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.