What is the ‘New Normal’?—Part II

There is no reason we have to accept predictions of a slower growth ‘new normal’, as I said in a recent column, unless we react as the Japanese government did with too little stimulus spending until it was too late. Most pundits define the current slowdown as a growth recession mirroring the Japanese malaise that resulted in falling wages and prices from 1996 to the present, due mostly to massive debt accumulated during the bubble years.

Why not accept it? Firstly, Bernanke’s Federal Reserve just announced another bond buy back of $400 billion that will keep long term interest rates low for an extended period. Secondly, manufacturing and exports are still growing. It is true that personal incomes have been falling in line with declining employment, which is typical as businesses keep cutting their costs. But that also means no danger of inflation, as wages make up 70 percent of product costs.

And the economic indicators are improving, in spite of the euro crisis, political stalemate, falling stock prices, and the more than 16 million unemployed or underemployed? So it would take much less to stimulate more new normal growth, such as Obama’s $440 billion jobs bill presented to Congress.

So we can stimulate faster growth if we will all pull together, as Fed Chairman Bernanke so eloquently said in his latest congressional testimony: “Monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector.”

Economic growth for the second quarter actually did end up stronger than previously estimated but remained anemic.  The Commerce Department’s final estimate for second quarter GDP growth was bumped up to a rise of 1.3 percent annualized, compared to the prior estimate of 1.0 percent annualized and to first quarter growth of 0.4 percent.  The anemic growth was due to declining incomes, which have been dropping since their high in January. This is what is being described as the ‘new normal’ for economic growth—i.e., not enough growth to keep up with population growth.

There is also some recovery in real estate, as construction made a comeback in August, largely from the public sector although major private components also gained. Construction spending in August rebounded 1.4 percent in August, following a 1.4 percent drop in July, and is in positive growth territory for the first time in more than a year. The rise in August came in much higher than the consensus forecast for a 0.2 percent decrease.

The latest month's rebound was led by a 3.1 percent jump in public sector outlays, following a 1.5 percent dip in July. Private residential construction spending made a partial rebound of 0.7 percent, following a 3.2 percent fall the prior month. Private nonresidential outlays edged up 0.2 percent after a 0.3 percent advance the prior month.
On a year-ago basis, overall construction outlays improved to up 0.9 percent in August from down 0.1 percent in July.

The ISM survey on overall non-manufacturing (service sector) activity is also looking better. Rates of monthly growth in orders are accelerating though employment is now contracting in what is a mixed report on the non-manufacturing sector for September. New orders rose a very solid 3.7 points to 56.5, over 50 to indicate monthly growth and well above August to indicate an accelerating rate of monthly growth. Backlog orders are now over 50, up five points to 52.5 to end three months of contraction. These are solid readings that point to rising overall strength for the sector in the months ahead.

Business activity, that is production, rose 1.4 points to a 57.1 level that shows the strongest rate of monthly growth in six months. Yet despite the rise in output, non-manufacturers are not hiring with the employment index falling 2.9 points to a sub-50 reading of 48.7 that indicates contraction in the sample's workforce. This is the first contraction in employment since August last year, and tells us that the service sector is not expanding fast enough to warrant more hiring.

And the manufacturing sector continues to improve, with employment and production up, but orders in the manufacturing sector flat at the very best, according to September data from the Institute For Supply Management. Its composite index came in slightly higher. The employment component rose two full points to 53.8 to indicate a tangible increase in hiring. This is in line with a tangible increase in production which rose more than 2-1/2 points to 51.2. One plus on the order side is a pick up in new export orders which rose two points to 53.5, signaling that exports are on the rise again.

What is the real reason for the current slow growth new normal that has continued since January? It could be that consumers haven’t paid down enough debt and are saving more, while incomes have been declining, as we have said. So to grow out of it more jobs must be created, and right now the rest of government isn’t doing its job to stimulate growth.

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Harlan Green © 2011

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

What is the ‘New Normal’?

Popular Economics Weekly

There has been much talk of late about the “new normal” of slower economic growth that we may see in coming decades. It is defined by bond trader PIMCO’s Bill Gross as what he calls declining global aggregate demand—the declining demand of consumers, businesses, and government for additional good and services. We have lived through an excess of consumption and debt, and must now pay for it, in other words.

“Developed nation consumers are maxed out because of too much debt, and developing nations don’t trust themselves to stretch their necks for the delicious leaves of domestic consumption just above,” he said in his current economic outlook.

How true is this? He might be correct for the short term—ten million jobs have to be created to replace those lost in just the past 2 years—but not about future growth. What is true is that we will have to live with less indebtedness. But substantial growth is continuing in new industries and developing nations—Brazil, India and China are the 3 fastest growing major nations in the world.

Consumers have been the first to pay down their debts, while businesses haven’t had to borrow much because of huge cash flows during the last decade that enabled them to finance their own operations without borrowing—and what little expansion there has been. So huge amounts of cash are sitting on the sidelines, which positions those with good ideas to expand rapidly.

Government will have to begin to size down as well, once this recovery picks up and the wars on terror have been resolved. This means consumers will be more selective in what they buy, and businesses more selective in who they hire. A recent New York Times article documented the ways industries have been able to achieve record profits (up 40 percent from late 2008 to Q1 2010), without much hiring.

This has resulted in profits rising much faster than revenues. Among the 175 companies in the S&P 500 that have already reported earnings last quarter, reported the NY Times, revenues averaged a 6.9 percent increase, while profits rose 42.3 percent.

How so? Firstly, productivity is rising faster than wages and salaries. Companies are investing more in technologies than workers, in other words. Year-on-year, productivity advanced 6.1 percent in the first quarter-up from 5.6 percent in the prior quarter. And unit labor costs—both wages and benefits—declined another 4.2 percent, compared to minus 5.1 percent the previous quarter. Output growth was a whopping 4.0 percent annualized, in other words, while hours worked barely budged up to 1.1 percent.

This is while personal income growth is barely rising. It grew just 1.6 percent in May, easing from 2.6 percent in April. Inflation was mixed in May. The headline PCE price index was flat as was also the case the prior month. The core rate, however, firmed to 0.2 percent from 0.1 percent in April.

The result is a basic disparity between income brackets, with the top 10 percent of incomes rising, and the majority of wager and salary earners with no income growth at all.  This is probably the main reason for the ‘new normal’.  Something that New York Times’ columnist Bob Herbert highlighted recently. 

A Yale study showed that more than 20 percent of Americans experienced a 25 percent or more loss in household income without any financial cushion from 1985-95, the highest in 25 years.  This is with our unemployment rate hovering around 9.7 percent. So many more than just the unemployed are suffering from the effects of the Great Recession.  But an income shift is occurring that should aid consumers, and shorten the era of falling incomes of the new normal—expiration of some of the most inequitable Bush II era tax breaks, and restoration of the taxable rates that helped to create a budget surplus during the Clinton era. 

Harlan Green © 2010

When Will Housing Market Bottom?

The Pending Home Sales Index, a forward-looking indicator based on contracts signed in January, fell 7.7 percent to 80.4 from a downwardly revised reading of 87.1 in December, and is 6.4 percent below January 2008. The index is at the lowest level since tracking began in 2001, when the index value was set at 100.

Since it is a leading indicator of future activity, what does this mean for reaching a housing bottom? Pending sales track escrows that close in 30-60 days. The West was the only region that showed increased activity, with it seasonally adjusted pending index up 2.4 percent in a month and 13.5 percent over last January. The West includes states like California, Nevada and Arizona that have seen the greatest price declines.

Lawrence Yun, NAR’s chief economist, said the downturn in the economy also weighed heavily on the data. “Even with many serious potential home buyers on the sidelines waiting for passage of the stimulus bill, job losses and weak consumer confidence were a natural drag on home sales,” he said. “We expect similarly soft home sales in the near term, but buyers are expected to respond to much improved affordability conditions and from the $8,000 first-time buyer tax credit.”

NAR’s Housing Affordability Index rose 13.6 percentage points in January to 166.8, a new record high. The HAI, a broad index of affordability that tracks the ability of a household with median income to buy a median-priced existing home, shows that the relationship between home prices, mortgage interest rates and family income is the most favorable since tracking began in 1970.

The HAI indicates a median-income family, earning $59,800, could afford a home costing $283,400 in January with a 20 percent down payment, assuming 25 percent of gross income is devoted to mortgage principal and interest; affordability conditions for first-time buyers with the same income and small down payments are roughly 80 percent of that amount. A year ago, the typical first-time family could afford a home costing $263,300.

The just unveiled Housing and Affordability Sustainability Plan (HASP) should also stimulate mortgage volumes for distressed borrowers with loan amounts less than $729,750. Eligible borrowers have to show either that their homes are more than 80 percent encumbered, or loan payments—including taxes and insurance—are more than 38 percent of monthly gross income. Lenders can then either cut the interest rate as low as 2 percent, forgive principal, and if that doesn’t work, extend amortization period to 40 years.

Harlan Green © 2009