Economy Hanging by a Thread

Party Like It's 1929
By MIKE WHITNEY

A bleak jobs report sent stocks and commodities tumbling on Wednesday, while new signs of distress gripped the service industries index. An updated report from the ADP showed that private sector hiring slowed more than expected from March to April as companies struggled to meet rising raw material costs and flagging consumer demand. The service industry index (ISM) --which "ranges from utilities and retailing to health care, finance and transportation"--slumped to its lowest level since August signaling widespread deceleration and a progressive deterioration in the fundamentals. The turnaround has forced economists to rethink their projections for 2nd Quarter GDP and to watch more vigilantly for signs of contraction. This is from the New York Times:

"The economy lost steam in the first quarter. Growth in personal consumption — the single largest component of the economy — slowed markedly. Business-related construction cratered and residential construction fell. Exports stumbled. The only unambiguous plus was continued business investment in equipment and software, which is necessary but not sufficient for overall growth.

In all, economic growth slowed from an annual rate of 3.1 percent in the fourth quarter of 2010 to 1.8 percent in the first quarter of 2011....

When lauding the economy, Mr. Bernanke and many other economists and politicians point out, correctly, that the unemployment rate has declined from a recession high of 10.1 percent in late 2009 to 8.8 percent now. That would be encouraging news if it indicated robust hiring for good jobs. It does not.

Over the last year, the number of new hires has been outstripped by the masses who have either given up looking for work or who have not undertaken a consistent job search, say, after graduating from high school or college. Those missing millions are not counted in the official jobless rate; if they were, unemployment today would be 9.8 percent. The rate would be 15.7 percent if it included those who took part-time jobs in lieu of full-time ones." ("The Economy Slows" New York Times)

So, even the New York Times agrees that unemployment would be nearly 16 percent if the figures were correctly calculated. Those are Depression numbers. 14 million people are out of work (with 11 million underemployed) and record numbers of people are on food stamps (44 million)

Wednesday's down-market sent commodities plunging as signs of emerging deflation pushed investors into Treasuries. Gold and silver fell sharply. Troubles in Japan, China and the eurozone have intensified fears of a global slowdown and perhaps another bout of recession. The dollar strengthened for the third straight session, in spite of the Fed's zero rates and $600 billion bond buying program. Trillions of dollars in monetary and fiscal stimulus have jolted stocks back to life, but debt-deflation dynamics in the broader economy are as strong as ever. 

Unemployment remains stubbornly high, consumer retrenchment has reduced discretionary spending, and housing continues its inexorable nosedive. The stock market continues to inch higher buoyed by central bank liquidity and margin debt, but investors are increasingly skittish and searching for direction.

The soaring price of gas has shifted consumer spending from retail to energy consumption, the opposite of what the Fed had intended. This from Early Warning:

"I doubt energy prices can go a whole lot higher without triggering another recession, so it depends on whether the world can scrape up a few more mbd of oil to keep growth going without prices rising too much more. We will be watching oil production statistics closely...

...We are in an era where the availability of natural resources is not sufficient to support the wealth levels that the developed world has grown accustomed to, along with the speed of growth with which the developing world is trying to approach those same levels..... the global economy keeps trying to grow in a way that is inconsistent with the resource constraints, and then some part of the system tears and gives way....

I would argue that this data is at least consistent with the narrative that, in the post 1973 era, energy is consistently in somewhat problematic supply, and you can think of many of the recessions as showing a pattern in which energy prices are rising as the world overshoots what can currently be supplied, or what can currently be supplied drops as a result of geopolitical events, and energy prices rise until some pre-existing weakness in the global economic fabric tears in the course of a recession, and prices fall back again...." ("Energy prices and recessions", Early Warning)

Welcome to Peak Oil; the era of resource scarcity has begun. Today's troubles will to be a recurrent theme in the years ahead as the economy goes from boom to bust and previous levels of growth become more short-lived and unsustainable. Naturally, our leaders have settled on a strategy for addressing the impending energy shortages; endless war disguised as humanitarian intervention. This is the type of shortsightedness that passes as policy.

The main economic indicators are still turned up, but just barely. The economy is hanging by a thread. Loan demand is weak, wages are flat, and markets are on a knife-edge. Here's a clip from The Big Picture:

"...the real problem is loan demand (confirmed while speaking to bank organizations in half a dozen states over the past year). Loans have to be repaid, meaning that the money must be used to finance the acquisition of employees or equipment that will "pay back" the loan. Common sense. But record numbers of owners (as high as 28%) have reported that "weak sales" is their top business problem while only 4% reported "financing" as a top problem..... Ninety-three percent reported all their credit needs met in March, including 53 percent who said they were not even interested in a loan. No customers means no need for a loan to finance hiring, inventory purchases or expansion (only survival – not a good bank loan!).

But they don't get it in Washington D.C. And not understanding the problem produces bad policy, and there has been plenty of that. If lending is picking up, it is because customers are showing up and there is a reason to invest and hire. The reverse doesn't work – you can't force feed the credit to owners and have more customers suddenly show up ....That's "pushing on a string". Just ask the banks." ("Loan Demand, Not Credit, Is the Problem", The Big Picture)

There's no demand for credit because consumers are in the red and need to balance their accounts. ("93 percent reported all their credit needs met in March.") It's pointless to focus on getting the banks to lend, when people are broke and don't want to borrow regardless of rates. Just like its pointless to dump monetary stimulus into the stock market if it pushes up food and energy prices (headline inflation) reducing consumers ability to spend on other things. This isn't hard to figure out; it's Econ 101. So, why is the policy upside-down?

That said, the stock market should continue to trend upward for another couple months until the Fed's bond buying program ends and investors realize that the real economy is stuck in the ditch. But, for now, it's "Party like it's 1929". Bernanke's punch bowl is overflowing and there's still plenty of time to make money. The hangover comes later.

The Retail Sales Slump

Should We Be Surprised?
By DEAN BAKER

The Commerce Department reported that retail sales in May were down by 1.2 percent from April. This surprised most economists who had expected a modest increase. The media were filled with accounts of economists trying to explain why consumers were still reluctant to open up their wallets and spend in a big way. It would have been much more interesting to hear accounts of why economists were surprised.

There is always a large random element in month-to-month movements in retail sales or any other economic variable. Therefore no one is ever going to be able to explain these changes with any precision. (The data are also subject to large revisions, so it is entirely possible that revised data will look very different from the report released last week.)

Nonetheless, there is little basis for the surprise shown by so many economic analysts. With few exceptions these analysts failed to see the $8 trillion housing bubble, the collapse of which sank the economy. Remarkably, even now they apparently cannot understand its importance.

To put it as simply as possible (so even an economist can understand it), the housing bubble was driving the economy in the period prior to its collapse, beginning in 2007. It drove the economy in two ways. The run up in house prices led to a building boom. Residential construction, which is typically less than 4.0 percent of GDP, rose to more than 6.0 percent, creating more than $300 billion in additional annual demand. A bubble in non-residential real estate added perhaps another $150 billion to annual demand.

The bubble also drove the economy through the effect of housing wealth on consumption. Economists usually estimate that $1 of additional housing wealth increases annual consumption by between 5 to 7 cents. This implies that the $8 trillion of housing bubble wealth would lead increase consumption by $400 billion to $560 billion a year.

With most of the bubble wealth eliminated by the collapse of house prices over the last three years, we should expect a sharp drop in consumption. Furthermore, stock prices have lost a bit less than a third of their value (around $6 trillion), which we should expect to cause a further decline in consumption. With the stock wealth effect estimated at 3-4 cents on the dollar, the decline in stock prices should have reduced annual consumption by $180 billion to $240 billion. In total we should expect to see annual consumption have dropped by between $600 and $900 billion as a result of the loss of housing and stock wealth.

This is all very simple arithmetic and basic economics. Consumption had been driven by the housing bubble prior to the recession. Now that the bubble has collapsed and trillions of dollars of wealth has disappeared we should expect much lower levels of consumption. To flip this around, the savings rate, which had averaged more than 8.0 percent in the decades prior to the 90s, fell to near zero in the years leading up to the recession. Now that the bubble has collapsed, we should expect consumption to fall and saving to return back to its normal level. In fact, it might even go higher since the huge cohort of baby boomers is now mostly in their 50s and most have almost nothing saved for retirement. This might lead savings rates to go above their long-term average.

There seems very little room for argument in this story. The existence and housing and stock wealth effects are among the least questioned propositions in economics. Nor is there too much dispute about their size. How could any economist see the collapse of an $8 trillion housing bubble and the destruction of more than $6 trillion in stock wealth and not expect to see a substantial decline in consumption?

Yet, we have dozens of economists being cited in newspapers and broadcast news, all saying that they are surprised by weak consumption. If anything the surprise should be that consumption is still as strong as it is. The saving rate is still near 4.0 percent, far below its historic average. Why on earth would any economist expect it to go still lower?

The reason that consumers are not spending more money has nothing to do with attitudes. The reason that most consumers aren’t spending is the same reason that homeless people aren't spending much money: They don’t have any money.

Economists used to be able to understand basic economic concepts. Apparently, most have lost this ability. As a result we are likely to see many more surprised economists and much proposed in the way of very bad economic policy.