Get ready for both inflation and deflation in the coming years. The deflation will come from assets that are dependent on credit creation, most notably housing, and the inflation will be on materials that come out of the ground, such as oil and copper, the stuff the world runs on and is made of.
Moody's is predicting an average decline in U.S. housing prices in 2011 of 7-10 percent. The problem is the number of distressed properties coming onto the market combined with tightening lending standards. Both factors will keep prices falling.
You’d think that rising prices of raw materials like lumber might be enough to increase the intrinsic value of homes in order to offset these head winds, but you’d be wrong. The combination of higher mortgage rates, oversupply and regulatory/legal factors will likely more than offset the rise in prices of materials that are needed to build a house. The demand for homes just isn’t there right now.
What Wealth Effect?
Jeremy Grantham recently argued in a CNBC interview that falling housing prices are complicating the Fed’s ability to create the wealth effect. Academics say that the improvement in sentiment associated with rising equities translates to about a $240 billion annual boost to consumption for every $1 trillion increase in stock market capitalization.
Cross-referencing some of the U.S. Treasury’s Flow of Funds data, it seems fair to conclude that a more than 5 percent decline in housing prices would more than offset any positive wealth effect caused by stock market appreciation.
I’ve argued in this column that the Federal Reserve’s “quantitative easing” program—so-called QE2—will not achieve sustainable economic progress in the form of "full employment" and “stable prices.”
The plan is clearly weakening the dollar, and between the solid demand pull for materials from expanding countries like China, prices of all sorts of commodities, such as cotton, are spiking.
Take the iPath Dow Jones-UBS Cotton Subindex Total Return ETN (NYSEArca: BAL). It has doubled in price in the past year and risen more than 80 percent in the past six months, as cotton climbs to highs not reached since the Civil War.
Considering sharply rising expenses like that, you can understand why the U.S. Bureau of Labor’s statistics on income and expenses paints a sobering picture that amounts to the opposite of the wealth effect.
Let’s say overall inflation of clothing, food and transportation increases by 30 percent, while your rent and income level stayed the same. What would that look like?
The quick and dirty math suggests that the bottom 40 percent of the country, by income bracket, would be spending more on necessities than they are making in after-tax income.
That would mean that nearly half of the country would need some sort of government assistance. So as the government and Fed try to inflate our way out of indebtedness, the social costs of economic policies will rise dramatically. The picture gets even gloomier when you add increased interest expenses on all the debt that will come as inflation causes bond yields to rise.
Don’t Hold Your Breath
Its not much of a stretch to assume that the same bottom 40 percent also made up many of the borrowers that were considered subprime and Alt-A.
Subprime and Alt-A represented anywhere from 30-40 percent of new mortgage origination between 2005-2006, according to some estimates. That compares with 10-15 percent in the 2002-2003 period. That leaves us with one troubling question: If the increase in commodity prices ends up destroying nearly half of the country’s financial means, how can we ever get demand for housing back to levels seen in 2004-2007? The answer is, don’t hold your breath.
The upside to this seemingly no-win situation is, ironically, that many people are already plenty pessimistic about the economic circumstances we find ourselves in. What I mean is that that people who save, and who at present are being punished via low interest rates, can find some bargains in housing. While I’m bearish on median house prices overall, I’m not ignoring the opportunity that distressed sales at extreme discounts represent.
Saturday, November 27, 2010
Get ready for both inflation and deflation in the coming years. The deflation will come from assets that are dependent on credit creation, most notably housing, and the inflation will be on materials that come out of the ground, such as oil and copper, the stuff the world runs on and is made of.
from UK Telegraph:
Reports that EU officials are hatching plans to double the size of EU's €440bn (£373bn) rescue mechanism have inevitably caused outrage in Germany. Brussels has denied the claims, but the story has refused to die precisely because markets know the European Financial Stability Facility (EFSF) cannot cope with the all too possible event of a triple bail-out for Ireland, Portugal and Spain.
EU leaders hoped this moment would never come when they launched their "shock and awe" fund last May. The pledge alone was supposed to be enough. But EU proposals in late October for creditor "haircuts" have set off capital flight, or a "buyers' strike" in the words of Klaus Regling, head of the EFSF.
Those at the coal-face of the bond markets are certain Portugal will need a rescue. Spain is in danger as yields on 10-year bonds punch to a post-EMU record of 5.2pc.
Axel Weber, Bundesbank chief, seemed to concede this week that Portugal and Spain would need bail-outs when he said that EMU governments may have to put up more money to bolster the fund. "€750bn should be enough. If not, we could increase it. The governments will do what is necessary," he said.
Whether governments will, in fact, write a fresh cheque is open to question. Chancellor Angela Merkel would risk popular fury if she had to raise fresh funds for eurozone debtors at a time of welfare cuts in Germany. She faces a string of regional elections where her Christian Democrats are struggling.
Mr Weber rowed back on Thursday saying that a "worst-case scenario" of triple bail-outs would require a €140bn top-up for the fund. This assurance is unlikely to soothe investors already wondering how Italy could avoid contagion in such circumstances.
"Italy is in a lot of pain," said Stefano di Domizio, from Lombard Street Research. "Bond yields have been going up 10 basis points a day and spreads are now the highest since the launch of EMU. We're talking about €2 trillion of debt so Rome has to tap the market often, and that is the problem."
The great question is at what point Germany concludes that it cannot bear the mounting burden any longer. "I am worried that Germany's authorities are slowly losing sight of the European common good," said Jean-Claude Juncker, chair of Eurogroup finance ministers.
Europe's fate may be decided soon by the German constitutional court as it rules on a clutch of cases challenging the legality of the Greek bail-out, the EFSF machinery, and ECB bond purchases.
"There has been a clear violation of the law and no judge can ignore that," said Prof Hankel, a co-author of one of the complaints. "I am convinced the court will forbid future payments."
If he is right – we may learn in February – the EU debt crisis will take a dramatic new turn.
Friday, November 26, 2010
BERLIN—The euro zone's sovereign debt crisis escalated Friday as the market homed in on Spain as another potential weak spot, leaving officials scrambling to quell investors' fears.
Spanish Prime Minister Jose Luis Rodriguez Zapatero moved to dispel the growing anxiety surrounding the country's fiscal position Friday, saying there was "absolutely" no chance the euro zone's fourth-largest economy would seek a bailout from the European Union. But his attempt to calm the markets had little effect, with the euro tumbling and the selloff in Spanish and Portuguese sovereign bonds continuing.
"If we continue to see the recent trend in Spanish bond yields then the crisis is going to be taken to a completely new level, as Spain accounts for approximately 11.7% of euro-zone [gross domestic product] which is pretty much double the figure of Ireland, Portugal and Greece [combined]," said Gary Jenkins, head of fixed-income research at Evolution Securities.
Sparking Friday's markets turmoil was a report in Friday's Financial Times Deutschland, which quoted unnamed German finance ministry officials as saying an aid package for Portugal would reduce the chances that Spain would also need a bailout.
The Portuguese and Spanish governments, the European Commission and Germany's finance ministry all denied the report, saying pressure wasn't being placed on Portugal to seek help. "It's absolutely, completely false—every reference for an aid plan for this country. It has neither been asked for and neither have we suggested it. It is absolutely false," said European Commission President Jose Manuel Barroso, a former Portuguese prime minister.
But the report still caused the euro to tumble against the dollar to $1.3252 from $1.3355 late in New York Thursday.
The yield premium that investors demand to hold 10-year Portuguese sovereign bonds rather than German bunds rose 0.3 percentage points to 4.35 percentage points, according to Tradeweb, while the spread between Spain's 10-year bonds and bunds spread rose to a fresh euro-era record high of 2.67 percentage points. The spread later recovered to 2.59 percentage points, still 0.07 percentage points higher than Thursday.
Stocks have given back 100 points of Wednesday's misguided gains
The Euro sinks to a new low
Headlines from FT:
Germany Rejects Larger Bailout Fund
The German government has rejected any suggestion of an increase in the size of the €440bn European financial stability facility – the eurozone rescue fund established by European Union finance ministers in May to help debt-laden members of the common currency zone.
“It really is a non-issue for the German government right now,” said Steffen Seibert, the government spokesman. “We have never been approached in any way about this. All conversations are taking place within the framework of the existing facility.”
Berlin’s approach - and that of the European Central Bank - to handling the eurozone crisis has come under strong attack from Peter Bofinger, economics professor at Würzburg university and an independent adviser to the German government. Without a profound change of strategy there was a “major risk of an unraveling of the euro area,” he has said.
A “dangerous” adjustment process is being forced on eurozone countries he told a Financial Times/Credit Suisse conference in Frankfurt. The weakest spot is Greece, which faces rising unemployment and debt levels. As a result, political opposition to euro membership would grow, according to Prof Bofinger. “Sooner or later we will have a discussion in Greece: ‘why not leave the euro?’” A new currency could then be devalued and much of the government’s debt cancelled out. Once Greece had left, others would follow.
IT'S GETTING WORSE, NOT BETTER:
Europe’s proposed “permanent crisis resolution mechanism” is aptly, if rather ironically, named. Trying to resolve a permanent crisis seems to be what the continent’s leaders have been doing all year and will no doubt be doing for some time yet. (One presumes they really mean a permanent mechanism for crisis resolution – the final language may well be different).
Whatever the final shape of the mechanism, designed to allow eurozone countries to default in an orderly manner, Europe seems little closer to resolving its debt crisis. To the financial markets, bail-outs for Greece and now Ireland are clearly insufficient, no more than plasters placed over gushing wounds.
U.S. Munis Sink Still Lower
Investors withdrew another $2.3bn from funds that buy US municipal bonds in the latest week, capping a sell-off that has taken about $5.4bn from the sector, according to Lipper, the fund tracker owned by Thomson Reuters.
The latest outflows from mutual and exchange traded funds for the week ended November 23 follow redemptions of $3.1bn in the previous week, the largest outflow since Lipper began compiling weekly data in 1992. The combined weekly outflows accounted for 1.5 per cent of the assets managed by the muni funds that Lipper follows.
Investors have cashed out of muni bonds this month after a rise in yields on benchmark US Treasuries and against a backdrop of warnings that the financial problems of local governments and municipalities will lead to a rise in defaults. The selling also came amid record amounts of new issuance into the end of the year.
The latest round of outflows from funds occurred even though the $2,800bn municipal bond market, where states, cities and other public entities raise money, had rebounded in the last few days.
Wednesday, November 24, 2010
Good for them! I don't blame them for a moment!
from China Daily:
St. Petersburg, Russia - China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday.
Chinese experts said the move reflected closer relations between Beijing and Moscow and is not aimed at challenging the dollar, but to protect their domestic economies.
"About trade settlement, we have decided to use our own currencies," Putin said at a joint news conference with Wen in St. Petersburg.
The two countries were accustomed to using other currencies, especially the dollar, for bilateral trade. Since the financial crisis, however, high-ranking officials on both sides began to explore other possibilities.
The yuan has now started trading against the Russian rouble in the Chinese interbank market, while the renminbi will soon be allowed to trade against the rouble in Russia, Putin said.
"That has forged an important step in bilateral trade and it is a result of the consolidated financial systems of world countries," he said.
Putin made his remarks after a meeting with Wen. They also officiated at a signing ceremony for 12 documents, including energy cooperation.
Significant drop in unemployment claims appears to be the main driver, but previous weeks' figures continue to be revised higher. All the other news is really awful. Home sales plunged and so did durable good orders. But consumer sentiment rose, perhaps due to the results of elections. Wall Street is thrilled on thin pre-holiday trading.
Tuesday, November 23, 2010
Federal Reserve officials downgraded their assessment of the U.S. economy at their last meeting three weeks ago as they debated the benefits and costs of a new bold step to support the recovery.
Minutes of the Fed's latest policy-setting meeting Nov. 2-3, released with the customary lag Tuesday, showed officials expect the economy to grow at a moderate pace next year, with unemployment staying disappointingly high and inflation uncomfortably low...
The minutes showed that, even though Fed officials voted with an overwhelming 10-1 majority to support the move, several worried about its consequences.
"Some participants noted concerns that additional expansion of the Federal Reserve's balance sheet could put unwanted downward pressure on the dollar's value in foreign exchange markets," the minutes showed. Several officials saw a risk the move could "cause an undesirably large increase in inflation."
The Fed projects U.S. gross domestic product, the broadest measure of economic activity, will rise at an annual rate of between 3.0% and 3.6% in 2011 after growing by around 2.5% this year. That compares with a previous June forecast that GDP would increase between 3.5% and 4.2% next year.
The economy grew at an annualized rate of just 2.5% in the third quarter, government data showed Tuesday, after rising by 1.7% in April to June. Since the recession ended in June 2009, the economy has been expanding at an average quarterly rate of less than 3.0%. That's too low to make a dent on unemployment and compares with a growth rate of nearly 8.0% that followed the previous deep U.S. recession in the early 1980s.
In fact, several Fed officials believed unemployment was more likely to rise than fall if the economy continues to grow so softly. "Participants agreed that progress in reducing unemployment was disappointing," the minutes showed.
The slow recovery should keep the unemployment rate, currently at 9.6%, around 9.0% at the end of next year, Fed officials predicted. In June, they had forecast the jobless rate would be around 8.5% in the last three months of 2011.
The upper range of the longer-run jobless rate was increased to 6.0% from 5.3%, indicating Fed officials believe the recession has caused some permanent damage to the labor market.
Existing home sales dropped from 5,980,000 in October 2009 (at $172,000 median price) down to 4,430,000 in October 2010 (at 170,500). The total existing home sales market size therefore dropped from $1.029 trillion down to $755 billion dollars, a $274 billion dollar drop in market size in one year.
"We can understand the pre-occupation with nonfarm payrolls, but frankly, the bloom comes off the rose when one turns to the Household Survey and sees that full-time employment has declined now for five months in a row." -- David Rosenberg
It's troubling to me that the only reason profits rose is that banks are setting aside fewer reserves for loan losses. Considering that the entire industry earned $14.5 billion, and expected losses for the foreclosure mess are now expected to hit nearly $750 billion, we're still is very deep trouble!
from Fox Business:
The BEA has released its second revision to Q3 GDP: "Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.5 percent in the third quarter of 2010, (that is, from the second quarter to the third quarter), according to the "second" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.7 percent." Expectation was of 2.4%. The reason: inventories, inventories, inventories. "The acceleration in real GDP in the third quarter primarily reflected a sharp deceleration in imports and accelerations in private inventory investment and in PCE that were partly offset by a downturn in residential fixed investment and decelerations in nonresidential fixed investment and in exports." As noted previously the $40-50 billion upcoming Q4 decline in inventories will likely push Q4 GDP flat to negative. In other news, US PCE Core (Q3 S) Q/Q 0.8% vs. Exp. 0.8% (Prev. 0.8%), while US Personal Consumption (Q3 S) Q/Q 2.8% vs. Exp. 2.5% (Prev. 2.6%).
The change in real private inventories added 1.30 percentage points to the third-quarter change in real GDP, after adding 0.82 percentage point to the second-quarter change. Private businesses increased inventories $111.5 billion in the third quarter, following increases of $68.8 billion in the second quarter and of $44.1 billion in the first.The second there is no more upward change in inventories, that 1.30% will go flat, or worse, negative. In other words, if Q4 GDP goes back to Q2 levels, that will be a swing factor of 2.6%, pushing Q4 GDP negative for the year.
Lastly, for those expecting final sales growth to persist in Q4 - good luck. The end of extended insurance benefits is estimated to take out about 0.5% of GDP alone. Then again, the data does comes from those funny, funny people at the BLS so be prepared for the glaringly and obviously impossible.
Monday, November 22, 2010
After two years in exile Fannie Mae and Freddie Mac are returning to center stage, ready to battle with the nation's lenders. The fight isn't over championship belts or gold medals, instead we'll find out who really owns foreclosure losses worth billions of dollars.
The unfolding war has significant implications for both foreclosure buyers and property owners in general. If mortgage investors start winning court battles, lenders will be forced to dump accounting fictions and show real losses. At that point there's little reason to hold foreclosed properties off the marketplace, hoping for higher prices. Instead, there will be a rush to dump distressed properties and accelerate short sales. While foreclosures now represent a quarter of all real estate sales, the percentage could quickly jump and force down home values, at least in the short run.
The “good” news — a term to be used cautiously — is that once foreclosure inventories fall, markets can then stabilize and in some areas home values might actually begin to rise.
The Secondary Market
Fannie Mae and Freddie Mac are “GSEs” or government-sponsored enterprises. They are special corporate concoctions at the heart of the “secondary” market, an electronic trading post where the GSEs buy loans from local lenders, package the mortgages into securities, and then sell the securities they created to investors. The continued functioning of the secondary market is a big deal because about 75 percent of all single-family mortgage originations are purchased by the GSEs.
A lender anywhere in the country can sell qualified mortgages to Fannie Mae and Freddie Mac. Investors from all over the world can buy and sell mortgage-related securities, an expression which can include pass-through securities and mortgage-backed bonds. The money investors pay for such securities enables the GSEs to buy more local loans and so the cycle continues. Along the way the GSEs “guarantee the timely payment of principal and interest on the mortgage-backed securities they issue” according to Freddie Mac.
The key to the system concerns those “qualified” mortgages. The GSEs are willing to buy conventional, FHA and VA loans because such mortgages have precise requirements and standards. A lender who tries to stick the GSEs with an unqualified mortgage can be tossed out of the program. No less important, a lender who sells a tainted loan can be forced to buy back the offending mortgage at face value.
Loan originators thus have every possible reason to carefully follow underwriting guidelines. A loan which fails because of nonpayment within 120 days — or a loan which fails at any time because of fraud — can generate an ugly and unpleasant buyback demand.
How Many Billions?
By the end of the third quarter the GSEs held massive numbers of foreclosures, properties that could not be unloaded with a short sale or through a foreclosure auction. Freddie Mac held 74,910 REO properties while Fannie Mae had 166,787 homes in its REO inventory.
“Not only do the GSEs have an REO problem, they also have a guarantee problem because they promised to make good on the securities they sold to mortgage investors,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “The potential liability of the GSEs is a matter of debate but there's little doubt that the final total will be enormous.”
Indeed, some of the loss estimates are astronomical.
- The Federal Housing Finance Agency (FHFA) says Fannie Mae and Freddie Mac have borrowed $148 billion to date from the Treasury but that additional draws could range “from $221 billion to $363 billion through 2013.”
- Credit Suisse says Fannie Mae and Freddie Mac could face $321 billion in losses if home values decline by 10 percent in a year, are flat the next year and rise 3 percent annually thereafter. Of course, if things don't go so well then the losses could amount to $448 billion.
- Standard & Poor's says “the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the $148 billion already invested — money largely spent to make good on loans gone bad.” Things could get worse, however. S&P says that $280 billion “could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize.”
If Fannie Mae and Freddie Mac are facing vast losses on the mortgages they bought then do they have any claims against the lenders who sold such loans? Can they force private-sector lenders to buy back failed mortgages?
Fannie Mae and Freddie Mac were taken over by the federal government in the summer of 2008. They are now operated by the Federal Housing Finance Agency (FHFA), a governmental entity that in July issued 64 subpoenas “to determine whether misrepresentations, breaches of warranties or other acts or omissions” were made by lenders who sold loans to Fannie Mae and Freddie Mac.
And just what documents does the government want? It's “seeking the contents of loan files, which include documents used in the underwriting process, such as loan applications and property appraisals.”
The potential for lender buybacks has not gone unnoticed and it involves not just Fannie Mae and Freddie Mac. The biggest case so far concerns the Maine State Retirement System and other mortgage investors who sued the Bank of America — the successor to Countrywide Financial — claiming that loans worth $352 billion should be bought back at face value. The suit has just been dismissed — but “without prejudice,” meaning it can be re-filed. As a result of the dismissal, says Bank of America, its liability has been reduced to not more than $31 billion — a sum greater than the profits of the entire banking system in the second quarter.
Meanwhile, other claims loom. As examples, the Federal Reserve Bank of New York and several large investors want Bank of America to buy back mortgage-related securities worth $47 billion. On the West coast, the Federal Home Loan Bank of Seattle has sued 11 lenders, seeking buybacks worth $4 billion.
In one suit, the bank alleges that a mortgage seller “made numerous statements to the plaintiff about the certificate and the credit quality of the mortgage loans that backed it. Many of those statements were untrue. Moreover, the defendants omitted to state many material facts that were necessary in order to make their statements not misleading.”
How much, if anything, mortgage investors can get back from loan originators and packagers is unknown. A report from Goldman Sachs says the nation's four largest banks will likely need $26 billion to cover “putback” claims during the next few years — that's $15.5 billion for the Bank of America, $5.3 billion for JPMorgan Chase, $2.2 billion for CitiGroup and $3 billion for Wells Fargo. The number for JPMorgan Chase could grow by an additional $3.5 billion if more loans from its Washington Mutual subsidiary do not work out. Whatever the case, the numbers suggested by Goldman Sachs can be easily absorbed by the larger banks.
But what if mortgage investor claims are more successful? What if settlements and remedies against dozens of lenders and Wall Street firms amount to hundreds of billions of dollars? Or more? Massive losses will need to be written off immediately so it will no longer make sense for lenders to have a foreclosure inventory or to wait for higher prices. Instead — under inevitably new management — the fresh strategy will be to clean up the books, dump REOs, speed short sales, blame old management, regain public confidence and move on.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.
Sunday, November 21, 2010
The CPI was out this week, and it showed a continued drop in inflation. There were those who immediately pointed out that this vindicated the Fed's move to QE2. We have to get ahead of this deflation thing, don't we? Well, maybe, depending on how you measure inflation/deflation. This week we look deep into the BLS website on inflation to see just exactly what it is we are measuring, and then take a walk down Nostalgia Lane. But first we look at what I think we can call The Sputtering Economy, because that will tie into our inflation discussion.
The Sputtering EconomyMy father, who would be 100 this summer, would hitch up the wagon on a farm in Castleberry, Texas, about 6 miles from downtown Fort Worth, to drive to church or to the Big City for supplies. He was 57 when they put a man on the moon. It was hard for me as a kid to relate to wagons and outhouses, although we grew up rather poor on the outskirts of a very small town on the edge of West Texas, living as country kids. It was a great life. We were all poor and didn't know it.
My kids have some of the same issues about understanding my early era. I grew up as we were first starting to get power lawn mowers, a dream for me, as I hated push mowers and slings. But you had to constantly tinker with them. Neglect them for too long and they would start to sputter. When that happened, you first looked at the spark plugs, then the carburetor and the gas/air mix, filters, etc. And as I got older, that helped with my transition to taking care of my car. I was not a great mechanic but, as nearly everyone was, I was adequate.
Today? I can't even figure out what is under the hood. No clue. And my tools back in 1967? Not designed for a 2010 model, let alone a hybrid.
Same with our old black and white TV of the late '50s. As a ten-year-old kid, when the TV went out I would take off the back of the set, take out every one of the 20 or so vacuum tubes, and test them all. You wanted to test them all because if more than one was bad it was two miles to the store on my bike, and it was uphill at least one way. Those old tubes went out all the time. Just part of the price of watching TV.
Our economy today is like that old lawn mower engine. We get one piece of economic data that is good to very good, and the next day we get some bad news. Let's look at some of the data for the past few weeks.
Last week we got the New York Fed Empire Index. It was simply ugly. It fell from 15.7 to a -11.4. But then this week we get the Philly Fed Index, and it's shockingly high. The consensus saw a mild increase to an index level of 5, but it jumped 21 points to 22.5. And all the underlying components were very solid. It is hard to square such a difference when the cities that spawned these reports are about an hour train ride apart.
Capacity utilization is slowly rising, but is still at a recession level 72.7%, up 4 points from 12 months ago and the highest since over two years ago. So are we getting better or are we still mired in the doldrums? I think the answer depends on how many hours you are working.
The surveys from the National Federation of Independent Business continue to indicate that small businesses are not out of the woods. Hiring is at a virtual standstill but is at least not falling, as it was most of this year and last year. Business conditions are mixed. The survey is better than it was but still shows a sputtering economy.
The latest establishment employment survey shows job growth, though not at a level that can bring down the unemployment level. And if you look at the household survey, two things leap out. First, there is a significant rise in the number of people employed part-time. The rise in employment is not of a sort that prompts a sigh of relief. Part-time work, while better than none, does not inspire consumer confidence. It is not the fabric of a solid recovery.
Second, there are not many small business start-ups, which are the source, the feedstock if you will, of job growth. Whether because it is harder than ever to find money (it is) or because entrepreneurs are uncertain about what the future holds (they are), or for whatever reason, that is a very troubling metric. And the household survey showed a large decrease in the numbers of jobs and people working, a different story than the establishment survey.
What it all suggests is an economy growing between one and two percent. That is better than recession but not good enough to really bite into the unemployment rate.
Old and OutmodedAnd that could mean trouble, as there are millions of people who are coming to the end of their 99-week extended unemployment benefits this next year. Although Congress rejected an extension this week, it was on a vote that required a 2/3 majority. That bill will be back as one that only needs a simple majority, and then it will be up to the Senate. Even so, as I understand it, benefits will only get extended for three months. At least that is the current plan.
Already, people are running out of their extended benefits. Earlier this year there were 12 million people on the extended and regular unemployment rolls. That is dropping each week and is now down to 8,854,206 people, according to the DOL. Since the regular continuing claims number is not really changing all that much, much of it is from people dropping off the rolls.
And the number of people on food stamps continues to rise. As of the end of August, when continuing benefits were running over 10M, a total of 42,389,619 people were receiving food stamps under the SNAP program. This was an increase of 553,379 people over July's number, or an increase month-over-month of 1.32%. The year-over-year increase was 6,147,762 people or 17%. In July the increase was 17.51%.
Now here's an interesting thing my friend John Vogel noticed. Households on food stamps are growing even faster than the number of individuals on food stamps. In August, 19,720,255 households were on food stamps, an increase of 284,877 households over the July numbers. This was a percentage increase of 1.47%. In terms of a yearly increase, the number of households grew by 3,159,502 or 19.1%, versus 19.53% recorded in July. As John wrote me:
"So, the numbers keep growing strongly, with households growing more rapidly than people. This still signifies more childless couples or single people being affected lately.
"I cannot figure this out yet, but I feel that we are going through a very significant change in household formation, in the type and quantity of available jobs, in small business stability and formation - and we are applying old, outmoded macroeconomic solutions to problems that will not and cannot respond."
We'll come back to that thought, but first we have to look at the definition of deflation.
We Have Deflation Exactly Where?President Clinton famously remarked about his escapades that "... it all depends on the definition of what is is." And similarly, whether or not we are in danger of deflation all depends on what your definition of deflation is. First, let's look at the recent headline numbers. What we find is that core inflation, at 0.6%, as well as trimmed inflation (which takes out the statistical outliers and anomalies) are both at post-war all-time lows.
Another way to look at inflation is all-items inflation vs. core inflation, that is, inflation without food and energy. From the BLS website:
I have often joked that when you become a Fed governor they take you into a back room and do a DNA change on you. When you come out you are at all times and everywhere viscerally opposed to deflation. You will not let it happen on your watch.
And that is what happened in 2003, as deflation became a concern. The Fed under Greenspan allowed interest rates to stay low "for an extended period of time" in order to make sure deflation did not take root. Notice that it was in late 2002 that Bernanke gave his famous "helicopter" speech on deflation. There was very real concern in policy circles.
But should there have been? What if the way we measured inflation was flawed in some regard? Let's play a thought game. Back in the early '80s there was some consternation about using the price of houses as a way to calculate inflation. Read this paragraph from the BLS website (emphasis mine):
"Until the early 1980s, the CPI used what is called the asset price method to measure the change in the costs of owner-occupied housing. The asset price method treats the purchase of an asset, such as a house, as it does the purchase of any consumer good. Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons, the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing. It was implemented for the CPI-U in January 1983."
Homeowner equivalent rent is 25.2% of the input when they calculate the Consumer Price Index (CPI). Thus it makes a big difference how you calculate the price of housing. It is extraordinarily difficult to find historical data on homeowner equivalent rent in the BLS database. You can find "shelter costs," which include energy, insurance, etc. and are 41% of the CPI, but for our purposes today I want to focus more narrowly.
I did find an old release that shows the index value for the year 2000 to be 198.7 ( http://www.bls.gov/cpi/cpid00av.pdf). The index value as of this October was 256.8. That means the rise in housing costs over the last decade was about 25% or roughly 2.5% a year, although in the last few years that number has gone deadline flat. And you can see that in the graph of total housing costs below.
But house prices went up by more than double that amount, and about 65% in the seven years from 2000 to 2007 (back-of-the-napkin estimate). That is an asset inflation of about 9-10% a year.
What if we had been using actual home prices as the measure of inflation? Let's look at the year-over-year change in inflation for the last ten years:
Homeowners equivalent rent is 25% of the index. So take the home price rise, divide it by four, and add it to the inflation index. Inflation in the middle of the decade would have been running 4-5-6% and in 2005 would have been over 7%!
Would rates have been kept low "for an extended period of time" if we had still been using actual home prices? I rather doubt it - alarms bells would have been sounding. The Fed would have been leaning into the rise in "inflation." Thus no housing bubble would have developed. And then no credit crisis.
And the difference all stems from how you measure inflation. These details matter. Now, let's go back to that highlighted portion from the BLS web site.
"Because the asset price method can lead to inappropriate results for goods that are purchased largely for investment reasons [emphasis mine], the CPI implemented the rental equivalence approach to measuring price change for owner-occupied housing."
In the 1980s the BLS (under Reagan, so not a liberal plot!) decided a home was an investment and not a roof over our head. It also conveniently allowed for lower official inflation, which is what Social Security and other government programs are tied to. But that change had significant unintended consequences.
O Deflation, Where Is Thy Sting?Now, if you have no social life (at least on Fridays, when I write) you can go to the BLS website and get a plethora of data. (I bet that breakout of HOER is somewhere there, I just can't find it, and their search engine needs an update.) One of the things they do is offer all sorts of ways to look at inflation, way down the page ( http://www.bls.gov/news.release/pdf/cpi.pdf).
First, we find that inflation for all items is 1.2% over the last year. All items less food and energy, or core inflation (which the Fed pays attention to), is only 0.6%. That is getting dangerously low, isn't it?
Maybe not. What you find is that inflation when you take out housing costs is a jaunty 1.9%. Right in the Fed target range of 1.5-2%. Even "core" inflation, when you take out housing, is 1.5%. That is not exactly something we should be worried about. That flat equivalent-rent number is showing a deflation risk that is simply not there.
But the Fed is worried about deflation and other things, so they are going to embark on a $600-billion quantitative easing, which among other things is going to help devalue the dollar and has already caused a rise in commodity, energy, and food prices.
We may in fact get some inflation, but precisely where we do not want it. While the Fed may prefer to look at core inflation, the rest of us live in a world where we buy food and consume energy. And for those in the lower part of the income spectrum, the rising cost of food and energy is disproportionately high. It acts like a tax on disposable income, which will hurt retail sales, which is PRECISELY what we do not need.
And all because we have the hubris to think we can measure inflation in some precise manner, and then choose policies to react to our imprecision.
Remember my 1967 tools? They wouldn't do me much good if I had to try and fix my car today. Not that if I were in the desert and my car broke down I might not try. It is after all still an engine, and somewhere in there must be something I can understand.
I wonder if the Fed is not trying to fix a modern 2010 economy with tools made in the '50s, based on theories based in the writings of a bunch of dead white guys. They were smart guys, I give you that. But times have changed. And our measurement tools seem flawed to me.
Thankfully, I rather think that the $600 billion can be absorbed without too much collateral damage. We do have a large economy, and the multiplier effect is at an all-time low. Or maybe I am just guilty of wishful, optimistic thinking.