Relevant and even prescient commentary on news, politics and the economy.

Flow of Funds Accounts: some are deleveraging, while others are not

by Rebecca

The Federal Reserve released its quarterly Flow of Funds Accounts, and the message is crystal clear: the private sector is dropping debt burden, while the public sector is growing it.

Quarterly private sector debt growth, households + nonfinancial business + finance, has been slowing or negative since the second half of 2007. In contrast, federal and state and local governments are selling debt like it’s going out of style, with 28.2% and 8.3% annualized debt growth in the second quarter of 2009.

It is no secret that the private sector is unwinding debt, but to what end? 100% of income? – 110%? – Or 65%?

According to Reuven Glick and Kevin J. Lansing at the San Francisco Fed, Japanese households dropped their debt burden to 95% of disposable income. If US households were to follow a similar path, then the debt cycle would be complete in 2018. An excerpt from the article:

After Japan’s bubbles burst, private nonfinancial firms undertook a massive deleveraging, reducing their collective debt-to-GDP ratio from 125% in 1991 to 95% in 2001. By reducing spending on investment, the firms changed from being net borrowers to net savers. If U.S. households were to undertake a similar deleveraging, their collective debt-to-income ratio would need to drop to around 100% by year-end 2018, returning to the level that prevailed in 2002.

There is deleveraging still left in the pipeline, but one cannot say that the Japanese experience foretells the path of US debt. The economic agents, their propensities to save, and underlying economic fundamentals are different: 100% debt to disposable income in Japan may not be the equilibrium level in the US. Unfortunately, though, nobody can tell you what the level is…just something less than 125%.

The path of saving (paying down debt)

The US economy has suffered a precipitous drop in consumer demand, as the marginal saving rate surged. Going forward, higher saving (the average saving rate) does not preclude income and economic growth per se, but increasing saving (the marginal saving effect) can.

As wealth effect ratios stabilize – the chart to the left features the wealth effect as household net worth/personal disposable income – I believe that household saving will stabilize and consumer spending will grow with income.

Admittedly, though, the lag structure of the recent anomalous wealth effect is not known, and the strong marginal effect on saving might continue (i.e., the saving rate grows, as in the San Francisco Fed paper). To be sure, the labor market has dropped wage growth to record lows (see Mark Thoma’s post here), and Q2 ’09 annual disposable income growth was negative (a first since 1951). Not good for contemporaneous saving and spending growth.

The next four quarters, or the early period of recovery, will be critical in setting the stage for income growth. The recovery is expected to be weak, with the consensus GDP growth forecast around 2.4% in Q4 2009. But given the precipitous decline in output, even a 5% annualized quarterly growth rate during the early recovery would be rather “weak”. There’s room for an upside surprise as financial and housing markets stabilize.

Rebecca Wilder (if you are interested, I listed additional Flow of Funds charts here)

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Central bankers: slow to acknowledge the start; quick to declare the end

by Rebecca Wilder

There is always an agenda when a central banker declares the recession is over – and Bernanke is no different. The following facts remain: US GDP contracted at a 1% annualized pace in the second quarter of 2009 (its fourth consecutive drop), industrial output grew just two consecutive months after declining every month (except one) since January 2008, employment is still falling, retail sales are improving somewhat, and real personal income has formed no discernible upward trend.

In that light, the most accurate description of Bernanke’s declaration is that he “thinks” the recession is over, rather than it “is” over. His strategic announcement plays on market expectations to the upside, just as announcing that the recession is underway would play on expectations to the downside.

Are central bankers generally more apt to declare the end of a recession sooner that the beginning? I bet that they are. Will an AB reader do a little investigative reporting to find the first time that Bernanke acknowledged the onset of the 07-09 recession? My money’s on 12/08, the date when the NBER declared it as such and a year after it began.

To his credit, much of Bernanke’s Brookings address was spent highlighting the weak recovery that is expected. Bernanke is brilliant and surrounds himself with likewise brilliant economists – but data is data; and he sees what I see, which is a murky bottom and expected positive growth.

The charts below illustrate the key monthly macroeconomic variables used by the National Bureau of Economic Research to date the recession peak and trough by month: real income (I use personal income through July), employment (through August), industrial production (through August), and wholesale-retail sales (through August).

George Cooper is on to something in his book “The Origin of Financial Crises” (highly recommended). He criticizes central banking for adhering to efficient markets thinking, which leads to lax policy on the upside of the business cycle, i.e., allowing aggregate demand to outpace underlying fundamentals, and overly aggressive policy on the way down.

In this light, central bankers might be quicker to face the end of the recession and slower to conclude the onset of one. It is akin to policy mistakes being made on the way up and a triumph on the way down.

Rebecca Wilder

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A housing bubble illustration

by Rebecca

Yesterday’s post on the Australian economy sparked some discussion of its housing market. I agree – Australia’s bubble is large relative to that in the US (interestingly enough) and Canada.

The chart illustrates the price to rent ratio in Australia, Canada, France, Ireland, the UK, and the US, which measures the trade-off between owning and renting. Across country, the housing indices are not perfectly comparable – for example, Statistics Canada measures the value of new homes, while the S&P/Case-Shiller index measures repeat sales of existing homes. Furthermore, countries often measure the owner-equivalent rents differently. Nevertheless, the trends are meaningful.

Australia’s bubble was (is) big, and relative to rents, home values recently turned upward. According to Steve Keen (thank you reader VtCodger for the link), government subsidies provided households the incentive to leverage up their balance sheets while the private business sector deleveraged. Basically, the crash is yet to come.

The recent uptick in the Australian price-rent ratio, i.e., jump in housing prices relative to rents, is interesting. Notice the same is happening in the UK and Ireland; however in their cases, seriously weak economic conditions are dragging down the CPI housing index (the denominator). (In the UK, prices are likewise rising, but rents are falling faster.) As rents slide, so too will the relative attractiveness of home ownership.

I expect that the same will happen in the US. In Q2 2009, the S&P/Case-Shiller home price index grew 1.4%, faster than did the owner-occupied rents index in the CPI. Owner-occupied housing (see CPI table here) inflation slowed dramatically in Q2; and given the long lag on core price fluctuations, there is a very good chance that it turns negative.

Rebecca Wilder

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Australia…escaped a total meltdown, but still far from healthy

by Rebecca

Australia is another on the short list of countries that “escaped recession” (another is Poland, which I wrote about earlier). As much of the developed world struggles with job loss and weak economic groundwork, Australia managed to push through the global meltdown with just one quarter of negative growth, -2.8% annualized growth in the fourth quarter of 2008. Since then, GDP in the first and second quarters of 2009 grew at an annualized pace of 1.6% and 2.5%, respectively. (Note: the chart on the left illustrates growth over the year, rather than annualized.)

To what does Australia owe this honor? Net exports and policy. First, while most of the developed world saw export demand plummet – in the US, exports dropped at an annualized rate of 29.9% and 5.0% in the first and second quarters of 2009, respectively – Australia, with its high concentration of primary products exports (foods, fuels, minerals, etc.), benefited from positive real export growth of 8.2% and 3.9% (annualized rates) during the first and second quarters of 2009. Imports fell even faster, and net exports picked up the slack for the huge drag on GDP coming from inventories and investment.

In 2008, 14.6% of Australia’s exports went to China, whose economy, as we all know, is faring much better than previously expected. And in July, Australia’s exports remained strong to China, growing 4.6% over the month.

Likewise, the Australian government underpinned the economy with huge fiscal stimulus, around $42 billion AUD or 3.5% of GDP, and robust expansionary monetary policy, cutting its cash rate 400 bps to 3.0%. The stimulus firmed household spending’s contribution to GDP growth above zero.

Australia escaped the recession, but it is not immune. Last week, the OECD released its updated forecast, which includes estimate of potential GDP. Although stimulus and exports kept Australia afloat, production remains well below the OECD’s estimates of potential output. And well, so does the rest of the world.

Against this backdrop, Poland really does shine.

Rebecca Wilder

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Weekend charts: the destruction of the "goods-producing" payroll


The BLS establishment survey (nonfarm payroll) reports that the accumulated job loss since December 2007 is 5.02% (almost 7 million jobs), blowing the total job loss of the previous “biggie” recessions, the 73-75 and 81-82 recessions, out of the water by 2.5% and 2%, respectively. There’s no question that it has been bad, with almost every industry slashing payroll.

The chart illustrates the total accumulated job loss across the major industries spanning December 2007 to August 2009 (nonfarm payroll listed here). Assuming that the recession is over (the consensus and key indicators seem to indicate that a business cycle trough has been found), then there are just two men left standing (adding jobs over the cycle), education and health services and government (barely). Even the historical job anchors , other services, professional and business services, and financial activities, are down between 1.8 and 8%! The job loss is broad and deep.

However, the industry contributions to total job loss show that the job destruction is heavily weighted in manufacturing and construction, which account for roughly half of the total drop in nonfarm payroll (-2.5% of the total -5%). But manufacturing and construction hold just a 16% share of the entire payroll.

Productivity numbers, i.e., growing amid record output loss, would suggest (even manufacturing productivity saw growth in Q2 2009) that factories are running on skeleton crews, which is efficient given the drop in demand. And a resumption of aggregate demand may be partially satisfied by adding hours, but that will only go so far. Firms will need to hire, and hire soon after demand starts to grow again.

Rebecca Wilder

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The pre-labor report labor reports


Let’s investigate these pre-BLS reports.

There are many job reports out there, but here are some of the biggies that come out right before the official government BLS employment situation (not a coincidence).

  • Monster Employment Index (not seasonally adjusted) – an index geared toward online recruiting trends.
  • Challenger job cuts (not seasonally adjusted) – follows announced layoffs at large companies.
  • The ADP report (seasonally adjusted) – estimates private nonfarm payroll using their payroll data (very different from the BLS survey methodology).
  • WANTED Technologies report (no information on seasonal adjustments on the website, but it must be, right?) – estimates total nonfarm payroll (private plus public) using “hiring demand data” stemming from online job boards.

Well, they are all generally trending in the positive direction – i.e., the “it’s getting worse less quickly” story. This is consistent with the BLS report. The trend is about all that they can match, the level value seems more like a hit or miss to me. (Note: except for the Challenger cuts, all of this data has been revised). Correction: Just heard from Charles Thibault over at WANTED – he says: “We do not ‘revise’ forecasts ex-post like ADP”. Will update if that changes. RW: Maybe there’s something to this one.

But I am a skeptical as to the exact value added from these reports. Although the ADP report does not explicitly claim this, I imagine that they do like the idea that markets generally use their number as an indicator of the upcoming BLS report on Friday.

WANTED Technologies is explicit in their claim to forecast the BLS report more consistently than does the “consensus”. And furthermore, they present a root mean square error of their forecast (a measure of how close the forecast comes to the actual data) as something below that of the BLS (see Table at the bottom of their methodology page). I am not quite clear on how they calculate the error, since they revise their data as does the ADP (again, correction: according to WANTED, they do not revise their forecast ex post, and the MSE comparison may be quite meaningful).

This gets me back to my first point, what is the value added of these pre-labor labor reports? I always thought that the various reports should focus on what are their comparative advantages. For example, the ADP payroll figures likely have information on wages that cannot be ascertained from the BLS’ survey approach. Or WANTED uses online job applications – perhaps it can provide an earlier indication of labor prospects than can the survey as a whole.

We will see what happens tomorrow.

Rebecca Wilder

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G-20 to talk about ‘exit strategies’…

Rebecca Wilder

With the developed and developing economies printing money like it’s going out of style, the exit strategy – i.e., taking back the hundred percent increase in the monetary base (at least in the US) – is rumored to be the topic du jour at the G-20 summit later this month.

According to Reuters, the “G20 countries have agreed it is too soon to withdraw measures to end the global economic crisis and will discuss coordinating policy to wind up the trillions of dollars in support at talks in London this week.”

The article focuses on fiscal policy, but only a delinquent discussion of exit strategy leaves out the record monetary easing of late. However, I would most certainly agree that it is too soon.

The global labor market is plummeting.

And global sticky wages are consequently growing at snail-speed rates.

I’ve always been a big believer in the output-gap story. And until that unemployment rate starts to fall, I just don’t see how global inflation is going to be much of a problem.

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Not all of Europe is in free-fall

Rebecca Wilder

Poland: the bull of eastern and central Europe. While most of central and eastern Europe are either defending exchange rate pegs – this limits the ability to stimulate the economy through monetary policy – and/or running large current account deficits (see chart 2 here), Poland grew a remarkable 1.1% in the second quarter of 2009 compared to the same quarter last year. Given that its regional trading partners are falling precipitously, that is a real economic feat.

2009 is a great year NOT to be part of the ERM II, which requires a relatively inflexible exchange rate policy. And since Poland can allow its exchange rate to fluctuate a bit more, strong expansionary monetary policy (lowering its policy rate by almost half) has helped to cushion the blow to regional exports.

In the meantime, Poland’s relative immunity to the globally synchronous crash has kept the fiscal balance in check (relatively speaking).

Even though Poland’s fiscal deficit is expected to rise in 2009 (perhaps outside the share of GDP allowed by the Eurosystem), its more stable growth pattern will clearly “cost less” in terms of government spending and fiscal deficits, making it a strong candidate for euro conversion growing out of the crisis currently scheduled for 2012)

As the IMF article suggests, the re-emergence of regional trade is important for sustainable growth. However, Poland’s relatively flexible currency should keep it competitive.

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Consumer confidence: fluff or thrill

by Rebecca Wilder

Thrill. The Conference Board reported that the August consumer confidence index (CCI) jumped 14% in August to 54.06. In contrast, the August University of Michigan Consumer Sentiment index (CSI) fell; but the two generally trend together, and the CSI is subject to revisions reported tomorrow.

Confidence can be swayed by current political agenda or asset prices, but nevertheless, it is a coincident measure of the business cycle. And broken down into its two components – the present economic situation index and expectations index – the August report was quite positive (as positive as can be coming off of record lows).

The expectations index surged almost 16% in August to 73.48, its highest level since December 2007 and 2.7% over its previous high in May 2009. The current conditions index grew around 7%, but is hovering at low levels with no strong sign of improvement.

Clearly, the expectations index is making much more headway than the present situation index. And this is why that information is important: historically, the expectations index, rather than the current conditions index, is a good indicator of consumer spending growth.

The chart illustrates annual personal consumer spending growth and the two components of the CCI, with associated simple correlation coefficients. The correlation between the overall CCI and annual PCE spending growth spanning June 1977- June 2009 is 0.63. However, the biggest weight is coming off of the expectations component of the CCI, correlation = 0.69, rather than the present situation component of the CCI, correlation = 0.45.

On the other hand, the present-situation component of the CCI is a decent indicator of current labor market conditions.

The chart illustrates annual employment growth (measured by the nonfarm payroll), and the two components of the CCI. The simple correlation between the overall CCI and employment growth is 0.59 (noticeably smaller than the PCE correlation), which according to its correlation, is more heavily weighted by the present situation component of the CCI.

Based on this simple analysis, the CCI reading is consistent with an oncoming surge in spending growth over the next six months. Even in the recovery after the 1991 recession, when the expectations index improved quickly while spending growth was sluggish to rise, spending growth jumped from essentially 0% annual growth to almost 3.6% in just four months – after the surge in expectations index and before the bottom in the current conditions index.

Yes, there are plenty of credit-related issues why this might not happen. And there is an obvious economic link between employment, income, and spending. However, for those indicators that are critical to recovery, i.e., consumer spending (housing and inventories are important, too – see the second chart on this post), the expectations index is certainly a positive signal for spending events to come.

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Trends in home values: becoming murky

by Rebecca Wilder

Actually, murky is something of a good thing when referring to business cycle dynamics. It usually means that a bottom is forming.

In some sense, the key to recovery is the stabilization of home values. If home values would just “stop” declining – I understand that there is a market mechanism going on here that is pushing home values to (or even below) an equilibrium – then the banking system can get on with its solvency issues. (Naked Capitalism has a nice piece today on banks not foreclosing in order to avoid further writedowns.) Let’s see what’s going on in the US from the perspective of several indicators.

The S&P/Case-Shiller and the Federal Housing Finance Agency (FHFA) reported their quarterly house price indexes today. Interestingly enough, the two (Q2 2009)reports diverge.

The S&P/Case-Shiller marked a quarterly gain of about 1.4%, while the FHFA reported a quarterly loss of about 0.7%. Is this the start of an interesting story on the downside? On the upside, the Case-Shiller index showed a much larger bubble in home values relative to imputed rents. Will the FHFA show a deeper trough than the Case-Shiller?

The chart illustrates the price to imputed rent ratio for the two measures of national real estate values. This can be thought as the tangible asset equivalent to a corporate stock price to earnings, or price to dividend, ratio. It measures the value relative to the flow of ownership gains, as represented by the imputed rent series measured by the BLS (owner occupied rent in the CPI table).

It is unlikely that the quarterly FHFA index will depart from the positive trend for too much longer (if indeed, it has stabilized), as the monthly index is showing more consistent gains over the last three months.

This is kind of interesting – the Case-Shiller, which includes foreclosures, is likely catching the upswing in foreclosure demand, while the FHFA is grabbing more of the downward trend in the “average” mortgage. But the LoanPerformance home price index likewise includes subprime loans and foreclosures, and it is showing some life (see chart below). Below is the 3-month annualized growth rate over the last two years for a cross-section of home value indicators. (In most cases, the monthly indexes are a subset of the national index.)

One indicator to note is the LoanPerformance house price index (LPHPI), which is used by the Fed to estimate the value of real estate in the flow of funds accounts, and is growing at a 9.1% annualized rate. States seeing at least a 4% 3-month gain include Ohio, Wisconsin, New York, Virginia, South Carolina, Georgia.

Likewise, the median existing home price and new home values are reported. These series are not seasonally adjusted; and therefore, are not extremely helpful in this context. But the 3-month existing home values remain in positive territory, although at a slowing rate of improvement. It should be noted that the median home prices is a cruder measure of home values – the Case Shiller and FHFA were developed in order to overcome the limitations of thinking in terms of the “median”.

So it looks like there is a chance that home values stabilize before 2010. We will see, as a 1 quarter increase by the Case Shiller index, although positive, is far from a trend.

Rebecca Wilder

(Edited slightly for readability….rdan)

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