Fed Watch: Short Takes for January 11, 2009

Tim Duy:

Short Takes for January 11, 2009, by Tim Duy: I am running low on time these first few weeks of the term. Bits and pieces of things I am worried about:

On the employment situation report: Mark catalogued links to a host of insightful commentary that pours over the details of this decidedly negative report. The headline figures tell a brutal story, with ongoing steep declines in payrolls and aggregate hours worked pointing to a sharp contraction in economic activity in the fourth quarter. Internal details are even more painful, with the number of part time for economic reasons skyrocketing, one factor pushing the U-6 measure of unemployment up almost a full percentage point to 13.5%. Moreover, the diffusion indexes (for one month, 25.4 in December for all industries, just 11.3 for manufacturing) reveal the staggering breadth of this downturn; outside of health care, virtually no sector is spared some pain. Finally, further declines in the temporary employment sector point to more reports like this one in the months ahead.

On consumers: Wednesday, we see retail sales numbers for December. It is not expected to be pretty; the holiday season is widely believed to have been the final straw for an array of retailers – see the WSJ story here. A rough estimate based on confidence numbers suggests to me that real PCE continued to run at a rate of negative 1% or so in December, a swing of roughly 4 percentage points from spending growth prior to the recession. The positive impact of lower energy prices ran up against the forces of joblessness and increased saving rates (household deleveraging). The latter two dynamics remain in play in the months ahead, whereas energy prices might not have much further to fall. To some extent, an increase in refinance activity should step up to compensate for any stagnation in energy prices, but I am not expecting any miracles, especially since, at least as of the third quarter, households had yet to significantly deleverage their balance sheets significantly:

While tracking at a sustained 1% decline in real spending is bad enough, odds are for further deceleration – I suspect that household deleveraging in the years ahead will amount to more than a trillion dollars of foregone consumption. Business models that relied on consumer spending, particularly luxury spending (from RVs to $600 pairs of shoes) are going to suffer greatly in this environment.

On international trade: The sustained weakness in consumer spending points to a massive amount of import contraction, a supposition supported by Brad Setser’s article today on Asian export growth (or non-growth). This, however, might not yet show up significantly in tomorrow’s release of the US monthly trade accounts for November. Of course, if you were concerned that the trade deficit would eventually need to correct, you were likely looking for import compression as one mechanism supporting that correction. And the faster the adjustment, the greater the degree of import compression. Unfortunately, the fastest way to get people to stop spending on imports is to put them out of work – which is where we are now. The dynamics have not played out as I expected, but the end result appears to be the same: There is no way out of this mess without a reduction in the standard of living for US households. Making the situation even worse is the inability of the world to break with the US dynamic, which means that rather than cushioning declining domestic growth, exports are likely aggravating domestic conditions. And the export decline is complicating predictions concerning the one potential silver lining – that at the end of this mess the US external accounts would be closer to balanced.

On fiscal stimulus: Lots of commentary on the incoming Administration’s spending plans; once again, Mark is keeping tabs. Given growing estimates of the output gap, there is substantial concern that the early numbers are woefully insufficient to meet the economic needs of the nation. The concern is accentuated by the large tax cut component of the package, which is widely expected to have little bang for the buck. Menzie Chen argues that, contrary to concerns about enough shovel ready projects, there is plenty of room for infrastructure stimulus given the depth and duration of the expected output gap. And Nate Silver suggests that the early numbers are lowballing the expected final figure to gain a strategic negotiating advantage. My take is that the current numbers, especially with a large tax cut component, are likely to pop the data in the second half of the year relative to the baseline. It is a lot of money. Behind that pop, however, the size of the package, and the timeline, are woefully insufficient to fix the economy. It took us almost three decades to get into this mess; it will take decades to get out. While Menzie is right, there is plenty of scope for infrastructure projects, they need time and planning; if the Obama administration tries to rush such projects, they will be vulnerable to charges of waste, fraud, etc. But they need to do something to get a floor under the economy now to provide hope that they can get the job done over the long haul. Hence, we get a policy that is more of the same – tax cuts. Quick to implement with bipartisan support, but with, I suspect, few lasting effects – especially given the newfound predilection for saving. Why we don’t get more safety net expansions, however, is still a mystery to me. Seems like an easy way to use existing program to quickly get money to those in need – and those who will spend.

On what should the little guy invest do with their 401(k)s. According to the Wall Street Journal, Americans are losing faith in the 401(k) system of retirement savings. I count myself in that group – the draw has not been good this decade for those following the rules:

Even if workers follow the golden rules of 401(k) investing -- saving early and diligently, holding a broadly diversified investment mix, never tapping their savings until retirement -- their success can still depend largely on the luck of the stock-market draw.

I would be willing to bet that the average person would sacrifice liquidity (money trapped in retirement accounts) to simply earn something like a 6% nominal return (assuming a real return closer to 4% or so) and avoid the headaches and stress of managing their own retirement portfolios. For the foreseeable future, however, if the Fed sees such a yield, they will want to snuff it out. So what are your ideas? What should I tell people who ask this question? Assuming you stick with a base 401(k) contribution for the tax benefits, where do you put extra retirement money? My recent answer – feel free to offer alternatives – is to pay off your mortgage, which earns a guaranteed return (admittedly, there are some tax considerations, as well as the issue of walking away if you are seriously underwater). An interesting question – does a low interest rate environment really encourage taking on debt and spending, or the opposite? I recall in the 1980s people would take out high interest mortgages (the cost of housing was much lower, and as such still affordable), but then work to pay off the mortgage as quickly as possible. Under what conditions could a low interest rate environment create similar behavior?

Enjoy your week – good luck.

Comments

[mmckinl]

A Plan for Public Sentiment … and Saving Millions of Jobs

The Plan must also take into account public sentiment. The turn around in public sentiment will be crucial to getting over the hump. And saving jobs is cheaper, quicker and more efficient than creating jobs.

That is why we need “Medicare for All” . Medicare for All will lift the morale long term and help fill the pocketbooks of the poor, the working poor and much of the middle class while saving millions of jobs by underwriting business and state and local government …

Don’t believe we can’t afford it. Every other G7 nation covers all their people for about half of what we spend to cover 85%. Their health outcomes are better and this subsidizes their business so that their products can be sold more cheaply both at home and abroad.

In fact if we don’t Nationalize health care with Medicare for All and reform the health care sector medical costs will bankrupt this country.

[wjd123]

Tim Duy asks:

Why we don’t get more safety net expansions, however, is still a mystery to me. Seems like an easy way to use existing program to quickly get money to those in need – and those who will spend.

This makes sense in the short run, however, there may be a long term problem brewing for our ability to expand our safety net: an inability to tax sufficiently.

This was taken from Dani Rodrik's blog asking "Does globalization erode the social safety nets?"

Giuseppe Bertola and Anna Lo Prete have now brought new evidence to bear on this question, and their findings bear out the simple intuition. As they put it, "as technological progress and multilateral trade liberalisation have made borders less of a barrier to economic activity, the scope of redistribution policies has become smaller." Here is the chart that goes along with their result: Dani Rodrik

This is from the paper he's discussing:

Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity.--Bertola and Lo Prete

http://rodrik.typepad.com/dani_rodriks_weblog/2008/12/does-globalization-erode-social-safety-nets.html

So economist have a dilemma if these findings are correct. They can't ask for a stronger safety net and expanded globalization at the same time--at least not globalization as it is practiced today--because the tax revenues won't be there. Are we going to borrow forever to maintain our social safety net?

[Beezer]

All everybody is saying points to the same conclusion: We have a ton of work to do. We don't have a lack of productive investments, we are being buried by the sudden realization that the biggest deficit we face is the deficit in infrastructure, environment, mis-allocation of resources away from productive activity etc. etc.

Even with all the stimulus added up, to date, estimates are it raises debt from 40% of GDP to 60% of GDP. Compare that to more than 100% of GDP for many developed countries, including Japan.

What standard of living? We're all running around so fast right now trying to make "ends" meet, reducing what we consider "ends" needs to be seriously revised. Happiness is decidely not another HDTV.

As for tax cuts, the only one that makes any sense is the payroll tax cut because, as has been pointed out by many, it helps folks who are likely to spend most of it.

Private investment money is totally iced. It's not coming out anytime soon, so tax cuts aimed at accomplishing the impossible are a total waste and counter-productive.

This is a 10 year deal. In human terms, especially in developed country terms, this will seem like an eternity.
Taxes need to get more progressive. A fossil fuel tax is badly needed in order to keep us from backsliding on sustainable energy.

Will this lower our standard of living? Our happiness? Maybe not. Everyone having access to basic health care will create health and happiness. Not killing 100,000 people annually in car accidents will probably boost happiness. Not to mention the savings in good 'ol dollars.

As for 401ks, put more into an all treasury fund.

[Beezer]

Think of it this way: We've badly mispriced (underestimated) risk. Free markets don't even try to price in risk, for heaven's sake. And from what we've recently experienced in the housing/derivatives/bank intermediary meltdown, maybe free markets shouldn't even try.

Now, we're finding out what the real price of things are when risk is taken into account. Way more than we realized, obviously.

What risks weren't priced? Environmental risk. Energy risk.
Ignorance risk. Unfettered free markets risk. Infrastructure deficit risk. Ocean pollution risk. List your risk.

says...

Tim..."There is no way out of this mess without a reduction in the standard of living for US households."

Yet policy is insisting that credit continue to expand from peak levels, despite dwindling foreign influx of loaned goods/services. This means that the entire burden of falling living standards will fall upon the consumer. A single job will continue to lose purchasing power, and pensions will lose purchasing power even faster. Putting monetary policy under the control of a private banking system has led to fleecing of the consumers for the enrichment of the banking system, shadow banks, and hedge funds.

One job used to be enough to support a family. Then the banking system started creating too much money, and now 2 jobs plus overtime is needed to make ends meet. Don't even ask how the baby boom is going to retire, since most of the extra resources generated by productivity improvements have already been confiscated by the private banking system.

Constant inflation, coupled with uneven distribution of newly created money, lowers the standard of living of consumers over time. Either send all consumers a check when the money supply is expanded, or get rid of inflation. Enough with confiscating all productivity improvements for the enrichment of a few.

[robertdfeinman]

A comprehensive discussion of outlooks would consider the possibility that we will never go back to the type of high growth, full employment, era we had before.

The US had a period of continual growth (punctuated by a series of financial meltdowns) because it had unlimited space, untapped natural resources and a continual supply of motivated, young and cheap new workers via immigration.

It also was industrializing faster than most of the rest of the world and could use its industrial and military strength to its advantage in trade and foreign policy.

There is no new frontier to expand into. Raw materials are become scarce domestically and internationally. The country is filling up and immigration is only a marginal effect, despite what the jingoists say. The population is below replacement level if immigration is ignored, so the work force will no longer expand as before.

What is to be done if we are faced with a permanent condition of an oversupply of labor and with "nothing" for them to do? Programs like universal health care are not solutions to an economic problem, they are a solution to a failure of the moral basis of society. Providing it won't solve the labor problems, although it will make life easier for the unemployed.

Other countries run consistently high unemployment rates, France is said to be around 10%.

I think this really needs to be considered. The more economist thrash around with the thought that the stimulus package won't be "enough" the more apparent it become that nothing will do the job of bringing back the 1950's.

What then?

says...

Tim..."For the foreseeable future, however, if the Fed sees such a yield, they will want to snuff it out."

The solution is to change the mandate. Get rid of inflation, and allow the market to set interest rates. Then 401k participants will be able to get a stable real return on bonds, as our ancestors did back in days of yore.

Before constant inflation became the norm, bond yields were consistently higher than equity yields, to compensate the public for the higher volatility. The public is not comfortable with the high volatility of equity, and bonds were destroyed as an asset class by constant inflation. Constant inflation is being used as a deliberate policy of ripping off savers (like 401k participants), and the general consumer (lowered living standard per single job/private sector pension).

Destroying bond return forced the public into inflation hedges (mostly homes and stocks, since gold was illegal for so long). The first in gained as inflation hedges went up in price to absorb savings that formerly was loaned out. The price rise drew speculators, bubbles formed, and the last people in lost heavily as the bubbles popped.

The ordinary citizen cannot reliably save for their retirement without a stable dollar (zero inflation). The ordinary citizen is simply not nimble enough to switch from inflation hedge to alternate inflation hedge as the bubbles unfold. The public is harmed greatly by the unintended consequences of constant inflation.

[reason]

mmckinl
While I don't disagree with your specific proposal it is not enough. We can't just continue with business as has become normal for the last few years. Major reform of the (dysfunctional) international financial system is needed. Once BO is in office it must become his top priority.

says...

"...Nationalize health care with Medicare for All..."

First, I agree that affordable basic health care for all is a sensible goal. However, merely extending Medicare will not by itself bring down the total cost per capita to other nations' levels. Other nations achieve lower costs by actively managing their health care industries. Sort of a VA for all.

Expanding the veterans health care system to cover the entire population could work, as long as someone sensible was put in charge of the expansion. Anyone who wants more than the basic services provided by the expanded veterans health care system could pay cash for it on the free market, as is customary in Europe.

The entire change over could be paid for by the stimulation program. Solving both today's slow down problem, and tomorrow's future projected Medicare cost problem. Don't waste the stimulation digging metaphorical holes. Not when heavy duty real problems need a serious solution.

says...

Tim..."An interesting question – does a low interest rate environment really encourage taking on debt and spending, or the opposite?"

In the long run, low interest rates lower the national savings rate. Witness the drop in Japanese savings rates during their extended low rate period. Witness how the US savings rate dropped as interest rates dropped. The charts show a very close relationship.

In the short run, savings rates can fluctuate according to economic circumstances unrelated to the interest rate.

says...

"The ordinary citizen is simply not nimble enough to switch from inflation hedge to alternate inflation hedge as the bubbles unfold."

To expand on this, let me give you an example of what is needed. In early Y2K, the S&P was badly overvalued by historic norms. However, REITs were selling for very enticing historic yields (over 9%). Buying REITs in Y2K, and selling them about 5 years later resulted in a very handsome profit (plus the 9% annual dividend). The average 401k was stuck with S&P type funds (or company stock like Enron employees), and lost a lot.

However, to switch from an S&P fund to REITs, commodities, shorting the market, or whatever is the current best inflation hedge requires a great deal of research, skill, thought, and luck. It is unreasonable to expect the average Joe or Jane to spend so much time researching various inflation hedges, and to be comfortable with the risk involved. They won't do it because they want to spend their time on enjoyable activities (like raising their families), or can't do it (wrong temperament or IQ).

If Joe and Jane average aren't given a simple, safe means of saving for their future (like an FDIC bank savings account with reasonable positive real after tax return), it won't get done. This is the lesson of history. If a nation deliberately decides to rip off ordinary savers, significant saving won't get done. The citizens will be helpless when hard times come, or they get too old/disabled to work in a high paying job. Carried to extremes, the nation will eventually become dependent upon easily repatriated foreign capital. A very vulnerable situation to be in.

[mmckinl]

reason says...
mmckinl
While I don't disagree with your specific proposal it is not enough. We can't just continue with business as has become normal for the last few years. Major reform of the (dysfunctional) international financial system is needed. Once BO is in office it must become his top priority.

~~~~~

I didn't say it was enough. This was the proposal for the stimulus.

I also believe this :

Economists and Financial Writers Newest and Biggest Failure ...Our Banking System is Insolvent yet Mum's the Word!

The fact is that almost All Wall Street Banks are insolvent, broke, bust ! ~~~ As most economists and writers missed the housing bubble, now almost all are missing the gaping hole in our solvency and indeed in the trust necessary for the proper operation of financial marklets. This can only be restored with tough transparent audits.

FDR did it successfully, as did Sweden and Norway. What is it ? Bank Balance Sheet scrubbing that restored trust and solvency to the system. It is called the Swedish Plan or a Bank Holiday

As it stands now we can't even get any answers on the $9 Trillions in Tax Payer Money that has been loaned or used as underwriting for our financial system.

William Greider wrote in The Nation over 6 weeks ago about this whole situation. Well it has only gotten geometrically worse. At that time , we, the tax payers were only on the hook for a couple of trilllion dollars. Now just weeks later , we, the tax payer are on the hook for over $9 trillions and counting.

Time for a Bank Holiday by William Greider @ The Nation

Here is what Greider wrote 6 weeks ago :

"From the outset of the crisis, the essential fallacy shared by governing influentials has been a wishful assumption that quick interventions with tons of public money would somehow restore the system to "normal" without disturbing free-market principles. Replenished banks would start lending again and lead us to recovery. "Normal" is not going to happen. If the new president does not break free of the denial and act decisively, his administration will be dangerously compromised from the start.
Obama can begin by declaring a "bank holiday" like FDR's in 1933--an opportunity to put the hard facts on the table and assume temporary control of the entire financial system. Nationalizing the banks sounds more radical than it is, since banking law already empowers regulators to impose extraordinary controls and close supervision over troubled institutions. Facing facts will be painful, but it's better than continuing a costly charade."

And yet, here we are, six weeks later, with a deafening, damning silence including the economists and financial reporters from the left.

~~~

Without a worldwide accounting of bank balance sheets the debacle will continue. Everything including this stimulus depends on cleaning up the banks first ... A World Wide Bank Holiday ...