Look at the Consumers!

Popular Economics Weekly

As stock and bond investors cringe and run to their rabbit holes on news that European, or even Chinese economic growth may slow, the American consumer doesn’t seem as concerned. Domestic consumer incomes and spending look better in May.

The consumer sector got another boost with a jump in spending power. Personal income in May rose a solid 0.4 percent, following a 0.5 percent advance in April. Analysts had called for a 0.5 percent increase in personal income for the latest month. The key wages & salaries component gained 0.5 percent, matching April's improvement.

Overall, personal consumption rose a modest 0.2 percent, following no change in April. A jump in auto sales helped offset softness in gasoline and other subcomponents in nondurables, as we said last week. By components, PCEs were led by a 0.8 percent boost in durables-reflecting motor vehicle sales. But services also were robust with a 0.5 percent jump.

Motor vehicles sales spiked to 14.1 million units annualized in August 2009 but plunged to 9.2 million units in September after special incentives ended.  But the good news was that sales returned to trend in just a few months with 11 million unit sales in May.  This was based on a stabilized consumer sector and credit that was not so difficult to get. Non-revolving credit, reflecting strong car sales, jumped $9.4 billion in April, according to the Federal Reserve.

Though consumer confidence is still shaky with conflicting U. of Michigan and Conference Board sentiment surveys, the Case-Shiller Home Price Index showed the first increase in home prices in 6 months. The unadjusted composite 10 index broke a long series of declines with a 0.7 percent surge, a surge that's less dramatic when seasonally adjusted but still very good at plus 0.3 percent. The year-over-year rate, a comparison less exposed to seasonal variation than the month-to-month comparison, is at plus 4.6 percent on the unadjusted side and at plus 4.7 percent when adjusted, up 1-1/2 percentage points from March on both scores. Details show broad gains across nearly all cities.

The results are consistent with the existing home sales report that likewise showed large price gains in April followed by even larger gains in May, though sales are still flat.

Existing home sales fell 2.2 percent to an annual sales rate of 5.66 million from April’s 5.79 million.  The recent peak in existing home sales was 6.49 million units for November 2009 when the original tax incentives expired.  The more recent bump in sales from the second round topped at April’s 5.79 million units.  High supply will continue to pressure prices which did, however, firm 4.2 percent in May for both the median price ($179,600) and average price ($226,400).  The price gains likely were related to a shift in composition to more expensive homes.

What does this mean? That consumers continue to be cautious spenders, largely because of the current deflationary environment, which means they are counting on prices to fall further. This is a sign that is worrying Nobel economist Paul Krugman, for one. He has been lamenting the current G20 consensus that paying down debts is more important than further stimulus spending.

In other words, consumers pull back when prices are falling, which further damages economic growth. So there is no danger of inflation, which is the fear deficit hawks foster to justify the pain they want to inflict on the real estate market in particular.

Overall, the consumer sector is slowly gaining strength in terms of spending power. Purchases have been a little erratic due to off and on auto incentives and consumer caution in general. But the consumer sector took one step forward in May, helping the recovery continue.

Harlan Green © 2010

Housing Affordability Still Improving

The Mortgage Corner

A very pessimistic Harvard University Joint Center for Housing Studies’ 2010 annual report says with the job market in dire straits, household incomes declining and foreclosures dragging down home values, the housing market may take years to recover. But the Harvard study is already outdated. Affordability is much better in 2010, and jobs and incomes have improved substantially.

The Harvard study says affordability is still a problem because household incomes have been falling; though not as much as housing prices. Calculate in record low interest rates that are forecasted to last at least through 2011, and we see that affordability is in fact very high. The good news is that prices have fallen up to 50 percent in some regions since 2008, while household median income has fallen about 6 percent.

“Very low mortgage interest rates and recovering labor markets, however, should be enough to shore up sales and housing starts once an expected dip due to the expiration of the federal homebuyer tax credit passes. “If history is a guide, what happens with jobs will matter the most to the strength of the housing rebound,” says Eric S. Belsky, Executive Director of the Joint Center for Housing Studies. “Right now, economists expect the unemployment rate to stay high, but if employment growth surprises on the upside or downside, housing numbers could too.”

In fact, the National Association of Realtors (NAR) reports that the median existing-home price has actually risen 6 percent in 2010, while the median household income is hovering around $60,500. This has kept the NAR’s affordability index at 167 percent—a family with a median income can afford 167 percent of a median priced home. Whereas, it was as low as 115 percent in 2005 when housing prices were in bubble territory (and interest rates were 1.5 percent higher).

Consumers are paying down their debts, in part because of high mortgage debt levels. The year-over-year debt to household income measure that includes mortgage debt has fallen from 23.5 to 21.5 percent, while total outstanding credit is still contracting at slightly less then 4 percent per year, as we said last week.

Consumer credit rose $1.0 billion in April in a gain far offset by a $7.4 billion downward revision to March which now shows a $5.4 billion contraction. Non-revolving credit, reflecting strong car sales, jumped $9.4 billion in April but was offset by a nearly as large of a fall in revolving credit. The drop in revolving credit reflects consumers’ reluctance to buy non-essential items.

What were consumers buying in May? Gasoline led the way because of higher gas prices, but the trend in overall sales is upward and healthy—in spite of the May decline.  Overall retail sales on a year-ago basis in May came in at 6.9 percent compared to 9.0 percent the month before.  Excluding motor vehicles, the year-on-year rate slipped to 6.1 percent from 7.8 percent in April. 

The other pleasant surprise was the continued rise in pending home sales. Already, February and March had spiked with help from last minute buyers wanting to ensure time to close before May 1. But apparently, many buyers decided to push their luck and buy during April in hopes of expedited paperwork by mortgage lenders. Pending home sales extended their surge through April, jumping 6.0 percent, following a 7.1 percent spike in March.  Year-on-year, pending home sales are up 22.4 percent.

The Harvard study seemed to concentrate on the bad news—an estimated one in seven homeowners has a home worth less than they owe on their mortgage, and 5 million need their home price to rebound by 25 percent before they are again above water. But there are more than 45 million outstanding home loans, and the inventory excess is in fact making home ownership more affordable—for those who can afford to buy.

Harlan Green © 2010

Economic Interdependence Is Good

How interdependent we have become! The lessons of this recession and the ongoing recovery, is that going it alone won’t work—whether when drilling oil wells, or evading financial regulations. We even have to thank our dependence on foreign trade with Asia, and our government-aided auto industry, for what is leading this recovery—the manufacturing sector.

Economic interdependence is becoming the norm in this decade—private industry (via innovation) and governments (via regulation) are becoming more interdependent. One can no longer exist without the other. And what affects one sector now affects the overall economy.

The bursting housing bubble almost caused the worldwide collapse of the financial system because financial markets are now interconnected. The BP Gulf oil disaster is an example of nature’s interconnectedness. A toxic spill has become toxic to all states in the Gulf region.

Overall industrial production in May surged 1.2 percent, following a 0.7 percent boost the month before. The latest number was stronger than the consensus forecast for 1.0 percent. Manufacturing has been robust over the last three months with this component gaining 0.9 percent in the two latest months and jumping 1.2 percent in March.

A jump in motor vehicle production also added significantly to May's overall production boost. Motor vehicle production jumped 5.5 percent, following a 1.4 percent dip in April. Nonetheless, gains were widespread in other industries, with business equipment up 1.3 percent, and consumer goods up 1.2 percent. Industrial production improved to 7.6 percent from 5.2 percent in April on a year-over-year basis.

The housing bubble has been a leading lesson in the recognition that housing is closely connected with other sectors; such as insurance, construction and finance.

And the construction industry is beginning to recover, a good sign for real estate. Expiring special tax credits for homebuyers and the recent surge in home sales have carried over to unexpected strength in construction activity. Apparently, this has cut into new home inventories enough to give homebuilders confidence to bump up the pace of new construction. However, gains are coming off low levels.

Construction outlays in April surged 2.7 percent, following a 0.4 percent rebound the month before, and rose to minus 10.5 percent in April from minus 12.5 percent in March, year-over-year. The April boost was led by a jump in private residential outlays which gained 4.4 percent after no change the prior month. Public outlays increased 2.4 percent in the latest month while private nonresidential construction rebounded 1.7 percent.

Lastly, and not so obvious, was the housing bubble’s effect on consumer confidence. It was probably a cascade effect—housing burst, then credit, which stopped both consumers and investors from borrowing. This resulted in the greatest credit contraction since WWII and the Great Depression that has now lasted 20 months.

Consumers appear to be focusing specifically on the health of the U.S. economy—shrugging off sovereign debt worries in Europe and the recent drop in stocks.  The Reuters/University of Michigan Consumer Sentiment Index rose to 75.5 in the mid-June reading versus 73.6 for the final reading of May. The nearly two-point gain was sizable and put the index at its best level since the January 2008 figure of 78.4.

There is a pent-up demand for housing. The Harvard Joint Housing study estimates 15 million new households will be formed in this decade 2010-2020. But there is uncertainty whether more will rent than own. Home ownership could also be a casualty of the housing bust, in other words. But that won’t hurt construction, as the latest housing starts numbers showed a big jump in rental construction (33 percent) vs. a 10 percent drop in single family housing starts.

Harlan Green © 2010

May Employment Shows Sustainable Recovery

Popular Economics Weekly

The headline number for payrolls in May was disappointing, according to the media, because of anemic growth in the private sector. But in fact it is leading to a more sustainable recovery. Most were temp help workers hired for the U.S. Census, but this will lead to more permanent jobs as overall production continues to increase. Overall payroll jobs in May surged 431,000, following a 290,000 boost in April, and a 208,000 gain in March.

The positive news in the payroll survey was in earnings, the workweek, and production hours. Wages picked up with a 0.3 percent rise in May, following a 0.1 percent advance the month before. The average workweek for all workers edged up to 34.2 hours from 34.1 hours in April. Production hours overall advanced 0.3 percent in May after a 0.4 percent rise the month before. For manufacturing, the improvement was even more notable with a 1.1 percent jump after a 0.8 percent gain in April.

Year-on-year, labor productivity has soared, the 6.1 percent increase in the first quarter-up from 5.6 percent in the prior quarter, which means very healthy economic growth with almost no inflation worries. It is a major gauge of future inflation because wage costs, which account for two-thirds of product costs, are barely rising.

Manufacturing hiring is also robust. Growth in new orders and employment highlighted another very strong ISM manufacturing report in May. New orders held steady at 65.7, a reading well over breakeven 50 and the third in a row over 60. Employment index was last above 60 back in May in 2004. May's reading came in at 59.8 for a 1.3 point gain to indicate significant acceleration in hiring.

In a sign that employers are hiring more permanent workers, the number of persons employed part time for economic reasons (some-times referred to as involuntary part-time workers) declined by 343,000 in May to 8.8 million. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job. This decline was more good news. The all time record of 9.24 million was set in October.

The unemployment rate decreased to 9.7 percent, and the lower number of part time workers (for economic reasons) helped to push down the total unemployed U-6 labor category to 16.6 percent (from 17.1 percent), which is still a large number.

But the ultimate sign of a sustained recovery is a declining inventories-to-sales ratio, which signals that pent-up demand is growing; which is why production is growing, employers are hiring again.

And key sectors of the economy are lining up together in what hopefully will be a sustained cycle of inventory replenishment. Business inventories rose 0.4 percent in March on top of a 0.5 percent gain in February and a smaller gain in January. In what is especially good news, its components show nearly uniform increases in March: manufacturers up 0.3 percent, retailers up 0.4 percent, wholesalers up 0.4 percent. In fact, we are already in a sustainable recovery.

Harlan Green © 2010

Consumers Financial Health Improving

Popular Economics Weekly

Consumers’ financial health continues to improve. They are managing to both save and spend more, in spite of worries about both federal and state deficits. In fact, deficits don’t seem to matter to consumers, at least, as the latest consumer sentiment surveys show consumers’ spirits improving with better job prospects and increasing income.

A little known economic indicator—the Federal Reserve’s monthly report on consumer credit (i.e, outstanding revolving and installment debt, but not mortgages)—shows that consumers are still paying down their credit card debt, but borrowing money for larger loans, like auto and appliances that require a standard monthly payment.

The year-over-year debt to household income measure has fallen from 23.5 to 21.5 percent, while total outstanding credit is still contracting at slightly less then 4 percent per year. Consumer credit rose $1.0 billion in April in a gain far offset by a $7.4 billion downward revision to March which now shows a $5.4 billion contraction. Non-revolving credit, reflecting strong car sales, jumped $9.4 billion in April but was offset by a nearly as large of a fall in revolving credit.

Though retail slowed in May, thanks to a huge drop in building supplies and materials, consumer sentiment rose to 75.5 in the mid-June reading vs. 73.6 at month-end May. The nearly two-point gain is sizable and puts the index at its best level of the year. Gains were posted for both the expectations and current conditions components. Another plus is a definitive fading in inflation expectations, falling an unusually steep 5 tenths in the 12-month outlook to 2.7 percent. Today's report, because of its strength, hints at underlying improvement in the jobs market and should offset the sting from the May retail sales report.

Higher vehicle sales were a pleasant surprise that reinforces strong overall retail sales. Car and truck sales proved very solid in May, at an annual adjusted rate of 11.6 million surpassing April's 11.2 million and ranking alongside March's incentive-driven spike of 11.8 million. Strength was centered in domestic-made trucks which jumped 8.6 percent to a 5.1 million unit pace.

The other pleasant surprise was the continued rise in pending home sales. Already, February and March had spiked with help from last minute buyers wanting to ensure time to close before May 1. But apparently, many buyers decided to push their luck and buy during April in hopes of expedited paperwork by mortgage lenders. Pending home sales extended their surge through April, jumping 6.0 percent, following a 7.1 percent spike in March.  Year-on-year, pending home sales are up 22.4 percent.

Harlan Green © 2010

The Great Stimulus Debate

Financial FAQs

It is called the Great Debate, because it began during the Great Depression. Should government stimulus be used to bring an economy out of recession-depression? Or, should private business play it out, and the weakest fall while the strongest survive to start anew?

A 25 percent jobless rate and closing of 9,000 banks during the decade of the Great Depression was horrific, and the reason no one wants a repeat performance. That is why President Obama pushed for ARRA, the American Reinvestment and Recovery Act. And it succeeded in stopping what could have been a second Depression.

Christina Romer, Obama’s chief economist and an economic historian of the Great Depression, told us why it was so important at a recent William and Mary College graduation. “The economic situation facing the new Administration was unlike any we had seen since the Depression. In January 2009, the economy was losing more than three-quarters of a million jobs per month. Output was plummeting and businesses were closing their doors at an alarming rate. The financial system was seized with fear and key flows of credit, the lifeblood of our economy, virtually evaporated. Though not a depression, this truly was a Great Recession.”

It is interesting who has taken sides on this debate—a debate really between the haves and have nots. Creditors—mainly banks and other holders of debts—don’t want their debts devalued, so they advocate letting the weak fall, which can cause deflation and so enhance the value of debt. The debtors on the other hand, want any stimulus they can get to ward off failure and preserve what equity they have left.

So demand and prices fall, and businesses cut back on production and jobs—unless government steps in. The signature trait of a serious recession is some form of hoarding—by consumers who stop spending to pay down their debts, and investors seeking safe investment havens like U.S. Treasury securities.

“The signature action to fight the recession was the American Recovery and Reinvestment Act. This was simply the boldest countercyclical fiscal stimulus in American history,” said Dr. Romer. “It was unquestionably bolder than the fiscal actions pursued in the New Deal. The Recovery Act included tax cuts and expenditures equal to more than 4 percent of GDP spread over two years. At its largest, the fiscal expansion under Roosevelt was just 1½ percent of GDP. And, that did not occur until the Depression had been going on for six years, and it was counteracted by an equally large fiscal (i.e., spending) contraction the very next year.”

The Congressional Budget office has estimated that up to 3.7 million jobs will be saved or created as a direct result of ARRA, and more as a result of the Federal Reserve holding down interest rates that stopped real estate prices from falling further. This is a veritable drop in the bucket compared to the estimated $4-5 trillion in lost output during this recession that cost 8 million jobs.

Despite the disappointing headline number for payroll jobs (just 41,000 of the 413,000 jobs created were non-governmental), there actually was some favorable news.  The gains in temps and workweek point to future hiring.  Personal income should be strong for May.  The aggregate hours jump for manufacturing suggests a robust increase in industrial production for the month.  Yes, the underlying trend in jobs is less than hoped, but recovery is still underway.  And we are getting some “fiscal stimulus” from the Census hires, says Econoday.

Construction spending also improved after a winter slump. The April boost was led by a jump in private residential outlays which gained 4.4 percent after no change the prior month.  Public outlays increased 2.4 percent in the latest month while private nonresidential construction also rebounded 1.7 percent after a sustained drop.

Another positive economic indicator was that car and truck sales proved very solid in May, at an annual adjusted rate of 11.6 million surpassing April's 11.2 million and ranking alongside March's incentive-driven spike of 11.8 million. Strength was centered in domestic-made trucks which jumped 8.6 percent to a 5.1 million unit pace. Why is the jump in truck sales important? Because trucks are used by businesses, which points to more economic activity!

So the recovery is not so sluggish, considering the obstacles it still faces with the $1 trillion drain of 2 wars being fought and Wall Street still looking for ways to evade regulation.  Spending and production are running ahead of jobs numbers.  These point to continued moderate improvement in the recovery—and a recession that is certain to be shorter than the Great Depression.

Harlan Green © 2010

The Debt Fallacy

Financial FAQs

The European debt crisis has re-triggered the debate over budget deficits, and even whether Europe’s problems could trigger a ‘double-dip’ return to recession in our own economy. The contention is that Europe will be burdened with debt for years to come, which slows their economic growth.

What has Europe to do with our own economy? It is mainly the relationship between currencies. When the euro is high, then our exports are cheaper, helping manufacturing employment in particular. So the reverse case boosts European exports and reduces ours. And the euro’s value has plunged as investors fled to dollar denominated investments.

But a more general debate is whether governments should incur additional debts to cure such financial crises as we are now weathering. So-called Keynesian economists say that government stimulus spending is crucial to any recovery, since it boosts demand for new products and services. But that only happens if it is directed to consumers—who account for up to 70 percent of economic activity.

So-called supply-side policies boost the producers by giving tax cuts directly to investors and businesses, in the hopes that it will induce businesses to expand and create more jobs. However that didn’t happen during the last recovery. The 5 million jobs created from 2000-08 was the lowest total since WWII.

Nobelist and columnist Paul Krugman came up with an interesting conclusion on just that subject. Were we better off under the supply-side policies of President Reagan in the 1980s who wanted to funnel more money to the supply-side, or of Clinton in the 1990s who wanted it to go to consumers, was his question.

“Here’s what I think,” said Krugman, “inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all. We could have gone on with a more progressive tax system, a stronger labor movement, and so on.”

Our debt-incurred stimulus spending is definitely working. The Congressional Budget Office reported the latest results of the $787 billion American Recovery and Reinvestment Act (ARRA) under this headline:

New CBO Report Finds ARRA has Preserved or Created up to 2.8 Million Jobs

While the report focuses primarily on the first quarter of 2010, CBO also includes new projections of the Recovery Act’s jobs impact through 2012. It finds that in the current quarter (the second quarter of 2010), there are 1.4 million to 3.4 million more jobs in the economy because of ARRA, and it predicts that ARRA’s jobs impact will peak this fall, when there will be 1.4 million to 3.7 million more jobs because of the legislation.

This is in line with the latest unemployment report, which showed 290,000 payroll jobs created in April, following a revised 230,000 advance in March, and 39,000 rise in February. April's boost topped the market estimate for a 200,000 gain. Net

combined revisions for March and February were up a 121,000-including turning February from negative to positive. But the key number is private payrolls as Census hiring added 66,000 to April's jobs, compared to adding 48,000 the prior month. Private nonfarm employment increased 231,000, following a 174,000 rise in March.

The real key to refuting the ‘debt fallacy’ is the benefit government stimulus does for consumers’ pocketbooks, and that is also looking better. Consumers are getting healthier— at least financially, as income gains enable them to spend and save more, with inflation almost non-existent. The headline PCE price index was unchanged in April-easing from up 0.1 percent in March. The core rate also was soft, gaining only 0.1 percent and matching both March and the consensus forecast.

Personal income posted a solid 0.4 percent increase for April, matching the gain the month before. The April figure came in slightly lower than the market forecast for a 0.5 percent boost. Importantly, the latest increase is in what really counts as the wages & salaries component advanced 0.4 percent after rising 0.3 percent in March.

The good news is that consumers are finding more greenbacks in their wallets and this should support additional spending and the recovery. The consumer on average is now pulling its weight in the recovery, while inflation remains benign.

What about paying back the $11 trillion in public debt? We can follow the post-WW II scenario, when it was 120 percent of GDP. That debt was paid down to its lowest level by 1980 in the post-war recovery. Today it is approaching 90 percent of GDP, because this was the worst downturn since the Great Depression. So once again the key to a recovery is keeping consumers healthy, which leads to more jobs and higher incomes.

Among ARRA’s most effective provisions for saving and creating jobs, according to CBO’s estimates, are direct purchases of goods and services by the federal government, transfer payments to states (such as extra Medicaid funding), and transfer payments to individuals (such as increased food stamp benefits and additional weeks of unemployment benefits). CBO’s estimates indicate that tax cuts are less effective job producers, and tax cuts for higher-income people and corporations have very low bang for the buck.

Harlan Green © 2010