Where is the Housing Market?

The Mortgage Corner

Housing construction surged for the first time in almost one year—but it was in apartments, as single family home construction has to compete with existing home inventories bloated by the burst housing bubble. Total housing starts were at 596 thousand (Seasonally Adjusted) in January, up 14.6 percent from the revised December rate of 520 thousand, and up 25 percent from the all time record low in April 2009 of 477 thousand (the lowest level since the Census Bureau began tracking housing starts in 1959).

But single-family housing starts in January were 1.0 percent below the revised December figure of 417,000. While the January rate for units in buildings with five units or more was 171,000, signaling that demand for rental units is rising, as vacancy rates fall. Those who have lost their homes and newly formed households have to live somewhere, in other words, if they can’t or won’t buy a home. And something like 1 million new households are still being formed per year.

So rental vacancy rates have been falling from a high of 11 percent since the end of the Great Recession to just above 9 percent. And this is reflected in rising rents, which is spurring the increase in apartment construction. In fact, rental units and condos are the only housing sectors growing nationally at present.

Existing-home sales have also been surging of late, and their inventory levels have dropped to an 8-month supply, which is still too high. Historical supply rates have ranged from 4-6 months. In fact, it wasn’t until 2005 that inventory levels began to surge above their long term 4-month average.

But the bottom line is how many units are completed, which tells us how many are on the market and competing with the excess of existing home inventory. Multi-family starts seem to be rebounding in 2011, but completions will probably be at or near record lows since it takes over a year to complete most multi-family projects. Single-family starts will probably stay low until the existing-home inventory declines substantially.

And we believe that it will take the rest of this year for the existing-home inventory to drop sufficiently to spur new single-family home construction. Why? Growing and pent up demand from new household formation will eventually bring down available inventories, as will a better jobs market that brings down the foreclosure rate. History shows that housing construction and job formation seem to go together.

Harlan Green © 2011

When is Inflation a Problem?—Part II

Financial FAQs

A recent column by MarketWatch columnist Rex Nutting shows us why inflation won’t be a problem for maybe years to come. U.S. businesses have become “world class” in squeezing the most from their existing workforce, rather than hiring more workers. This is in part because of the availability of technology to replace workers, but also a mentality that puts profits (and CEO salaries) first. CEO incomes now average more than 400 times the average worker’s salary with stock options and benefits, vs. just 40 times workers’ incomes in past decades.

And so labor costs continue to trend downward, which is why inflation is no problem. In 2010, for instance, the first full year of growth after the recession, U.S. total output increased 3.7 percent, reported the Bureau of Labor Statistics reported. But to produce all those extra goods and services, American workers put in just 0.1 percent more hours on the clock. And so labor productivity increased 3.6 percent.

What did we get for that extra effort, asks Rex Nutting? Just a little extra hay: Wages rose 2 percent, but most of that was inflated away. After adjusting for higher prices, real compensation rose just 0.3 percent. If you earned $1,000 a week in 2009, you got the equivalent of $1,003 in 2010, enough for an extra doughnut at the coffee shop.

What is making the deficit hawks nervous is that headline inflation—i.e., overall inflation including food and energy prices—has been steadily rising since July, 2010. This is using the Personal Consumption Expenditure price index, which is the best overall measure of domestic prices. But the core rate without food and energy prices hasn’t budged. Why? Because there aren’t enough consumers buying the products and services affected by food and energy prices—such as motor vehicles (though demand for vehicles is rising).

Much of what makes inflation hawks nervous has nothing to do with economic theory, or of common sense. The hawks theorize that if consumers have expectations that prices will increase in the future, they will spend more in the present, creating a self-fulfilling prophecy. It is true that when prices are rising, consumers buy more. But which comes first, the horse or cart?

It is only when consumers feel wealthy and their incomes are growing that they create more demand for goods and services, and so drive up prices. Conversely, during recessions when everyone feels less wealthy, consumers hold back driving prices lower. This is the feared Japanese deflationary cycle that has lasted more than 20 years, shrinking the size of Japan’s economy and its citizens’ life styles.

The U.S. has only experienced real deflation during the Great Depression (really 2 depressions back-to-back—1933-37, and 1938-39). And the Federal Reserve knows this. So by pumping more monies into banking reserves with QE2, and holding down interest rates, the Fed is attempting to keep prices within an acceptable range of inflation—1.5 to 2 percent.

Overall inflation trend is still trending downward, as we said last week. The core rate came in unchanged after edging up 0.1 percent in November. On a year-ago basis, headline PCE prices are up 1.2 percent, compared to 1.1 percent in November. Core inflation eased to 0.7 percent year-on-year versus 0.8 percent in November.

Businesses’ costs are the main driver of inflation, and labor is the main cost of doing business. Due to the rapid increase in productivity in 2010 and the pathetic increase in wages, the cost of the labor needed to produce a ton of steel or a loaf of bread fell by an average of 1.5 percent in 2010 after a 1.6 percent drop in 2009.

That is why inflation is still way below the Fed’s ‘implicit’ target range of 1.5 to 2 percent. It is also why the Fed wants to continue with QE2. Right now, the emphasis has to be on creating jobs, and keeping the inflation rate from falling further. For, falling prices mean lower profits for employers, which mean shedding jobs rather than adding them.

The decline in unit labor costs also means businesses aren’t being pressured to raise prices to maintain their profits. In fact, they can cut prices compared with a year earlier and still earn higher profits. They can even afford to give their hard-working employees an extra crumb as a reward.

Most people tend to think inflation comes from higher prices for oil or other commodities, as we said last week. But that’s wrong: Inflation isn’t an increase in a few prices, but rather it’s a general increase in almost all prices across the board. So why don’t we have an inflation problem? Because American businesses are world class at squeezing labor costs — that is, wages, says Mr. Nutting. Unfortunately, the rapid increase in productivity in the American workplace is also keeping millions of willing and able people on the unemployment lines.

Harlan Green © 2011

Egyptians’ Democracy Movement Will Win

Popular Economics Weekly

We now know how Egyptians plan to bring down the Mubarak dictatorship. They are on strike, despite the pleadings of Mubarak supporters who fear it will not only keep the tourists away, but bring all economic activity to a standstill. And it is the perfect event to explain what really drives economic growth.

Egyptian Vice President Omar Suleiman, a former Brigadier General, said recently the ongoing political protests in the country will sharply cut its economic growth this year.

Suleiman, who is trying to convince protesters to end the demonstrations, said Wednesday that Egypt's economy might advance by 3.4 percent in 2011. In December, the government predicted 6 percent growth for 2011, but that was before the street protests started two weeks ago against the 30-year reign of President Hosni Mubarak.

So what really drives growth everywhere in the developed and underdeveloped countries, is the amount consumers spend and investors invest, something economists call aggregate demand. It is the amount of those assets in circulation that drives further spending and investment. Employers will not hire more employees until they see a greater demand for their products and services, in other words, and consumers will not buy more things until they have more jobs. For instance, saving or hoarding assets, as corporations and banks are now doing doesn’t stimulate growth. But spending or lending those assets so that they are in use, does.

There is also the factor of animal spirits that Nobelist George Akerlof and economist Robert Shiller conjecture in their book, “Animal Spirits”, that could account for up to 50 percent of aggregate demand. I.e., it takes a certain level of confidence to cause those monies to be put back in circulation.

And the Egyptian people know this. By bringing their economy to its knees in the now 2 week protest, they know that the Egyptian Army who is a major owner of factories, who now control from 20 to 50 percent of economic activity, must join them or its own pocketbook will be damaged.  It is an economic boycott, in other words.

Analysts at Bank of America Merrill Lynch said Egypt's annual economic growth could slow even more, perhaps to 1 or 2 percent. The Egyptian economy grew by 5 percent last year. Thousands of workers at some key industries in Egypt walked off jobs or staged protests this week, apart from the Cairo-focused demonstrations against the government.

Egypt's economy has not come to a complete halt with the protests, but the effects have been widespread, report various news agencies. The government reported that about one million tourists fled the country in the first nine days of the protests. The vital Asia-to-Europe shipping link through the Suez Canal is still operating but 6,000 workers in the canal zone have started a sit-down strike.

And numerous international companies have shut their operations in Egypt and laid off workers. Norway's Statoil said it was no longer drilling in Egypt. The country's stock market is still closed and not scheduled to reopen until next Sunday.

We therefore see that the Army, in particular, must accede to the strikers’ demands, including a lifting of emergency regulations that have been in effect for 30 years.

And the Obama Administration also knows this. "We're certainly mindful of the economic impact. We're certainly monitoring it closely," said Ben Rhodes, White House deputy national security adviser for communications. Egypt's turmoil is costing the country about $310 million a day, according to an analysis from Credit Agricole bank. The impact on commerce included a 1.6 percent drop in revenue in January from December for the Suez Canal, a vital source of income.

Rhodes, speaking in a conference call with reporters, said that "insufficient steps" by the Egyptian government to meet the demands of protesters were exacerbating the economic woes. President Barack Obama and his aides have urged Egyptian President Hosni Mubarak's government to move more quickly on a transition of power and to do more to engage a broad swath of Egyptian society in talks on the country's political future.

"The way to move out of this period of instability into one of greater stability is for the government to take concrete action, to demonstrate irreversible political progress (and) to get into a set of negotiations with the opposition," Rhodes said. "Stability is not going to come from the status quo. It's going to actually come from steps that demonstrate meaningful change and to channel this into a set of negotiations that lead to free and fair elections," he added.

Harlan Green © 2011

Are Consumers Beginning to Play?

The Mortgage Corner

Big news. At long last, shopping looks like fun again. Consumers have pulled out their credit cards for the first time in many months, according to the Federal Reserve. And this will boost economic growth in 2011. Consumer credit rose $6.1 billion in December showing, for the first time in the recovery, gains for both revolving (credit card) and non-revolving credit (installment). Revolving credit, up $2.3 billion, rose for the first time in 27 months. Consumers are buying more cars even with higher gas prices, it seems. Non-revolving credit, reflecting strength in vehicle sales, extended its run of strength with a gain of $3.8 billion.

The quarterly uptick is a huge upward pivot, at an annual plus 2.6 percent in the fourth quarter vs negative 1.7 percent in the third quarter. The rise in revolving credit is important, reflecting the strength of the holiday shopping season and the new confidence among consumers to finance their purchases once again with their cards. And note a continuing drop in the household debt-to-income ratio, which means incomes are rising at the same time.

Motor vehicle sales in particular are approaching pre-recession levels. Vehicles sales have been on a steady uptrend since the 2009 drop off after the end of “cash for clunkers.” Sales of domestic light motor vehicles in January sold at a healthy 9.6 million rate, up 2 percent from prior month. Combined domestics and imports rose fractionally in January to a 12.6 million.  For the month, sales were strongest for the cars component of domestic units, up 2.9 percent, while the weakest was for import cars, down 6.2 percent.

Holiday sales over the last two months have been quite good, says the Commerce Dept.  But there are several stories in the details, according to Econoday. Overall retail sales in December rose 0.6 percent after jumping 0.8 percent the month before. 

A key source of strength in recent months has been the autos which advanced 1.1 percent in December, following gains of 0.2 percent in November and 5.4 percent in October. For the latest month, excluding autos, sales were not quite as strong, rising 0.5 percent, following a 1.0 percent surge in November. Analysts had called for a 0.7 percent gain.  With moderate pent up demand, this category likely will keep retail sales on an uptrend in coming months.

Another reason consumers are willing to shop are that prices are still being discounted. The Personal Consumption Expenditure (PCE) Index most favored by the Federal Reserve still shows very little inflation, as we say in our Financial FAQs column.

Though so-called headline inflation has been rising of late—mostly due to higher commodity prices elsewhere in the developing world—the core rate without food and energy prices continues downward.

Harlan Green © 2011

When is Inflation a Problem?

Financial FAQs

Does it seem like the price of everything is rising these days—particularly food and gas prices? It really depends on who you talk to, and this is reviving the age-old debate between deficit hawks and doves. The old saw that inflation is first and foremost a monetary phenomenon was coined in the 1950s. Thank you, Milton Friedman, for the most simplistic formula ever to come out of academia.

Of course, he meant that inflation depended on the amount of money in circulation vs. the amount of goods available to purchase—the most basic Law of Supply and Demand. Wars tend to be more inflationary, because employment is high while much of production is tied up in making guns instead of butter. During recessions such as we just experienced, on the other hand, there is a surplus of goods and deficit of money in circulation. Fewer people are working, in other words, so they can’t buy as much.

And right now we are in a disinflationary trend—which means prices are falling, but there is still some inflation—vs. outright deflation such as Japan is still experiencing, where wages and prices are actually shrinking.

What is making the deficit hawks nervous is that headline inflation—i.e., overall inflation including food and energy prices—has been steadily rising since July, 2010. This is using the Personal Consumption Expenditure price index, which is the best overall measure of domestic prices. But the core rate without food and energy prices hasn’t budged. Why? Because consumers aren’t buying enough of the products and services affected by food and energy prices—such as motor vehicles (though demand for vehicles is rising).

Therefore, the overall inflation trend is still downward. The core rate came in unchanged after edging up 0.1 percent in November. On a year-ago basis, headline PCE prices are up 1.2 percent, compared to 1.1 percent in November. Core inflation eased to 0.7 percent year-on-year versus 0.8 percent in November.

What is happening to interest rates? Longer term rates are rising in tandem with the rising loan demand from consumers and businesses, as evidenced by the Treasury Yield Curve. Employment is picking up, in other words. Approximately 1 million jobs were created last year, of the more than 8 million jobs lost during the recession, and the unemployment rate has dropped to 9 percent from its 9.8 percent high.  But short term rates that control the Prime Rate and mortgage ARM indexes are still close to zero because of the Fed’s QE2 program of buying back Treasury Bonds.

So inflation is still way below the Fed’s ‘implicit’ target range of 1.5 to 2 percent. That is why the Fed wants to continue with QE2. Right now, the emphasis has to be on creating jobs, and keeping the inflation rate from falling further. For, falling prices mean lower profits for employers, which mean shedding jobs rather than adding them.

Then why are food and energy prices rising, if inflation is still low? Firstly, food prices have been rising because of major droughts in Russia, China and parts of Africa; major bread baskets of the world. And energy prices are rising because of rising energy us from the developing countries—including major population centers like China, India, and Brazil.

This means those prices are totally out of Federal Reserve control. In fact, some energy inflation is good because it speeds up incentives to convert to alternative fuels, which means cleaner energy use and less dependence on Middle East oil.

What about our soaring budget deficit? That is the other reason the Fed is pushing down interest rates. Right now, the costs of borrowing are at record lows. Something like just 10 percent of the federal budget goes to interest payments. So raising interest rates would only increase the budget deficit.

There is more good news on the hiring front. The Labor Department’s latest Job Openings and Labor Turnover Survey (JOLTS) said the number of job openings in December was 3.1 million (yellow line on graph), which was little changed from 3.2 million in November. Since the most recent series trough in July 2009, the level of job openings has risen by 0.7 million, or 31 percent. In December, about 4.162 million people lost (or left) their jobs, and 4.184 million were hired (this is the labor turnover in the economy) adding 20 thousand total jobs. Even with the decline in December, thought, job openings (yellow) are up significantly over the last year.

So there is a connection between inflation and interest rates. Rising interest rates are a sign that more money is in circulation—i.e., the demand for its use is rising. And that is a good thing at present. But inflation is more closely connected to employment, and past history says that inflation only becomes a problem when we get close to full employment—which is in the 6 percent range. That last happened in 2006 at the top of the housing and credit bubbles. And we are a long way from that place today.

Harlan Green © 2010

Higher GDP Growth = More Jobs

Popular Economics Weekly

The economy expanded at a 3.2 percent annual rate in the fourth quarter of 2010, according to the preliminary report on gross domestic product (GDP) from the Commerce Department.  Final sales of goods and services — a better measure of underlying demand than GDP — grew at a blistering 7.1 percent annual rate, offering hope for job creation going forward.

Although last Friday’s unemployment report was subpar, it was mostly due to weather.  The  Bureau of Labor Statistics estimated that 886,000 workers either stayed home, or weren’t hired because of the horrific weather, which translates into 100-200,000 jobs lost that would have been counted in better weather, according to Barron’s economist Gene Epstein.  So look for a big jump in job creation next month.

The pace of monthly job losses slowed dramatically soon after President Obama and Congress enacted the Recovery Act in February 2009. The trend in job growth this year has been difficult to discern because of the rapid ramp-up and subsequent decline in government hiring for the 2010 Census (which is now largely over), but private employers added a total of 1.3 million jobs to their payrolls in 2010, an average of 112,000 jobs a month.

The bottom line is that final sales, which are sales made by domestic producers, have picked up significantly, which means employment has to pick up.  Growth in real final sales to domestic purchasers (takes out net exports) picked up to 3.4 percent, following a 2.6 percent boost in the third quarter, almost in line with the increase in consumer retail sales. 

The first indication of a jobs pickup in the New Year is the Institute of Supply Management’s manufacturing survey, which increased across the board. Indicating a true surge underway in the nation's manufacturing sector, the ISM composite index jumped nearly 2-1/2 points to a rare plus 60 reading at 60.8 for a seven-year high (prior month revised to 58.5). New orders are the leading component, up nearly six points to 67.8 in a gain that points to a run of 60 readings ahead for the composite index. The other four components of the composite also show month-to-month acceleration including employment which is also in rare territory at 61.7 for a nearly two-point gain and the first plus-60 reading in seven years.

Another sign of increased employment is the rise in personal incomes and spending, which means consumers feel more confident about their jobs. Both income and spending continued to advance at the consumer level in December. Personal income in December rose 0.4 percent for the second month, while real personal consumption expenditures is rising at almost 3 percent annually.

GDP got a nice lift from the consumer sector (i.e., retail sales) last quarter and it looks like the consumer mood is improving slightly this quarter. This past week both the Conference Board’s consumer confidence index and the Reuters/University of Michigan consumer sentiment index improved from their prior readings. Consumer confidence picked up sharply in January led by a big improvement in the assessment of the jobs market. The Conference Board's index jumped more than seven points in January to 60.6 with those saying jobs are currently hard to get falling more than 2-1/2 percentage points to 43.4 percent for the best reading in two years.

The University of Michigan consumer sentiment index Consumer optimism is as strong as it's been since mid-year based on the implied second-half January reading of the consumer sentiment index. The index rose 1.5 points to 74.2 from the mid-month reading of 72.7.  For final January, details show special strength in expectations, the index's leading component which is also at its best level since June.

On the inflation front, the PCE price index jumped 0.3 percent, following a 0.1 percent uptick in November. But the he core rate came in unchanged after edging up 0.1 percent in November. On a year-ago basis, headline PCE prices are up 1.2 percent, compared to 1.1 percent in November. Core inflation eased to 0.7 percent year-on-year versus 0.8 percent in November.

So it should mean a surge in hiring this year with both employers and employees more optimistic about future prospects. And inflation looks to be at the bottom end of the Fed’s range, so the Fed is in no hurry to raise interest rates. Such low interest rates also mean real estate has the chance to improve this year.

Harlan Green © 2010

Productivity Soaring--Where Are the Jobs?

Financial FAQs

In spite of Mideast unrest (when was it restful?), and the massive snow job hitting most of the U.S. (the biggest storm of the century?) the output of goods and services continues to improve. Businesses through the fourth quarter made the most of the workers already on payrolls, while resisting any temptation to add new employees to their payrolls. At some point, however, businesses will have to boost hours and hiring to grow, says Econoday, of the latest Labor Dept. release on labor productivity.  Where are those jobs coming from?

Unit labor costs—which make up two-thirds of product costs—are at record lows, which is why corporate profits are soaring while wages and salaries are basically stagnant. Businesses are still keeping a rein on labor costs, in other words. Workers are again producing as much as prior to the recession, but with approximately 7.2 million fewer jobs, according to Barron’s. This is while real compensation per hour adjusted for inflation actually fell 0.6 percent.

Nonfarm business productivity itself rose an annualized 2.6 percent in the fourth quarter after gaining 2.4 percent in the prior quarter. This gain in productivity reflects increases of 4.5 percent annualized in output in the nonfarm business sector and 1.8 percent in hours worked. Annual average productivity is up a whopping 3.6 percent, the highest in this decade.

Meanwhile initial jobless claims, the best predictor of job growth, continued to edge downward offering some hope to the unemployed, but remained above the crucial 400,000 weekly number that signals enough jobs are being created to absorb new entrants to the labor force. A weather-related pile up of claims in the South unwound in the January 29 week which saw initial claims fall a very steep 42,000 to 415,000 (prior week revised 3,000 higher to 457,000).

Alabama, Georgia, North Carolina and South Carolina posted some the biggest declines after the four states posted big increases in the prior week due to snow effects. Distortions always put the emphasis on the four-week average which, unfortunately, is signaling trouble for tomorrow's monthly employment report. The four-week average is up 1,000 to 430,500 to show a roughly 15,000 rise from a month ago.

So the employment component of the ISM's non-manufacturing (service sector) survey, a reading that offers a broad measure of labor demand, is more closely watched than ever since the service sector makes up two-thirds of our economic activity. This index jumped nearly two points in January to 54.5, by far the best reading of the recovery and pointing to a positive surprise for tomorrow's big employment report.

January's ISM non-manufacturing results are very similar to its report on the manufacturing side released on Tuesday. Gains are wide and convincing led by a nearly 2-1/2 point jump in the headline composite index to 59.4, also a recovery best. Details show especially strong monthly acceleration for new orders, a reading that points to greater acceleration for the broad economy in the months ahead.

The pace of monthly job losses have slowed dramatically soon after President Obama and Congress enacted the Recovery Act in February 2009, as we have said, but is lagging past recoveries when job growth was as high as 6 percent, vs. the current paltry 2 percent growth rate. The trend in job growth this year has been difficult to discern because of the rapid ramp-up and subsequent decline in government hiring for the 2010 Census (which is now largely over), but private employers added a total of 1.3 million jobs to their payrolls in 2010, an average of 112,000 jobs a month.

The latest unemployment report showed the jobless rate dropping to 9 percent, with 600,000 more jobs added in the Household survey.  The payroll survey said most of those jobs were in manufacturing, in part due to the horrible winter.  Producers are only hurting themselves by hoarding their profits as they are now doing (to the tune of $2 trillion in cash on their books) instead of hiring more workers, as greater employment also means more demand for their products.

Harlan Green © 2010