest level since May."
There's also a bullish momentum in retail sales lately too. October spending rose 1.2%, the fastest pace since March. Meantime, the holiday shopping season appears to be strong too. Retail e-commerce spending for November 1-29, for instance, rose 13% over the same period last year, reports comScore.
The government's November reading of retail sales is scheduled for release later this month, on December 14.
December 1, 2010
QE2 AND CONSERVATIVE ECONOMICS
Mark Calabria, director of financial-regulation studies at the Cato Institute, responds to David Beckworth’s "conservative case for QE2" in National Review. Minds will differ on the topic, of course, since this is economics (and politics) and so what constitutes "evidence" one way or another is forever debatable. That risk aside, it looks like Calabria's reasoning is less than airtight.
The first point is that he's worried about inflation as an imminent threat. "I would not claim we are facing hyper-inflation," Calabria writes, "but two facts should be borne in mind. First, over time even low levels of inflation erode away wealth; and second, a large surge of inflation is likely to occur quite suddenly, without giving the Fed months or years of warning."
Granted, inflation is the path of least resistance in the long run for fiat currencies. No one disputes that trend. But for the foreseeable future, given the blowback from the financial crisis and Great Recession, inflation isn't likely to be a top priority for the foreseeable future. Arguing otherwise requires more than simply fearing higher inflation. Easier said than done these days. As economics professor Menzie Chinn writes, "I struggle and struggle to understand the fear of near-term, rapid inflation…This struggle becomes even more profound when I examine actual data." Indeed, the numbers just don't add up.
Calabria also criticizes Beckworth for effectively exaggerating the disinflation trend of late. But Beckworth is hardly alone in recognizing that inflation has been falling. Whether you define inflation by way of headline or core consumer prices, the rate of increase is in decline, as the latest CPI report shows.
One could, of course, dismiss the government's CPI reports as inaccurate. But the market's been pricing Treasuries in anticipation of lower inflation recently as well. True, the recent disinflation has reversed course. Why? Because the crowd was expecting the Fed to launch QE2, which in fact the central bank did by way of a formal announcement in early November—an act that's in direct contrast with Calabria's views.
Another complaint is that Beckworth's prescription runs afoul of conservative principles, despite claiming otherwise. "If Beckworth wants to preach 'conservative' values and principles, he might start with the observation that it is savings and work that provide wealth, and reject the Keynesian notions that we can spend or debase our way to prosperity," Calabria argues.
But QE2 isn't Keynesian, or at least not fully Keynesian. Milton Friedman, one of the greatest—perhaps the greatest conservative economist of modern times—would surely have supported QE2. How do we know? Friedman all but said so when he explained a few years before his death in diagnosing the Japanese malaise that's not wholly unrelated to the macro challenges now facing the U.S.
The dramatic increase in the Fed's balance has understandably raised questions about the central bank's ability and willingness to tighten monetary policy at the appropriate time. Yes, that's always an open question in the world of central banking. The good news is that there is, in fact, precedent in recent history for central banks contracting their balance sheets to nip future inflation in the bud. As a new study of recent monetary policy history reminds,
During the past two decades, large increases—and decreases—in central bank balance sheets have become a viable monetary policy tool. Historically, doubling or tripling a country’s monetary base was a recipe for certain higher inflation. Often such increases occurred only as part of a failed fiscal policy or, perhaps, as part of a policy to defend the exchange rate. Both economic models and central bank experience during the past two decades suggest that such changes are useful policy tools if the public understands the increase is temporary and if the central bank has some credibility with respect to desiring a low, stable rate of inflation. We find little increased inflation impact from such expansions.
ADP SAYS PRIVATE PAYROLLS RISE AGAIN IN NOVEMBER
Private-sector payrolls rose by a net 93,000 last month, according to this morning’s release of the ADP National Employment Report. That’s the 10th straight month of increases and the largest monthly rise in three years for this series. The news comes just in time to temper the sour trend in yesterday’s update on housing prices for the third quarter.
ADP labels last month's gain as an "acceleration" in the labor market, which "suggests the nation’s employment situation is brightening somewhat." That's welcome news, of course, but even an optimistic spin can't change the fact that job growth is still sluggish. As ADP explains in the accompanying press release:
Employment gains of this magnitude are not sufficient to lower the unemployment rate, which likely will remain above 9% for all of 2011. Furthermore, given modest GDP growth in the second and third quarters, and the usual lag of employment behind GDP, it would not be surprising to see several more months of only moderate gains in employment even as the economic recovery gathers momentum.
The next installment on reading the labor market arrives tomorrow, with the release of initial jobless claims for last week. The stakes are fairly high for the next data point, considering last week's news that new unemployment applications dropped to 407,000 for the week through November 20—the lowest since July 2008. Is that the long-awaited sign that new jobless claims are finally poised to trend lower after a year of moving sideways?
Economists aren't expecting a big change in tomorrow's jobless claims from the week before. In fact, the consensus forecast is 422,000, or a slight rise from the previous week, according to Briefing.com. But that would be good news if only because it suggests that the lower levels of new filings are holding, and that last week's report wasn't a fluke.
But even if tomorrow's news is good, there's no quick fix in sight. "We’re not growing fast enough to materially reduce the unemployment rate,” Fed chairman Ben Bernanke reminded yesterday in a speech. At least there's one opinion from the central bank that's not controversial.