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Consumption: Full Steam Ahead

The American consumer has not yet showed any sign of slowing down, despite higher interest rates and slower house price appreciation. Today’s release of January retail sales by Census reported the following:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for January, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $365.4 billion, an increase of 2.3 percent (±0.7%) from the previous month and up 8.8 percent (±0.8%) from January 2005. Total sales for the November 2005 through January 2006 period were up 7.1 percent (±0.5%) from the same period a year ago. The November to December 2005 percent change was revised from +0.7 percent (±0.7%)* to +0.4 percent (±0.4%).

Retail trade sales were up 2.3 percent (±0.8%) from December 2005 and were up 8.5 percent (±0.8%) above last year. Gasoline station sales were up 22.7 percent (±3.1%) from January 2005 and sales of building material and garden equipment and supplies dealers were up 14.7 percent (±2.0%) from last year.

Though higher gas prices certainly played a role in the strong retail sales growth of 2005, price increases only account for part of the rise in spending. The following chart shows the 12-month change in retail sales once you subtract inflation. The red line shows total real retail sales excluding purchases of cars (which are very volatile due to incentives programs that come and go) and gasoline. For comparison, the green points show the 12-month growth in real personal consumption expenditures from the national income accounts, which is a slightly different measure of consumer spending since it does not focus specifically on retail purchases.

Note: Monthly series smoothed by taking 3-month averages, and both retail spending series were deflated using the appropriate CPI measure of inflation.

It seems clear that the US’s current (and quite impressive) consumption boom persisted all the way through 2005, with the slight slowdown in spending at the end of 2005 seemingly temporary and due primarily to autos.

Whether spending by consumers will be able to continue to power the US economy through 2006 remains to be seen, however, particularly given that real income growth is nearly stagnant. If households stop spending more than they are earning, consumption growth will probably have to slow from current rates of growth, perhaps substantially.


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Don’t Fret over Deficits – Creative Accounting to the Rescue

While Tyler Cowen is playing the Ricardian Equivalence card, he opens with the central concern that an increase in consumption means a reduction in investment:

Assume that government spends some money today on consumption. That money could have been spent on a durable bridge, but it wasn’t. Some current people benefit from the consumption and future generations get nothing.

Michael Mandel reads Tyler and then writes:

But of course, there’s a big problem with his scenario. The latest budget pegs the FY 2006 deficit at $423 billion. But federal spending on major physical capital, research and development, and education and training – all long-lived investments – is estimated at $425 billion. We are not borrowing to finance consumption, we are borrowing to finance long-lived investments.

Not to be snarky, but there is a big problem with Michael’s ability to understand Tyler’s point. Let me put the point in terms of comparative statistics. Suppose that a nation was investing say 10% of its income in the form of private investment and public investment when the nation decided to increase its consumption from 90% of income to 95% of income. Simple arithmetic says national investment just declined from 10% of income to 5% of income.

The graph uses the much maligned national income accounts to show the ratio of private investment to GDP and the ratio of government investment to GDP (depreciation has not been deducted from any series). The simple point is that public investment has NOT increased even as private investment has declined. Mandel’s usual reply is that national income accounts fail to count investments in R&D and education, which is fine. But we have not dramatically increased the share of national income in either R&D or education.

The concern being properly raised by Tyler Cowen is not so much that one entity is running deficits – but rather when we “give people their money back so they can consume more” AND increase public consumption, we reduce national savings. Tyler is right – even if Michael fails to grasp his simple point.

Update: Michael Mandel replies with what he sees as partial agreement but then adds:

which is exactly why I am so insistent calling R&D and education investments! pgl wants the U.S. to invest and save more–so do I, but I just have a broader definition than he does. I want to encourage more resources devoted to R&D. I want to encourage more resources devoted to science and engineering education, and funding college for low-income and middle-income kids. I want to do the investment in the Knowledge Economy. From this perspective, I don’t like the latest Bush budget. The proposed 2007 budget takes a hacksaw to education outlays, cutting it by 18%, or 21% in real terms. Spending on R&D goes up slightly, but slower than the growth of the economy.

As I noted in a comment to his post, I would call R&D an investment as well. Actually, Michael and I are in complete agreement on this particular point.

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Fuzzcharts Insults the Memory of Coretta Scott King

The graph presents the black unemployment rate since 1995 to counter these lies from Jerry Bowyer:

Even more striking than the booming job market, however, is the rapid improvement in black employment. Last August, BuzzCharts pointed out that black unemployment was historically low. Since then, it has fallen even further. In fact, it has dropped from 10.6 percent in November to 9.3 percent in December to 8.9 percent in January. You have to go all the way back to July 2001 to find lower levels of black unemployment. This drop also undercuts the stereotype that the Democratic party is somehow the party that looks out for minorities: Today’s level of black unemployment is lower than the 9.5 percent average realized between 1995 and 2000, supposedly the height of Clinton’s “economic miracle.” We’ve said it before and we’ll say it again: Bush’s policies are good for jobs – jobs for all Americans of any color.

Black unemployment fell from 10.3% as of January 1995 to 7.4% as of December 2000. Then it rose to 11.4% as of October 2003. Yes, it is true that this meager economic recovery has reduced some of the increase in unemployment rates during the 2001 to 2003 period for both white and black Americans.

We should also note that unemployment can fall simply because labor force participation rates decline. So I have also graphed the black employment to population ratio since 1995. After a significant rise during the 1995 to 2000 period, this ratio has declined since 2001 with only a very modest recovery over the past couple of years. But as usual – the National Review cheers what in part is a discouraged worker effect.

Jerry Bowyer decides to remember Mrs. King’s life by lying to the readers of the National Review. But look at what a tired old stupid lie it is. He also insults his own readers’ intelligence with this garbage.

Update: Mark Thoma had celebrated the birthdate of Rev. King with a very thoughtful post on the same topic. Also check out the discussion from William Polley.

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Deferment Dick Goes Quail Hunter

Maybe we should be relieved that Dick Cheney did not serve in Vietnam – especially as we see what Josh Marshall has learned:

Things can get chaotic and excited when a bunch of birds (I’ll just try, as a blanket matter, not to use the jargon) come into range or rise up. But if you don’t shoot outside that safe fire zone, then everyone should be safe … The birds ‘flush’. Cheney picks out a bird and starts following it. In the process he basically wheels around doing a 180. So he’s spun around and is now firing backwards relative to the direction he had been facing. And Whittington was just, for whatever reason, where Cheney didn’t expect him to be.

I’ve never been quail hunting – but it cannot be as chaotic as the fire zones during the Vietnam War. If Cheney is this careless with a rifle, would you have wanted to serve next to him?

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Krugman: Debt and Denial

Dr. Thoma excerpts from Paul Krugman’s NY Times Commentary: Debt and Denial.

Dr. Krugman writes:

“In 2005 spending on home construction as a percentage of G.D.P. reached its highest level in more than 50 years. People who already own houses are treating them like A.T.M.’s, converting home equity into spending money: last year the personal savings rate fell below zero for the first time since 1933. And it’s a sign of our degraded fiscal state that the Bush administration actually boasted about a 2005 budget deficit of more than $300 billion, because it was a bit lower than the 2004 deficit.”

To add to Dr. Krugman’s comments: Residential investment was 6.1% of G.D.P. in 2005, the highest percentage since 1950. If residential investment falls back to the average for the ’70s, ’80s and ’90s of 4.5% that will be a drag on G.D.P. growth and reduce housing related employment. See: Housing Slowdown Threatens Inland Empire’s Economy

Click on graph for larger image.

With regards to the “housing ATM”: Mortgage debt increased 7.7% in 2004 and an estimated 7.8% in 2005 – the highest percentage increases ever. Some of that additional debt was related to residential investment, but much of it was M.E.W. (Mortgage Equity Withdrawal) that helped drive personal consumption. With rising mortgage rates and flattening or even falling housing prices, M.E.W. will probably drop substantially in 2006.

Krugman concludes:

“… it seems all too likely that America’s borrowing binge will end with a bang, not a whimper, that spending will suddenly drop off as both the bond market and the housing market experience rude awakenings. If that happens, the economic consequences will be ugly.”

And that is the question: will the debt binge end with a “bang” or a “whimper”. Will the US economy see slower growth or will it slide into a recession? Or will some new engine of economic growth emerge to replace the debt fueled growth of recent years.

Best to all, CR Calculated Risk

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What Tax Cut?

Tyler Cowen cuts through a quarter of a century of free lunch Republican spin in just two sentences:

Taxes already were raised when the government spending occurred. In that sense the “tax cuts” never were permanent.

This is what I love about conservative economists – they get right to the point. Twenty-five years ago, I’m afraid we liberals spent too much time screaming about the Reagan tax cuts, while a few conservatives nailed the real problems with the philosophy of “give people their money back so they can spend more”. It’s called classical crowding-out in the sense that more private consumption with no offset in terms of reduced government purchases equates to less savings and investment – not more.

We also saw twenty-five years ago the publication of “Some Unpleasant Monetarist Arithmetic” by Thomas Sargent and Neil Wallace that declared the reduction in current taxes back then would lead to greater taxes in the future. Years later, this idea became known as “generational accounting”, which put forth the simple proposition that the present value of taxes over time must cover the present value of spending plus past accumulated government debt. Of course, Ricardian Equivalence types would say this arithmetic predates even Sargent & Wallace.

Federal debt as a share of GDP had dropped to 57.4% by the end of fiscal year 2001 but is projected to rise to 67.5% by the end of this year. Republicans want to tell us that they can make the tax cut permanent by spending cuts, but let’s just think about the projection of Federal spending today versus what a reasonable forecast would have been back in 2000.

Total Federal spending was only 19% of GDP in 2000 as compared to 20.4% in 2005. Much of this increase is related to Federal defense purchases, which rose from 3.8% of GDP in 2000 to 4.7% of GDP in 2005. A small portion of the increase comes from Federal nondefense purchases, which rose from 2.1% of GDP in 2000 to 2.3% of GDP in 2005. It is true that the Global War on Terror necessitated some of the increases – as did that decision on March 19, 2003 to invade Iraq, which was likely a major blunder from our point of view or a “gift from God” as Osama bin Laden would put it. In other words, the clowns running the show in the Administration have insured that this Global War on Terror will be prolonged and very costly. And read the analysis on “The Future of National Security” provided by Kevin Drum as one reviews Bush’s proposals to further increase defense spending to fight the Cold War (for some odd reason) rather than Al Qaeda.

Tyler says he is hoping for reductions in entitlements. Note, however, the explosive in deficit spending has not been due to an increase in transfer payments – YET. But the pork-filled prescription drug benefit program has just begun. Speaking of pork, the increases in pork during the Bush Administration swamp whatever reductions in transfer payments that Congress had imposed – often on the needy. But suppose we simply eliminate this prescription drug benefit program. Massive General Fund deficits will continue unabated if the tax cut is made permanent. But be of good cheer as Bush wishes to slash our Social Security retirement benefits. Now if he does so and gives us payroll taxes cuts of equivalent amounts, the deficit will continue unabated. So what is the conservative plan to reduce the deficit without repealing these pretend tax cuts? Is it slashing Social Security benefits while maintaining high payroll contributions, which will be transformed by fiat into employment taxation. Is this the plan – to reduce taxes on capital income by increasing taxes on labor income? If so – could we have one Republican with the integrity to simply admit it?

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Yield Curve Update

It seems that we can now move beyond talking about a flat yield curve to talking about a truly inverted yield curve:

Yield curve inverts after strong auction

NEW YORK (MarketWatch) — The Treasury yield curve turned completely upside down early Friday, pushing the 2-year yield above the yields of both the 10-year and 30-year instruments, intensifying a debate over whether the inversion signals a looming recession.

The inverted yield curve effectively undermines the incentive for making long-term loans.

Long-term yields are being pushed lower by intense demand that has led to higher prices for longer-maturity bonds, following Thursday’s highly successful auction of 30-year bonds, the first sale of these maturities since 2001.

Given that this morning the 30-year yield is 4.48%, the 10-year yield is 4.52%, the 2-year yield is 4.63%, and the 6-month T-bill yield is 4.67%, I guess that fairly qualifies as a modestly, but fully inverted yield curve. I stand by my earlier assessment that this is a Not-Very-Good-Sign for the economy in 2006.


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The Savings Debate: Mandel v. Setser

The New Economist provides links to a piece by Michael Mandel noting his usual argument that the national income account definitions understate savings as well as a reply from Brad Setser and the Michael’s reply to Brad. As you will notice in a moment, I’m a bit biased to what Brad said so let me start with a couple of things that Michael said starting with his opening salvo:

But what if we told you that the doomsayers, while not definitively wrong, aren’t seeing the whole picture? What if we told you that businesses are investing about $1 trillion a year more than the official numbers show? Or that the savings rate, far from being negative, is actually positive? Or, for that matter, that our deficit with the rest of the world is much smaller than advertised, and that gross domestic product may be growing faster than the latest gloomy numbers show? You’d be pretty surprised, wouldn’t you? Well, don’t be. What you may not realize is that the government’s decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas. “As we’ve become a more knowledge-based economy,” says University of Maryland economist Charles R. Hulten, “our statistics have not shifted to capture the effects.” The statistical wizards at the Bureau of Economic Analysis in Washington can whip up a spreadsheet showing how much the railroads spend on furniture ($39 million in 2004, to be exact). But they have no way of tracking the billions of dollars companies spend each year on innovation and product design, brand-building, employee training, or any of the other intangible investments required to compete in today’s global economy.

In other words, Michael is still lecturing us that the national income accounts might be not properly measure investments in intangible assets. While that may be a fair point, there are other data sources that allow us to review how much is spent on items such as R&D each year.

In his rebuttal to Brad, Michael writes:

First, Brad writes, that “the US now saves a lot less than it used to.” How does he know this?

In other words, why should we simply trust the dramatic reduction in the amount of national savings as reported by the national income accounts. In keeping with my New Year’s resolution, let me offer up from the folks over at the National Review, the David Malpass measure of wealth accumulation. To be fair to Michael, he has a variation of this measure that corrects for two of the problems with the National Review continued nonsense on this matter: (1) Michael includes the rising Federal debt as a deduction (Ricardian Equivalence types rejoice); and (2) Michael deflates the increase in nominal wealth by the ever rising price level. Let me simply suggest to Michael that he look at the fact that his measure of real wealth today is only slightly higher than it was at the end of 1999.

Brad reminds us that the Malpass and Mandel argument is also the essence of the Dark Matter explanation as to why those massive current account deficits are nothing to worry about. But note that Brad and I have been wondering how much of the net foreign income from abroad puzzle can be explained by transfer pricing manipulation rather than the Dark Matter claim that we are somehow creating more intangible wealth than the national income accounts capture.

Tyler Cowen and Café Hayek also weigh in on the Mandel and Setser debate.

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Too Many Choices?

This Knight-Ridder piece about Bush’s Health Savings Accounts raises an interesting question: do people have too many financial choices in their life already?

WASHINGTON – President Bush’s proposed expansion of Health Savings Accounts depends on a premise that research shows is questionable: that Americans want more financial choices in their lives.

Experts point to a lack of participant activity within 401(k) plans as a sign that many Americans already feel overwhelmed by financial options. The 401(k) experience points to both the risks of HSAs and the road ahead for health-care management.

…Do Americans, as Hubbard suggests, really want to shop for a cheaper doctor, x-ray or blood test? Research into Americans’ behavior with retirement savings plans suggests that they don’t. It shows that people, in fact, shrink from such decisions.

In 2004, Hewitt Associates, a global consultant specializing in workforce issues, found that only 17 percent of participants in 401(k) plans had made a single transaction beyond automatic contributions deducted from their paychecks. Only half of eligible workers in their 20s opt into 401(k) plans.

“The average person is not making any choices on a proactive basis, on an annual basis. We have more anecdotal evidence that the individuals are not really sure what the choices are,” said Lori Lucas, director of retirement research for Hewitt.

Economists generally assume that having more choices is better than having fewer choices. The reasoning is as follows. Suppose you give someone a third choice about something when they originally had only two choices. It’s possible that the person will choose one of their original two choices, in which case the addition of the third option was irrelevant to them. But it’s also possible that the person will select the new option, which will necessarily make them better off (since they presumably liked the third option more than the first two). Thus the worst that can happen is that the person is left no better off from the third choice, and it’s possible they could be decidedly better off.

But this reasoning ignores the fact that it may be costly for individuals to learn enough about the new choice to be able to eliminate it from consideration. This cost of having to make more choices is what the piece quoted above is referring to. And in an area about which people are already often confused and at a huge informational disadvantage (health care), it seems like a distinct possibility that this story has it exactly right.


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Social Security: Should We Applaud a Sneaky Proposal?

Kevin Drum writes:

Like the creature that won’t die no matter how many bullets you put through its heart, Social Security privatization is back for an encore in President Bush’s 2007 budget proposal … The full faith and credit of the United States government is just an “empty promise.” It’s sort of like listening to an angry five-year-old, isn’t it?

If you are wondering what Bush was referring to in regard “empty promise”, Kevin explains. Meanwhile Andrew Samwick is pleased that the White House snuck this one into the budget. Andrew provides a short excerpt from this document starting with this line:

The President has proposed reforms to address the system’s long-term financial shortfall while making Social Security a better deal for today’s young workers.

In a way, Andrew draws our attention to the great LIE from this White House. It’s a standard GOP canard – we can at the same time reduce entitlements AND make those receiving benefits from those entitlements better off. Yes, free lunches are everywhere! Is there some great inefficiency out there that the White House is eliminating? No.

So what IS the White House trying to pull here? While Dr. Samwick is proposing some very good ideas for real reform, this White House is neither listening to his proposals nor the proposals of other economists who care about fiscal responsibility and the long-term well being of young workers. If this President were to be trusted on fiscal matters – I could understand why sensible economists might be happy he is addressing the long-term issues the nation faces. But did we here a peep about real reform during the State of the Union address? Of course not – that would have required leadership. Being sneaky is not leadership but it is one of the devices Karl Rove abuses to steal elections.

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