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

Who cares about the unemployed…

…it seems that way, at least, when I listen to much of the rhetoric coming out of Washington.

But it’s not just Washington, it’s Wall Street, too. In my line of work, finance, market participants grapple with the monthly economic data flow, eyeing each release as if it’s telling a new story about the current prospect for US economic growth – that it isn’t just treading water. ‘Consensus’ economists forecast their expectations for the economic release of the day, the market then trades based on the surprise to which the data beat or disappointed expectations. Day in, day out, that’s what we do.

I have a problem with this automated way of viewing the world. It’s tough to hear Wall Street economists defend their forecasts, stating that ‘oil’ or ‘Europe’ are the primary risks to the outlook; or that the structural unemployment rate has risen markedly so that harmful inflation is right around the corner. Step back, take a look at where 2.7% annual growth (current Consensus for 2011) actually gets the US labor market (see chart below).

The biggest risk to the outlook is not oil, it’s unemployment. The longer that the labor market remains idle – in fact, the labor force is now trending downward – the lower will the average skill level will go. Then you’re going to get something much more structural, the so-called positive feedback loop.

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People move to the US for the American Dream – I wonder where they’ll go now…. Germany?


The chart above illustrates the harmonized G7 unemployment rates indexed to 2007 for comparability. The latest readings (June mostly) are listed in the legend.

The US labor market, as measured by the unemployment rate, deteriorated much more precipitously than that in any other G7 country. Germany stands out as the sole labor market that’s shown any marked improvement, furthering a trend that started with the the Hartz Concept. (I just did a Google search of the Hartz commission and came across this Economist article written in 2002 – remarkable.)

Policy drives the structural level of unemployment, not the other way around. In the US, there are currently no true boundaries to the supply of labor, rather it’s demand. Congress should be targeting job creation and aggregate demand, not the 2012 elections.

Stephen Gandel is right: there is no upside to high unemployment, just downside. You want to drop the deficit? Create jobs and aggregate demand so that the population ‘can’ pay taxes.

Rebecca Wilder

Here’s to hoping: wage, salary, and income gains

There are reasons to expect the second half of the year to be be stronger than the first. Here are two: (1) the rebound in industrial activity following supply chain disruptions, and (2) possible impetus to investment spending coming from the depreciation allowance that expires this year. These factors, though, are just dressing up what may be weak underlying demand. Why? Because without significant jobs growth, it’s unclear that we’ll see the wage, salary, and income generation needed for a healthy continuation of the deleveraging cycle.

On the bright side, the Q1 2011 Gross Domestic Income, GDI, report does show a smart rebound in wage and salary accruals. The problem is, that corporate profit growth, which generally leads wage and salary accruals growth, is slowing. (GDI is the income side of the BEA’s GDP release and you can download the data here.)


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The chart illustrates annual domestic profit and wage/salary growth spanning 1981 Q1 to 2011 Q1. The series are deflated by the GDP price index. Real domestic profit growth has been robust, peaking at 65% Yr/Yr in Q4 2009 and decelerating to 7% in Q1 2011. The surge in corporate profits brought real wage and salary accruals growth to a 2.1% annual pace in Q1 2011.

With higher input costs and slowing productivity gains, domestic profit margins are likely to be squeezed unless demand re-emerges smartly. The implication is that real wage and salary accruals growth may be nearing ‘as good as it gets’ territory during the aftermath of a balance sheet recession.

And labor’s losing it’s share of the pie. The chart below illustrates the various component contributions to annual gross domestic income growth. (the best that I could do on size vs. clarity – click to enlarge)

The data are quarterly data spanning 1981 Q1 to 2011 Q1 and deflated by the GDP price index. Wage and salary accruals have become a smaller part of income growth in the last decade. Spanning 1981-2000, the average contribution to income growth from wage and salary accruals was 1.5% (simple average), where that spanning the years 2001-current was just 0.3%. The average corporate profit contribution held firm over the same two periods, roughly 0.3%.

Growth momentum has slowed over the period, however, the deceleration in wage and salary contribution is quite striking. I can’t explain it even with the ‘demographic shift’; but this trend is likewise reflected in the employment to population ratio.

Wages, income, spending power, consumption, saving – they’re all different ways to say the same thing: earned income can be spent in one of three ways, on taxes, consumption, or saving. And in this recovery, saving via income gains is important as households further deleverage. We can’t afford compensationless expansion.

The key to growth in 2011 and 2012 is wages, salaries, and income – here’s to hoping.

Rebecca Wilder

Update: Spencer has a foreboding point in comments from my earlier post on GDP. He notes that inflation measured by the GDP deflator probably understates the impetus to domestic prices – domestic purchases is more appropriate at a 3.8% annual rate. The implication, according to Spencer via Email is, “If the inflation rate is really 3.8%, not 1.9 %, it strongly implies that the dominant cause of the economic weakness is higher inflation, not supply chain disruptions.”

GDP – a disappointing report

Yesterday I addressed the weak high-frequency indicators, specifically with respect to leading indicators of investment spending on equipment and software (durable goods). I argued that Q2 has not started off well, given that the real core orders for capital goods are down compared to the January to March average.

The BEA reported that Q1 2011 growth was 1.8% on a seasonally-adjusted and annualized basis, which is unrevised from the first release but the composition of spending changed somewhat. On the margin, Q1 2011 looks a bit less stellar (if you can call 1.8% annualized growth ‘stellar’) with consumption growth being revised downward to 2.2% over the quarter (previously 2.7%). Below is an illustration of the Q1 2011 contributions to GDP growth before 8:30am (1.75%) and after 8:30am (1.84%).

I think that the story is pretty simple: higher gasoline prices is even worse for consumption than initially anticipated, and inventory accumulation remains a large driver of economic performance.

It’s still way to early to predict what the entirety of 2011 will bring – the IMF forecasts 2.8% annual growth – but the bar’s rising on the quarterly growth trajectory to attain that level of growth. I suspect that forecasts will be revised downward.
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Although this is purely conjecture since the April figures are only recently rolling out, Q2 2011 growth is unlikely to be much better. Investment spending is already looking weak for April. And consumption growth may be lackluster on auto sales (H/T spencer) – durables consumption accounted for half of the quarterly growth rate in consumption (0.66% contribution to total GDP quarterly growth). Government spending is a drag, so it’s up to net exports!

Let’s look at what’s happened to the spending components of GDP during the ‘recovery’.

The chart illustrates the cumulative growth in the spending components of GDP (ex inventories). Exports and imports have bounced back on a strong rebound in international trade, 21% and 20%, respectively. Domestic spending is being driven largely by investment spending: consumption is 4% above it’s lows, while fixed investment spending is up 8% (of course, the decline was much larger). Government spending is broadly unchanged (-0.2%) since the outset of the recovery.

There’s much more to this report, like profits and wages, so I’ll revisit if time permits.

Rebecca Wilder

Durable goods orders: more evidence of near-term weakness in the US economy

They keep calling it a ‘soft patch’ in my business; but when’s the data going to show otherwise? This soft patch is persistent, and durable goods orders confirm it into Q2 2011.

Note: The ‘all manufacturing’ orders Y/Y growth rate are available through March only in Datastream for the chart above; the nondefense capital goods ex aircraft orders are current through Aptil.
READ MORE AFTER THE JUMP!From the Census April preliminary release on durable goods orders and shipments:

New orders for manufactured durable goods in April decreased $7.1 billion or 3.6 percent to $189.9 billion, the U.S. Census Bureau announced today. This decrease, down two of the last three months, followed a 4.4 percent March increase. Excluding transportation, new orders decreased 1.5 percent. Excluding defense, new orders decreased 3.6 percent.


We know that the auto industrial production print was influenced by the supply chain disruptions stemming from the Japanese earthquake. This probably affected the durable goods orders and shipments as well. Furthermore, the big monthly drop was driven (partially) by a large 30% decline in nondefense aircraft and parts orders over the month.

But the gist of the report, in my view, was disappointing. Total durable goods shipments fell 1% over the month, while new orders plummeted 3.6%. This is a very volatile series, and the March growth in new orders was revised upward to 4.4% over the month from 2.5%; but the average growth rate in ‘core orders’ is showing holes.

Core durable goods orders, ‘nondefense capital goods excluding aircraft’ – a leading indicator of domestic investment spending on equipment and software – fell 2.6% over the month. Volatile, yes; but the real core goods orders turned negative, -0.33% on a 3-month average growth basis, furthering a downward trend that’s been in place since January 2011. The April figure was down 0.2% on a real basis compared to the January-March 2011 average – not a good start to Q2 2011.(The real series is constructed using the CPI durable goods deflator.)

The contributions to Q1 2011 fixed investment spending demonstrate that the entirety of fixed investment growth came from equipment and software, 0.8% quarterly contribution. (On data, you can view the contributions data in Table 2 of the release here or download the data for the entire report here.)

So when will this ‘soft patch’ end? Neil Soss today tells me that 2H 2011 will be quite the kicker, as the temporary supply chain disruptions to industrial activity wear off. We’ll see. It’s going to take quite a bit of growth in 2H 2011 to get the US back on track to the consensus 2011 growth forecast of 2.7% (according to Consensus Economics May report).

Rebecca Wilder

"Survey says"…. German growth has probably peaked

This week further evidence has emerged of Germany’s slowing growth trajectory. At 4.9% annual growth (calendar-adjusted) and a tightening bias from the ECB, this was, of course, to be expected.

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Yesterday the Manufacturing May ‘Flash’ PMI by Markit Research highlighted, in my view, that sentiment is unlikely to remain at these absurdly elevated levels indefinitely, as the index dropped to 58.2 from 62 in April. Notably, the index remained above 60 for five consecutive months.

Today the Ifo Institute released its business survey for May, revealing that industry and trade remained stable in May. This index hovers at record highs compared to a post-unification time series.

Overall, while the two sentiment indicators diverged this month (the PMI waning, while the Ifo holding firm), the story remains that Germany is slowing down. Furthermore, the Ifo survey portends a deceleration in industrial production growth (IP), perhaps over the next quarter.

Exhibit 1 The ratio of the components of Ifo – expectations and current conditions – suggest a sharp reversal in the industrial production growth trend.

The chart correlates annual industrial production growth with the % differential between the expectations and current conditions components of the Ifo index at a 6-month lead. I don’t expect IP growth to turn negative, but a slowdown is certainly due.

Exhibit 2 Take the Ifo sentiment with a grain of salt!

Ifo really is more of a coincident indicator of economic growth than anything else. For example, the Ifo composite has a 77% correlation coefficient with annual real GDP growth. Previous to the current recovery/expansion, the Ifo index hit a peak of 108.7 in March 2008 only to see growth decelerate sharply the next quarter, 2.7% Y/Y to 1.6% Y/Y. My point is, while it’s a decent indicator of economic strength during expansions, it’s a terrible predictor of turning points.

We’re not at a turning point now – Ifo plus PMI demonstrate that the German economy continues to expand, albeit at a slower pace.

The real question is, what does this mean for the rest of Europe, specifically the Periphery? It’s not totally clear, but certainly with Germany contributing more than 50% to the quarterly growth rate in Q1, downside risks are emerging. Prieur du Plessis argues that this is related to the global slowdown in manufacturing.

Rebecca Wilder

Greece is in a pickle

There is growing discord between the ECB and national politicians over a ‘soft restructuring’ of Greek debt. The ECB doesn’t want it, while national policy makers grapple over it.

And just in case you were wondering what a soft restructuring actually is, Joseph Cotterill at FT Alphaville explains.

Beyond the gobbledygook restructuring talk is a simple story of incentives and the outlook for the Greek economy in the face of default. Over at Roubini Global Economics, Edward Hugh investigates the issue:

Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue?

The problem is that Greece’s manufacturing sector is NOT competitive, nor will it be under even the most severe fiscal austerity measures…not to mention that the fiscal austerity measures make their problems worse by deepening the domestic recession. Barring permanent fiscal transfers, they need a currency devaluation in order to gain any sort of competitiveness back.
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According to the Surveillance of Intra-Euro-Area Competitiveness and Imbalances (.pdf here), Greece faces the following:

In view of Greece’s weakened competitiveness in the euro area and its persistent current account deficit, adjustment in the context of the euro area would be facilitated by relative price and cost adjustments and a shift of resources from the nontradable to the tradable sector.

This is difficult to do without devaluation. An it’s not going to improve with a lower stock of debt (through restructuring)!

According to Eurostat, the 4-quarter MA (Angry Bear blog calculations) of Greece’s export base as a share of GDP has improved by just 0.6% of GDP from its low, while Ireland’s export base as a share of GDP has improved a large 22% of GDP.


Greece is getting most of the impetus to net exports via a sharp drop in import demand. A squeeze in import demand can technically grow GDP, but only so far.


Again – how’s the economy to grow after default? Greece needs a devaluation to shift resources from the nontradable to the tradable sector. (from the EU report)

Rebecca Wilder

Euro area inflation: gaining momentum below the hood

Today Eurostat released April 2011 inflation for the Euro area. Prices are increasing at a 2.8% annual pace, up from 2.7% in March and very much above the ECB’s comfort zone of around but slightly below 2%.

Today’s report is the second release and includes the cross section of price gains below the headline number. The first ‘flash’ estimate does not specify the breakdown.

Inflation’s hitting all sectors, goods (primarily) and services alike, via inputs to production.

READ MORE AFTER THE JUMP!April core prices rose 1.6% over the year. The goods-price inflation is flowing into the the service-sector as well – headline service-sector inflation is 2.0% in April, up from its low of 1.2% one year ago. There may be some seasonal distortions here associated with the Easter holiday, but the upward momentum has been established.

Price gains at the country level are broad based.

2% annual inflation is increasingly ubiquitous for key countries, Periphery and Core core alike. Below is the diffusion of 2% annual price gains, where an index value above 50 indicates that the majority of component prices are rising at a 2% rate. The legend indicates the longer-term average diffusion of price gains.

Germany is still seeing the majority of annual price gains below 2% – the current index is 43 – but the breadth of 2% inflation is increasing beyond its longer-term average of 34.8. In Spain and Italy, current inflation diffusion indices are likewise increasing, where Spanish price gains are broad, 55.6 in April.

And it’s not just VAT taxes.

The chart below illustrates the tax-adjusted inflation rate across the Eurozone (ex Ireland, unfortunately, whose data is unavailable, Austria, Estonia and Cyprus). This series is lagged one month.

The tax-adjusted inflation rate assumes that all tax hikes are passed fully through to final goods prices. It gives a proxy for the inflation effect of fiscal austerity (hike in VAT, for example).

Although the uptick in inflation is warranted at this stage in the recovery, especially in the core, the momentum in prices can no longer be attributed to taxes only – it’s broader than that. Greece, for example, saw its inflation rate peak around 5.6% in September 2010 when its tax-adjusted inflation rate (inflation excluding VAT) was just 1.1%. Now, however, the headline and tax-adjusted inflation rates are converging, 4.5% vs 1.7% in March. Much of the tax-adjusted inflation can be attributed to food and energy; nevertheless, the base effects of the VAT hikes are wearing off.

Tricky times for Euro area policy makers when the Core AND the Periphery are showing such broad price gains. Meanwhile, the Periphery are contributing little by way of growth.

Rebecca Wilder

The Euro area is ‘miserable’

For all of our economic problems here in the US, a simple measure of ‘misery’ illustrates that US households are less miserable in March 2011 than those in the Euro area.

The chart below illustrates the simple ‘misery index’, which is the unemployment rate plus inflation. The blue line is a 45-degree line; those countries below it have seen their misery index fall on a y/y basis. Not one Euro area economy misery index fell since this time last year – French and German misery indices are unchanged despite improving employment. In contrast, the US misery index improved over the year with labor market conditions.

The problem is, that European fiscal austerity is clinching aggregate demand, raising inflation (via higher taxes) and producing unemployment. Consumers and firms alike are feeling this in Europe.

In the US, fiscal policy has been accommodative enough to allow for private sector deleveraging while keeping the economy on an upward trajectory. However, food and energy price inflation in April stabilized the misery index compared to last year (not shown) – i.e., it’s no longer improving. Unless the labor market shows marked improvement in coming months, US misery will turn “Euro” as inflation batters consumers amid elevated unemployment. Please see Marshall Auerback’s piece at the New Deal 2.0 regarding QE2 – QE2: The Slogan Masquerading as a Serious Policy.

Rebecca Wilder

Euro area GDP report: unbalanced

Today Eurostat released their estimate of Euro area growth for the first quarter of 2011. The economy grew smartly, or 0.8% on the quarter on a seasonally- and working day- adjusted basis. On the face of it, Euro area growth, which is 3.3% on an annualized basis, dwarfs the 1.8% seen in the US economy. Really, though, it’s joint German and French growth that tower US Q1 GDP growth.

Eurostat doesn’t explicitly highlight how inordinately unbalanced is growth across the region in their report . Germany and France alone accounted for roughly 72% 78% of the quarterly growth of Euro area GDP.

(As I highlight below, the Euro area quarterly growth rate in the chart is slightly different to that in the Eurostat report since some euro area members are missing. The cross-sectional contribution should be roughly unchanged during the revisions, though.)

Update: This chart has been re-posted with only slight modifications from the original. It does not change the article’s premise in any way. H/T to Philippe Waechter in comments below.


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If final demand was growing so quickly in Germany, I would say that the Euro area is adjusting more healthily than I had expected. Spenders become savers and vice versa, and capital flows adjust current account balances (and trade) accordingly. Germany spends more at home and abroad, while the Periphery less so. This does seem to be occurring according to the Federal Statistical Agency:

In a quarter-on-quarter comparison (adjusted for price, seasonal and calendar variations), a positive contribution was made mainly by the domestic economy. Both capital formation in machinery and equipment and in construction and final consumption expenditure increased in part markedly. The growth of exports and imports continued, too. However, the balance of exports and imports had a smaller share in the strong GDP growth than domestic uses.

Euro area average growth is likely slow down a bit, as the global economy moves toward a tightening bias and fiscal austerity clenches demand further. However, the outlook for the Euro area as a whole does look increasingly reliant on the trajectory of German and French economic conditions. This is a risk, especially since Germany is an export-driven economy.

As a comparison, 2005 saw growth as broadly more balanced, where Germany and France contributed a smaller 50% to total Euro area growth.


The Q1 2011 growth trajectory (top chart) is entirely consistent with ECB targeted at the core countries.

Rebecca Wilder

What? Greece has to raise capital in 2012 and meet a 7.5% deficit target this year?

Over the last couple of months, a string of events made policy makers and investors alike say, what? Greece must raise capital next year and meet a 7.5% deficit target this year? Yes, they do, unless circumstances change. It’s near impossible to bet successfully on what Euro area policy makers are going to do, so let’s just review the facts here.

Greece missed its 2010 budget deficit target by near 1%, 9.6% of GDP projected (see .pdf page 45) vs. 10.5% actual (see Eurostat release, .pdf). The 2011 target is 7.5% of GDP.

Greece needs to raise roughly 30 bn euro in the private market next year – see .pdf page 50 here, where the IMF projects that Greece will finance 40.3bn in 2012, up from the 11 bn required in 2011. Furthermore, they’ll need to issue debt with longer maturity than the 3-month bills they’ve been marketing this year. At 1200 basis points over German bunds on a 10yr note, Greece cannot ‘afford’ this and is very unlikely to be tapping markets for term loans anytime next year.

Greece’s privatisation plan – selling state-owned assets – is probably too aggressive, amounting to roughly 4% of GDP per year through 2015 (10 bn euro average per year, see .pdf of presentation here, as a percentage of average GDP spanning 2010-2012).

But here’s something that is really important, and another reason why I do not believe that Greece would voluntarily default until at least next year: they’re expected to run a primary surplus in 2012. I take note that one can challenge the IMF’s forecast, but it’s the best information that I have at this time.

The chart illustrates the IMF’s 2011 and 2012 primary balance forecast across the Euro area (16) from the April 2011 World Economic Outlook. Those countries above the zero axis are expected to run 2012 primary surpluses – Greece, Germany, and Italy.

The primary balance is general government net lending (borrowing) excluding net interest expense. Better put: if the government runs a primary surplus, tax revenues are sufficient to pay all the government’s bills except the interest payments on the outstanding debt. Restructuring when an economy is in primary surplus makes much more sense.

If Greece runs a primary surplus in 2012, it will have a strategic ‘default card’ to play. This year it doesn’t, or Greece still needs the EFSF/EU/IMF to finance its spending. Next year, Greece can say “hey, we don’t need your money anymore.”

What to expect

Barring an immediate secession, I anticipate that Greece’s ‘circumstances’ will change in one of two ways over the near term: (1) Greece terms out its loans – a very soft restructuring – in the amount of 30 bn euro (or roughly thereabouts), or (2) the EFSF raises another 30 bn – that’s what it’s for.

On default, there’s a body of literature that attempts to quantify the costs of sovereign default – see the Economist article for a short literature review. Broadly speaking, the true economic impact could be ‘short-lived’ but is difficult to measure (see specifically this IMF paper).

It all comes down to this: I’m Greece, and I’ve put through structural reform that gets me a primary surplus next year – why subject the economy to further depressionary austerity measures rather than haircut my creditors and start from scratch? It’s been done before (see Table 2 of this paper). Or, I’m Germany (or France), do I want to write a check to Greece? Or recapitalize my banks outright.

Rebecca Wilder