A look at the state of the US economy. Join me in confusion!

Larry Kummer, Editor

13 years ago

Summary: The current economic situation of the US is fascinating. Repeated disappointments in the past, great optimism about the future, confusion about today, all occurring amidst one of the greatest monetary experiments in history. The stakes are high. Growth will force perilous withdrawal of the current massive monetary stimulus; a slowdown will force more stimulus in ways difficult to predict. See the links at the end for more information about these complex matters.

Contents

A nickel summary of the US economy
A note about QE3
For More Information
Trust in Chairman Bernanke

(1) A summary of the US economy

(a) The US has been running near the “stall speed” of 2%, with the government applying fiscal or monetary stimulus when we fall below it.

(b) Wall Street, Fed, and CBO economist for the past 3 years have annually predicted a breakout from this trend. See chart 6 above! With Q1 at 1.77% and Q2 perhaps 1%, we will need a big second half to get 2.5% for the year. They do expect big results. Perhaps incorrectly; see Do you see the coming boom?.

(c) There are many reasons for this, but mostly from confidence that QE3 will work, largely by inflating asset prices. See The World of Wonders: Monetary Magic applied to cure America’s economic ills. It might work; it might not work. It is The greatest monetary experiment, ever. Unless there is a large wealth effect boosting spending of top quintile households (the bottom 4 have too few assets to matter), which I doubt, I do not see what will drive the acceleration later this year.

(d) These repeated failed forecasts might indicate an analytical failure in their models. Richard Koo talks about this as a failure to understand the “balance sheet recession”.

(e) Correct or not, these forecasts of accelerating growth prompt forecasts that the Fed will begin “tapering” — a slowing of the Fed’s QE3 buying of securities, followed by increased interest rates.

(f) That might not be the only reason for tapering. It might not even be the primary reason. Last month Bob Januah of Nomura gave what might be the actual explanation:

“But the Fed is NOT going to taper because the economy is too strong or because we have sustained core (wage) inflation, or because we have full employment – none of these conditions will be seen for some years to come. Rather, I feel that the Fed is going to taper because it is getting very fearful that it is creating a number of significant and dangerous leverage driven speculative bubbles that could threaten the financial stability of the US. In central bank speak, the Fed has likely come to the point where it feels the costs now outweigh the benefits of more policy.”

(g) While growth might accelerate later this year, now the economy is probably slowing. Estimates of Q1 real GDP have quickly dropped from 2%. Many are in the 1% – 1.3% range (QoQ, seasonally adjusted, annualized), Barclay’s is at 0.6%. If so, this would be the 3rd sequential quarter of slow (<2%) growth. Now there are even more contractionary forces at work:

The rise in oil prices (WTI is up 1/4) and rates (the yield on the 10 year Treasury has doubled), both are bad for housing and autos (although producing a quick buying blip before higher rates hit).
Most of the sequester’s effects have taken effect, but some will continue to hit through end of September.
Monetary velocity continues to fall.

(h) The brightest spot in the economic picture is growth in jobs. But not all employment indicators are shiny.

The good news: New claims for unemployment insurance have been steadily dropping (down 6% YoY).
Also good: 196 thousand new non-farm jobs per month for the past 3 months, although with several anomalies. Also, the birth-death addition (not reliable) was the largest as a share of the total since last June (31% of the total). Next month we will see if the pattern of large semi-annual revisions continues (generating revisions of -1.2 million in July 2012 and -2.9 million in Jan).
Not good: the U-3 unemployment rate (the “official” number) has been flat at 7.6% for 4 months, and February was only 7.7%.
Bad: the other Unemployment numbers (U-4 to U-6) are at 4-month highs.

(i) How unfortunate that we are too smart to use this opportunity borrow at low rates to rebuilt America’s infrastructure at relatively low cost, and stimulate the economy. Instead we rely on monetary stimulus on a scale never successfully attempted. Future generations will never understand.

(2) A note about QE3

Key to the reflation story, especially with weak growth in household income, is more borrowing! Credit growth is up only 2.5% YoY (NSA, excluding Federal education loans, the new subprime) and up the same YTD (total, seasonally adjusted). Here’s an acute analysis by Chris Wood of CLSA: “Addiction and lack of conviction”, 4 July 2013:

The bull case is, therefore, clear. If house prices keep rising the amount of negative equity in the system will continue to decline, household balance sheets will recover, as has already begun to happen, and the path should be set for the resumption of the credit multiplier in what remains a consumption driven economy.

Thus, US household net worth (total assets less liabilities) rose by 10%YoY in 1Q 2013 and is up 35% from the recent low reached in 1Q 2009 to a record US$70.3tn at the end of 1Q 2013. Owners’ equity in household real estate also rose by 29%YoY and is up 45% from the 1Q 2009 low to US$9.1tn at the end of 1Q 2013 (see Figure 3). Similarly, CoreLogic reported that 850,000 more homes returned to positive equity during 1Q 2013. The number of residential properties in negative equity declined from 10.5m, or 21.7% of all residential properties with a mortgage, at the end of 4Q 2012 to 9.7m or 19.8% at the end of 1Q 2013.

… The above thesis of an investment property boom, as opposed to a conventional housing recovery, raises another consequence of unconventional orthodoxy. This is that the practical way these policies work is to lead to ever more extreme wealth distribution, as reflected in America’s Gini coefficient which measures the degree of income inequality. The Gini coefficient has risen from 0.386 in 1968 to 0.47 in 2006 and was 0.477 in 2011, according to the US Census Bureau. This is because the wealthy are geared into rising asset prices, particularly prices of financial assets, whereas ordinary people are geared into average hourly earnings growth. In this respect the Gini coefficient had apparently reached in 2006 the previous high seen in 1929, prior to the Great Depression.

This is a reminder that capitalism’s natural way of dealing with excesses is via business failure and liquidation; which is why wealth distribution would have become much less extreme as a consequence of the 2008 crisis if losses had been imposed on creditors to bust financial institutions, for example owners of bank bonds, in line with capitalist principles; as opposed to the favoured ‘bailout’ approach pursued for the most part by Washington.