Friday, October 28, 2011

A Brief Note on the Limited Power of the Fed

Some people give the Fed too much credit while others give it too much blame.  As an example of the limits of the power of the Fed, consider the aftermath of Operation Twist.  Briefly, Operation Twist is the Fed's latest attempt to try to stimulate economic growth by selling short-term Treasury bills and buying medium-to-long-term Treasury notes and bonds.  By purchasing medium-to-long-term bonds, it hoped to reduce interest rates that would more directly affecting borrowing (consumers and businesses tend to borrow for long periods of time; 5-year auto loans, 30-year mortgages, etc.).  After declining to about 1.7%, the yield (interest rate) on ten-year Treasury bonds rose to 2.4% yesterday, despite the Fed's actions.  Financial markets are much bigger than the Fed and thus many other factors have a larger impact on interest rates.  In this case, reduced fear over the European debt crisis along with perceptions that the US economic growth is slightly stronger than previously expected reduced the attractiveness of US bonds, resulting in a significant increase in market-based interest rates. Though the Fed is powerful, its power is limited.

Report on Income and Spending

This morning's income report confirms what was released in the GDP report yesterday.  Disposable income adjusted for inflation (real disposable income) declined for the third straight month (July, August, September) while spending increased, resulting in a decline in the savings rate to 3.6%, the lowest since right before the recession (fourth quarter of 2007).  Total real disposable income is still about $150 billion below its peak in Spring 2008.  Unless incomes start growing more quickly, it's going to be hard for consumers to significantly increase their spending, thus limiting how quickly the economy can grow in 2012.

Update on the European Debt Crisis

Europe made another attempt at solving its debt crisis with its most comprehensive plan to date.  The initial reaction of financial markets was quite positive (for example, the German stock market was up over 6% on Thursday).  What is the plan and is the problem "solved"?  The basic elements include private investors in Greek debt taking a voluntary 50% haircut.  A 50% haircut means that those that purchased a 10,000 euro bond will receive only 5000 euros back (50% loss).  Private investors may be willing to accept this because it's better than receiving even less.  Greece likes it because it reduces thier debt load.  Why make it "voluntary"?  Since it's voluntary, Greece won't officially default on the debt so, among other things, credit default swaps won't be triggered (they can be seen as insurance against default, so without an official default, there's no need to pay the insurance.

In addition, Europe will modify and expand the European Financial Stability Facility (EFSF); a fund established in a previous solution to the crisis.  Under the new plan, the EFSF will be used to insure against the initial losses of future haircuts (reducing the risk of bonds somewhat since losses to investors will be reduced somewhat).  The hope is that this will keep interest rates relatively low by limiting the risk of bonds (normally need higher interest rates to compensate for higher perceived risk; so less risk results in lower interest rates).  The second change in the EFSF involves introducing new investment vehicles (i.e., bonds) that will be purchased by sovereign wealth funds (i.e., China, Brazil, etc.) that will provide more funds for future bailouts.  Ideally, if investors knew that there were funds available to bailout Greece, Portugal, and others, they will feel more secure about their investment and thus be more willing to buy bonds at a relatively low interest rate. 

The haircut is a good thing.  Private investors know that there's a risk of buying bonds and are compensated in the form of higher interest rates.  Greece cannot sustain their bond payments, so holders of Greek bonds should suffer a loss (they knew the risk when they bought the bonds).  For now, I'll side step the issue of whether the market determine the amount of the loss.  Regarding the new investment vehicles, will it raise enough funds to be successful?  Many think that China (and Brazil) will be willing to help finance it in exchange for more influence in multilateral organizations.(IMF, etc.).  In addition, will it raise enough funds to convince investors that there's enough funds in case of other countries needed haircuts (Portugal?  Italy?).

Finally, European banks are given to June to increase capital ratios to 9%. Among the ways they can do it are be issuing equity (investors buy new stock which provides the banks with more funds) or by tightening lending and holding onto more deposits. Most analysts expect banks to primarily follow the latter approach, which will mean credit will become harder to come by in Europe, contributing to the likelihood of a recession in Europe.

Did it solve the problem?  Probably not.  It gives Europe more time, but much more work needs to be done to get the debt problems under control.

Thursday, October 27, 2011

A First look at third quarter GDP

Today's GDP report came in as expected, with economic growth of 2.5% in the third quarter.  Business investment continues to be a strength, increasing at an annualized rate of 16.3% (both equipment investment and investment in structures performed well).  Consumer spending increasing at a slightly faster pace than in the second quarter (2.5%), led by a bounceback in purchases of durable goods.  Inventories grew more slowly, thus subtracting about a percent from economic growth (a good sign that companies are not likely to face a need to significantly reduce inventories in the coming quarters).  So far, it sounds like a pretty good report.  However, real disposable income declined at a 1.7% annual rate, following a 0.6% increase in the second quarter.  It was the first decline since 2009 and real income per capita is now slightly below what it was in Spring 2010.  Add it up and it points toward a continuation of a sluggish recovery as consumers remained constrained by stagnant income and high debt levels.

Monday, October 24, 2011

Spectator's Guide to the Euro Crisis

The NY Times has an interesting graphic, "A Spectator's Guide to the Euro Crisis" which includes information about the financial linkages between nations in Europe (as well as US bank exposure to the eurozone).  It also explores possible scenarios for how the crisis may evolve (best case, worst case, and likely scenarios).  Simon Johnson (former IMF economist, currently at MIT) provides comments about the graphic as well as an analysis of the European financial crisis (a policy brief from July 2011).

The guide does a nice job illustrating the interconnections of the global financial system and how problems in one country can reverberate around the world.

Saturday, October 22, 2011

Consumer Deleveraging

The Wall Street Journal has an article (subscribers only as of Saturday morning), "Americans Debt Cutting Hampers Growth," which states that "Household thrift sparked by the financial crisis three years ago has proved surprisingly persistent and is a key reason the recovery that began in 2009 has been so weak."  To economists who study the effect and aftermath of financial crises, this is not a surprise and is a major reason why they have forecasted a sluggish economy for years to come since the start of the crisis.  Consumers accumulated a large amount of debt leading up to the crisis and now must deleverage to get their debt under control.  What led to the accumulation of debt?  Most people know the story by now.  The housing bubble made people feel wealthy, encouraging people to tap into that wealth through home equity loans, 100% (or more) financing of homes, etc.  When the bubble burst, the wealth was gone but the debt remained.  It will take an extended period of time to get debt back in line with wealth, thus constraining economic growth for years to come.  Here is a chart that compares the growth of household debt during recoveries from recessions since 1950.  As you'll notice from the chart, this time was different.

Friday, October 21, 2011

State and Local Employment Report for September

Florida has something to cheer about today!  More jobs were created in Florida in September than any other state (net increase of 23,000 - seasonally adjusted); if you want to get picky, it was not the biggest in percentage terms (0.3% compared to Washington, D.C.'s 1.6%).  Here's a link to the BLS site, which contains all the details.

Florida has added 93,500 jobs over the past year (placing it fourth behind California, Texas, and NY), an increase of 1.3% (outpacing the nation, which experienced a 1.1% increase in employment since September 2010).  Most of the growth in employment has been due to two sectors: (1) leisure and hospitality, which added over 10,000 jobs in September and 58,500 in the last 12 months; and (2) education and health care, which added almost 8000 jobs last month and 33,000 in the last year.
The unemployment rate in Florida declined slightly to 10.6% (from 10.7% in August and 11.7% in September 2010).  Florida is tied with Mississippi for the fifth highest unemployment rate in the nation, behind Nevada (13.4%), California (11.9%), Michigan (11.1%), and South Carolina (11%).  North Dakota continues to shine with an unemployment rate of 3.5%.

What about Orlando?  The unemployment rate declined to 10.2% (not seasonally adjusted), down from 11.6% in September 2010.  Over the last year, Orlando has added 11,900 jobs, with one sector accounting for the increase - leisure and hospitality, which added 12,200 jobs over the last 12 months. Education and Health Care did add 3000 jobs while many other sectors experienced declines including construction; manufacturing; trade, transportation and public utilities; information; and financial activities.
Overall, it's still not a pretty picture, but it does represent some improvement compared to where we stood in 2010.

Jobless Recovery

I was asked yesterday about what's happened to private sector employment and government employment during the recovery.  The numbers below reflect the change in each type of employment from June 2009 to September 2011 (27 months):

Total employment: +841,000
Total private employment: 1,413,000
Total government employment: -572,000
Total federal government employment: +6,000
Total state & local government employment (education): -217,000
Total state & local government employment (not education): -360,000

Given the above figures, private employment has increased by just over 52,000 per month since the end of the recession.  The strongest growth in private employment took place between February 2010 (when employment bottomed) to April 2011, during which the private sector added over 2 million jobs, just over 150,000 jobs per month.  Since April, the economy has added about 100,000 jobs per month.  Most economists think that jobs growth should be well in excess of 200,000 coming out of a recession (it averaged almost 300,000 per month coming out of the 1981-82 recession, the last time the unemployment rate reached 10%).

Why has employment growth been so weak?  In order for the economy to generate a significant number of new jobs, economic growth needs to exceed the growth in productivityFor example, if output per worker rises by 1% and the US economy grows by 2%, the number of workers increases by the difference, 1%.  Why was there so many jobs created following the 1982 recession but not this time?  The number of jobs stopped declining in the first quarter of 2010.  Since then, the economy grew by 2.58%, output per worker grew by 0.62%, and employment grew by 1.95%.  During a comparable period following the 1982 recession, economic growth was 9.8%, output per worker rose by 3.3%,  resulting in employment growth of 6.33%.

Why aren't companies hiring workers?  The answer may sound too simplistic, but it's because economic growth (sales) is too weak.  Other issues may be playing a small role  in limiting job creation (uncertainty, regulation, cost of hiring workers, etc.), but it comes down to weakness in economic growth.  The best policy for job creation is one that results in sustainable economic growth.  Unfortunately, that's easier said than done following a financial crisis as consumers deleverage and the financial system heals. 

Friday, October 14, 2011

Some observations about declining incomes and rising income inequality

There have been many reports in recent weeks regarding declining incomes as well as rising income inequality.  For example, a report by Sentier Research shows the behavior of median real household income since 2000:

The significant drop since the end of the recession reveals the continuing effects of the Great Recession.  Why did it spike midway through the recession?  One reason was that there was deflation and the figures are inflation-adjusted (so deflation pushes real income up).

What about the distribution of income?  Menzie Chen (Econbrowser) provides a chart showing changes in the income share of the top 5% and top 1% of earners during the last century (based on data from Saez/Piketty). 

The peak in the income shares for both groups occurred immediately prior to the Great Depression, declined until about 1950 and then remained relatively flat until 1980.  They rose slightly until the mid-1980s before spiking up in the late 1980s, following the tax reform act of 1986, before leveling out for a few years.  They began a steady climb up beginning in 1993 until 2000, declined during the early 2000s before rising again.  Why did the income share of the top earners rise so much in recent decades?  Looking at the data (see table 7 from Saez/Piketty) , a major reason is the increasing role of entrepreneurial income in the earnings of top earners, rising from about 10% in the late 1970s to mid 1980s, to over 30% in recent years (entrepreneurial income includes profits from S-corporations, partnerships, and sole proprietorships).

Menzie Chen also provides a chart that illustrates estimates of changes in the distribution of wealth

Similar to income, the share of wealth of the top 1% peaked right before the Great Depression and declined until about 1950.  It stabilized for a period of time before beginning a new decline in the mid-1960s until 1980.  Though it rose in the early 1980s, it was relatively stable from 1985 to 2000 before rising again in the mid-2000s.  Wealth does not show as much of a rise in inequality as income (though wealth inequality appears to have risen somewhat in recent years).

A major increase in inequality is a serious concern, particularly during times of decling real incomes.  However, it's important to explore the sources of inequality as well as the costs/benefits of policies designed to address poverty or inequality.

Wednesday, October 12, 2011

China's manipulation of its currency

The Senate voted yesterday to punish China unless it stops controlling the value of its currency against the dollar.  Should the President support the action of the Senate?  China began controlling the value of its currency around the time of the Asian Financial Crisis in the 1990s.  The financial crisis was spreading from country to country in Asia, leading to major devaluations of exchange rates, beginning in Thailand before eventually stopping with China.  Most supported China's policy at that time.  Over time, as China became a top exporter, the policy became more controversial as other nations saw it as a way of ensuring China's exports were cheap (and thus a threat to producers in other countries).  In 2005, China began to allow its currency to gradually increase in value, resulting in a 30% increase in the value of the renminibi between 2005 and the present, pausing for a period of time during the global financial crisis before resuming the policy of gradual increases in 2010.  How does China control its exchange rate and how does it affect China and the rest of the world?

China's currency (known by two names, the yuan and renminbi) can be exchanged for other currencies, thus its value is determined in the foreign exchange market (supply and demand).  If China thinks its currency is increasing in value too quickly, it will sell yuan in the foreign exchange market and buy US dollars (or possibly some other currency).  Rather than just buying dollars, its central bank buys US government bonds (or recently, bonds of various European governments as well).  Selling yuan/buying dollars causes the exchange rate value of the yuan to be lower than it otherwise would be in terms of dollars.  Meanwhile, the Chinese central bank accumulates a large amount of US government bonds.  A significant impact of these bond purchases is that US interest rates are lower than they would have been had the Chinese central bank not have loaned the US government money (i.e., bought US bonds).  Thus the US economy benefits in terms of lower interest rates.

Most people think that the US buys goods from China, but China doesn't buy US goods.  However, China is the #3 destination for US exports, behind Canada and Mexico, with exports to China growing rapidly during the last 5 years (more than 20% per year other than the recession years of 2008-2009.  In fact, China buys more US exports than Japan and Germany combined (July 2011).  Of course US imports from China far exceed our exports to China, resulting in trade deficits with China typically in excess of $200 billion per year.  However, China tends to run trade deficits with the rest of the world (excluding the US).  Why does the US run trade deficits with China while the rest of the world does not?  Two reasons stand out; first, the US economy is very consumer-oriented while the Chinese economy is very producer/export oriented.  Second, the manipulation of the Chinese currency.  In the past China linked its currency only to the US dollar and, while it has modified that policy in recent years, it still links its currency primarily to the US dollar.  Thus the Chinese currency is undervalued in terms of the dollar more so than other currencies.  As a result, China's trade with the US is distorted more than its trade with other countries.

It's in China's interest to move towards a freer currency, reducing the amount of control that it exercises over time.  A stronger yuan would benefit Chinese consumers by increasing their global purchasing power while also re-orienting the Chinese economy away from an overdependence on the global economy and towards its growing domestic market.  In fact, the leaders of China have set this as one of their priorities in the coming years (one of the goals in its current 5-year plan is to increase domestic consumption).  As the Chinese central bank slowly shifts away from a policy of buying US bonds as a means of controlling its currency, the US government will need other sources of funds to finance its budget deficit or risk significantly higher interest rates (unless it enacts policy to get the budget deficit under control).

Should we risk a trade war with China (US puts sanctions on China and China retaliates) to try to stop it from controlling its currency?  It's never a good time for a trade war, but especially not now, given the fragile state of the US and global economy.  A change in China's exchange rate policy, resulting in a stronger yuan, seems likely, since it's in China's interest.  Though US exporters may benefit, higher interest rates in the US resulting from the change in policy will mean that there will be losers as well as winners in the US due to China reducing the manipulation of its currency.

Friday, October 7, 2011

One politician's plan to increase employment

A state representative from Melbourne, Florida is proposing legislation to lift the ban on "dwarf tossing" as a way to broaden job prospects for dwarfs.  No, I didn't make this one up; here's a link to the story.

A few comments on Europe and Credit Markets

Europe continues to be a major concern for the global economy.  Today, Fitch downgraded Italy and Spain while earlier in the week, Moody's downgraded Italy.  Meanwhile, the French and Belgian governments promisted earlier in the week to bailout and/or restructure Dexia (a bank with ties to both  governments).  European leaders have begun to discuss recapitalizing banks to prepare them for "restructuring" of Greek debt, which seems to be just a matter of time (November or December?).  This is an important step to limit the potential damage of a Greek default (prepare banks for losses on sovereign debt), but it should have taken place a long time ago, particularly when Europe conducted stress tests for its largest banks (you may recall that Europe conducted stress tests on banks earlier this summer, but neglected to account for a possible/likely default by Greece).

The global financial system is showing more stress than any time since the end of the financial crisis in 2009, as evidenced by increasing credit spreads for investment-grade debt globally as well as high-yield debt in the US.  Given the fragile financial environment, corporations have chosen to step back from issuing bonds, thus hindering investment plans and economic growth.  Clearly, the US and global economies are facing many headwinds, but resolving the European debt crisis is essential to restoring economic stability.

More thoughts on the employment report

Though the headline numbers indicate a relatively "good" employment report, there are some significant concerns beneath the surface.  As mentioned in a previous post, the U6 measure of unemployment rose to 16.5%, a 2011 high.  One reason is that the number of people working part-time for economic reasons rose to 9.2 million, the second highest level ever recorded (second only to September 2010).  Combine this with temp agencies adding about 20,000 jobs in each of the last 2 months and it indicates that, though jobs are being created, companies have become more cautious over the summer (increased reliance on temporary and part-time workers).  The cloudy economic outlook is making firms hesitant to commit to new full-time workers.  Meanwhile, average weekly earnings rose to $793, a 2.1% increase over the previous 12 months.  Unfortunately, inflation is currently 3.8%, so earnings adjusted for inflation have declined by 1.7% in the last year.

Today's job market report - first thoughts

At first glance, this morning's report looks OK - better than expected, but not strong.  The good news is 137,000 new private sector jobs were added in September, though that includes the 45,000 Verizon workers who returned to work after a strike (so it's a 92,000 net increase in jobs).  Also, August's numbers were revised upward to show a gain of 57,000 jobs (originally estimated at no change).  Temp agencies added about 20,000 jobs in each of the last two months.  An important gauge of the labor market, the index of aggregagte hours worked, rose in September, more than reversing a decline from August and is now higher for the third quarter.  Recent trends indicate that the economy is adding about 75,000 jobs a month.   Unemployment remained at 9.1%.  Both the employment-population ratio and labor force participation rate rose in August.  The bad news is that the broad measure of unemployment (U6) rose to 16.5% from 16.2% in August.  Add it up and it continues to point to a sluggish economy rather than a recession.  More later...

Thursday, October 6, 2011

Portion of households receiving government benefits?

According to Census data, nearly half of households received some form of government benefits in 2010.  Specifically, 48.5% received benefits in 2010 compared to 44.4% in 2008.  On the flip side, 46.4% of households did not pay income taxes in 2010 compared to 39.9% in 2007.  Many households that did not pay income taxes still paid payroll taxes (social security and medicare); 18.1% did not pay either income or payroll taxes.  Given nearly half of households don't owe income taxes and nearly half receive government benefits, it will prove quite difficult to reduce the growth of government benefits or raise income taxes in order to cut the budget deficit.  People are likely to think that they deserve the benefits they receive and only benefits received by others should be reduced.  Difficult decisions need to be made, but with such a high proportion of households receiving benefits, will the government (and voters) have the political courage to make the tough choices?