Which Deficit is Most Important?

Popular Economics Weekly

All the talk of budget deficits really focuses on the wrong deficit. It is the output deficit of goods and services lost because of the Great Recession that is most important, not the state and federal budget deficit(s), since budget deficits will only be paid down with increased tax revenues that come from increased production.

The Center on Budget and Policy Priorities (CBPP.org) has been tracking the output deficit since the beginning of the downturn, and it shows that overall production (GDP) has now returned to its 2007 level, hence the end of the recovery cycle we have been discussing. But for significant deficit reduction GDP now has to continue to expand to its potential above $14 trillion.

With the latest congressional compromise, analysts are predicting a higher GDP growth rate in 2011—which if true might boost growth to that $14 trillion plus level. The legislation’s extensions of federal unemployment insurance and Obama-era tax cuts for low-income households (i.e., the 2009 improvements in the Child Tax Credit, Earned Income Tax Credit, and college tuition tax credit) — all policies insisted upon by the White House — are a big reason for the increased estimate.

Economist Mark Zandi of Moody Analytics gave the best analysis of the compromise. “The deal’s surprisingly broad scope meaningfully changes the near-term economic outlook. Real GDP growth in 2011 will be nearly 4 percent, approximately 1 percentage point greater than previously anticipated. Job growth will be more than twice as strong, with payrolls growing by 2.6 million. Unemployment will be more than a percentage point lower; instead of hovering near 10 percent through the year, it will end 2011 well below 9 percent.”

In fact, economic growth has been subpar since 2000, with just 5 million jobs created 2000-08 and another 1 million jobs added since January 2010, after the loss of 8 million jobs during the Great Recession.

Most of the budget shortfall has been due to the lost revenues of the Bush tax cuts during the last decade, with military spending adding another $1 trillion, whereas the output deficit comes mainly from lost jobs—8 million from this recession alone, as we said. So the best revenue enhancer would of course be more robust growth. In fact, if GDP growth exceeded 3.5 percent longer term as it has over the last 75 years (i.e., including the Depression), social security would never be in danger of running out of funds. The current projections are based on a long term forecast 2.6 percent GDP average growth rate, which has never happened.

The bottom line is that higher GDP growth increases personal incomes, which began their most recent decline at the beginning of the Great Recession and only started upwards again after it ended in July 2009. Real, after inflation, personal incomes are currently 95.5 percent of the last peak, so demand can’t pick up substantially until consumers’ financial health is restored.

In sum, the best bang for the buck is boosting incomes of the middle and lower classes who were most affected by the Great Recession. Unemployment insurance has been the most effective boost for the 15 million unemployed, followed by the current one year-2 percent income tax cut for all wage and salary earners. Since consumers will no longer be able to rely on massive borrowing from their homes, they will only be able to spend money the old fashioned way, by earning it.

Harlan Green © 2010

The 2011 Mortgage Mess

The Mortgage Corner

Will real estate finally show a sustained recovery in 2011? Much depends not only on a general economic recovery, but bringing back the mortgage markets. Right now, there’s a tug of war in Washington, over whether more aid should be given to borrowers with underwater mortgages under the various loan modification programs.

So the question is in part, just how many homeowners are ‘underwater’ these days, and when will housing values begin to rise again—is it 3 million or 8 million homes? The underwater statistic is somewhat misleading, as it is still cheaper for most homeowners to pay their mortgage with the record low interest rates rather than rent, even when the mortgage amount is more than current value. Rents have not fallen substantially, mainly because of the record number of homeowners who have become renters due to the loss of their homes.

Right now, a popular mortgage program is the ‘Refi Plus’ offered by both Fannie Mae and Freddie Mac, in which those with good credit and incomes can refinance at a market interest rate up to 105 percent of the loan to value of their home.

The latest FHFA (Federal Housing Finance Authority) price index, the regulator in charge of both Fannie and Freddie, shows some improvement. House prices for homes sold under government agency financing surprisingly rebounded in October. The FHFA purchase only house price index rebounded 0.7 percent in October, following a 1.2 percent decrease in September.

On a year-on-year basis, the FHFA HPI is down 3.4 percent, compared to down 3.8 percent in September. This index is based on resale prices for homes financed or bundled by Fannie/Freddie, VA/FHA, or the FmHA.

Sales of existing homes are slow but improving, up 5.6 percent in November to 4.68 million, an annual rate that's a little slower than expected. Details show gains across all regions along with a strong 6.7 percent rise in sales of single-family homes, the report's key component. Another plus is that prices didn't soften, up slightly to a median $170,600 to end a nearly six-month run of declines. Supply on the market fell for a third straight month yet at 9.5 months is still very heavy.

Another housing boost comes from third quarter GDP growth being revised up for the second month in a row, this time to 2.6 percent annualized from the prior estimate of 2.5 percent. And Q4 growth is looking to be even higher.

All of these indicators point to slow but steady growth in 2011. NAR chief economist Lawrence Yun is hopeful for 2011. “Continuing gains in home sales are encouraging, and the positive impact of steady job creation will more than trump some negative impact from a modest rise in mortgage interest rates, which remain historically favorable,” he said.

Yun added that home buyers are responding to improved affordability conditions. “The relationship recently between mortgage interest rates, home prices and family income has been the most favorable on record for buying a home since we started measuring in 1970,” he said. “Therefore, the market is recovering and we should trend up to a healthy, sustainable level in 2011.”

But any real estate recovery is still depending on whether interest rates stay below 5 percent. They have been rising of late, so that the 30-year conforming fixed rate is about 4.625 percent for a 1 pt. origination fee, up from 3.75 percent at its record low point. And so the Mortgage Bankers Association reported mortgage applications have trended down over the past 2 weeks, in line with the latest increases.

The four-week moving average of the purchase index is still at about the levels of 1997 - and about 17 percent below the levels of April this year before expiration of the homebuyer tax credits - suggesting weak existing home sales through January 2011, at least.

The bottom line is that housing values—and so sales—will only continue to improve substantially with improving employment. And this means improved wages and salaries that qualify more home buyers. There is no question that the economy will continue to improve in 2011. Let us hope that also improves the jobs market

Harlan Green © 2010

Is The Great Stimulus Debate Over?

Financial FAQs

The stimulus debate over what form government aid should take to the recovery is only over for the moment. The headlines tell us both the rich and poorer among us will receive various tax breaks under the Democratic-Republican Party compromise, while businesses will have their research and development (R&D) tax credits extended. This is bound to lead to more hiring, say most of the pundits.

What was the debate about? A hint was the House Democratic majority’s unsuccessful attempt to cut the inheritance tax exemption from $5m to $3.5 million. If the goal is over what gives the most bang for the buck, then it is important to know who will benefit. Economic growth is already back to its pre-recession level (See my Popular Economics Weekly column of this week.).

So the real debate yet to be settled is who will receive most of the benefits of the recovery. The Bush II recovery was fueled by tax cuts for the wealthiest, which brought us a wealth distribution that matched 1928 before the Great Depression. The theory being was that the investor class was in the best position to boost growth.

Alas, that didn’t happen, as just 5 million jobs were created from 2000-08 after the Bush II tax breaks, the lowest since WWII, vs. 22 million jobs created during the Clinton Administration (when tax rates were higher). Why? Incomes were much more eqalitarian then, creating much more demand from the income brackets that do most of the spending.

The solution really isn’t such a puzzle; more like common sense. The wealthiest tend to spend less of their incomes, whereas the middle and lower brackets spend almost all of their incomes. So simple math tells us the more income that flows to the lower income brackets, the more of it gets spent. And it is overall spending that fuels growth in our 70 percent consumer-driven economy.

What do the top income brackets do with their wealth, other than conspicuous consumption? They invest it, in part by lending it back to the rest of us. That happened from 2000-08. The record low interest rates engineered by Chairman Greenspan’s Fed created easy money that allowed the 90 percent income earners to borrow from the wealthiest 10 percent in record amounts. But, as Roosevelt’s Fed Chairman Marriner Eccles said during the Depression, the game ended once those players ran out of borrowed chips.

Though leaving the Bush tax cuts in place for those earning more than $250,000 per year benefits the highest income earners most, the other 90 percent also benefits somewhat with the temporary payroll tax reduction. Adding the 2 percent payroll tax cut lowers revenues to social security, however. The maximum tax drops to 12.2 percent from 14.2 percent, shared equally by employer and employee for salaried workers.

It is basically above the $500,000 annual income level that the Democratic and Republican Parties’ tax proposals differ. Preserving all the Bush II tax cuts boosts tax savings of the $500k to $1million incomes from $6,701 to $17,467 and for $1 million plus incomes from $6,309 to $103,835, a huge jump.

So the tax cut compromise doesn’t give as much bang for the buck as we would like. The strong retail sales report for November points to consumers feeling wealthier in certain areas, however. The latest (October) Federal Reserve consumer credit report showed consumer credit expanded $3.4 billion in October, following a $1.2 billion rise in September.  Outstanding credit has not risen for two consecutive months since mid-2008.  The latest rise was led by a $9.0 billion boost in non-revolving credit, following a $10.1 billion jump in September.  Both months reflect healthy motor vehicle sales.

Revolving credit, a category centered in credit cards, continues to contract, down $5.6 billion in October following September's $8.8 billion drop. The decrease in revolving credit means consumers are not pulling out the plastic for purchases—disappointing news for retailers.   It also likely is due to continued charge offs by banks of bad loans, conjectures Econoday. 

Basically, consumers are still cautious about spending, maintaining a relatively high saving rate.  With so many of the tax benefits still going to the wealthiest, this means only a moderate pickup in overall consumer spending is sustainable. So it looks like the U.S. public will have to wait longer for a more egalitarian tax structure that both benefits most Americans, and pays our bills.

Harlan Green © 2010

Good News--End of Recovery in Sight!

Popular Economics Weekly

What does it mean that pundits/economists are now saying the end of the recovery is in sight? Barron’s economist Gene Epstein maintains, “The Recovery from the Great Recession of 2008-09 is almost definitely over. Starting Jan. 2 the expansion will resume.”

The ‘recovery’ ends when Gross Domestic Product (GDP) reaches the peak before the recession began—in Q4 2007, says Epstein. Growth will have made up for the loss in output sustained during the Great Recession, in other words, and the economy can finally begin to expand into new territory.

A look at the unemployment numbers tells us why. A survey from the U.S. Bureau of Labor Statistics—called the Job Openings and Labor Turnover Survey (JOLTS)—gives us the most accurate picture of the labor market. In October, about 4.047 million people lost (or left) their jobs, and 4.196 million were hired (this is the labor turnover in the economy) adding 149 thousand total jobs. Four million has been the historical monthly job turnover, so huge is our economy. So the jobless numbers relate to how many jobs are gained or lost above or below that number.

Also, total job openings increased from 3.0 million in September to 3.4 million in October, though overall labor turnover was still low. (The dark blue line (hires) is now above the light blue bars (quits + layoffs) with the yellow graph line of job openings steadily rising. 

Economic growth reached its low point in Q2 2009, having fallen about 4.1 percent from its peak, the steepest loss since the Great Depression—hence this one being called the Great Recession. The latest (Q3) quarter probably expanded at 2.5 to 3 percent after all revisions, bringing growth back to its highpoint before the recession. Year-on-year, real GDP in Q3 is up 3.2 percent. Both Final Sales to domestic purchasers and Final Sales of domestic product (F.S.), a measure of overall demand, continued to increase.

Just as consumers take up almost 70 percent of GDP activity, retail sales are the most important component (50 percent) of consumer spending. And sales continue to rise for the fifth consecutive month. Overall retail sales on a year-ago basis in October was a huge 7.7 percent, slightly below 8.0 percent of the prior month.

Today's retail sales numbers should lead to upward revisions to forecasts for the Personal Consumption Expenditures component in fourth quarter GDP, says Econoday.  Overall, sales are quite healthy overall despite price issues. (Since retail sales do not adjust for inflation, it is difficult to determine if ‘real’, after inflation sales are staying ahead of inflation.

A more esoteric measure of sustainable demand is the inventory-to-sales ratio that tells us how fast shoppers are emptying the shelves. Business inventories rose 0.7 percent in October in a light build given a very strong 1.4 percent rise in business sales. The mismatch pulled the inventory-to-sales ratio down one notch to 1.27. The comparatively small build is a plus for the economic outlook, pointing to the need to build inventories faster which requires output and employees, says Econoday.

The strong retail sales report for November points to the possibility of a further draw in November retail inventories. Based on government data, retailers appear to be having trouble keeping goods on store shelves.

What should not be hard to understand is that private businesses begin to hire only when they see sustainable demand for their goods and services increase, as we said last week. And because we have returned to pre-recession growth levels, that demand seems to be sustainable.

Harlan Green © 2010

Who Are The Job Creators?

Popular Economics Weekly

The November unemployment report was bad news, after a string of good jobs reports, so it is important to understand what spurs job creation. The unemployment rate based on a small sampling of both the salaried and self employed rose to 9.8 percent. The broader payroll survey of businesses showed a net increase of 39,000 nonfarm payroll jobs—50,000 in private industry less 11,000 government jobs lost.

So based on the jobs’ numbers, the recovery is shaping up to be not V or U-shaped, but W-shaped. That is, the recovery that began in earnest when the various government stimulus programs kicked in—TARP (for banks), ARRA (for infrastructure and job creation), HAMP (for mortgage modification), and the Fed’s purchase of Treasury and Mortgage backed securities—reversed when the effects of the stimulus spending weakened.

Most of the TARP monies have been repaid, as well as the ARRA monies that have created or saved between 1.5 to 3.5 million jobs, according to the Congressional Budget Office, and the small number of mortgage modifications are barely making a dent in home foreclosures.

What should not be hard to understand is that private businesses begin to hire only when they see sustainable demand for their goods and services increase. That demand comes both from consumers and businesses, investors and producers, in both the private and government sectors. All use those goods and services, so when the private sector shrank in 2007 government stepped in, but it could not make up for all the private sector demand that was lost (something like a $6 trillion shortfall).

The private sector meanwhile has been sitting on their money. Corporations with a year of record profits have more than $1.8 trillion in cash salted away, banks have $1 trillion in excess reserves they are not using, and even consumers have been paying down debts faster and saving more than they have spent.

So the recovery which began January 2008 abruptly stalled when that aid declined. In part this was because state and local governments then began to shed jobs as their revenues shrank. It is only in 2010 that private business is beginning to hire again to the tune of 86,000 per month since January 2010. Both the manufacturing and service sectors have been expanding and are now hiring again.

The reason hiring has been slow, is that companies have been squeezing out as much output as possible from the current workforce instead of adding to payrolls—investing in more technology to replace workers—which is why productivity for the third quarter got a boost. Nonfarm business productivity for the third quarter was revised up to a 2.3 percent gain from the initial estimate of 1.9 percent, as we said last week.

The Institute for Supply Management’s November manufacturing survey, the best indicator of domestic manufacturing activity, shows businesses are continuing to add employees. The 57.5 index level for employment is very strong.

The ISM's non-manufacturing index rose seven tenths to 55.0, the highest reading in six months and reflecting strong monthly gains for new orders and employment. The latter gain, taking the component to 52.7 for its strongest reading of the recovery, is notable given the softness in the employment report. This report's employment index, until this month, had been very flat indicating that non-manufacturers had been reluctant to hire. Unadjusted gains for retail and corporate management led the month's employment gain.

So there is a broad misconception that only jobs created by the private sector—though desirable—are the only engine of sustainable economic growth. Government always has been, and will continue to be a partner in this growth. Especially in a modern and overcrowded world where the water we drink, the air we breathe, the resources we consume, as well as our neighborhoods have to be preserved and protected.

And both governments and the private sector have to borrow to be able to function effectively. So those who decry government spending are really ignoring the obvious—that we will always have business cycles with recurring recessions that don’t ‘cure’ themselves.

We have to remember, though, all this depends on a continuing demand for goods and services, which in turn needs readily available credit. Banks are only now beginning to lend again to small businesses, as various small business sentiment surveys indicate. Such optimism must continue to grow for the hiring to continue.

Harlan Green © 2010

Is Pending Sales Index Rise Good News?

The Mortgage Corner

The Pending Home Sales Index, a forward-looking indicator, rose 10.4 percent to 89.3 based on contracts signed in October from 80.9 in September. It was the highest jump since early 2003 when the surge in housing began. The index remains 20.5 percent below a surge to a cyclical peak of 112.4 in October 2009, which was the highest level since May 2006 when it hit 112.6.

This, and the continued rise in mortgage purchase applications signals an upsurge in housing demand. But is it sustainable? Is there enough pentup demand for housing—whether via increased household formation, or continued low interest rates—to sustain the surge? The seasonally adjusted Purchase Index increased 1.8 percent from one week earlier. This is the third weekly increase for the Purchase Index which reached its highest level since early May 2010, and is now back to its mid-1998 level, when housing was at the beginning of its last surge.

NAR chief economist Lawrence Yun said excellent housing affordability conditions are drawing home buyers. “It is welcoming to see a solid double-digit percentage gain, but activity needs to improve further to reach healthy, sustainable levels. The housing market clearly is in a recovery phase and will be uneven at times, but the improving job market and consequential boost to household formation will help the recovery process going into 2011,” he said.

“More importantly, a return to more normal loan underwriting standards and removal of unnecessary underwriting fees for very low risk borrowers is needed and could quickly help in the housing and economic recovery,” Yun said. Recent loan performance data from Fannie Mae and Freddie Mac clearly demonstrates very low default rates on recently originated mortgages, much lower that the vintages of 2002 and 2003 before the housing boom.

That is the real issue. Probably because almost 90 percent of all mortgages are either guaranteed or insured by the federal GSEs, Fannie Mae, Freddie Mac, or FHA/VA, their guidelines have become increasingly restrictive, with heightened credit score and lower allowable debt ratios restricting many eligible borrowers.

But housing pricing haven’t yet stabilized, with the S&P Case-Shiller same-home price index still at the bottom. he S&P/Case-Shiller 10-city home price index (seasonally adjusted) fell for the third month in a row and fell very steeply, down 0.7 percent in September and down 0.3 percent the prior month. At only plus 1.5 percent, the adjusted on-year rate extended its run of weakness. Weakness is no longer concentrated in the West or Florida with declines sweeping across regions.

Also, with badly depreciated housing prices, the current appraisal system hurts housing values on legitimate, arms-length purchases by not taking into account compensating factors, such as whether a neighborhoods value has been damaged by a recent foreclosure, or short sale.

But the PHSI fell only in the Western region, while in the Northeast it jumped 19.6 percent, in the Midwest the index surged 27.3 percent, and in the South rose 7.1 percent. So we are in an uneven recovery, with those regions that have resumed growth leading the way, while those states with huge foreclosure backlogs—like California, Nevada, Arizona, and Florida—holding back growth in their regions.

Harlan Green © 2010

Redistributing Great Wealth (is) The Path to Recovery

Popular Economics Weekly

We are in the deepest economic malaise since the Great Depression. And there is a good reason for it. We also have the greatest maldistribution of wealth since 1928. Researchers are finding that the two—the greatest inequality and greatest downturns—are intimately connected. So restoration of what is in effect our Middle Class, where at one time the majority of wealth resided, would restore both the jobs and financial health to an economy sorely out of balance.

This will not be easy. Witness the vociferous opposition to any restoration of equality—which conservatives label the redistribution of wealth to those less worthy, in their eyes. The current example is Republicans refusal to give up the Bush tax cuts for the wealthiest, which would restore tax rates of the Clinton era when 22 million jobs were created.

The sad fact is that unless we do begin to level the economic playing field, we are fated to experience more boom and bust cycles that will only debilitate the U.S. economy further, and so our standing in the world. And history will continue to repeat itself. Roosevelt’s Federal Reserve Chairman, Marriner Eccles, understood in 1933 the main cause of the Great Depression.

“… a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand (my italics) for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”

Thomas Piketty and Emmanuel Saez among others have documented the disappearance of Middle Class wealth (See Feb. 2003 Quarterly Journal of Economics). The Center for Budget and Policy Priorities (CBPP), a non-partisan think tank, using Piketty and Saez data, verify that income and asset inequality has risen to levels last seen in the 1920s (see graphs).

Income disparities before that crisis and the recent one were the greatest in approximately the last 100 years, according to Harvard Professor David Moss, who is among a small group of economists, sociologists and legal scholars trying to discover if income inequality contributes to financial crises. In 1928, the top 10 percent of earners received 49.29 percent of total income. In 2007, the top 10 percent earned a strikingly similar percentage: 49.74 percent. In 1928, the top 1 percent received 23.94 percent of income. In 2007, those earners received 23.5 percent.

There is no good reason for such wealth disparity, in spite of the severity of this Great Recession. It was a problem that began in the 1970s and only now is catching public attention. An estimated 43.6 million Americans in 2009 were living off incomes below the federal poverty line, or around $11,000 for an individual under 65 or $22,000 for a family of four. The total number, an increase of 3.7 million over 2008, is the largest in 51 years, since the government first started tracking poverty data.

And that is the main reason for the slowness of this recovery. “It’s no coincidence that the last time income was this concentrated was in 1928,” wrote former Labor Secretary Robert Reich in a recent Op-ed. Professor Reich hedges his bets, however. “I do not mean to suggest that such astonishing consolidations of income at the top directly cause sharp economics declines. The connection is more subtle.”

This debate goes back to the Great Depression, as we have said. By effective demand, Eccles was referring to what economists today define as aggregate demand. Eccles was maintaining that the growth in income inequality created a credit bubble that burst and so led to an sharp diminishment in aggregate demand, which is measured today by our Gross Domestic Product.

The relationship is intuitively simple, yet was hard to verify before Piketty and Saez, et.al., did their research. As more income flowed to the top income brackets, middle and lower income classes had to borrow more to keep up their consumption patterns. And the easy credit available with the housing bubble accelerated that borrowing, to the tune of $2.3 trillion extracted from housing in the last decade. But then the excess of supply produced during the bubble caused housing values to crash, losing more than $4 trillion and counting of the $11 trillion in housing assets.

Professor Reich says we have to find ways to raise the wages of working people—the 90 percent who have suffered stagnant wages since the 1970s. Lowering payroll taxes for the lowest income earners who spend most of their incomes, while restoring the Clinton era taxes on those earning more than $250,000 is the most discussed remedy for such income disparity.

In fact, the underlying effects of such income inequality hasn’t been researched at all. But a new book by Professors Jacob Hacker and Paul Pierson, “Winner Take-all Politics”, is beginning to give us a picture of its results.

Publisher Simon & Schuster’s advertising blurb succinctly describes their thesis: “Winner-Take-All Politics—part revelatory history, part political analysis, part intellectual journey— shows how a political system that traditionally has been responsive to the interests of the middle class has been hijacked by the superrich. In doing so, it not only changes how we think about American politics, but also points the way to rebuilding a democracy that serves the interests of the many rather than just those of the wealthy few.”

There is some good news on the wealth redistribution front. Forty billionaires led by Warren Buffet and Bill Gates have pledged to donate one-half of their wealth to philanthropic causes. From Ted Turner to George Lucas, these 40 billionaires joined Warren Buffett and Bill Gates in making the pledge as part of their The Giving Pledge, a campaign launched earlier this year "to urge wealthy individuals to give the majority of their money to charities of their choice either during their lifetime or after their death," said one headline. If only more of the superrich would follow their example.

Why would they do so? Because it not only helps to build their wealth, but the wealth of those who have lost so much to the wealthiest since the 1970s. This is an economic fact—that greater wealth equality creates more wealth for all—that is increasingly difficult to deny. We are only now becoming aware of the damage that such unequal wealth has wrought to our economy via the excesses of Wall Street and deregulation. It is something that economists weren’t really aware of until Piketty and Saenz did their groundbreaking research.

Harlan Green © 2010

High Labor Productivity = More Jobs

Financial FAQs

Why are we seeing more job creation? All the indicators—from Challenger and Gray’s corporate layoff and ADP private payrolls surveys, to the U.S. Bureau of Labor Statistic’s (BLS) unemployment report—point to a big pickup in hiring, in spite of government downsizing.

This is because it is becoming too expensive for the existing workforce to produce more as demand grows, hence small businesses in particular are beginning to hire to keep their production costs down. I.e., workers are demanding higher wages and more overtime, says the Labor Department’s Nonfarm Productivity Report.

Companies have been squeezing out as much output as possible from the current workforce instead of adding to payrolls, which is why productivity for the third quarter got a boost. Nonfarm business productivity for the third quarter was revised up to a 2.3 percent gain from the initial estimate of 1.9 percent.

The key is unit labor costs (ULC), which have been rising steadily since late 2009. Labor makes up two-thirds of production costs, so any upsurge in those costs is a red flag to businesses. The higher hours worked is also a sign that demand for their goods and services is picking up.

Productivity is up largely due to a 3.7 percent rebound in nonfarm business output after a 1.6 percent rise in the second quarter, as demand for their products and services grew. Also, hours worked continued to grow at a 1.4 percent increase from 3.5 percent in the second quarter. Compensation rose an annualized 2.2 percent after a 2.9 percent boost the quarter before.

ADP employment services, a payroll processor for private businesses, estimates November private payrolls rose by 93,000 vs. a rise of 82,000 in October (revised from plus 43,000). It tends to closely mirror the Labor Department’s November’s nonfarm private payrolls unemployment report, since it represents roughly 500,000 U.S. business clients. During the twelve month period through June 2010, this subset averaged over 340,000 U.S. business clients and over 21 million U.S. employees working in all private industrial sectors, says ADP.

Challenger's count of layoff announcements totaled 48,711 in November, up from October's 37,986. Announcements were up in the government/non-profit sector as well as consumer products and pharmaceuticals. Retail and computers showed a dip in layoffs.

And initial weekly claims for unemployment insurance, the best forward looking indicator of job losses, has been falling sharply of late. Initial claims fell 34,000 in the November 20 week to a far lower-than-expected level of 407,000 (prior week revised slightly higher to 441,000). The four-week average is down 7,500 to 436,000 for a nearly 20,000 improvement in the month-ago comparison.

More good hiring news came from the Institute for Supply Management’s November manufacturing survey, the best indicator of domestic manufacturing activity. New orders came in at 56.6, indicating solid month-to-month growth that's only slightly slower than October's very strong growth of 58.9. The pace of production slowed noticeably but, at 55.0, is still strong though less strong than the prior month's 62.7. And ISM's survey shows businesses are continuing to add employees. The 57.5 index level for employment is very strong for this reading, says Econoday.

We have to remember, though, that all this depends on a continuing demand for goods and services, which in turn needs readily available credit. Banks are only now beginning to lend again to small businesses, as various small business sentiment surveys indicate. Such optimism must continue to grow for the hiring to continue.

Harlan Green © 2010

Why Such a Mortgage Mess?

The Mortgage Corner

What is causing the mortgage ‘mess’ to continue, in this case the controversy over ownership of mortgages that is embroiling Wall St. and Washington? Much of it is exaggerated by the media and attorneys for the plaintiffs suing various banks to take back those mortgages packaged and sold as mortgage backed securities. So it is not easy to understand the underlying facts, especially when real estate values have yet to stabilize.

The beginning of the mortgage origination process is fairly straightforward. When a bank, mortgage bank, or other entity originates a mortgage, it is either held by that lender in its “portfolio”, or sold to someone else. Many commercial banks still hold onto their shorter term loans—such as for businesses or construction projects. These are usually due within 5, and so don’t tie up a bank’s capital reserves for a longer period.

But most mortgages are permanent, meaning not due for 15-30 years. These are usually sold onto the secondary market—Wall Street firms who bundle them into mortgage pools that are sold to investors as mortgage backed securities (MBS). Some such securities for the VA/FHA, Fannie Mae, and Freddie Mac (the GSEs), are considered AAA rated, because either guaranteed or insured by the Federal Government. So someone holding a ‘Ginnie Mae’ Certificate knows it has an ownership share in a pool of AAA rated FHA/VA loans on which it receives a percentage yield.

The main ownership problem is that banks in particular may hold on to servicing the loan, even though it has been sold to investors. This means that said bank still collects the payments and passes them on for a fee of usually 3/8 to ½ percent of the loan amount. So if the ownership papers weren’t properly documented to the MBS investors, either servicers or investors may not have clear title to sell or auction the underlying property held as security if the property is foreclosed on.

Another ‘mess’ is if there was fraud involved—i.e., the loan originators didn’t follow their own underwriting guidelines when funding the mortgages. It is hard to believe that is the case, as lenders know they must buy back a loan if fraud—i.e., misrepresentation—is involved. But given the huge number of foreclosures—more than 2 million this year—so-called foreclosure mills in those 22 states who have judicial foreclosures may have taken shortcuts in not verifying all the documentation, or even faking lost documents.

Meanwhile, the delinquencies have declined substantially in 2010, and consumers incomes are improving--indicators that say real estate values may be stabilizing. And that is the bottom line in improving the foreclosure rate. Lenders tend to panic when housing values are falling, and so are quicker to foreclose in order to recoup as much as possible of loan principal.

Calculated Risk cites a report by LPS Applied Analytics that foreclosures leveled off at 3.92 percent, from a 1 percent historical rate and delinquencies at 9.29 percent in October, up from its historical 4 percent rate. So there is a long way to return to normal. Delinquencies began to take off at the beginning of 2007 (i.e., 3+ years ago), so it should take another 3 years to return to historical levels.

Home prices are coming under weakness again due to distressed sales adding to housing supply and tighter credit standards cutting demand, but that may be mainly to seasonal factors. Fewer homes are put on the market and sold during the winter months. The Federal Housing Finance Authority purchase only house price index for homes with conforming loans slipped 0.7 percent in September after no change the month before.

On a year-on-year basis, the FHFA HPI is down 3.4 percent, compared to down 2.8 percent in August. This index is based on resale prices for homes financed or bundled by federal housing agencies (i.e., the GSEs).

The price weakness is reflected in lower new and existing-home sales in October, down 2.2 and 14 percent, respectively. The National Association of Realtors also said the sales drop was mostly due to seasonal factors and tightened lending standards.

“A review of recently originated loans suggests that they have overly stringent underwriting standards, with only the highest creditworthy borrowers able to tap into historically low mortgage interest rates. There could be an upside surprise to sales activity if credit availability is opened to more qualified home buyers who are willing to stay well within budget,” said NAR chief economist Lawrence Yun.

The consumer is making a moderately strong comeback in October in both income and spending. Meanwhile, core inflation is subdued and still too low for Fed comfort. Personal income in October posted a healthy 0.5 percent gain, following no change in September. Income growth topped analysts' forecast for 0.4 percent increase. Importantly, the wages & salaries component jumped 0.6 percent, following a 0.1 percent improvement the month before.

Household spending also showed strength. Personal consumption expenditures rose 0.4 percent, following a 0.3 percent increase in September. For the latest month, strength was led by a 1.9 percent monthly spike in durables. Nondurables advanced 0.8 percent while services edged up 0.1 percent.

The bottom line? If consumers continue to consume as much as during this holiday season, employers will hire more employees, which leads to more housing sales and higher prices. So we see slow and steady improvement and a return to normalcy in real estate sales and values over the next 3 years.

Harlan Green © 2010

Employment vs. Inflation?

Popular Economics Weekly

Many politicians (and economists) don’t seem to understand the relationship between unemployment and inflation. It should be obvious that when unemployment is high, consumers who make up 70 percent of the economy don’t spend much, and therefore can’t push up prices. But tell that to the ideologues, who claim that the fear of future inflation is what keeps employers from hiring.

Well, since Q3 Gross Domestic Product growth was just revised upward to 2.5 percent with declining inflation, and real GDP growth is up 3.2 percent in 12 months, we hope that canard is being put to rest.

The best way to look at the behavior of inflation vs. unemployment is the historical record. CPI inflation peaked in 1980 at 13.5 percent, and caused Fed Chairman Paul Volcker to raise interest rates into double digits. The unemployment rate was hovering around 6 percent then. Once the unemployment rate rose above 10 percent due to the Fed’s tightening, inflation plunged below 4 percent.

And the inflation rate has been trending downward ever since. In fact, there has never been appreciable inflation with an unemployment rate above 6 percent. And since no economist sees the unemployment rate improving much before 2011, if then, we know why the Fed is so concerned about deflation.

The increase in Q3 GDP was led by consumers and exports, as the cheaper dollar overseas is increasing manufacturing, in particular. Exports are up over 14 percent, while consumers are opening their wallets for the holiday season. Final sales in Q3 to domestic purchasers—the best measure of consumer demand—increased to 2.9 percent.

Consumer spending is beginning to lift growth, in other words, as are increasing Q3 corporate profits, up 28 percent in a year. But businesses cannot continue to produce more without hiring more employees. The severity of this 2007-09 recession is shown in the 30-year record of GDP growth by Calculated Risk (blue bars are recessions), which was negative for 6 quarters during this recession. The average annual Q3 growth rate is again above 3 percent.

Retail sales are the best measure of consumer spending, and sales are soaring again. With four impressive gains in a row, it is becoming apparent that the consumer sector is stronger on the spending side than would be suggested by high unemployment and low measures of consumer confidence.   On a year-ago basis, retail sales are up a huge 7.3 percent in October and, after excluding autos and gasoline, up 5.2 percent.  Those with jobs appear to have decided that it is safe to spend, in other words.

Also, corporate profits in the third quarter increased an annualized 13.5 percent, following a 3.8 percent gain the previous period. Corporate profits are up 28.2 percent on a year-on-year basis. We doubt that corporate profits will continue to increase without more employment, because existing employees tend to demand higher wages when working longer hours, so it is cheaper to hire additional employees.

It therefore looks like consumers are not worried about inflation, as they mend their balance sheets. They are paying down their debts with a vengeance, while household deposits have increased a staggering 32 percent to $7.5 trillion in the past 5 years. They are also defaulting less on consumer and mortgage loans, reports Barron’s Magazine’s Jacqueline Doherty.

A major reason for the pickup on growth is the Fed’s efforts to maintain record low interest rates. And we see the Fed can do so for a “prolonged period” because they have no worries about inflation with unemployment so high—another reason we are seeing growth (and employment) picking up sooner rather than later.

Harlan Green © 2010

The Fed Has Two Mandates—Growth + Price Stability

Financial FAQs

Why has there been so much debate over the Fed’s monetary policy of so-called Quantitative Easing? The simplest answer is that it pits those countries and ideologies that see the world as a zero-sum game—the I Win, You Lose crowd—vs. those who see the world as having enough wealth for everyone, if we would only share more equitably.

In fact, both sides of the debate mirror the Federal Reserve’s twin mandates—encourage maximum growth without excessive inflation. Among the I Win, You Lose crowd are those foreign countries who want to protect their export surpluses—read China, Germany, and Japan primarily—and the wealthiest individuals and creditors (read banks) who want to protect their wealth—i.e., don’t like deficits of any kind because it cheapens the value of their holdings.

Quantitative easing is the Fed’s policy of pushing down interest rates to encourage spending, instead of hoarding. We know that both consumers and businesses are holding onto their cash because of their loss of confidence in those financial institutions that almost brought down Wall Street. Household deposits held in such as banks and money market accounts are up 38 percent to $7.5 trillion over the past six years, according to the Federal Reserve, while banks have excess reserves they are not lending, and corporations more than $1.8 trillion in cash they are not investing.

Bernanke and the Fed Governors are with the Win-win crowd. They maintain that unless we all cooperate, so that the major exporting countries allow their currencies to appreciate, then everyone will be poorer. The U.S. will continue to lose jobs to the cheaper overseas wages of exporting countries, and the exporters won’t divert the resources necessary to develop their own domestic economies.

If China, for example, allowed its yuan to appreciate, goods would be cheaper for its own people, thus raising their standard of living. As it stands today, almost all that is made in China is exported, so China has to worry about inflation, since not enough is produced to satisfy its domestic demand for goods.

“Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals,” Bernanke said in a recent speech to the EU.

Chairman Bernanke’s timing may be right. Economic indications have been strengthening going into QE2, gains reflected by two strong back-to-back 0.5 percent gains for the Conference Board's index of leading economic indicators (September revised from plus 0.3 percent). A wide yield spread continues to be the biggest positive though to a smaller degree given declines underway in long rates, declines triggered and furthered by QE2. A rise in money supply, also related to QE2, is an increasingly significant plus. Another central positive is the factory workweek, strength that is likely to continue given the uplift underway in the manufacturing sector.

A rise in the M2 money supply, meaning money that is actually circulating in the economy, is what fuels growth. Because unless this money is put back into circulation—whether as investments in plants and equipment, or consumer goods and services—economic growth stagnates, as we have said.

But right now the M2 supply has risen just 2.8 percent since April, which is why some inflation indexes are at their lowest level in 50 years—since the Labor Dept. has kept records. And the Fed considers this level to be dangerously close to deflation.

The slow growing money supply is probably why the Personal Consumption Expenditure price index rose just 0.1 percent in September after rising 0.2 percent in August.  The core rate was flat after nudging up 0.1 percent in August.  Year-ago headline PCE inflation held steady at 1.4 percent.  Year-ago core PCE inflation fell to 1.2 percent from 1.3 percent the prior month.  Both series are below the Fed's implicit inflation target of 1.5 to 2 percent, hence the deflation worries.

So is the Win-Win crowed right? Is there enough wealth for everyone, if we would only learn to share? Dr. Bernanke maintains that those countries who keep their currencies devalued harm their own people, by not allowing them access to a better life. While the developed countries have to increase growth to pay off their debt and find employment for their citizens.

Leaving aside politics, economists such a Robert Shiller believe there is enough wealth for everyone. In his groundbreaking book, The New Financial Order (2003, Princeton U. Press), Dr. Shiller postulates that though incomes are never guaranteed, they can be insured against ones profession. In fact, social security and unemployment insurance are limited examples. If insurance underwriters can calculate the rate of fires for fire insurance, or life expectancy for life insurance, why not that for professions? It is just a matter of accumulating sufficient data, which modern computer technology is now capable of doing. So that an policy can be taken out on one’s earning potential. When it falls below a certain level, insurance payments kick in, as with unemployment insurance.

We even have something that resembles it—the Earned Income tax credit for those earning annual incomes of less than $10,000. European Union countries have developed it even further. We know that enough is produced in the world to feed itself. The question is how to distribute it.

Harlan Green © 2010

Where is the Inflation?

Popular Economics Weekly

Paradoxically, the latest inflation numbers show that the Fed’s various attempts to keep us out of a deflationary spiral of wages and prices aren’t yet working. That is, the lowest interest rates since the 1950s plus wholesale purchases of Treasury Bonds and Mortgage Backed Securities by the Fed have not boosted aggregate demand sufficiently—i.e., the demand of consumers and businesses for more housing, consumer and capital goods—to stop wages and prices from continuing to fall.

That is the real goal of the Fed’s QE2 Quantitative Easing program. The problem is reversing the downward spiral—which only decreases the demand for more products and services—and creating some upward push in wages and prices.

The most looked at gauge—the Consumer Price Index for retail prices (CPI)—has been literally flat for the last 3 months, while the Producer Price Index for raw materials and wholesales goods has risen slightly. The Personal Consumption Expenditure Index, the broadest gauge of prices used by the Fed, is still falling.

The overall CPI in October posted a 0.2 percent boost, following a 0.1 percent rise in September. The market consensus had expected a 0.4 percent boost for the latest month. Excluding food and energy, core CPI inflation was unchanged for the third month in a row.

Year-on-year, overall CPI inflation crept up to 1.2 (seasonally adjusted) from 1.1 percent September. But the core rate slipped to 0.6 percent from 0.8 percent the prior month, the lowest core rate in 50 years of record keeping by the Labor Dept.

Inflation at the producer level was more moderate than expected in September with the core tugged down by discounts in motor vehicle prices. The overall Producer Price Index inflation rate held steady at 0.4 percent in October, coming in significantly below the consensus forecast for a 0.8 percent increase. At the core level, the PPI surprisingly fell 0.6 percent, down from a 0.1 percent gain in September and coming in lower than the median forecast for a 0.1 percent uptick. The core was led down by a 3.0 percent drop in passenger car prices and a 4.3 percent decrease in light truck prices.

For the overall PPI, the year-on-year rate increased to 4.3 percent from 4.0 percent in September (seasonally adjusted). The core rate softened to 1.4 percent from 1.5 the previous month. This shows moderate inflation at the wholesale level, mainly in petroleum prices, due to the lower dollar exchange rate. When its value drops, oil and commodity producers raise their prices to compensate for the cheaper dollar.

Meanwhile, the PCE price index rose just 0.1 percent in September after rising 0.2 percent in August.  The core rate was flat after nudging up 0.1 percent in August.   Year-ago headline PCE inflation held steady at 1.4 percent.  Year-ago core PCE inflation fell to 1.2 percent from 1.3 percent the prior month.  Both series are below the Fed's implicit inflation target of 1.5 to 2 percent, hence the deflation worries.

So why is the Fed easing when there is such concern about budget deficits and too much debt? Because inflation is caused by an overheating economy, not one such as ours with so much excess production capacity and unemployment. Historically, inflation hasn’t become a problem until our unemployment rate has fallen to the 6 percent range—which might not happen for years, according to most economists.

In fact, inflation is caused by too much money in circulation with too few goods to purchase. But right now almost no money is in circulation. The M2 measure of dollars in circulation has been falling because it is being hoarded by consumers and corporations. This is while the exporting countries are producing so much that there is a surplus of goods and services—which is why imported goods are so cheap, in spite of the weaker dollar exchange rate.

Fed Chairman Ben Bernanke has been vociferously defending QE2 in recent speeches. ““Fully aware of the important role that the dollar plays in the international monetary and financial system, the [Federal Open Market Committee] believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in the context of price stability in the United States,” said Bernanke.

So now is not the time to worry about inflation. Consumers can’t spend what they don’t have, and businesses won’t spend until they see some increase in demand for their products and services. Hence the stalemate we are in. It isn’t only the congress that is in gridlock at the moment, but most of our economy.

Harlan Green © 2010

The Blame Game—Political Economics 101

Financial FAQs

Everyone played the blame game in this election. Did Obama deliver the change in Washington he promised? Both conservatives and progressives are unhappy with the slow growing economy; and jobless rate still hovering around 10 percent. And no one is quite sure who to blame—Obama or Dubya Bush; too much government, or too little?

But in fact, there is really only one underlying cause of the lingering high unemployment and slowness of this recovery. Real (after inflation) household incomes have been declining since the 1970s for all except the top 20 percent of income earners. And that is because most of the income went to the top 1 percent, who took in 23.5 percent of pre-tax income in 2007, vs. just 8 percent in the 70‘s.

So the rest of the middle and lower classes have had to borrow anywhere they could to keep up their standard of living. There are lots of books to explain the tremendous redistribution of wealth—from Robert Reich’s high tech revolution in “The Future of Success”, to the corporate takeover of our political system in Professors Jacob Hacker and Paul Pierson’s new book, “Winner Take-all Politics”.

The bottom line is that paying down debt has become the priority for most Americans because they don’t have the income to do otherwise. This happened in Japan as well, so that Nomura Securities’ Richard Koo has named such down turns ‘balance sheet’ recessions. And the high debt leveraging won’t go away until income distribution again becomes more equitable. This really means bringing tax rates back to the 1970’s more progressive levels, when the top 1 percent had rates one-third higher than they are today, according to New York Times’ Frank Rich in his latest Op-ed column.

In fact economist Paul Krugman maintains that letting the above $250,000 Bush II tax cuts expire would save revenues equivalent to the social security shortfall over the next 75 years! That is to say, such wealth redistribution would also help the federal budget deficit, the US dollar, and therefore our trade deficit (and keep down commodity prices).

So where are consumers these days in rebalancing their balance sheets? Consumers are becoming thriftier, with the personal savings rate up to 5.8 percent from below 1 percent in 2003; and they have begun spending again.

The consumer sector is continuing to prop up the recovery-maybe even giving it a modest strengthening, says Econoday. October Motor vehicles & parts led the way, jumping 5.0 percent. And apparently, households are fixing up homes as building materials & garden equipment posted a 1.9 percent boost, in spite of the housing recession. Gains were also seen in food & beverage, gasoline stations, clothing, sporting goods & hobby, general merchandise, nonstore retailers, and food services & drinking places.

Overall retail sales in October jumped 1.2 percent after gaining 0.7 percent in September. The latest number sharply topped analysts' projection for a 0.7 percent increase. Excluding autos, sales posted a still healthy 0.4 percent increase, following a 0.5 percent advance in September and coming in a little higher than the median market forecast for a 0.4 percent boost.

This is mainly because personal incomes are again growing. Year on year, personal income growth for September came in at up 3.1 percent, down slightly from 3.2 percent in August. Personal Consumption Expenditures’ growth increased to 3.7 percent in September from 2.8 percent in August, a very large jump.

And we know average hourly earnings gained 0.2 percent in October from the October unemployment report, after rising 0.1 percent in September, while the average workweek for all workers edged up to 34.3 hours from 34.2 hours. In fact, the workweek has been on a rebound since mid-2009.  Between the gains in temp workers and average workweek, one should expect a pickup in hiring as these two series typically rise before overall employment.

Frank Rich blames both political parties for the economic damage caused by catering to the richest in their quest for campaign donations. “The bigger issue is whether the country can afford the systemic damage being done by the every-growing income inequality between the wealthiest Americans and everyone else, whether poor, middle class or even rich.”

In fact, economists are discovering that much of the financial markets’ instability has resulted from such inequality. The cheap money and lax financial regulation caused everyone to over leverage, not just consumers, resulting in the twin real estate and financial market bubbles that had to burst.

But there is some good news on the wealth redistribution front. Forty billionaires led by Warren Buffet and Bill Gates have pledged to donate one-half of their wealth to philanthropic causes. From Ted Turner to George Lucas, these 40 billionaires join Warren Buffett and Bill Gates in making the pledge as part of their The Giving Pledge, a campaign launched earlier this year "to urge wealthy individuals to give the majority of their money to charities of their choice either during their lifetime or after their death," said one headline. If only more of the superrich would follow their example.

Harlan Green © 2010

Jobs Are Growing Again

Financial FAQs

Just maybe, we are turning the corner on the jobs picture.  Payroll jobs finally returned to positive territory as the impact of layoffs of temporary Census workers has dwindled and the private sector is strengthening.  Payroll employment in October rebounded 151,000—159,000 private payroll jobs less 8,000 government jobs lost. And private employment in September was revised to a 107,000 increase.

And, as a sign that consumers are consuming more, service-providing jobs added most to payrolls--advancing 154,000 after an 111,000 increase in September.  We are now a service economy, as many manufacturing jobs have moved offshore. Within services for October, temp help gained 35,000; health care added 24,000 jobs; and retail trade jumped 28,000.  Goods-producing industries edged up 5,000 after a 4,000 dip in September.  In the latest month, manufacturing was little changed, slipping 7,000; construction rose 5,000; and mining increased 8,000.

More good news was that the average workweek for all workers edged up to 34.3 hours from 34.2 hours in October, marginally topping expectations for 34.2 hours. The workweek has been on a rebound since mid-2009.  Between the gains in temp workers and the average workweek, one should expect a pickup in hiring as these two series typically rise before overall employment, as I said in this week’s Popular Economics Weekly. 

Could this mean that small businesses are in fact hiring again? “The depression in small business pretty much explains everything in the weakness of this cycle,” said Ian Stepherdson of High Frequency Economics. “I reckon in the last cycle they accounted for two-thirds of all new job creation. Not only are they big, they are better job-creation engines than big companies, which are more inclined to do their new hiring offshore.”

There was some confirmation in October’s National Federation of Independent Business small business optimism index rise of 2.7 points, to a reading of 91.7. However, their optimism index remains stuck in the recession zone established over the past two years and not a good reading. But job creation plans did turn positive and job reductions ceased, , according to the NFIB.

Service sector activity in October is following the manufacturing sector surge we reported on last week, according to the ISM's non-manufacturing index, which rose 1.1 points in October to 54.3.  This survey of ISM members covers services, construction, mining, agriculture, and forestry.

New orders show special monthly acceleration, at a 56.7 level for a nearly two point gain, as did backlogs orders moving back over 50 at 52.0 to indicate a month-to-month build. Rising orders and rising backlogs mean rising employment in coming months.

And, despite sluggishness in the latest home sales numbers, we may have seen the bottom in actual construction, another service industry. At a minimum, construction is no longer the sizeable drag on the economy that it had been during the recession. There is even the possibility that this sector will be a very mild positive for economic growth in coming months, says Econoday.

The large pickup in service-sector employment, which now makes up almost 70 percent of U.S. business, is a sign that the U.S. economy is growing again. Gross Domestic Product has now grown 3 percent in 12 months, meaning both consumer and commercial demand is increasing which is why employers have to add to their payrolls.

Harlan Green © 2010

QE2 Will Stimulate Economic Growth

Popular Economics Weekly

In a bid to stimulate banks to lend more by increasing their reserves, the Federal Reserve announced QE2 (Quantitative Easing 2). It will be buying up to $600 billion in Treasury securities from banks who hold them. We have no doubt this will kick start economic growth for several reasons. Not least, because there are signs of an additional pickup in both investment and hiring among small businesses.

In a New York Times’ column by Gretchen Morgenson, Ian Shepherdson of High Frequency Economics—noted for predicting the housing bust—sees growth increasing in the small business sector that creates the most jobs, because of a pickup in commercial and industrial bank lending.

And as commercial and industrial lending expands, Shepherdson maintains, it will unleash a pent-up demand among smaller companies for capital equipment, software, vehicles and other goods:

“The depression in small business pretty much explains everything in the weakness of this cycle,” he said. “I reckon in the last cycle they accounted for two-thirds of all new job creation. Not only are they big, they are better job-creation engines than big companies, which are more inclined to do their new hiring offshore.”

The deficit hawks maintain this will stimulate inflation down the road, because it puts too much money in circulation. But in fact buying back securities that banks have purchased from the U.S. Treasury doesn’t directly put money in the pockets of the consumers who spend it. It builds up banks’ cash reserves, which enables them to lend to small, as well as large businesses, as we have said.

Fed Chairman Bernanke downplayed the inflation danger in a recent Washington Post Op-ed: “Our earlier use of this policy approach (QE1) had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable, he said.”

The big news was that October private nonfarm payrolls (excluding government jobs) jumped by 159,000, and September was revised upward to 107,000. With wages and hours worked also increasing, it looks like credit is already expanding. In fact, the $30 billion small business credit bill passed recently will also inject additional liquidity into small businesses.

Average hourly earnings gained 0.2 percent in October after rising 0.1 percent in September, while the average workweek for all workers edged up to 34.3 hours from 34.2 hours in October. The workweek has been on a rebound since mid-2009.  Between the gains in temp workers and the average workweek, one should expect a pickup in hiring as these two series typically rise before overall employment.

Service sector activity in October —which accounted for 154,000 of the 157,000 private payroll pickup—followed the manufacturing sector surge. So the bulk of the economy picked up steam in October, according to the ISM's non-manufacturing index which rose 1.1 points in October to 54.3.  This survey of ISM members covers services, construction, mining, agriculture, and forestry.

And lastly, motor vehicles sales continued to surge, as all 3 Detroit automakers reported surging profits, with GM on track to pay back its government bailout with an upcoming IPO. Combined domestic and import nameplate autos and light trucks (includes minivans, vans, and SUVs) jumped 4.2 percent to an annualized pace of 12.3 million units. While still below the cash for clunkers recent peak of 14.2 million in August 2009, the October number represents nearly steady growth from the recession low.

Deficit hawks tend to forget that some inflation is necessary for an economy to grow. The Japanese deflationary experience is crucial to understanding this. That is why the Fed is still in effect easing credit conditions by adding to bank reserves. And why small businesses should be the biggest beneficiaries of QE2.

Harlan Green © 2010

The Double Dip Has Happened

Popular Economics Weekly

No, we are not talking about a double dip recession, or two scoops of ice cream. The much touted double-dip in economic activity has happened—only it was a dip in activity, rather than outright recession. In fact, as many including Alan Greenspan have said; such dips, or ‘troughs’ are common during recoveries. There is an initial burst—such as Q4 2009’s 5+ percent jump in GDP growth—followed by consolidation, as casualties of the recession continue to shed jobs and newer businesses begin to add employees.

The best evidence is that preliminary Q3 GDP growth edged up to 2.0 percent growth from its 1.7 percent trough in Q2 2010. And the Institute for Supply Management’s manufacturing index also jumped after several months of decline. We can therefore expect other sectors—including employment, personal income, the service sector, and even real estate—to pick up in coming months.

The manufacturing sector surged in October led by a burst in new orders and supported by strong employment gains. The composite headline index jumped nearly 2-1/2 points to 56.9. New Orders are the standout, up nearly eight points to 58.9 to indicate strong month-to-month growth for the best reading since May. Employment rose more than one point to 57.7 indicating no let up in hiring.

Personal income and expenditures (PCE) also seem to be coming out of their doldrums. Personal income’s trough was in June. It slipped again in September, following a 0.4 percent boost in August, but was still positive. Weakness was led by a sharp drop in government unemployment insurance benefits, rather than the private sector, where incomes are again expanding.

Spending was also positive in September. Personal spending rose 0.2 percent, following a 0.5 percent jump in August. By components, durables jumped 0.7 percent, nondurables rose 0.1 percent, and services edged up 0.1 percent. Annual PCE growth increased to 3.7 percent in September from 2.8 percent in August.

While the consumer sector is still slow, we are seeing improvement in construction and manufacturing today. Construction spending rebounded in September, gaining 0.5 percent after a 0.2 percent dip the month before. The boost in September was led by a 1.8 percent increase in private residential outlays, following a 4.2 percent decline in August. These numbers reflect recent improvement in housing starts. Also, public outlays advanced 1.3 percent after a 2.2 percent rise in August. So, we may finally be seeing some of the effects of fiscal stimulus in gains in public construction.

The double dip fears weren’t propagated because pundits had any evidence there would be a double recession. Rather, conservative economists in particular conjectured—with no basis in fact—that employers were holding back on investments and hiring because of too much government. You can name their pet peeves—the health care or Dodd-Frank bills that required health insurance for all and put new regulations on the financial industry, including consumer protections.

It is hard to believe that corporate CEOs, known for their hard-headedness, would act on a result that might happen in 4 years, which is when most of those provisions kick in. In fact, the Consumer Protection Act has yet to be fleshed out, so no one currently knows its effects.

But we can see the result of such unfounded conjecture. It has affected consumer confidence, which is still experiencing the double-dip, though much above its 2009 lows.

So it is more likely that most of the double-dip talk was because of the political season. They were more likely attempts, in other words, to sway opinion and install fears in those unsettled by these unsettled times.

Harlan Green © 2010