The Japanese yen, the Eurozone euro, and the British pound have appreciated 16%, 14%, and 9%, against the USD, respectively, since their 2010 lows. Some say that the “US wins” since the Fed’s quantitative easing (QE2) will drive export growth via a weaker dollar. (Note that the Fed has not actually announced QE2, this is all just speculation.)
I’m not suggesting that the stated Fed policy will be to drive down the dollar. What I do know, however, is that the United States production model is not structurally positioned to enjoy the economic panacea that is a persistent debasement of the dollar, neither in the near- nor medium- term.
The bottom chart illustrates the export share in overall economic GDP, as forecasted by the European Commission (you can download this data at the Eurostat website). Notice that the US share of exports, expected to be just 12.3% in 2010, is minuscule compared to the export markets in Europe. So what I gather from a chart like this is that the weak dollar will hurt Europe much more than it will “help” the United States.
We need domestic policy to support full employment and the expansion of our export sector that will eventually arise. See Marshall Auerback’s post this week at Credit Writedowns for a discussion on austerity, currency wars, and exchange rates.
I present an update on aggregate demand using the highest frequency of economic data available, US Treasury tax receipts. Tax receipts serve as a proxy for nominal aggregate demand via a nominal indicator of private payroll growth.
The chart illustrates the federal deposits of income and employment taxes that are recorded on a daily basis and presented here as the annual pace of the 30-day rolling sum. The red line illustrates the average annual growth rate spanning the period 2005-current.
Since roughly April of 2010, the annual pace of income and employment tax receipts has been above the average, 2.8%. In the third quarter, the annual pace of income and employment tax receipts remained around 4%, consistent with the second quarter pace. Hours and employment are improving, supporting wage gains and higher tax receipts. But more importantly, the pace of tax receipt growth has not faltered, demonstrating ongoing recovery in the labor market and consumer demand.
But it’s not enough. The gains in tax receipts are likely a function of firms adding back hours instead of pumping up the work force. (see my previous post with links on the “hourless recovery“).
The chart above illustrates the cyclical loss from recession and gains during the recovery of private net-jobs (payroll) and aggregate weekly hours (you can see the summary data from the September payroll report here).
Both series found a trough in the third quarter of 2009, which is consistent with the bottom in tax receipt growth (chart above). However, the hours index has recovered quicker than has its payroll counterpart (of course it fell farther, too). To date, both private hours and payroll are 7% short of their values at the peak of the economic cycle.
China took the world by surprise on Tuesday by raising bank lending and deposit rates for the first time since 2007. The story is, that restrictive monetary policy (i.e., raising rates) is needed to curb excessive lending, with an eye on mitigating inflation pressures. See this Bloomberg article to the point.
While restrictive monetary policy is needed, raising rates is not the only tool available to policy makers: China could allow their currency (CNY) to appreciate. With support from the fiscal sector, a broad CNY appreciation would improve prospects for global growth ex China via import demand. Instead, the higher domestic rates may crimp domestic demand, perhaps reducing inflation, but contemporaneously lowering import demand.
In my view, China’s move yesterday should be viewed as competitive devaluation: reducing domestic prices in order to capture a competive edge. The currency war, as so-called by Brazil’s finance minister, Guido Mantega, is afoot; and China just confirmed its participation.
Textbook economics says that a central bank cannot have it all: independent monetary policy, a fixed exchange rate, and open financial markets (the impossible trinity). China has a fixed exchange rate (currently, it’s effectively pegged to the USD, see chart below) with tightly monitored capital markets. This means that the Chinese economy effectively matches the “easy monetary conditions” of its counterpart, the US. Monetary policy in China is too loose.
Going forward, further accommodative monetary policy in the US will likewise loosen policy further in China; inflation pressures will be even more robust. But, large-scale asset purchases on the part of the Fed will likewise weaken the USD, which is positive for US exports and negative for US import demand.
All in all, policy makers in China are looking at the USD move with tunnel vision. If the CNY maintians its current trajectory (effectively flat), then any shift in relative prices based on the recent (or future) rate hikes will reduce the CNY real exchange rate (all else equal, of course) – that’s competitive domestic devaluation.
The table has already been set.
Chinese policy makers have slowed the nominal appreciation. Think about what could be if the CNY had maintained its 2005-2008 trajectory, where the CNY appreciated against the USD nearly 20%. Using the compounded annual growth rate (CAGR) over the same period, where the CNY gained 0.5% on a monthly basis against the USD, the month-end September CNY would be valued 11% higher against the USD than it is now.
They slowed real appreciation, too. The real appreciation of the CNY against its trading partners – the real exchange rate accounts for both nominal appreciation and price differentials across countries – slowed from an average 0.4% monthly gain spanning the period 2005-2008, as measured by the CAGR, to just 0.05% since then. (I use the JPMorgan real exchange rate index, but the BIS makes similar data available free of charge.)
The Chinese authorities are fully aware of the economic value of external demand (exports). The media will say that China’s trying to “cool” domestic inflation by raising domestic bank rates; but that’s not the full story. In my view, what they’re really trying to do is to “cool” domestic inflation in order to shift relative prices and depreciate the real exchange rate, all to gain a competitive advantage in global goods markets.
…Corporations. Since earnings season is now well underway, I decided to look at the breakdown of aggregate domestic income (gross domestic income). Corporate profits are up 44.7% since the outset of the US recovery, while wages and salary accruals are up just 0.9%.
The chart above illustrates the peak-trough losses (total loss), trough-Q2 2010 gains (total gain), and peak-Q2 (relative to peak) deviations of nominal gross domestic income, disaggregated by income type.
First up, wages and salaries (employer contributions for employee pension and insurance funds and of employer contributions for government social insurance) and private enterprises net of corporate profit incomes grew in sum spanning the recession (private enterprises net of corporate profits includes proprietor’s income, which did fall). Furthermore, the drop in wage and salary accruals, -3.6%, was small compared to the drop in corporate profits, -18.1%.
Second, the corporate profit gains during the recovery massively outweigh the wage and salary gains over the same period, 44.7% versus 0.9%. Corporate profits are now 18.5% above the peak in 2007 IV, while wages and salaries hover 2.8% below.
The problem here is, that the deleveraging cycle is heavily weighted on the household sector (the workers at the corporations) – if corporate profit gains do not translate into hiring and wage gains, or even to further capital spending, economic growth will suffer going forward.
Better put, at the very minimum, the recent surge in corporate profits is not sustainable if firms do not distribute the gains to the real economy. Also, meager wage gains does make healthy deleveraging difficult for household sector. Therefore, the recent surge in gross domestic income (hence, it’s spending counterpart, GDP) is not sustainable if corporate profits are not recycled.
Dean Baker finds gaping holes in deficit hawk rhetoric using the simple accounting identity that national saving must equal the current account (S-I = CA). If the domestic private-sector’s desire to save is positive, then the only way for the public sector (i.e., government) to net save is for the economy as a whole to run a sizable current account surplus.
Singapore does just that. Spanning the years 2004-2009, the average current account surplus was near 21% of GDP, which enabled the government to run surpluses near 5% of GDP and the private sector to save 16% of GDP. Singapore is a net-saver in all sectors of the economy: private, public, and international. However, it’s Singapore’s huge current account surplus that allows the domestic sector to net save, and not all financial balances are created equally.
The chart illustrates the combination of private and public surpluses (or deficits) that prevail at each of three “zones” of the Balanced Current Account Line (BCAL). The BCAL zones are: CA > 0 to the right of the red line, CA World Economic Report database, October 2010, is used to construct the average 3-Sector Financial Balances Map for the IMF’s Advanced Economies spanning the years 2004-2009. (Note: Singapore, Norway, and Iceland are not illustrated because their respective sector financial balance points lie outside the normal range and distort the map.)
The public-sector financial balance (PubS) for each economy is the IMF’s measure of general government net lending as a percentage of GDP. The domestic private-sector financial balance (PrivS) is the residual of the current account as a percentage of GDP less PubS such that the following identity holds:
PrivS + PubS = Current Account (please see Rob’s post for further detail on the sectoral balances approach)
In the chart, the four quadrants of public-sector and private-sector financial balances that account for the CBAL zones across the Advanced Economies are:
I. PubS > 0 (public-sector surplus) and PrivS II. PubS III. PubS > 0 and PrivS > 0 IV. PubS 0
The quintessential savers are listed in quadrant III and to the right of the BCAL: Sweden, Hong Kong, Luxembourg, and Singapore (not shown). The classic debtors are listed in quadrant II and to the left of the BCAL: Ireland, Spain, Portugal, Greece, and a couple of other Eurozone economies that are not labeled (Cyprus, Malta, and Slovak Republic). Finally, quadrants I and IV list economies that have positive saving in one of the domestic accounts: public (I) or private (IV).
The point is pretty clear: in order for the government to net-save, PubS > 0, either the private sector must dissave and/or the current account must be in surplus. It’s that simple.
Notice that the financial balances of Spain, Portugal, Ireland, and Greece are in quadrant II and to the left of the CABL. These are averages, and the fiscal deficit worsened markedly in 2009 and 2010 as the private sector incentive to save surged. Currently, though, the fiscal adjustment requirements are huge (deep into quadrant II). For example, Spanish policymakers announced a deficit reduction path to take the PubS Given that Spain, for example, is starting from a point of hefty private-sector deficits over the last five years, on average, the sole hope for a successful policy tightening lies with external demand growth (the current account). Spain needs massive export income in order to finance such reductions in the government deficits.
So who will succeed in reducing their public fiscal deficits? Pretty much any country with private surpluses has a fighting chance: Germany, France, the Netherlands, Belgium, the UK, and the US even (on the corporate side). The problem is, that policy makers can’t just tell the private sector to start dissaving. Well, it can, but incentives may be needed.
Update: one of our readers caught a mistake in the chart. I indexed the data to December 2008, or one year after the recession actually started in December 2007. The statistics that changed are formatted in bold, and the chart in the article has been updated. The analysis doesn’t change at all, but the number of jobs lost during the recession is higher than those indicated in the original article.
As part of efforts to address record-high levels of long-term unemployment, President Obama plans to announce a new national public-private partnership on Monday to help retrain workers for jobs that are in demand.
The national program is a response to frustrations from both workers and employers who complain that public retraining programs frequently do not provide students with employable skills. This new initiative is intended to help better align community college curriculums with the demands of local companies.
“The goal is to encourage community colleges and other training providers to work in close partnership with employers, to design a curriculum where they want to hire the people coming out of these programs right away,” said Austan Goolsbee, chairman of the President’s Council of Economic Advisers.
The White House has coined this program Skills for America’s Future. The complication is, that lack of skills is not the problem for the 66% of the labor force aged 25 years and over without a bachelor’s degree. The problem is the lack of jobs.
The chart illustrates the dynamics of employment by level of education through August 2010, as measured by the Bureau of Labor Statistics. Note that the data are indexed to the onset of the recession, December 2007, where 100 implies that employment is now at its pre-recession level.
The only category to recover employment in full is that requiring a Bachelor’s degree or higher. Furthermore, no material change in employment for BA’s (or higher) has occurred since about a year ago, as indexed employment hovers around 100. No new jobs.
The levels of employment for those workers with the lowest levels of educational attainment, 1. and 2., are 10.2% and 6.6% below pre-recession levels, respectively. That is over 3.5 million jobs.
The White House program is targeted at community college students, or education category 3., some college or associate degree in the chart above. Employment for workers with a community college degree sits over 3.2% below pre-recession levels, or 1.1 million jobs. Retraining workers will not raise the employment level further.
The government needs to “add jobs”, not “retrain workers”, and stimulate domestic aggregate demand.
The Federal Reserve, the Bank of England, and the Bank of Japan are considering further quantitative easing. It’s an explicit statement, as with the Federal Reserve and the Bank of England, or implied by the fact that the foreign exchange intervention will eventually be sterilized if the policy rule is not changed, as with the Bank of Japan. Why more easing?
In response to this question, BCA Research (article not available) presented a version of the quantity theory of money. They looked at the simple linear relationship between the average rate of money supply growth (M2) and nominal GDP growth (P*Y).
The chart is a reproduction of that in the BCA paper, but with a sample back to 1959 (they went back to the 1920’s when M2 was not measured). The relationship illustrates the 5-yr compounded annual growth rate of money (M2) against that of nominal GDP, and has an R2 equal to 50% – okay, but not perfect. Nevertheless, the implication is pretty simple: the current annual growth rate of M2, 2.8% in August 2010, corresponds to an average annual income growth just shy of 4%. Sitting beneath a behemoth pile of debt relative to income, 4% nominal GDP growth is unlikely provide sufficient nominal gains for households to deleverage quickly or “safely“.
However, notice the 2000-2005 and 2005-2009 points, where the relationship between M2 and nominal GDP growth deviated away from the average “quantity theory” relationship. Would a broader measure of money account for the weak(ish) relationship in the chart above? Yes, partially. (Note: the relationship almost fully breaks down at an annual frequency.)
These days it’s all about credit. I’m sitting in Cosi right now – bought a sandwich and charged the bill on my credit card. Actually, I prefer to use cards. But M2 doesn’t account for this transaction as money if the balance is never paid in full. M2 is essentially currency, checking deposits, saving and small-denomination time deposits, and readily available retail money-market funds (see Federal Reserve release).
One can argue about the merits of including credit cards balances as “money”, per se. However, the sharp reversal of revolving consumer credit, and likely through default (see the still growing chargeoff rates for credit card loans), would never be captured in M2. The hangover from the last decade of households using their homes as ATM’s (i.e., home equity withdrawal) and running up credit card balances to serve as a medium of exchange is dragging nominal income growth via a sharp drop in aggregate demand.
The Federal Reserve discontinued its release of M3 in 2006, which among other things included bank repurchase agreements (repos). Including M3, rather than M2, in the estimation improves the the R2 over 30 percentage points (to 81%).
This is a very small sample, and removing the latest data point from the original estimation improves the R2 slightly to 64%; but clearly there’s something going on here. I think that it’s fair to say that we may be disappointed by the M2 implied average nominal GDP growth rate over the next 5 years (4%).
According to John Williams’ Shadow Statistics website, M3 is still contracting at (roughly because I don’t subscribe to the data) 4% over the year. The relationship in the second chart implies that nominal GDP will fall, on average, about 4.5% per year. Japan’s nominal GDP never contracted more than 2.08% annually during its lost decade, but the implication is that “things” may not be as rosy as the M2 measure of money suggests.
In a NY Times op-ed, Rob Parenteau and Yves Smith reminded us that the private sector financial balance is a function of the household financial balance and the corporate financial balance. They concluded the following regarding excess corporate saving:
So instead of pursuing budget retrenchment, policymakers need to create incentives for corporations to reinvest their profits in business operations.
In my view, it’s not that simple (not that passing this type policy would be easy at all). As I illustrate below, firms, like households, are in a deleveraging cycle, where corporate excess saving is likely to persist for some time. (Note: US total corporate financial balance, excess saving if the balance is positive, is roughly undistributed profits minus gross corporate domestic investment)
In their NY Times article, Rob and Yves cite a 2005 JP Morgan study, “Corporates are driving the global saving glut”. In that study, JP Morgan argues that the global saving glut has been driven largely by G6 excess corporate saving, and to a lesser extent emerging economies. In the US, positive corporate excess saving persisted through the latest print, 2010 Q2.
The illustration above plots the total corporate financial balance as a percentage of GDP. I calculate the Total Corporate Financial Balance (TCFB) as in the JP Morgan study, which is the residual of the national accounting identity of the Current Account Balance minus the Household Financial Balance minus the Government Financial Balance. According to this measure, the TCFB was roughly +3% in 2010 Q2, or about +1% above the 2008-2010Q2 average (2.1%).
About the same time as JP Morgan published their research, the IMF and the OECD were wondering why global TCFBs were rising. Several factors are attributed the upward trend in the first half of the 2000’s, including (this is not a complete list of factors):
Repurchase of stock shares relative to dividend payouts
The falling relative price of capital goods dragging nominal investment spending as a share of GDP (see Table 3.2 of the OECD publication)
The overhang of leverage build in the 1990’s
Rising profits via falling taxes and low interest payments (especially in other OECD economies)
Although firms likely worked out much of the debt overhang from the 1990’s, the debt accumulation spanning the second half of the 2000’s was precipitous.
It’s very unlikely that the excess corporate saving will fall anytime soon, as non-financial business leverage is high just as household leverage is high. Total non-financial business debt peaked in 2009 Q1 at 79.5% of GDP and is now trending downward, hitting 74.9% in 2010 Q2.
If history is any guide, then the “excessive” borrowing spanning 2005-2008 will take some time to repair. Spanning 2002 to 2004, the non-financial business sector dropped leverage 2.5% to 64%. If this 2-year period of de-leveraging indicates an “equilibrium” level of leverage, then non-financial businesses are likely to run consecutive financial surpluses (excess saving) in order to reduce debt levels by another 11 percentage points of GDP for a decade more.
If firms run excess saving balances, then they’re not investing in future profitability via capital expenditures nor increasing marginal costs, like wages and hiring, relative to profit growth. So while it is true that some fiscal policy should be targeted directly at investment incentives (Rob Parenteau and Yves Smith article), these measures may prove less effective since the non-financial business sector’s desire to “save” and repair balance sheets is high.
I leave you with one final chart to inspire more discussion: a breakdown of the total corporate financial balance into its two parts, financial-business and non-financial business.
The financial balances in illustration 2 are computed directly from the Flow of Funds Accounts, Table F.8, rather than taking the residual as calculated in illustration 1. Thus, the total corporate financial balance will not match that in illustration 1.
The point is simple: the small drop in excess saving in total corporate financial balance in illustration 1 is stemming from the financial side. The non-financial corporate sector continues to raise excess saving by investing retained earnings into liquid financial assets relative to capital investment.
Fiscal policy should be targeted at the high desired saving by the corporate and household sectors alike. The idea is to pull forward the deleveraging process by “helping” households and firms lower debt burden via direct liquidity transfers (lower taxes or subsidies, for example). Only then will healthy private-sector growth resume.
I wonder why near half of those polled think that Clinton did the best job of “managing the economy”. Using one simple metric, private-sector financial leverage (accumulated dissaving), Clinton ranks among the top three worst economic managers, behind George Bush (Jr.) and Ronald Reagan.
The chart illustrates private-sector leverage as a stock of debt to GDP indexed to the start of each Presidential term. Therefore, the numbers are not the debt ratios, rather the appreciation of the debt ratios since the onset of each President’s term. The data are from the Fed’s Flow of Funds Accounts.
The sector financial balances model of aggregate demand posits that fiscal policy must shift in order to normalize GDP amid deviations of the private-sector surplus (desire to save) and the current account (see Scott Fullwiler’s article on the sector financial balances model of aggregate demand, which references similar work by Bill Mitchell and Rob Parenteau; or you can see last week’s answers and discussion to Bill Mitchell’s quiz for a simple outline).
When the private sector is levering up, the public sector is not doing its job. Since the 1990’s, the private sector loaded up on debt (ran private-sector deficits) in order to maintain GDP closer to full employment in the face of shrinking government deficits relative to those of the current account (since 1991 the current account trended down as a % of GDP). Deregulation, of course, contributed as well.
According to this metric, Barack Obama ranks highest to date, thanks to the automatic stabilizers and the ARRA. But we’ll see what happens when 2011 rolls around: the waning stimulus will drag economic growth; the Congressional tides may turn; and the immediacy of the crisis continues to fade. Unless firms start to “dissave” and pass on profits to households via hiring and wage growth, we may be in for a rocky ride, since the household desire to save will hover at very high levels for years to come (see David Beckworth’s post on the growing mismatch between mortgage debt load and real estate valuations).
So generally, this simple analysis would suggest that Menzie Chinn’s skepticism of a “status quo” of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture – certainly for the Eurozone, but possibly for the global economy as well.
The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.
The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the “household”) as a share of personal disposable income. In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).
Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.
The problem is: that according to the sectoral balances approach, it’s impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it’s not). Therefore, the £6.2billion in public “savings” may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.