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Federal Reserve: Making A Huge Mistake With Inflation

Mon, 16 Jul 2007 04:48:17 -0700

For economic commentary and market analysis, go to the Bonddad Blog

I’m not one who usually criticizes the Federal Reserve’s ideas or policy. This is an organization that is filled with some really bright people who have a very thorough understanding of economics and the economy. However, the Federal Reserve does have an underlying policy that makes little to no sense. Regarding inflation, the Fed focuses on core rather than total inflation. Below I will explain why this is a a bad policy idea and how this policy is damaging the middle class.

Core inflation is inflation less food and energy. The central idea to targeting core inflation is sound. Food and energy prices are far more volatile than core prices. Because of this volatility, food and energy prices could skew inflation higher during a shorter-term volatile price period (say 3-6 months), thereby misrepresenting the actual inflation picture. However, suppose the economy had a prolonged period of energy and food price inflation that was not seasonal, but instead was part of a longer term trend of increasing prices. Then focusing on core prices would misrepresent the underlying inflation picture by stating that inflation was too low. This is exactly the situation going on right now in the US economy. Food and energy prices are increasing at higher rates than core inflation. But the Fed is not looking at these areas of increasing prices when they set interest rate policy. As a result, the Fed is letting daily expenses of food and energy eat away at the small pay gains for most Americans.

Here's how the policy has played out for the duration of this expansion. According to the Bureau of Labor Statistics the average hourly pay of production workers was $14.74 in November 2001 when this expansion started. Pay increased to $17.28 in May 2007 for an increase of 17.28%.

Now, over the same period, the total inflation rate increased from 177.4 to 207.28 for an increase of 17.22%, making the total inflation adjusted pay gains of production workers .01%. In other words, 80% of the population isn't making any more money now than they were when this expansion began.

But using the core rate, everything looks fine. For the duration of this expansion, the core rate increased from 188.1 to 210.316 for an increase of 11.81%. That would make the core-adjusted gain of production workers salary 5.42% - which is great if you don't happen to buy food or energy.

For example, here is a chart of the year over year change in core inflation for the last 5 years.

For the Fed’s perspective, this chart indicates they don’t have to increase interest rates. Core prices are coming down and everything is fine.

However, consider this chart which is the year-over-year change in energy prices for the last 5 years:

There was some serious energy inflation for the last 5 years. While it dipped at the end of last year, it is once again on the rise. Currently, oil is over $70/bbl and while gas prices have come down, we are still at high levels. In other words, a vital expense in today’s economy has been increasing at high rates, yet this increase does not enter the Fed’s inflation calculation.

In addition, consider food prices. Here is a chart of the year-over-year change in food prices.

Notice how these prices are spiking right now. (Also note the agricultural price charts below which indicate food prices have been rising for the last two years.) Yet these price spikes aren’t entering into the Fed’s inflation equation.

Finally, here is a chart of the year-over-year change in total inflation (in blue) and the year-over-year change in core inflation (in red). Note two things. First, the blue line's left side scale is higher than the red line's right hand scale. Also note the blue line is almost consistently higher than the red line.

While total inflation has been below core for the last 9 months, note the relationship between total inflation and energy prices. Then consider the following:

World oil and gas supplies from conventional sources are unlikely to keep up with rising global demand over the next 25 years, the U.S. petroleum industry says in a draft report of a study commissioned by the government.

In the draft report, oil-industry leaders acknowledge the world will need to develop all the supplemental sources of energy it can -- ranging from biofuels to nuclear power to oil extracted by unconventional means from the oil sands of Canada -- to meet soaring demand. The surge in demand is expected to arise from rapid economic growth in such fast-developing countries as China and India, as well as mounting consumption in the U.S., the world's biggest energy market.

I address this point in a bit more detail on my blog but the short version is we have strong technical and fundamental reasons to expect higher energy prices for the foreseeable future.

Finally, consider these charts of various agricultural and energy futures. Prices are obviously increasing, yet these price increases are irrelevant to the Fed’s inflation calculation.

Cattle prices:

Corn

Gas

Oil

Soy Beans

Wheat

So – what is the implication of this policy of targeting the core inflation rate? The Federal Reserve is not addressing the increasing inflation that is eating away at pay. Food and gas prices are a necessity -- and they are prices that people have to pay every week. As these prices go higher, people will cut back on other purchases which slows overall economic growth.

If the Federal Reserve were targeting total inflation rather than core, they would have to raise interest rates further, possibly causing a recession. And that is something the Fed does not want the responsibility for. The core argument gives them an easy out.

The bottom line is the Fed is targeting the wrong inflation rate.

Please Don't Sell the WSJ to News Corp -- Pretty Please

Tue, 05 Jun 2007 08:36:28 -0700

It looks as though there is a split within the controlling shareholders of the WSJ. According to the latest news, the younger shareholders are interested in selling while the oldest shareholders are holding off. While any reports of the inner-workings of the controlling interests are by definition questionable, there is one fundamental point to all of this. The Wall Street Journal is a bastion of great business and economy reporting. Selling this paper to News Corp would mean an incredible loss the the US newspaper and business community.

First -- let's skip the debate about the editorial page. I rarely read any WSJ editorial and when I do I am almost always less than impressed (to say the least).

But the business reporting is top-notch and has been for a long time. Th WSJ is the first paper I read every morning -- and I am not alone. WSJ economic reports are written by writers who have a solid grasp of economics and write in an incredibly even-handed way. Writing about economics inherently involves the often-aggravating "on the other hand" statement. But that's the way economics is. There is never a clear-cut answer to literally any economic situation. And the WSJ's writers present all sides of the economic story with a very fair hand and excellent overall writing.

News Corp is starting a business news channel and wants the WSJ's economic writers to become denizens of all things News Corp. And here come the problem with this deal. News Corp's "news" is in fact pure, factually challenged garbage. The most recent, egregious example is confusing Representative Conyers with Jefferson. But that's just the tip of the ice berg. Neil Cavutto - Fox news' "business" editor -- provides great salacious descriptions of news, but has one of the most factually challenged business reporting styles around. The weekend "stock programs" on Fox are more pure garbage. I have watched a few episodes and was amazed that anyone would want to take any economic or investing advice from any of those programs. The short version is Fox "news" is long of sensationalism and short on substance.

And that's where the real rub comes. Fox news is a great news source if you are interested in the latest saga of the most recently kidnapped or murdered pretty white woman between the ages of 18 and 25. It's a terrible source of pure information. The Wall Street Journal is a great source of information. But selling to News Corp would ruin this reputation in a matter of years as News Corps sensationalistic presentation overcomes journalistic integrity.

So to the majority stockholders of Dow Jones -- if you are going to sell, please sell to a source that will respect over 100 years of fine business reporting.

In addition, if you are interested in real business reporting, I would highly recommend Bloomberg if the WSJ is sold.

Hey Rudy -- The 1990s Economy Was Great, You Idiot

Sat, 02 Jun 2007 16:03:24 -0700

Rudy recently made the following comment:

"This would be an astounding, staggering tax increase," Mr. Giuliani told reporters yesterday after a visit to a restaurant on the edge of California's Silicon Valley. "She wants to go back to the 1990s. ... It would hurt our economy. It would hurt this area dramatically. That kind of tax increase would see a decline in your venture capital. It would see a decline in your ability to focus on new technology."

It shows a complete ignorance of what actually happened in the 1990s, which was one of the best economic periods we will see in out lifetime.

So let's take a stroll down memory lane, shall we?

The National Bureau of Economic Research dated the 1990s cycle from March 1991 to March 2001 a full 10 years of solid economic prosperity.

According to the Bureau of Economy Analysis, the median quarterly increase in GDP was 3.3%.

According to the Bureau of Labor Statistics, total seasonally adjusted nonfarm employment increased by 23,962,000.

The unemployment rate hit a low point of 3.9% late in the cycle in 2000. Here's a chart. Notice it decreased continually.

People were also making a lot more money -- at least according to the Federal Reserve's Survey of Consumer Finances:

From the 1998 Survey

In the 1998 survey, inflation-adjusted mean and median family incomes continued the upward trend between the 1992 and 1995 surveys; they also surpassed the levels observed in the 1989 survey toward the end of the previous expansion....

From 1995 to 1998, the proportion of families with incomes of $50,000 or more rose from one-fifth to 33.8%, while the proportion with incomes below $10,000 fell about one-sixth to 12.6%.

And from the 2001 survey:

Between 1998 and 2001, inflation-adjusted family incomes rose notably faster than they did in the 1995-98 period. The median rose 9.6% percent (2.5 percent during the 1995-98 period) and the mean rose 17.4% (12.2 during the 1995-98 period).

Under Clinton, the median family income increased from 27,900 in 1992 to 32.7 thousand in 1995, 33,400 in 1998 and 39,900 in 2001. Over the same period inflation increased 28%, making the total inflation adjusted gain 15%. Average income increased from $44,000 in 1992, to $47,500 in 1995, to $53,100 in 1998 to $68,000 in 2001 for an inflation adjusted increase of 23%.

And government debt as a percentage of GDP decreased -- something the Republicans haven't done in forever.

And Clinton raised taxes in 1993 on upper level incomes. And it didnt' kill growth at all.

SO Rudy -- please shut-up about the 1990s economy, OK?

Housing: Headed Lower; Nowhere Near Bottom

Wed, 30 May 2007 04:39:28 -0700

This article is a compilation of articles from my blog, the Bonddad Blog

We've had a fair amount of news on the housing front over the last few weeks, and none of it is good. It all points to the continuing downtrend of the housing industry with a rebound still far off.

From Bloomberg:

Home prices in the U.S. dropped last quarter for the first time in almost 16 years, as 13 out of 20 cities reported declines in March.

The value of a house dropped 1.4 percent in the first three months of the year from the same period in 2006, according to a report today by S&P/Case-Shiller. Prices last fell during the third quarter of 1991.

The retreat may deter owners from tapping into home equity for extra cash, economists said. Combined with record gasoline prices, lower home prices raise concern consumer spending, which accounts for more than two-thirds of the economy, will slow.

``We don't see a big rebound in economic growth,'' said Scott Anderson, a senior economist at Wells Fargo & Co. in Minneapolis.

For anyone who is calling a bottom to the housing market, this news essentially blows you out of the water. There is no good news coming from this part of the economy right now.

Compounding the problem is the sentiment of industry insiders who don't see a rebound in homebuilding until 2011:

New home construction in the U.S. may take until 2011 to return to last year's level, said David Seiders, chief economist for the National Association of Home Builders in Washington.

Monthly construction starts would need to jump by 21 percent to reach Seiders's benchmark for full recovery, which is 1.85 million. There were 1.53 million in April, the Commerce Department said. At the height of the five-year housing boom in January 2006, construction began on 2.29 million homes.

``We've fallen way below trend because we soared way above trend during boom times,'' Seiders said in an interview. ``The upswing will be relatively slow, unlike earlier cycles.''

The inventory of unsold homes is the largest since the Chicago-based National Association of Realtors started counting them in 1999 and house prices have suffered the steepest drop since the Great Depression, according to the realtors' group. Defaults and foreclosures also may rise as about $650 billion of loans to subprime borrowers, those with poor or limited credit histories, reset at higher interest rates by 2009.

When people who build houses say it's going to be awhile, you really should listen. People who run companies are media savvy; they know their statements have weight with investors. When these people start to say the market won't rebound for awhile, you know there's a fair amount of truth to the statements.

The article points out a very important point: we're still working our way through the ARMs resets, and will be for the remainder of this year. I would guess the fallout from that part of the market will continue for at least another 6 months, and probably longer.

And inventory is still at incredibly high absolute levels.

This is from the blog Interest Rate Roundup.

* Census data on new home inventory goes back to 1963. Prior to the latest down cycle, the highest inventory level recorded was 432,000 units in August 1973. Throughout the 1980s and 1990s, it was customary to have about 300,000 to 320,000 homes for sale, with peaks (in 1989 and 1995) of around 370,000.

This time around, supply has come down somewhat from the July 2006 peak of 573,000 units. But it's clear that we still have a major inventory glut -- something on the order of 150,000-200,000 units.

* So what about the existing home market? That 4.2 million inventory reading is quite literally off the charts. My data for combined SFH+co-op+condo inventory only goes back to early 1999. Between that year and 2004, inventory typically ran in the 2 million - 2.5 million unit range. In other words, we are potentially oversupplied to the tune of 1.7 million to 2.2 million units.

If you just look at the single-family only data (3.59 million units in April 2007), it's the same story -- a historical inventory glut. This measure typically ranged from around 1.5 million units to 2.3 million units throughout the 1990s and early 2000s.

These are simple, back of the envelope calculations. They don't take into account the demand reduction that is happening as credit standards tighten thanks to the sub-prime shake-out. When you add that into the calculation, time to clear the market to decent levels greatly increases.

And then there is the recent news of new and existing home sales.

From Bloomberg:

Purchases of new homes in the U.S. unexpectedly jumped in April by the most in 14 years, a sign low lending rates and incentives may be reviving demand.

Purchases rose 16 percent to an annual pace of 981,000 last month from an 844,000 rate the prior month that was lower than previously reported, the Commerce Department said in Washington. The supply of unsold homes at the current sales pace dropped.

Lower prices and incentives offered by builders such as Centex Corp. are stirring demand for new homes after two years of falling sales. Still, a glut of unsold properties suggests homebuilding is likely to remain a drag on growth throughout this year and into 2008.

Let's add a very important piece of information from the AP:

However, the median price of a new home sold last month fell to $229,100, a record 11.1 percent decline from the previous month. The big price decline indicated that builders are slashing prices in an effort to move a huge overhang of unsold homes.

First -- I'm going on the record as saying these numbers are getting revised lower. Why? Because every major publicly-traded builder's announcements were bearish.

Toll Brothers:

Second-quarter revenue fell 19 percent to $1.17 billion.

Net contracts were down 25 percent to $1.17 billion. Net of cancellations, contracts totaled 1,647 units, down 24 percent.

The second-quarter cancellation rate was 18.9 percent, down from the prior quarter's rate of 29.8 percent, but still higher than the company's historical average of about 7 percent, Toll said.

"Given the uncertainty surrounding sales paces, and market direction and, thus, the potential for and size of future impairments, we are not comfortable giving full earnings guidance," Chief Financial Officer Joel Rassman said in a statement.

Pulte and Beazer report lower earnings (May 14, 2007):

It became more of the same this week when two more large builders -- Pulte Homes (NYSE: PHM) and Beazer Homes (NYSE: BZH) -- reported first-quarter losses and refused to issue earnings guidance for the current year.

For the quarter, Pulte recorded a net loss of $85.7 million, or $0.33 per share, compared with earnings of $262.6 million, or $1.01 a share, a year ago. With the nation's depressed housing circumstances worsening steadily, the company's revenues declined 37%. All of Pulte's seven regions experienced declining revenues, and all but the Southwest saw net new orders decline.

For its part, Atlanta-based Beazer reported a loss of $1.12 a share, versus $2.35 a share a year ago. The company's closings fell 36% for the quarter to 2,743 units, while its revenues slid 35% to $826.3 million.

"Overall, the homebuilding environment remained challenging during the first quarter of 2007, as elevated inventory levels, combined with weak consumer confidence for housing, continue to place pressure on results," said Richard J. Dugas Jr., Pulte's president and CEO, when he released his company's results.

"Challenging" -- that's a word that builders have been invoking more frequently than Aaron Burr and Alexander Hamilton ever thought to do before their famous duel. Beazer CEO Ian McCarthy took his turn when he described the climate for his company: "We continued to experience extremely challenging operating conditions during our second quarter of fiscal 2007. Most housing markets across the country continue to experience lower levels of demand, coupled with higher levels of inventory, resulting in increased competition and continued significant discounting."

Hovnanian reports loss (May 7, 2007):

On Friday, Hovnanian Enterprises (NYSE: HOV) joined several of its peers in painting a bleak picture of its markets. The homebuilder expects a total loss for the second quarter in the range of $0.45 to $0.50 per share. Of that amount, about $0.30 is expected to occur before land charges, with the remainder related to land impairments and write-offs of predevelopment costs and land deposits.

The company's net contracts for the quarter dipped about 21% to 3,116, but without the especially hard-hit Fort Myers-Cape Coral market, net contract additions would have declined just 17%.

Hovnanian's prerelease follows recent reports from other major builders, including Beazer (NYSE: BZH), Centex (NYSE: CTX), and Pulte (NYSE: PHM), all of which have declined to provide guidance on the rest of the year's results, given the climate for continued soft housing conditions. On Friday, however, Hovnanian said that when it formally releases second-quarter results, "the company expects to update its 2007 guidance to reflect the charges and operating results for the first half of the year and its expectations for the remaining quarters of the year."

Builders have lower contracts, they call the environment challenging and they refuse to give guidance. There is no mention in any of these reports of a "rebound", or "the worst is over" or similar statements.

In short, the new home sales numbers do not jibe with the latest reports from the industry. In fact, today's report is diametrically opposed to the news we have been hearing from the housing industry

We also have an 11.1% price drop. While this will obviously make homes more affordable, it indicates how far builders are going to sell homes. This is the first big drop we've seen, despite the fact the housing market has been slumping for the better part of a year. As noted above, inventory levels are still very high, making future price cuts a high possibility.

Price drops will also negatively impact the mortgage equity withdrawal and refinance markets. This will lower the amount of money consumers withdraw from their homes which will dry-up a source of funds for consumer spending.

From Bloomberg:

Sales of previously owned homes in the U.S. unexpectedly fell in April to the lowest level in almost four years, dimming prospects for a quick recovery in the housing industry.

Purchases fell 2.6 percent to an annual rate of 5.99 million last month from 6.15 million in March, the National Association of Realtors said today in Washington. A measure of the supply of homes for sale rose to the highest since August 1992.

The decline comes a day after a government report showed sales of new homes surged as buyers took advantage of a slide in prices. Today's figures suggest that owners of existing homes may have to cut prices further during the prime spring selling season. The drop also reflects the impact of banks making it tougher to get subprime loans, a response to rising defaults.

``The housing market correction won't be resolved quickly,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``Downward pressure on prices will persist and sales will be sluggish for some time.''

Here's a link to the NAR report.

There are several interesting points in this report, especially compared to yesterday's report.

1.) This report is consistent with all of the earnings releases from the major homebuilders. As I noted yesterday, no homebuilder has issued a positive report. In fact most have refused to give future guidance. Considering the housing market has been dropping for about a year now, you'd think homebuilders would be shouting "reversal" from the rooftops.

2.) According to yesterday's new home sales report, the South saw a jump of 27.8% and the West saw a jump of 8.5%. Yet in today's existing home sales numbers, the south dropped 1.2% and the west dropped 1.7%. The existing home sales market in the west is 5.4 times the size of the new home sales market, while the existing home sales market in the south is 4.24 the new home market.

The bottom line is the housing market still doesn't look that solid. The new home sales figures are suspect given the recent public announcements from homebuilders. Even if the number remains, there is still the price drop issue which will hurt consumers going forward. The existing home sales numbers are more in line with recent public announcements from the housing industry.

Going forward, we have a huge inventory to work off. And this is at time when lending standards are tightening.

This problem is going to be with us for quite awhile.

Housing Bottom -- NOT!!!!!

Fri, 25 May 2007 12:47:30 -0700

Below is a compilation of articles I posted on my blog, the Bonddad Blog

Housing is still showing big weakness. While yesterday's new home sales numbers were supposedly good, I think they are highly suspect. I will explain why below. In addition, today's new home sales numbers continued to show weakness. Short version? Housing is still not in a good place.

From Bloomberg:

Purchases of new homes in the U.S. unexpectedly jumped in April by the most in 14 years, a sign low lending rates and incentives may be reviving demand.

Purchases rose 16 percent to an annual pace of 981,000 last month from an 844,000 rate the prior month that was lower than previously reported, the Commerce Department said in Washington. The supply of unsold homes at the current sales pace dropped.

Lower prices and incentives offered by builders such as Centex Corp. are stirring demand for new homes after two years of falling sales. Still, a glut of unsold properties suggests homebuilding is likely to remain a drag on growth throughout this year and into 2008.

Let's add a very important piece of information from the AP:

However, the median price of a new home sold last month fell to $229,100, a record 11.1 percent decline from the previous month. The big price decline indicated that builders are slashing prices in an effort to move a huge overhang of unsold homes.

First -- color me really surprised.

However, let's look a bit deeper at some of the housing news.

Toll brothers reports decline (posted yesterday):

Second-quarter revenue fell 19 percent to $1.17 billion.

Net contracts were down 25 percent to $1.17 billion. Net of cancellations, contracts totaled 1,647 units, down 24 percent.

The second-quarter cancellation rate was 18.9 percent, down from the prior quarter's rate of 29.8 percent, but still higher than the company's historical average of about 7 percent, Toll said.

"Given the uncertainty surrounding sales paces, and market direction and, thus, the potential for and size of future impairments, we are not comfortable giving full earnings guidance," Chief Financial Officer Joel Rassman said in a statement.

Pulte and Beazer report lower earnings (May 14, 2007):

It became more of the same this week when two more large builders -- Pulte Homes (NYSE: PHM) and Beazer Homes (NYSE: BZH) -- reported first-quarter losses and refused to issue earnings guidance for the current year.

For the quarter, Pulte recorded a net loss of $85.7 million, or $0.33 per share, compared with earnings of $262.6 million, or $1.01 a share, a year ago. With the nation's depressed housing circumstances worsening steadily, the company's revenues declined 37%. All of Pulte's seven regions experienced declining revenues, and all but the Southwest saw net new orders decline.

For its part, Atlanta-based Beazer reported a loss of $1.12 a share, versus $2.35 a share a year ago. The company's closings fell 36% for the quarter to 2,743 units, while its revenues slid 35% to $826.3 million.

"Overall, the homebuilding environment remained challenging during the first quarter of 2007, as elevated inventory levels, combined with weak consumer confidence for housing, continue to place pressure on results," said Richard J. Dugas Jr., Pulte's president and CEO, when he released his company's results.

"Challenging" -- that's a word that builders have been invoking more frequently than Aaron Burr and Alexander Hamilton ever thought to do before their famous duel. Beazer CEO Ian McCarthy took his turn when he described the climate for his company: "We continued to experience extremely challenging operating conditions during our second quarter of fiscal 2007. Most housing markets across the country continue to experience lower levels of demand, coupled with higher levels of inventory, resulting in increased competition and continued significant discounting."

Hovnanian reports loss (May 7, 2007):

On Friday, Hovnanian Enterprises (NYSE: HOV) joined several of its peers in painting a bleak picture of its markets. The homebuilder expects a total loss for the second quarter in the range of $0.45 to $0.50 per share. Of that amount, about $0.30 is expected to occur before land charges, with the remainder related to land impairments and write-offs of predevelopment costs and land deposits.

The company's net contracts for the quarter dipped about 21% to 3,116, but without the especially hard-hit Fort Myers-Cape Coral market, net contract additions would have declined just 17%.

Hovnanian's prerelease follows recent reports from other major builders, including Beazer (NYSE: BZH), Centex (NYSE: CTX), and Pulte (NYSE: PHM), all of which have declined to provide guidance on the rest of the year's results, given the climate for continued soft housing conditions. On Friday, however, Hovnanian said that when it formally releases second-quarter results, "the company expects to update its 2007 guidance to reflect the charges and operating results for the first half of the year and its expectations for the remaining quarters of the year."

In short, today's numbers do not jibe with the latest reports from the industry. In fact, today's report is diametrically opposed to the news we have been hearing from the housing industry

However, let's assume the Census does not revise these numbers lower. We still have an 11.1% price drop. While this will obviously make homes more affordable, it will also negatively impact the mortgage equity withdrawal and refinance markets. This will lower the amount of money consumers withdraw from their homes which will dry-up a source of funds for consumer spending.

From Bloomberg:

Sales of previously owned homes in the U.S. unexpectedly fell in April to the lowest level in almost four years, dimming prospects for a quick recovery in the housing industry.

Purchases fell 2.6 percent to an annual rate of 5.99 million last month from 6.15 million in March, the National Association of Realtors said today in Washington. A measure of the supply of homes for sale rose to the highest since August 1992.

The decline comes a day after a government report showed sales of new homes surged as buyers took advantage of a slide in prices. Today's figures suggest that owners of existing homes may have to cut prices further during the prime spring selling season. The drop also reflects the impact of banks making it tougher to get subprime loans, a response to rising defaults.

``The housing market correction won't be resolved quickly,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``Downward pressure on prices will persist and sales will be sluggish for some time.''

Here's a link to the NAR report.

There are several interesting points in this report, especially compared to yesterday's report.

2.)According to yesterday's new home sales report, the South saw a jump of 27.8% and the West saw a jump of 8.5%. Yet in today's existing home sales numbers, the south dropped 1.2% and the west dropped 1.7%. The existing home sales market in the west is 5.4 times the size of the new home sales market, while the existing home sales market in the south is 4.24 the new home market.

Housing Still Stinks; Impacting Other Areas of the Economy

Wed, 16 May 2007 04:39:44 -0700

The following is a compilation of posts from my Blog, the Bonddad Blog.

The hits just keep coming in the housing market. For all of those calling a bottom, well, it just isn't happening yet. The news continues to indicate the housing market will continue to disappoint for the foreseeable future.

From Bloomberg:

U.S. home prices tumbled to a two-year low in the first quarter, with declines in almost half of U.S. cities, the National Association of Realtors said.

The median price for houses and condominiums slid 1.8 percent to $212,300 in the first three months of this year, the lowest since the first quarter of 2005 when it was $199,700, the Chicago- based real estate trade group said. The median price for a single- family home fell in 62 of 145 metropolitan areas.

Tumbling prices sparked an increase in sales as bargain shoppers snapped up the cheaper properties. Seasonally adjusted, home sales rose 2.4 percent to an annualized 6.41 million from 6.26 million in the fourth quarter, the association said. Compared with a year earlier, the number of sales fell 6.6 percent.

Let's coordinate this data with some other news from the lending front.

U.S. banks dramatically tightened their standards for approving residential mortgages in the first quarter, the Federal Reserve said Monday

In particular, banks made it harder to get subprime residential mortgage loans and nontraditional loans such as interest-only loans, the Fed reported.

All told, at least 23 of the 53 domestic banks surveyed, or 43%, tightened their mortgage lending standards, up from 16% in the fourth quarter. The latest data are not strictly comparable to previous numbers, because the Fed has changed the wording of its questionnaire. Read the Fed survey.

In its quarterly senior loan officer survey, the Fed said 31% of banks surveyed "considerably" tightened credit standards for subprime loans, while 25% of banks tightened those rules "somewhat." None eased standards.

Prices are dropping for two reasons.

1.) There's a ton of supply on the market still. According to the Census Bureau, the available inventory of new homes for sale was 553,000 in March 2006 and 545,000 in March 2007 -- a year over year decline of 1.44%. According to the National Association of Realtors, the inventory of existing homes was 3,198,000 in March 2006 and 3,745,000
in March 2007 -- an increase of 17.1%. In other words, after a year of declining sales, there is still a ton of inventory on the market.

In my neighborhood there are 5 vacant houses that I know of. I realize that's an informal survey of a small neighborhood in Houston, Texas, but it's indicative of what's happening at the macro-level. It's going to take a larger price drop to get things back to normal.

2.) It's harder to get a bank loan now. A small majority of banks tightened lending standards and none loosed standards. This means banks understand they are getting hurt from their looser standards of the last few years. As loans dry-up, demand will drop, which means there is added downward pressure on home prices right now.

The above factors played into another decline in builder confidence:

Ongoing concerns about subprime-related problems in the mortgage market caused builder confidence about the state of housing demand to decline three more points in May, according to the National Association of Home Builders/Wells Fargo Housing Market Index (HMI), released today. With a current reading of 30, the HMI has now returned to the lowest level in its current cycle, which was previously hit in September of 2006.

“Builders are feeling the impacts of tighter lending standards on current home sales as well as cancellations, and they are bracing for continued challenges ahead,” said NAHB President Brian Catalde, a home builder from El Segundo, Calif.

“The crisis in the subprime sector has infected other parts of the mortgage market as well as consumer psychology, and as a result the housing outlook has deteriorated,” added NAHB Chief Economist David Seiders. “We’re now projecting that home sales and housing production will not begin improving until late this year, and we’re expecting the early stages of the subsequent recovery to be quite sluggish. There still are tremendous uncertainties regarding our baseline forecast going forward, owing largely to the subprime crisis that is having widespread effects throughout the mortgage market.”

.....

All three component indexes declined in May. The index gauging current single-family sales slipped two points to 31, while the index gauging sales expectations for the next six months fell three points to 41 and the index gauging traffic of prospective buyers fell four points to 23.

Here's a chart from the blog Calculated Risk that shows just how confident builders are:

And the housing market problems are starting to bleed into other areas of the economy:

The Home Depot Inc. posted a 29.5 percent drop in first-quarter profit Tuesday and warned the rest of the year will be challenging. The company also said it still hasn't decided the fate of its wholesale distribution arm three months after announcing it might shed the unit.

Home Depot had 90 billion in sales at the end of 2007.

And it's also impacting car sales:

GM noted the entire market was "a little weakish." Why? Reduced ability to pull out equity and spend it, not just at GM, "but across the industry."

And the CEO of Autonation weighs in:

Mr. Jackson said AutoNation expects 2007 U.S. auto sales "in the low 16-million range" and down from their 2006 level. He said the slump in home values has kept many consumers from buying new cars, especially in California and Florida, which account for 20% of new-vehicle sales in the U.S.

Florida, where real estate speculation pushed up home prices in the past several years, now has one of the highest rates of foreclosures in the nation, Mr. Jackson said. In California, many home owners have adjustable rate mortgages that have risen recently, eating up disposable income they might have used to buy new vehicles, he said.

As I've been saying for about a year now, we're nowhere near the bottom in the real estate market right now. And the impact is starting to spread into other areas of the economy.

Is Copper Signaling a Recession?

Sat, 06 Jan 2007 05:57:21 -0800

For market and economic commentary, go to the Bonddad Blog

From CBS MarketWatch

A sell-off in commodities -- from copper to crude oil -- over the past few sessions is telling some veteran market watchers that a slowdown in economic growth, likely one of considerable magnitude, is already underway.

In the last two days alone, commodity prices seem to have fallen off a cliff. Copper futures, which tumbled 7.7% on Wednesday, fell another 1.8% on Thursday -- and have dropped 27% from their December highs.

Crude-oil prices fell nearly 5%, following a 4% drop in the previous session. The front-month futures contract was trading at its lowest level since June 2005. See Futures Movers.

Here's a daily copper chart. The price has gapped down and continued downward last week:

The reason copper is predictive?

Most commodities are used in the production of industrial goods. When producers start demanding fewer raw materials, it becomes noticeable in commodities prices much earlier than in official economic statistics, explained Barry Ritholtz, chief market strategist at Ritholtz Research & Analytics.

Copper, in particular, is often used as a reliable economic indicator because of its widespread use in production.

"Copper is the metal with a Ph. D. in economics," Ritholtz said. "It's used in the wiring of homes and offices, in plumbing in construction, and it's also a key component in electronic goods.

High stockpiles are one of the reason for the drop in copper prices:

Stockpiles of copper monitored by the LME have doubled since the start of last year. The exchange said earlier today copper stocks held in its warehouses had risen another 1,700 tonnes to total 194,875 tonnes

However it also reported that cancelled warrants, which represent warehouse stocks booked and due for delivery, have climbed to just over 17,000 tonnes, suggesting copper might soon start leaving LME warehouses

"With the large inflows of metal believed to be nearing an end, net falls in LME stocks could start to resume, which would support prices," said UBS Investment Bank analyst Robin Bhar

Simple supply and demand comes into play here. Higher supply = lower price.

Bloomberg has a bit more to flesh out the story:

Copper prices in New York had the biggest weekly decline in 10 years as slower U.S. economic growth and a building slump reduced demand for the metal used in homes, appliances and cars.

Global stockpiles are at the highest since June 2004.

The U.S. economy grew at the slowest pace of 2006 in the third quarter, led by a decline in homebuilding. Builders are the biggest consumers of copper. Prices tumbled 12 percent this week, touching a nine-month low.

``I don't think anybody has predicted it would go this low,'' said Karen Poniachik, Chile's mining and energy minister and chairwoman of state-owned Codelco, the world's biggest copper producer.

According to Bloomberg, the slowdown in the US housing market is a prime reason for the drop:

Construction spending fell for a third month in November as homebuilding fell by 1.6 percent, the eighth-straight drop, the Commerce Department said this week. Fewer Americans signed contracts to buy previously owned homes in November, suggesting continuing weakness in the real estate, an industry group said yesterday.

``If overall housing sales stay slow, you could easily pare another 30 or 40 cents off of copper,'' Frank McGhee, head metals trader at Intergrated Brokerage Services Inc., said yesterday. ``Copper is a leading indicator. It's very sensitive to perceived economic conditions.''

Something to keep in mind is the futures markets have become the high tech market of the late 1990s. A ton of money flooded into the futures markets over the last 6 years. This is one of the reasons for the huge price run-ups over the same period. Increased demand = higher prices. Some of this selling may simply be people taking profits. In other words -- this could be speculators leaving the market.

However, the fundamentals indicates there may simply be weaker demand. Housing construction in the US is down. Overall stockpiles are up. This indicates copper production may be too high right now, anticipating a level of demand not warranted by the underlying economic fundamentals.

Why Clinton's Economy Was Better Than Bush's

Mon, 04 Dec 2006 06:53:04 -0800

As one of the main architect's of the Clinton economy, it's vitally important to review Robert Rubin's work in order to understand what can be done in the future. In short, Rubin's policies worked. It's that simple.

First, let's start with the balanced budget, which was part of Clinton's plan from the beginning of his Presidency.

The following is from On the Edge, by Elizabeth Drew, page 60:

Following the election [during the transition], Clinton realized there was little he could do about raising spending for his investments if he didn't tackle the deficit.....He [Clinton] gradually came to see that the debt posed a threat to what he wanted to do to spur competitiveness and economic growth, as well as to revive the economy, and was using up capital that could otherwise go to public and private investment.
(from page 73)The result was an economic program that was bold by conventional standards and did seek to reverse Reagonomics and redirect the country's economic resources from consumption to longer-term investment, and at the same time to take a major bite out of the federal budget deficit. Clinton proposed deficit cuts of $493 billion over 5 years; increased spending, most of it on longer term investments such as job training, rebuilding the nation's infrastructure, education, and promoting high-tech tax increases of $246 billion over five years; and net cuts in federal spending of $247 billion.

Clinton's economic team of Robert Rubin, Lloyd Bentson (RIP), Leon Panetta and Alice Rivlin were all deficit hawks. All continually argued for a balanced budget. ;They won. Clinton came to realize the importance of balanced budgets.

But, why is a balanced federal budget so important?

It prevents crowding out. This is a fancy way of saying money that would finance the federal budget deficit is instead invested in private capital. Let me use the current situation as an example. According to the Congressional Budget Office, the US had a $318 billion budget deficit in 2005. That means $318 billion dollars was not invested in the private economy, but instead invested in US government bonds. The larger the deficit, the less money available for private investment.

Psychology and uncertainty. A budget deficit detracts from individual's confidence in the market and the overall economy. As individual's look to the federal deficit, they understand that at some time the government must pay back the money it borrows. That means the government will probably have to either raise taxes (more likely) or decrease spending (far less likely whichever party is in control of the government). ;Deficits create psychological uncertainty. The larger and more persistent the deficit, the less happy people are and the less prone they are to take economic risks.

Interest rates. The government is the largest borrower in the credit markets. The treasury market is the base interest rate for other credit market borrowers. If the government has to increase the amount of debt it issues, it has to ask for a higher interest rate. The reason is simple supply and demand. When you sell more of a good, you usually have to drop the price (price and yield are inversely related). Therefore, if the government issues more debt, it has to ask for a lower price and higher yield. The inverse is also true. Lower interest rates helps anybody who wants to borrow money because they will borrow at a rate based on the US Treasury curve.

Let's coordinate three sets of data to illustrate the point. According to the Congressional Budget Office, the deficits/surpluses for years 1993-2000 were (respectively and in billions) $-255, -$203, -$164, -$21, +$69, +$125, +$236, +$128. So, the budget deficit continually decreased from 1993-1996, the budget surplus increased from 97-99 and the budget showed a surplus in 2000 although this was lower than the preceding year. In other words, the record indicates a clear path towards balancing the federal budget. This was not the result of a happy accident - it was deliberate.

One of the prime reasons why the 1990s economy was so successful is the incredible amount of confidence this gave private investors. They could look at Washington with confidence, knowing politicians managed national finances were maturity. There was no talk to the deficit - was it too high, could it be maintained at current levels, will they ever get around to fixing it etc..... Simply put, investors had a sense of certainty and confidence about the economy. This encouraged them to take risks which helped everybody.

Jobs

From an overall jobs perspective, the Clinton team created 22,759,000 from January 1993 to December 2000. This breaks down to 2.8 million jobs/year. The labor participation rate increased from 66.2% in January 1993 to 67% in December 2000. The unemployment rate decreased from 7.7% in January 1993 to 3.9% in December 2000.

The Clinton team was focused in opening up new avenues of job creation that would benefit the middle class. Previously, manufacturing was the primary economic sector the helped the middle class. Total employment in this area increased from 16,790,000 in January 1993 to 17,181,000 or an overall increase of 391,000. This isn't bad, but it certainly could be better (Under Bush, the manufacturing sector has lost 2.8 million jobs). However, the Clinton team's focus on high-tech provided new avenues of wealth creation. Total information jobs increased from 2,656,000 in January 1993 to 3,706,000 in December 2000, or an increase of 1,050,000 million (Under Bush, information services have lost 560,000 jobs).

In addition to the beneficial effects of balancing the budget, Clinton's economy was geared toward helping the middle class attain a better life. According to the Bureau of Labor Statistics, the hourly pay for non-supervisory workers increased from $10.63 in January of 1993 to $14.26 in December 2000 for an increase of 34.14%. Over the same period, the inflation measure increased from 138.1 to 174 for an increase of 25.99%. Therefore, the inflation adjusted hourly wage increased 8.15%.

Looking deeper in the data provided by the Federal Reserve's Survey of Consumer Finances for 1998, the change is apparent:

In the 1998 survey, inflation-adjusted mean and median family incomes continued the upward trend between the 1992 and 1995 surveys; they also surpassed the levels observed in the 1989 survey toward the end of the previous expansion....
From 1995 to 1998, the proportion of families with incomes of $50,000 or more rose from one-fifth to 33.8%, while the proportion with incomes below $10,000 fell about one-sixth to 12.6%.

And from the 2001 survey:

Between 1998 and 2001, inflation-adjusted family incomes rose notably faster than they did in the 1995-98 period. The median rose 9.6% percent (2.5 percent during the 1995-98 period) and the mean rose 17.4% (12.2 during the 1995-98 period).

Compare this to the 2004 survey:

The survey shows that, over the 2001-04 period, the median value of real (inflation-adjusted) family income before taxes continued to trend up, rising 1.6%, whereas the mean value fell 2.3 percent....These results stand in contrast to the strong and broad gains seen for the period 1998 and 2001 surveys and to the smaller but similarly broad gains between the 1995 and 1998 surveys.

Conclusion

The answer to the current situation of weak jobs and wage growth and runaway spending is straightforward.

1.)Balance the budget. This will require repealing some of the rich's tax breaks. My heart bleeds.

2.)Target economic areas that will create jobs. I would personally target alternative energy, nano technology and stem cell research, although there are many others.

3.)Give the middle class -- and only the middle class -- a tax break.

All we have to do is follow the directions.

Links are available here

Jim Webb Class Warrior!

Thu, 16 Nov 2006 02:23:52 -0800

Jim Webb wrote an editorial for the Wall Street Journal today titled Class Struggle. And damn if he didn't hit the ball out of the park on this one. His statements are dead-on accurate and clearly outline the basic problems of economic inequality in the US. Thank-God he wrote this editorial.

There are a ton of excellent points in the editorial. I want to highlight just a few. However I encourage you to read the whole editorial for yourself because it is that good.

The most important--and unfortunately the least debated--issue in politics today is our society's steady drift toward a class-based system, the likes of which we have not seen since the 19th century. America's top tier has grown infinitely richer and more removed over the past 25 years. It is not unfair to say that they are literally living in a different country. Few among them send their children to public schools; fewer still send their loved ones to fight our wars. They own most of our stocks, making the stock market an unreliable indicator of the economic health of working people. The top 1% now takes in an astounding 16% of national income, up from 8% in 1980. The tax codes protect them, just as they protect corporate America, through a vast system of loopholes.

The US Gini index -- which measures wealth inequality -- has steadily risen for the last 35 years. In other words, the rich are getting richer.

Here's one of the prime reasons, at least in the latest expansion:

In the age of globalization and outsourcing, and with a vast underground labor pool from illegal immigration, the average American worker is seeing a different life and a troubling future. Trickle-down economics didn't happen. Despite the vaunted all-time highs of the stock market, wages and salaries are at all-time lows as a percentage of the national wealth. At the same time, medical costs have risen 73% in the last six years alone. Half of that increase comes from wage-earners' pockets rather than from insurance, and 47 million Americans have no medical insurance at all.

Here is a chart of median US income from the Census Bureau. I should note that median income rose a little over 1% last year, but that was the first time it did so in 5 years.

Manufacturing jobs are disappearing. Many earned pension programs have collapsed in the wake of corporate "reorganization." And workers' ability to negotiate their futures has been eviscerated by the twin threats of modern corporate America: If they complain too loudly, their jobs might either be outsourced overseas or given to illegal immigrants.

Yep. Here's an ugly chart for you

I would add high-tech to that as well:

Ladies and gentlemen -- I am pleased to have this man in our party. He is talking about what the basic problems are. I hope the Dem majority starts to address these issues.

Speaker Pelosi, We've Got BIG Economic Problems, Pt. 3

Mon, 13 Nov 2006 05:01:14 -0800

Speaker Pelosi,

First, I wanted to offer my congratulations regarding the recent election. You were one of the architects of our victory, for which I and the American country as a whole are extremely grateful.

However, you will assume power at a very difficult economic time. Below are the problems you face. None offer easy answers. In fact, solving these problems will cause a fair amount of pain and difficulty, which may harm our majority's future electoral prospects.

A Slowing Economy

To top off the problems of a fiscal situation in tatters and an international trade deficit, the US economy is clearly slowing possibly moving into a recession.

Overall GDP growth is clearly decelerating:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.6 percent in the third quarter of 2006, according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.6 percent.

GDP growth has decreased from over 5% in the first quarter to 2.6% in the third to 1.6% in the third. While there is great debate within the economic community regarding what will happen in the coming quarters, consider the following.

Merrill Lynch and the Federal Reserve are both saying the possibility of a recession are increasing:

The U.S. economy is ``on a knife's edge,'' and growth may slump to less than a 2 percent pace next year unless the Federal Reserve cuts interest rates, according to Merrill Lynch & Co. economists.

``Our recession-risk indicator is now at 51 percent odds for an actual economic downturn in the coming year,'' writes David A. Rosenberg, chief North American economist at Merrill Lynch in New York, in a note today. The last time the indicator registered that high was in the recession year 2001. product growth, adjusted for inflation, compared with Rosenberg's forecast of 2 percent growth in 2007 (the blue line). The 10-year trend in real GDP growth is shown in green.

The odds of a recession in the United States in the next year are now greater than 50-50, according to a simplified version of a model developed by an economist at the Federal Reserve.
The model, which relates the shape of the yield curve to the Fed's interest rate target, has been extremely accurate at predicting recessions in the past. But economists who study the business cycle say the model may be delivering a misleading message today.
Fed economist Jonathan Wright developed the model in a paper published earlier this year, based on research by, among others, new Fed Gov. Frederic Mishkin and New York Fed economist Arturo Estrella. Read his paper.
If bond yields stay at current levels for the next three months, Wright's model would predict a recession. Current yields have been in a recession-zone for only a day so far.
In Wright's model, a steep, sustained inversion of the yield curve, combined with a relatively high federal funds rate, would point to a recession.

In addition, we have the following problems:

The housing market - which subtracted a full percentage point from 3rd quarter growth - is still falling. Housing starts have dropped 25% from their high in 2005, new home prices year over year changes are currently negative, existing home prices year over year changes are falling fast, inventory levels are shy high and undercounted, residential construction has fallen five months straight, and the US consumer is already in debt up to his eyeballs -- household debt over 90% of GDP and over 120% of disposable income.

Consumer credit is contracting, which may not bode well for the holiday shopping season.

U.S. consumer credit outstanding fell by the biggest amount since April 1992 in September as households took out fewer loans for items like automobiles and boats, the Federal Reserve said Tuesday.
Total consumer credit fell by $1.20 billion in September, or by a seasonally adjusted annual rate of 0.61%, to $2.366 trillion, the Fed

said.

Considering the sheer magnitude of the increase in consumer credit during this expansion, this development is not surprising:

And total household debt payments are taking a record amount of household income:

Job growth is the worst of the last 40 years:

And the recent employment reports indicate we are adding lowering-quality jobs to the economy:

But the larger point of all these numerical details -- and we apologize if you're feeling a trifle numbed by numbers -- is that the bulk of jobs being added are not big payers, and the bulk of the jobs being lost are."

Productivity increases - which have buoyed this expansion - are slowing:

Productivity increased 0.1 percent in the business sector, as both output and hours grew 1.4 percent (seasonally adjusted annual rates). Nonfarm business productivity remained unchanged as output and hours both increased 1.6 percent (table A).

Finally, a select few are actually benefiting from the recent expansion. First, note how corporations are taking a record share of national income.

And finally, the rich are getting richer:

In conclusion Ms. Speaker, you have your work cut out for you. The Republicans have left a federal budget in tatters, an international trade deficit of record proportions that threatens the dollar and finally an economy built on debt and disproportionate distribution of the benefits that is near a recession. I wish I had better news for you.

Speaker Pelosi, We've Got Big Economic Problems, Pt. 2

Sun, 12 Nov 2006 06:29:45 -0800

Speaker Pelosi,

First, I wanted to offer my congratulations regarding the recent election. You were one of the architects of our victory, for which I and the American country as a whole are extremely grateful.

First I discussed the ruinous federal budget situation. Below is a discussion of the trade deficit, which is just as dangerous.

The Trade Deficit

Although the trade deficit contracted last month, it is still on path to set another record this year. To the uninitiated the trade deficit is a theoretical construct devoid of any real world application. The reality is it is a very real situation that can cause serious harm to an economy.

The trade deficit means the US consumers more than it produces. Here's a simple explanation. Suppose you and your neighbor regularly buy and sell goods to and from one another. You sell apples to your neighbor and your neighbor sells oranges to you. However, you regularly buy more oranges from you neighbor than the apples your neighbor buys from you. Therefore, on a monthly basis you have a net capital outflow - money going to your neighbor. Where does this money come from? Well first you draw down your savings. However, your savings eventually runs out. Therefore you essentially borrow money from your neighbor to pay for the excess oranges you buy. At some point your neighbor will wonder when he's actually going to get paid for all the oranges he's sold you. To compensate for his risk (the risk of not getting paid), your neighbor will eventually start to charge you a higher interest rate on the money he has lent you. Eventually, your neighbor will call in all the notes he has lent you, forcing you to either pay the entire bill or declare bankruptcy.

Former Fed chairman Paul Volcker laid out the problem about a year and a half ago:

It's not that it is so difficult intellectually to set out a scenario for a "soft landing" and sustained growth. There is a wide area of agreement among establishment economists about a textbook pretty picture: China and other continental Asian economies should permit and encourage a substantial exchange rate appreciation against the dollar. Japan and Europe should work promptly and aggressively toward domestic stimulus and deal more effectively and speedily with structural obstacles to growth. And the United States, by some combination of measures, should forcibly increase its rate of internal saving, thereby reducing its import demand.

But can we, with any degree of confidence today, look forward to any one of these policies being put in place any time soon, much less a combination of all?
The answer is no. So I think we are skating on increasingly thin ice. On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb markets, with damaging volatility in both exchange markets and interest rates. We had a taste of that in the stagflation of the 1970s -- a volatile and depressed dollar, inflationary pressures, a sudden increase in interest rates and a couple of big recessions.

Not a pretty picture is it - especially when the capital markets start to lose faith in the dollar? That has already started to happen to a small degree. Various central banks (China, Russia, Japan, South Korea, Taiwan and several smaller countries) around the globe have already started to diversify away from the dollar as their primary reserve currency, opting to create a portfolio composed of dollars, yen and euros. There is - in essence - a giant game of international chicken going on right now as central banks attempt to get rid of any risk associated with a possible run on the dollar without they themselves causing the initial panic. It's a difficult game that offers not easy solutions.

As with the budget deficit, there are no simple or easy answers to this problem in the short run. However, in the long run there are some good possibilities and options.

Increasing energy independence will help. As the Federal Reserve Bank of San Francisco recently noted:

Oil prices have almost quadrupled since the beginning of 2002. For an oil-importing country like the U.S., this has substantially increased the cost of petroleum imports. International trade data suggest that this increase has exacerbated the deterioration of the U.S. trade deficit, especially since the second half of 2004. One factor can explain this evolution: The real volume of U.S. petroleum imports has remained essentially constant. One explanation for why the demand for petroleum imports has not declined in response to higher prices comes from a model in which firms are fairly limited in their ability to adjust their use of energy sources, such as oil, in the short term.

Secondly, measures that will force China to allow its currency to rise to market rates will help to alleviate some of the problem with Chinese imports. However, this is not a cure-all. It will help, but it will not solve the problem. A simple revaluation will lower the trade imbalance with China; it will not solve it.

Third, it is imperative we start to move from a consumption-based economy to a more balanced economy of production and consumption. Currently, 70% of US GDP growth comes from consumer spending. This has resulted in policies that promote consumption at the expense of savings. The US savings rate has been negative for the last 5 quarters. Therefore, policies that promote savings will slow consumer spending, which will in turn lower consumer consumption, which will in turn lower the trade deficit. This will lower overall GDP growth in the short-term. However, it will also allow the US to build-up savings reserves. This will increase banking reserves increasing the pool of capital banks have available to lend. This will help to lower interest rates, encouraging business borrowing which will increase our productive capacity.

Finally, we must develop policies that promote the creation of business that increase our exports. There are several areas that come to mind: alternate energy, nano-technology and stem cell based business. (I am sure there are countless others; however, these three spring to mind). These are businesses that play to American's technical know-how and which our sophisticated capital markets can finance.

None of these proposals will solve the problem overnight. In fact, these are policy answers that will require up to a decade to successfully implement. However, they will help to gradually lower the problem. It will take discipline and concerted effort. However, if you implement them they will solve the basic problem and take downward pressure away from the dollar.

Speaker Pelosi, We've Got BIG Economic Problems, Pt. 1

Fri, 10 Nov 2006 12:15:16 -0800

Speaker Pelosi,

First, I wanted to offer my congratulations regarding the recent election. You were one of the architects of our victory, for which I and the American country as a whole are extremely grateful.

Balancing the Budget

The Bush administration and their Republican enablers have left a terrible fiscal situation. Despite entering office with a surplus, the Bush administration has once again returned to the Reagan era policy of deficit spending.

The central problem is the tax cuts have not paid for themselves in any way, shape or form. In 2001, tax revenue from individuals totaled $994 billion. At the end of fiscal 2005, they totaled $927 billion. This is a 6.7% decrease. While this number is now currently over $1 trillion, it took this administration 6 years to increase revenue from individual taxpayers (before adjusting for inflation. After adjusting for inflation, total tax revenues from individuals have decreased for the length of the Bush administration). This is the longest it has taken for any administration to accomplish this task. Another way to look at this situation is tax revenues as a percentage of GDP calculation. Over the above listed years, this number decreased from 9.9% to 7.5%.

At the same time (2001-2005), federal discretionary spending increased from $649 billion to $967 billion. Essentially the Bush administration lowered revenue and increased expenditures at an alarming rate. As a result, the Treasury has issued over $550 billion in net new debt per year for the last 4 years. This has increased the possible financial burden our children will inherit. Below is a graphical representation of the problem:

Unfortunately, there is no easy answer to this problem. Or perhaps a better way to phrase this situation is there are no politically beneficial ways to solve this problem - especially in a day and age when Right Wing hosts saturate the AM radio dial. However, we must offer solutions to this situation.

The 2003 tax cuts must be repealed. However, the timing of this event must be planned, especially with the increased possibility of a recession next year. While record low interest rates (and the resulting housing bubble) are the primary economic drivers of this expansion, the Republicans have claimed the tax cuts are the primary driver. Regrettably, their followers have bought this line of reasoning at the expense of all economic logic and common sense.

Here are several courses of attack on the Republican charges.

First, 70% of the benefits of dividend cuts and 90% of capital gains benefits went to annual incomes over $100,000. These were essentially rich people's benefits. I would strongly suggest the Democrats find spokespeople to go on right wing outlets such as Fox news and gets these facts out to the American people.

Secondly, record low interest rates are responsible for this economic expansion. Ask any economist (actually, ask anyone who has taken a macro-economic class) about the correlation between economic growth and interest rates and they will tell you the following: interest rates and economic growth are inversely related. Raise rates and the economy slows. Lower rates and the economy grows. It's that simple. Again, it is imperative you find spokespeople to make these basic points all across the media.

Navigating the terrain ahead will be difficult at best. The Republicans have done their best to leave as many land mines behind. However, this situation can be solved with a strong combination of sound policy and aggressive political strategies.

Bush's Job Record: STILL THE WORST OF THE LAST 40 YEARS

Sat, 04 Nov 2006 11:25:07 -0800

From the Bureau of Labor Services:

Employment increased in October, and the unemployment rate declined to 4.4 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Nonfarm payroll employment grew by 92,000 in October following gains of 148,000 in September and 230,000 in August (as revised). In October, job growth continued in several service-providing industries, while employment declined in manufacturing and construction. Average hourly earnings rose by 6 cents over the month.

So, how does this expansion compare to other expansions with the addition to today's number? Bush still has the worst record of job creation of any expansion in the last 40 years.

2/61 - 12/69

Beginning number of jobs: 53,556,000

Ending number of jobs: 71,240,000

Total Jobs Created: 17,684,000

Compound rate of establishment job growth: 3.283%

11/70 - 11/73

Beginning number of jobs: 70,409,000

Ending number of jobs: 77,909,000

Total Jobs Created: 7,500,000

Compound rate of establishment job growth: 3.43%

3/75 - 1/80

Beginning number of jobs: 76,649,000

Ending number of jobs: 90,800,000

Total Jobs Created: 14,151,000

Compound rate of establishment job growth: 3.56%

11/82 - 7/90

Beginning number of jobs: 88,770,000

Ending number of jobs: 109,773,000

Total Jobs Created: 21,003,000

Compound rate of establishment job growth: 2.8%

3/91 - 3/01

Beginning number of jobs: 108,542,000

Ending number of jobs: 132,504,000

Total Jobs Created: 23,962,000

Compound rate of establishment job growth: 2.01%

11/01 - ?

Beginning number of jobs: 130,883,000

Ending number of jobs: 135,884,000

Total Jobs Created: 4,526,000

Compound rate of establishment job growth: .71%

Here's a chart from Stirling Newberry to illustrate:

There are some points of concern in the latest report. First, construction lost 26,000. This means the housing slowdown is starting to hit employment levels. A conservative reading of employment for this expansion gives 30% of total growth as occurring from housing. Construction employment has been level this year. Now we are just starting to see construction employment dip.

Manufacturing lost 39,000.

Education/health increased 28,000.

Leisure and hospitality increased 35,000

Government employment increased 34,000.

Business and Professional Services increased 43,000. However -- slightly less than half of these jobs (21,000) were administrative.

Let me add this important caveat. The BLS has revised the employment figures upwards of 810,000 last month, and then revised the August and September upwards again this month. Here's the most important part: IT'S STILL THE WORST RATE AND LEVEL OF JOB CREATION IN THE LAST 40 YEARS. Despite the fact the BLS is clearly having problems of some sort with their model which is undercounting job growth, job growth -- as revised -- is still the lowest we have seen in our lifetimes.

Here's one final point: Unemployment rates have no predictive power for recessions. Take a look at this chart from Calculated Risk

Fed and Merrill: Possibility of Recession Increasing

Fri, 03 Nov 2006 13:52:45 -0800

The U.S. economy is ``on a knife's edge,'' and growth may slump to less than a 2 percent pace next year unless the Federal Reserve cuts interest rates, according to Merrill Lynch & Co. economists.

``Our recession-risk indicator is now at 51 percent odds for an actual economic downturn in the coming year,'' writes David A. Rosenberg, chief North American economist at Merrill Lynch in New York, in a note today. The last time the indicator registered that high was in the recession year 2001. product growth, adjusted for inflation, compared with Rosenberg's forecast of 2 percent growth in 2007 (the blue line). The 10-year trend in real GDP growth is shown in green.

Rosenberg has been fairly bearish for the better part of a year that I know of. He was one of the first economists to point out the weak job growth of the Bush administration along with this economy's heavy reliance on housing. The fact his model is calling for a recession indicates other Wall Street economists are probably starting to think the same thing in one capacity or another. The Fed certainly is:

The odds of a recession in the United States in the next year are now greater than 50-50, according to a simplified version of a model developed by an economist at the Federal Reserve.
The model, which relates the shape of the yield curve to the Fed's interest rate target, has been extremely accurate at predicting recessions in the past. But economists who study the business cycle say the model may be delivering a misleading message today.
Fed economist Jonathan Wright developed the model in a paper published earlier this year, based on research by, among others, new Fed Gov. Frederic Mishkin and New York Fed economist Arturo Estrella. Read his paper.
If bond yields stay at current levels for the next three months, Wright's model would predict a recession. Current yields have been in a recession-zone for only a day so far.
In Wright's model, a steep, sustained inversion of the yield curve, combined with a relatively high federal funds rate, would point to a recession.

The yield curve has been inverted at varying times and at varying degrees since the beginning of the year. In case you are wondering why, here's a brief and overly simplistic explanation of the yield curve. Federal Reserve interest rate policy has the most impact on the short end of the yield curve - say 2 years and under. When the Fed raises rates, the short of the yield curve increases and visa versa.

However, inflation expectations govern the long end of the yield curve. When bond traders think inflation is increasing they sell bonds which increases interest rates. When traders think inflation is decreasing, they buy bonds which decreases interest rates. As a corollary, inflation usually increases in an economic expansion and decreases in an economic contraction. So, if the Fed is increasing interest rates the short end increases and if traders think inflation is decreasing because of a slowing economy they buy bonds sending long-term rates lower.

There are no economic predictors that predict a recession with 100% accuracy, and an inverted yield curve is no exception. However, add to that a contracting housing sector, mountains of household debt, the weakest job growth of the last 40 years, and stagnant wage growth and you have problems.

Tax Cuts? There Weren't Any.

Wed, 01 Nov 2006 06:58:33 -0800

Over substantial Democratic opposition, Bush and a Republican-controlled Congress have cut taxes significantly over the past six years. The problem is that -- with plenty of cooperation from Democrats -- they have also greatly increased spending.
From fiscal 2001 to 2006, federal outlays shot up 42 percent, more than double the 19 percent increase over the previous five years.
In the short run, you can cut taxes and spend more. In the long run, as Nobel laureate economist Milton Friedman has potently argued, to spend is to tax.
In that vein, economist V.V. Chari of the University of Minnesota explained at a conference for journalists on Oct. 17, ``The true burden of government is what it spends today and in the future.'' When a politician brags, ``I cut your taxes,'' that's not what really matters, he said.

No matter how you describe it, Bush's tax cuts (90% of which went to the top 10% of income earners) are really tax deferrals. The reason is simple: THE FISCALLY CONSERVATIVE REPUBLICAN MAJORITY SPENDS FAR WORSE THAN "TAX AND SPEND" LIBERALS.

According to the Congressional Budget Office, discretionary spending increased from $649 billion in 2001 to $947 billion in 2005. Over the same period, discretionary spending increased as a percentage of GDP from 6.5% to 7.9%. Over the same period, the Bush "individual tax revenue miracle" is actually near stagnant. According to the same source and over the same time period, tax revenue from individuals decreased from $994 billion to $927 billion. Individual income tax receipts as a percentage of GDP decreased from 9.9% in 2001 to 7.5% in 2005. The bottom line is simple: revenues decreased and spending increased.

This means the total net amount of debt issued had to increase, and the record indicates it certainly did. According to the Bureau of Public Debt, the US Treasury has issued over $550 billion dollars in debt each year for the last 4 years. This indicates the deficit is nowhere near under control.

When a government spends money, it commands resources that are no longer available for use by the private sector. If it chooses to borrow the money rather than levying taxes to finance transfer payments and the purchase of goods and services, the government is only postponing the inevitable taxes, Chari said.

I want to give special kudos to John Berry - the article's author - for the following paragraph. Notice how he mentions the White Houses deliberate obfuscation of the real story of individual tax revenue.

A good example of such obfuscation is a White House fact sheet about the fiscal 2006 budget results released on Oct. 11.
The fact sheet said the Bush tax cuts ``have helped fuel economic activity that has produced two years of record revenue growth,'' 14.5 percent and 11.8 percent in fiscal 2005 and 2006, respectively.
It conveniently overlooks the fact that revenue in 2004 was lower than back in 2001. So while spending was going up 42 percent from 2001 to 2006, revenue was up only 21 percent, half as much.
One result of spending rising twice as fast as revenue was that the budget swung from surplus to deficit in a big way. The inevitable consequence was a large increase in the sale of Treasury securities to the public.

So - here's the real story. At some point one or a combination of two things has to happen. Either:

1.) Taxes have to increase and/or
2.) Spending has to decrease
There is no way to get around the fact.

The Republican noise machine is selling a false bill of goods (funny, I almost wrote "goofs" instead which would probably be far more accurate.) Different people have labeled Republican economic theory in different ways. Kash at Angry Bear calls it the "free lunch" crowd. Stirling Newberry calls it "borrow and squander". I call it "you can have your cake and eat it to". However, all of us are saying the same thing.

It's a false bill of goods. There is only so long you can charge growth on the national credit card before you hit your limit.