Government Spending, GDP Drops

A 22% decline in government defense spending is being blamed for a 0.1% drop in the country’s GDP in the fourth quarter of 2012, while consumer spending grew at a 2.2% annual rate in the same period. Investment was also up in the fourth quarter, particularly in the housing sector, and overall performance is trending toward an overall GDP gain of as much as 3% over the coming year. Inflation, which was once thought to be a significant threat, actually moved lower and experts note that statistics point to there being no real impact from “fiscal cliff” concerns during the quarter. For more on this continue reading the following article from Economist’s View.

Dean Baker on todays' news the GDP shrank in the 4th quarer of last year:

Falling Government Spending and Inventories Push Growth Negative in Quarter, by Dean Baker: A sharp drop in government spending, heavily concentrated in defense, coupled with a decline in inventories caused GDP to shrink at a 0.1 percent rate in the 4th quarter. Government spending fell at a 6.6 percent annual rate, driven by a 22.2 percent decline in defense spending, subtracting 1.33 percentage points from the growth rate in the quarter. A 40.3 drop in the rate of inventory accumulation reduced growth by another 1.27 percentage points. Without these factors, GDP would have grown at a 2.5 percent annual rate in the quarter.

Pulling out these extraordinary factors, the GDP data were largely in line with prior quarters. Consumption grew at a 2.2 percent annual rate, driven mostly by 13.9 percent growth in durable goods purchases, primarily cars. This number was inflated due to the effects of Sandy, which destroyed many cars, forcing people to buy new ones. Growth in this category will be substantially weaker and possibly negative in the next quarter. On the other side, housing and utilities subtracted 0.47 percentage points from growth in the quarter. This is likely a global warming effect with warmer than normal weather leading to less use of heating in the quarter. (There was a comparable falloff in the 4th quarter of 2011 when we also had unusually warm weather.)

One especially noteworthy item is the continuing slow pace in the growth of spending on health care services, which accounts for almost three quarters of all health care spending. Nominal spending grew at a just a 2.3 percent annual rate in the quarter. Over the last year, nominal spending is up by just 1.8 percent, far less than the rate of growth of GDP, and well below the projections from the Congressional Budget Office (CBO). It seems increasingly likely that we are on a slower health care cost trajectory. The deficit picture will look very different when CBO incorporates this slower growth trend into its projections.

Investment rebounded from a weak third quarter in which non-residential investment actually shrank. This quarter it added 0.83 percentage points to growth, with investment in equipment and software growing at a 12.4 percent rate. Housing continued to be a big positive in the quarter, adding 0.36 percentage points to growth.

Net exports were a modest drag on growth. While both exports and imports fell in the quarter, the 5.7 percent drop in exports more than offset the positive impact of a 3.2 percent decline in imports. The state and local sector government sector shrank at a 0.7 percent annual rate, knocking 0.08 percentage points off growth. Non-defense federal spending rose at a 1.4 percent annual rate.

The inflation hawks will be disappointed in this report with the overall price index rising at just a 0.6 percent annual rate. The core CPE rose at a 0.9 percent rate. Insofar as there is any trend in these data it is toward lower inflation.

One interesting item in the report was a $122.90 jump (85.2 percent at an annual rate) in dividend payouts. This was the result of companies deciding to pay out dividends to shareholders in 2012 when a lower tax rate was in effect on high-income taxpayers.

There is little evidence in this report to believe that the economy will diverge sharply from a 2.5- 3.0 percent growth path, except for the impact of the deficit reductions that Congress is considering or already put in place. Higher tax collections from the ending of the payroll tax holiday are likely to knock around 0.5 percentage points from growth. The sequester, or whatever cuts are put in place in lieu of the sequester, are likely to have an even larger impact on growth beginning in the second quarter.

One item worth noting is the GDP report provides zero evidence that "fiscal cliff" concerns had any impact on growth in the quarter. Consumer durable purchases and investment in equipment and software were the two strongest components of GDP. If worries over the fiscal cliff were supposed to cause people to put off purchases, consumers and businesses apparently did not get the memo.

Nevertheless, with the slow recovery of output and employment all is not well no matter how we spin the numbers. We need more spending on infrastructure to help with the recovery.

This article was republished with permission from The Economist's View.

Ron Paul Slams Paul Ryan’s Budget Plan

Independent presidential candidate Ron Paul recently used the FOX News podium to bash Paul Ryan’s proposed budget plan. Ryan is presumptive Republican nominee Mitt Romney’s choice for running mate and Paul contends that the plan has no teeth, criticizing Ryan’s assertion that his approach would draw down U.S. debt within 30 years. Paul went on to tout his own plan, which focuses on ending the wars in Iraq and Afghanistan and using the saved money to fund domestic programs while also cutting back on the spending for some of those programs. For more on this continue reading the following article from Iacono Research.

Rep. Ron Paul (R-TX) doesn’t seem to think too much of Paul Ryan’s budget plans, as expressed to Neil Cavuto the other day, since the goal of “maybe balancing the budget in 30 years” doesn’t fundamentally address the ongoing trouble the nation has in squaring its books (if that’s even possible anymore).

On a related note, Mineweb reports that Paul (Ron, not Ryan) has launched a new campaign to legalize alternate domestic currencies, citing Ludwig von Mises who noted, “sound money is an instrument that protects our civil liberties against despotic government. Our current monetary system is indeed despotic, and the surest way to correct things simply is to legalize competing currencies“.
It’s too bad he’s not running for another term in the House this fall – he will be missed.

This blog post was republished with permission from Tim Iacono.

Americans Losing Hope Economic Recovery

It is no secret that the U.S. public’s outlook on the economy has been suffering, but new Gallup polls indicate confidence is sinking even lower. One poll measuring sentiment from 2009 to 2011 shows that those who once believed the economy was getting better has fallen nearly 30%, while those who feel the economy is the same or worse has risen nearly 30% over two years. Another poll covering the same period indicates that fewer Republicans, Democrats and Independents feel the economy will get better “one year from now.” Moreover, the number of people who blame President Obama for the economic mess has risen 32% in the last two years. For more on this continue reading the following article from Tim Iacono.

It shouldn’t be too surprising to see the kind of polling data that Gallup has been reporting this week, given that, to many Americans, there never really was an economic recovery from the 2008 recession. From this survey published yesterday, it seems there is little optimism left out there as the hope that many had two years ago has faded.

Even more bad news for President Obama comes via this separate Gallup poll in which, for the first time ever, more than half the respondents blame him for the nation’s economic woes, up from 32 percent two years ago. Of course, 69 percent still blame former President George W. Bush, down from 80 percent in 2009, however, those trends are certainly not the friends of anyone in or near the White House.

This blog post was republished with permission from Tim Iacono.

Advice for Obama

Economist Brad DeLong has some suggestions for President Obama regarding how he should handle the country’s current economic crisis without expecting any help from Congress, because they can’t agree on anything. This means that regulatory reform is a non-starter and the president will have to result in putting pressure on the Federal Reserve to increase quantitative easing, close the spending gap and be willing to invest government dollars in infrastructure projects. It would also help, he argues, if the Treasury Secretary spoke on the benefits of a weak U.S. dollar to help exports and give a boost to the struggling European economy. For more on this continue reading the following article from Economist’s View.

Brad DeLong:

...What in most important is not just what Obama proposes on Thursday (because nothing will get done by congress), but rather what he does in the weeks and months afterwards to actually tune the economy so that it creates more jobs. I think Obama should:

1. Apply a full-court press to the Federal Reserve to get it to target nominal GDP to close the spending gap, for it is fear of risk that nobody will spend to buy what you make and confidence that your purchasing power is safe in cash that is holding back businesses from spending money to hire people.

2. Apply a full-court press to the Federal Reserve to get it to engage in more quantitative easing--into taking more risk onto its own balance sheet, for it is an unwillingness on the part of Wall Street to hold the risk currently out there that is making it very difficult for a wide range of risky spending projects to get financing.

3. Quantitative easing does not have to be done by the Fed: the Treasury can use residual TARP authority to take tail risk onto its own books as well, and should be doing so as much as possible.

4. Expansion does not require that the federal government spend: using Treasury (and Fed!) money to grease the financing of infrastructure and other investments by states would pay enormous dividends.

5. For the Treasury Secretary to announce that a weak dollar is in America's interest right now would not only boost exports, but it would immediately lead to a shift in monetary policy in Europe toward a much more expansionary profile--which would be good for the world.

None of these is first-best. All of these are likely to do some good. All should be tried.

What's discouraging is that there doesn't seem to be any sense of urgency about the employment crisis itself. It's more of a reluctant and begrudging response driven by a shift in the political winds. If the polls weren't falling, I doubt we'd even be hearing a speech on job creation. So I hope there's follow-through as well -- these things should be happening already -- but we'll see.

This article was republished with permission from Economist's View.

Choices Few in US Economic Fix

Economist Tim Duy provides a broad overview of the current state of U.S. economic affairs by examining the Federal Reserve’s role and options in supporting a turnaround. Duy’s guess is that monetary policy is the only card left to play as the administration’s plans for an economic boost will likely fall short and new legislation seems out of the question given policymakers’ inability to find consensus. This makes the Fed and its choices on quantitative easing, mortgage-backed securities and long-term policy positions as the deciding factors in whether the country will experience another recession. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Questions and Answers, by Tim Duy: I thought this might be an easier way to get back into the game after an extended hiatus.

Does the economy need more stimulus?

Always good to start with a softball question - YES! The US economy is two years into an economic expansion, and yet the unemployment rate remains above 9 percent. National output growth averaged just 0.7 percent in the first two quarters of the year. Job growth was zero in August, albeit with some downward pressure from the Verizon strike. Output is $1 trillion below CBO potential – and the gap is expanding. The 30-year inflation indexed Treasury bond just traded at 90 basis points. None of which should be happening two years into an expansion. Yet here we are.

Will the private sector provide the needed stimulus?

Federal Reserve President Dennis Lockhart summarizes the situation:

It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future.

Lacking the equity wealth provided by the housing bubble, households are simply unable to sustain the debt loads of years past. Hence, deleveraging continues. Without anyone else to pick up the slack, it is tough to see how we eek out anything other than subpar growth, trend growth (2.5 - 3.0%) at best. Not enough to quickly lift the economy back to trend output.

Will the government provide the needed stimulus?

On the fiscal side, the answer is no, or at least not yet. As Paul Krugman points out, fiscal policy is already contractionary, while the recently passed budget deal promises only more austerity. And, via Brad DeLong, Macroadvisors predicts that President Barack Obama’s impending jobs plan is not likely to provide much if any of an economic boost. That leaves monetary policy as the only game in town. And here we can anticipate that more easing is coming. But will it be enough to pull the economy from its slump? At this point, almost certainly not.

Why will monetary policy fall short?

Here again it is useful to refer back to Lockhart’s recent speech:

Given the weak data we've seen recently and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

Lockhart is not ruling out additional policy responses, but makes obvious his view the Fed is nearly, if not already, out of bullets to deal with a balance-sheet recession. Moreover, he shows his sympathy with the camp, I think best identified with the views of Kansas City Federal Reserve President Thomas Hoenig, that the Fed at this point risks doing more harm than good. This, I believe, represents the center of FOMC thought at the moment. This group is simply not inclined to initiate a new large scale easing in the absence of clear deflationary pressures. The five and ten-year TIPS breakevens are 1.81 and 2.05 percent, respectively. Combined, I believe they argue, at least from the Federal Reserve point of view, for more easing, but nothing dramatic.

But didn’t the most recent FOMC minutes reveal a more dovish constituency?

Yes. From the minutes:

A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation

Chicago Federal Reserve Bank President Charles Evans is a good example of this group. Via a recent CNBC interview:

In his view, QE needs to stay in place until unemployment plunges to 7 percent or if inflation gets past 3 percent. Core inflation, which strips out food and transportation, is about 1.8 percent, though the number is 3.6 percent including the more volatile measures.

Evans is a voting member on the fed Open Market Committee and traditionally has been among its more dovish members when it comes to interest rates and inflation.

"Strong accommodation needs to be in place for a substantial period of time," he said. "If we could sort of make everybody understand that this is going to be in place for a longer period of time, we could knock out some of that restraint that comes about when people talk about premature tightening."

As far as I am concerned, he is preaching to the choir. There has been a remarkably irresponsible tendency of Fed policymakers to turn hawkish at the slightest hint of economic improvement. I think this belies their discomfort with the expansion of the balance sheet, and renders the rest of us unsure of their commitment to the dual mandate. And I believe the Fed needs to accept the possibility of higher inflation.

What can the Fed do at this point?

The usual suspects: Reduce the interest paid on reserves, extend the maturity of the Fed’s portfolio, expand the balance sheet further, shift the portfolio in favor of mortgage-backed securities to support the housing market, make a firm commitment to zero interest rates regardless of the inflation outcome, or raise the inflation target from 2 percent to 3 or 4 percent. I suspect the first three are most likely in play, although the magnitude of an additional balance sheet expansion will likely fall short of what is needed.

Wait a second. Didn’t the Fed already commit to zero interest rates until 2013?

No – they just said that given current forecasts, they anticipated an extended period on low interest rates. This does have some value in marginalizing the hawks. That said, the minutes make clear this is only a soft commitment:

Most members, however, agreed that stating a conditional expectation for the level of the federal funds rate through mid-2013 provided useful guidance to the public, with some noting that such an indication did not remove the Committee's flexibility to adjust the policy rate earlier or later if economic conditions do not evolve as the Committee currently expects.

What we really need is a hard commitment that can weather a period of higher inflation.

Where is Federal Reserve Chairman Ben Bernanke is this mix?

It appears that Bernanke is right of the dovish contingent revealed in the most recent FOMC minutes. I think this first became evident in his June press conference, when he made clear the bar to QE3 was high. The bar was high because inflation expectations had rebounded, and inflation was the only clear target the Fed had control over. This basic idea was evident in Bernanke’s Jackson Hole speech:

The Federal Reserve has a role in promoting the longer-term performance of the economy. Most importantly, monetary policy that ensures that inflation remains low and stable over time contributes to long-run macroeconomic and financial stability. Low and stable inflation improves the functioning of markets, making them more effective at allocating resources; and it allows households and businesses to plan for the future without having to be unduly concerned with unpredictable movements in the general level of prices.

Once inflation is close to the Federal Reserve’s target, Bernanke apparently sees little else monetary policy can do to relieve the cyclical pressures on the economy:

Notwithstanding this observation, which adds urgency to the need to achieve a cyclical recovery in employment, most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.

I think the Bernanke’s focus on the 2 percent inflation target will severely limit the magnitude of additional easing to support job growth. It is increasingly my opinion that to lift the economy beyond the zero bound, we need a commitment by the Fed to lift inflation above 2 percent to allow nominal spending to return to the pre-recession trend. This is policy the Fed Chair appears dead set against, leaving only half-measures.

Note, however, the above only applies when inflation and inflation expectations are near the Fed’s target. I do believe Bernanke will press for more dramatic action should deflationary pressures become evident. I just don’t think we are there yet.

Would a shift to additional mortgage-backed assets help?

It wouldn’t hurt, and could push mortgage rates down further and thus encourage additional refinancing. Back in the day I would have been worried that the Fed risked looking like it was trying to sustain bubble-level prices, but I think we are beyond that. Still, note the problem in mortgage markets is deeper than interest rates – the problem is the inability to finance due to tougher underwriting standards and underwater mortgages. I am not confident that lower rates would alleviate these challenges. This seems more like the purview of the US Treasury, which could push for all federally guaranteed mortgages to be refinanced at a lower interest rate, regardless of the loan to value ratio.

Are we headed for recession?

I would not discount the possibility of recession given the US economy was clearly operating near stall-speed in the first half of the year. That said, it would be easier to embrace the recession story had the US economy ever returned to trend output during the recovery. As noted earlier, the economy is operating well below trend, and typical sources of strong downdrafts in demand – housing and autos – remain below pre-recession levels. Indeed, the absence of any rebound in housing is striking. Under these circumstances, I find it easier to embrace the “Japan” scenario, a sustained period of choppy and low growth. Recession or not, a tragedy by any measure.

What’s going on in Europe?

The Europeans are vexed with a political establishment that is not conducive to maintaining a single currency (of course, we too in the US are vexed with a dysfunctional political establishment, just a different one). In particular, they lack a mechanism to make sizable fiscal transfers within the Euro area. This is simply an important element of running a “one size fits all” monetary policy. As it stands, Euro-policymakers are attempting to enforce IMF-style austerity packages on troubled economies without the usual currency depreciation that helps offset the resulting fiscal contraction. It is obvious this approach is not working – Greek two-year debt is trading at 50 percent and the spread on Italian and Spanish debt widens. Paul Krugman asks where is the ECB? Where indeed? Perhaps they see their earlier debt-buying efforts as a failure, thus concluding the problem is a solvency problem, not a liquidity problem. And there is no European solution for a solvency problem, other than more austerity for troubled economies. Where does this end? Either the Euro-area comes together as a strong fiscal union or the periphery is jettisoned from the Euro. It really looks like the smart money is on the latter outcome. Drachmas anyone?

Update: 10:09PM PST

I see the ECB was not completely asleep at the wheel and was buying bonds. From the Wall Street Journal:

The ECB purchased Italian and Spanish government bonds Monday in a bid to keep 10-year borrowing costs from rising further above 5%—a threshold analysts say is key to their ability to finance their high debt loads. The ECB has purchased over €50 billion in bonds since reactivating the program four weeks ago.

This post was republished with permission from Economist's View.

National Bureau of Economic Research Still Convinced Of Recession's End

Although many indicators seem to point to an ending for the recession, the National Bureau of Economic Research continues to wait to officially declare its end. The NBER's reticence appears to stem from a desire to avoid making a premature announcement, especially since consumer behavior has not yet taken on the characteristics of an economy in recovery. See the following post from The Capital Spectator.

Is the recession over? No, or at least not officially, according to the National Bureau of Economic Research, the non-profit group that makes the official pronouncements on business cycle dates. In a statement yesterday, NBER said it was too soon to mark the end of the contraction that began in December 2007.

"Although most indicators have turned up," the NBER explained, "the committee decided that the determination of the trough date on the basis of current data would be premature." The press release went on to say,

Many indicators are quite preliminary at this time and will be revised in coming months. The committee acts only on the basis of actual indicators and does not rely on forecasts in making its determination of the dates of peaks and troughs in economic activity. The committee did review data relating to the date of the peak, previously determined to have occurred in December 2007, marking the onset of the recent recession. The committee reaffirmed that peak date.

But one panel member on NBER's Business Cycle Dating Committee thinks otherwise. Economist Robert Gordon, who teaches at Northwestern, says that "it is obvious that the recession is over," according to Bloomberg BusinessWeek. The U.S. "is enjoying strong upward momentum that is evident every day in the announcement of retail sales, service-sector production, and almost everything else."

So, why the delay in declaring the finale to the recession? In a word, caution. "The committee is very careful to guard against surprises," the chairman of the Business Cycle Dating Committee told The Wall Street Journal. "We wait until the numbers come in even if we have a fair level of certainty about what they're going to be," explained Stanford University economist Robert Hall.

Meantime, Ken Goldstein, an economist at the Conference Board, summed up the thinking of some in the dismal science: "While we, the professional egghead economists, feel we are in a recovery and that there is only a small chance we are wrong, consumers are still saving and not spending, as if they think this thing is not completely over."

So, is it over? Probably, although that doesn't mean the danger's gone. It's too early to rule out the possibility of a fresh round of weakness in the economy later this year, as we discussed here. Regardless of what's coming, the clues that suggested the recession was over have been bubbling for nearly a year. As early as June 2009, for instance, we considered the case for thinking that the economic contraction was at or near an end.

Officially speaking, however, it still ain't over till the NBER says it's over. Does it matter? Probably not, although that's debatable too. At least one economist thinks there may be a risk in the absence of the rhetoric that everyone wants to hear. "By not calling an end to the recession," warned MarketWatch.com's chief economist Irwin Kellner, "the NBER might inadvertently cause economic policy to remain too easy too long."

This post has been republished from James Picerno's blog, The Capital Spectator.

The Worst Of The Recession Is Behind Us

Steve Sjuggerud from Daily Wealth believes that the worst of the recession is behind us based on a comparison of previous financial crises in the history of the United States. Stocks and housing have already fallen more than historic averages and have already been recovering for months. See the following post from Daily Wealth.

We're out of the woods with this financial crisis...

That's my best guess at least, based on a study of the major financial crises through history.

The recent book This Time is Different: Eight Centuries of Financial Folly, by Kenneth Rogoff and Carmen Reinhart, takes a look at the history of major financial crises...

Boiling the book down to its simplest conclusions, here's what happens after a banking crisis:

• Home prices and stock prices collapse dramatically over the course of several years.

• The economy tanks and unemployment rises dramatically.

• Government debts soar.

The book gives specific timelines based on history... It tells us how far things fall and how long these things last. And it gives us a pretty good idea of what to expect going forward.

Let's look at a few of their conclusions more specifically, starting with stocks...

Stock Prices

The authors found that real stock prices typically fall 56% over three and a half years, on average. In the current financial crisis, stocks already fell a bit more than that, in a much shorter period of time, bottoming in March 2009. Then they rallied dramatically.

Is the worst over in stocks? Or is another leg down coming?

I personally believe the worst is over.

At first, the crisis blindsided us, so the effect was dramatic. Now we're aware... more sober... So I think the lows we saw in March 2009 will be the ultimate lows for this crisis in stocks.

Home Prices

The authors found real home prices typically fall 35% over six years. This time around, home prices (like stocks) fell a bit more than the authors' average in a much shorter period of time.

Like stock prices, home prices have been recovering.

Is the worst over? Or did the recent home-buyer tax credit prop prices up?

I think the worst is over. I think we've seen the lows. But home prices may do basically nothing for many years.

Unemployment

According to the authors, unemployment typically rises by seven percentage points in a banking crisis... and unemployment stays "bad" for four years. So far, unemployment has risen by about five percentage points, and we're two years into this thing. So if the authors are right, unemployment could hit 12% and last two more years.

Government Debt

The authors state that government debt explodes by 86% above pre-crisis levels, on average. In the current crisis, quite frankly, I have no idea how much government debt has REALLY exploded. Nobody can know that answer... with all the creative things going on at the Federal Reserve and the Treasury Department.

So where does that leave us?

This crisis has been worse in magnitude than most, according to the authors' numbers. It's also been devastatingly quick.

The good news here is that we may already be out of the woods... Stock prices and home prices have been recovering for months. And unemployment has leveled off in the 10% range.

The bad news is the government's explosion in debts. But risks associated with that won't likely come home to roost in the next couple of years. That's a topic for another day.

In short, based on past crises, it's easy to make an optimistic case that the worst is behind us in the economy.

This post has been republished from Steve Sjuggerud's Daily Wealth.

5 Reasons That The US Economy Is Far From Recovery

Moses Kim discusses factors that indicate that the US economy is far from being out of the woods. Rising energy costs, ongoing contraction of consumer credit, and a very weak labor market are just a few of the factors that weigh heavily on consumers and businesses alike. See the following post from Expected Returns.

I think we are past the period when economic indicators and company earnings surprise to the upside. Case in point, Alcoa's big earnings miss yesterday. Forward earnings estimates for 2010 are in the stratosphere, which means surprises will come on the downside.

As we move ahead, here are some key economic trends that will determine whether our economy recovers or not in 2010.

Rising Energy Costs

We all remember the economic dislocations rising energy costs brought in 2008. Job losses were just beginning, yet consumers were hit hard by high energy costs. Consumers received a temporary and much-needed reprieve from high energy costs as crude oil collapsed to $33 dollars a barrel. However, crude oil has rallied over 100% in a little over a year, which means consumers are getting wacked again at the pump.

Demand for crude oil is relatively inelastic, meaning consumers are going to bear the brunt of price spikes. With gasoline prices approaching $3 dollars a gallon, discretionary spending is going to be seriously constrained moving forward.

Trade Deficit Growing

The government announced yesterday that the November trade deficit increased. The economic spin is that rising imports reflect an economy that is on a strong upward trajectory. However, digging beneath the report we see the following:

1. Crude imports are at the lowest level since February 1999

2. 7.3% rise in petroleum import prices in November

3. $72.54 average per barrel cost- highest since October 2008

The collapsing imports of crude oil strongly evidence an economy that is weakening. If crude oil prices remain elevated in the $70-$80 dollar range, I expect consumer spending to fall sharply.

Consumer Credit

In November, consumer credit contracted for the 10th straight month to the tune of a record $17.5 billion dollars. This is a historic contraction of credit that trumps the credit contraction during the Great Depression. The Fed is turning on the printing presses to counteract this credit contraction, but as the massive rise in commodity prices shows, with most commodities up over 100% YoY, the massive reflationary programs of the Fed have consequences.

Weak Labor Market

The surprisingly weak December unemployment report with the recent report that job openings declined by 156,000 in November. Firms are still reluctant to hire, and this holds especially true for small businesses.

Small Business Optimism Falling

Small business optimism dropped again in December, and remains at recessionary levels. The report shows that small businesses are losing pricing power in this abnormally weak economic environment, which means profit margins will remain low along with new hirings.

Small businesses will be absolutely critical to any economic recovery. We just aren't seeing the kind of optimism we need to see from a sector that accounts for over half of the jobs in America. Many small businesses have seen their access to credit disappear, which has forced small businesses into cost-cutting measures. With not much margin of error left, small businesses will start going bust if the economy doesn't improve quickly.

Conclusion

There is no recovery. Rising energy costs in particular should be enough to bring about a double-dip recession in 2010. Pretty soon, it will be hard for the government to conceal the true state of the economy, which at the very least, is still at recession levels.

This post has been republished from Moses Kim's blog, Expected Returns.

Falling Tax Revenues: A Bad Sign For Economic Recovery

As federal and local governments increase spending to stimulate the economy, their revenues through taxes continue to fall. According to the Wall Street Journal state and local tax revenues are falling due to lower consumer spending while property taxes are sure to decline as property assessments catch up to the depressed home values. See the following discussion from Moses Kim at Expected Returns.

I'm becoming increasingly wary of news of a nascent economic recovery, especially with news from the WSJ that state and local tax revenues declined 7%. Declining tax receipts evidence the weakness in both the labor market and consumer demand. All signs point to this weakness to persist as credit continues to contract for consumers who are deemed by banks to be less and less creditworthy.

State and local tax revenues fell 7% in the third quarter of 2009 from a year ago, the Census Bureau said in a report underscoring how the economic downturn is stressing government collections.

Sales taxes declined 9% to $70 billion in the third quarter compared with the year-ago period, the Census Bureau said. Income taxes plunged 12% to about $58 billion. Together, sales and income taxes make up roughly half of state and local tax revenue.

"We expect continued weakness well into 2010 if not further," said Lucy Dadayan, an analyst at the Rockefeller Institute of Government at the State University of New York.

What more objective indicator is there of economic conditions than sales tax receipts? The consumer is conspicuously not participating in this "economic recovery". There is hardly room to spin this glaring hole in the recovery thesis, but that probably won't stop permabulls from trying.

Property Tax Receipts Rise...For Now

Property taxes increased 3.6% in the third quarter compared with a year ago. But as property assessments catch up with falling residential and commercial real-estate values, property-tax revenues are expected to be weak. That will have a particularly severe impact on local governments, which fund much of their operations from property taxes.

Property taxes were the only bright spot in this report, but don't expect that trend to last. Housing assessments, which determine property tax receipts, haven't fully accounted for the decline in housing prices yet.

Keep an eye on the real estate market. The latest Case-Shiller report shows that housing is flatlining, and suggests further downside risks. The government, through its homebuyer tax credits, has effectively crushed future demand, which should weigh on housing in the months ahead. Of course the government has the option of repeatedly extending tax credits to artificially inflate prices and cause the next major housing crisis, but they can't be that stupid, can they?

States in Crisis Mode

State and local tax revenues tend to lag behind the downturns as well as the upturns in the economy because of the time it takes for collections to catch up with depressed store sales and diminished incomes. The third quarter was the fourth consecutive quarter in which tax collections were below year-ago levels.

Through the first three quarters of 2009 state and local tax revenues totaled $875 billion, nearly 8% below the $951 billion collected in the first three quarters of 2008. In the same period, federal receipts were down nearly 19%.

While the recession appears to have ended during the summer, government revenues are expected to continue to be weak. State and local governments employ 15% of American workers outside of agriculture.

States are about to face some tough choices. Declining tax revenues, which are at depression levels, will force states to cut services and layoff more employees. We are facing a huge fiscal crisis at the state and federal level that is being patently ignored. 2010 should bring these key issues to the fore as deteriorating balance sheets of governments become too much to ignore.

This post has been republished from Moses Kim's blog, Expected Returns.

The Tenuous Rebound Continues

James Picerno describes two economic indicators that are providing good signs of economic recovery - the positive yield curve and a peak of unemployment claims. On the other side, the lack of job creation and lending could threaten economic expansion. See the following post from The Capital Spectator.

The news on new filings for unemployment benefits once again favors the idea that economic recovery is continuing. It’s a tenuous rebound, one ripe with caveats, including a big one we’ll discuss below. But it’s a rebound nonetheless.

The Labor Department today reports that initial jobless claims dropped to 502,000 last week, down from the previous week’s 514,000. That leaves us at the lowest level since the week through January 3, 2009. As our chart below reminds, the trend has certainly been our friend this year for the general change in jobless claims.



Back in March, we wrote about the possibility if not the likelihood that a peak in jobless claims would signal the end of the recession. In subsequent months, we revisited the mounting evidence that the initial claims pattern was on a sustainable downtrend, including here and here. Jobless claims alone don’t suffice as a definitive sign of things to come, but this data series is on the short list of clues to watch for judging turning points in the business cycle.

Changes in the yield curve are also worth monitoring, and this too has been flashing a positive signal for some time. History tells us that when the yield curve turns negative (short rates above long rates), the odds of recession go up sharply. The subsequent return of a positively sloped yield curve (short rates below long rates) provides the opposite message: rebound is coming. As we've discussed in the past, when the yield curve turned positive after signaling recession in 2007, the implications were bullish. The signal was early, as it usually is, but proven durable once more.

Today, a variety of economic trends continue to point in the direction of recovery. We routinely dissect and analyze a variety of macro indictors in each issue of The Beta Investment Report, your editor's monthly review of asset allocation, portfolio strategy and economic news. The newsletter’s proprietary set of economic yardsticks are still flashing encouraging signs, as illustrated in the second chart below (republished from the current issue of the newsletter). Based on the last full month of data reported (through Sep. 2009), our composite measures of U.S. economic activity remain upward biased. The October data reported so far, along with today’s initial jobless claims update, further support the idea that recovery momentum remains intact.



The natural tendency of the economy to snap back after stumbling is still alive and kicking, strengthened by ongoing monetary and fiscal stimulus efforts. But this isn’t a normal recovery, in part because the labor market losses have been unusually deep and long lasting. Indeed, the great challenge still lies ahead, as we’ve been discussing for some time. The problem isn’t so much job loss from this point forward; rather, it’s the lack of job creation that may threaten.

In essence, we should distinguish between recovery and growth. The business cycle is now in recovery mode, but growth of a meaningful, sustainable sort has yet to arrive.

There are other ills afoot as well. As we discuss in the current issues of the newsletter, lending activity continues to shrink. Commercial and industrial loans fell nearly 6% in September from the previous month and are off by nearly 11% over the past year. Lending is a critical factor in fueling future growth and so the trend here suggests that expansion will be muted for the foreseeable future beyond the snapback effect that’s prevailed recently.

Minting new jobs and juicing lending are among the last great cleanup actions for mending the Great Recession. But the statistical clues at the moment don’t offer much encouragement for an imminent recovery on these fronts. Yes, the forces of contraction per se are rapidly fading, as suggested in today’s jobless claims report. It's the weakness on the outlook for growth that worries us.

This post has been republished from James Picerno's blog, The Capital Spectator.

Another Round Of Stimulus Anyone?

Although most economists proclaim the recession to be at an end, the expected surge in foreclosure and unemployment rates could precipitate the recurrence of a recession which has some economists calling for more government stimulus. The argument is that another round of effective stimulus could prevent the slowest recovery in modern memory. See the following from Economist's View.

As many of us have been saying for some time now, more stimulus would speed the recovery -- the jobs outlook is particularly worrisome -- but unfortunately, it doesn't appear that more stimulus is politically feasible:

The Case for More Stimulus, Editorial, NY Times: The consensus among economists is that the recession is over, and, technically, the herd is probably right. ... Immense federal stimulus has jolted the economy.

But... The economy is going to need more government support, or it is bound to be very weak for a very long time — and vulnerable to a relapse into recession. Unemployment is expected to worsen well into next year, exceeding 10 percent. Foreclosures are expected to rise, which will push home values down further. Hundreds of small and midsize banks are likely to fail in coming years. State and local governments face budget shortfalls in 2010 that are as bad or worse than this year’s.

Yet Washington is not providing a coherent plan for effective stimulus. The Senate has been hamstrung for nearly a month over the most basic relief-and-recovery boost: an extension of unemployment benefits. ... Lawmakers in both parties fret that large budget deficits preclude more stimulus, lest the burden of debt outweigh the benefit of deficit spending. ... Deficits are a serious issue, but the immediate need for stimulus trumps the longer-term need for deficit reduction. A self-reinforcing stretch of economic weakness would be far costlier than additional stimulus.

The Senate could take a step in the right direction by extending unemployment benefits without further delay. ... Next, Congress and the administration should agree on ways to ease the dire financial condition of the states. Most important is continued aid for state Medicaid programs... As long as the states are suffering, any economic recovery efforts by the federal government are undermined. ...

Without another round of effective stimulus, the worst recession in modern memory will likely become — at best — the weakest recovery in modern memory. Another boost to federal spending that is targeted and timely should not be too much for politicians to deliver.

Recall this recent graph from the San Francisco Fed:



Output is not expected to return to potential until well into 2012.

Now recall the long delay between the end of the last two recessions and the peak in the unemployment rate (or just about any other labor market indicator):



And the recovery for the labor market could be even slower this time.

To be fully effective, plans for additional stimulus should have been in place long ago. However, given how long the recovery is expected to take, it's not too late to do more if we get started right away. But the political climate makes it highly unlikely that labor markets and the economy will get the help that they need.

This post has been republished from Mark Thoma's blog, Economist's View.

Will Economic Recovery Be Behind Door V, U, or W?

Economist's say that there are three major possibilities for how the economy will exit the current recession, but the outcome remains highly uncertain. Some new information on the leading indicator of new orders for manufactured durable goods may provide some clues on what to expect. The following post from The Capital Spectator describes some factors that may shed light on the type of recovery that is most probable.

Is today's update on new orders for durable goods a sign of an approaching V, U or W? Translated: Is the economy poised to rebound sharply and deliver strong growth—a V recovery? Or is a U-type future, with slow to negligible growth, approaching? Even worse, could an imminent rebound be little more than a prelude to a second recession, a.k.a. the W cycle?

That summarizes the great questions that prevail as the world attempts to handicap the winding down of the Great Recession. As always, the central challenge is that we're left with a great unknown, even if today's news on durable goods suggests otherwise.

As monthly numbers go, July's update for the series is undoubtedly encouraging. New orders for manufactured durable goods in July increased 4.9%, the U.S. Census Bureau reports. That's the third increase in the last four months and the largest percent gain in two years.



No one can deny that such news constitutes progress. Ditto for the accumulating evidence in other economic reports that the economy, if not quite on the mend, is no longer contracting. A number of clues have been suggesting no less for months, as we've been discussing on these digital pages for some time, including the all-important weekly updates on initial jobless claims. Additional support for thinking the economy's stabilizing arrived in yesterday's upbeat news on consumer sentiment and housing prices: both are rising.

None of this is particularly shocking, although the timing was always in doubt. But surely no one expected the U.S. economy, still the world's largest, to remain in downsizing mode indefinitely. The emotional bias in the dark days of this year's first quarter may have convinced us to see a continually dire future. But the recession at that point was already more than a year old, by NBER's accounting, and the natural economic order tells us that recovery arrives eventually. Meanwhile, the massive countercyclical efforts of the Federal Reserve, plus the fiscal stimulus embraced back in February, was sure to have an impact. In fact, one might argue that President Obama's reappointment of Fed Chairman Ben Bernanke to a second term is formal recognition of the success in the central bank's aggressive actions intent on slowing if not ending the downturn.

What's more, the financial and commodity markets have reacted by elevating prices, in effect offering additional corroboration that the business cycle was turning. But while it's tempting to see us headed for a V recovery, the odds seem to favor a U. We've been forecasting just that future for some time by emphasizing that the "technical" end of the recession was imminent if not already here but it would be followed by a tepid recovery.

As welcome as that revised outlook is relative to what preceded it, there's a danger of overlooking the risk that follows this time around. Namely, a series of generational adjustments that threaten to conspire by leaving the economy in a weakened state for an unusually lengthy stretch. The most conspicuous risks: the likelihood that consumer spending growth will remain subdued for some time and the labor market will be slow to respond to so-called recovery.

There are any number of other challenges looming as well, starting with the nuances tied to the timing and magnitude of the Fed's so-called exit strategy. The challenge looks unusually bland at the moment, but it won't stay that way. Indeed, to the extent the economic recovery is stronger than expected, the exit strategy problems will be that much bigger.

Perhaps then the principal question is: Has the crowd priced in the post-recession risks that await? The first half of the business cycle has been unusual on a number of levels, as the last two years remind. We're probably just about midway, perhaps a bit more, through this extraordinary period. Thinking that the second half will be any less rocky and risky is asking for too much.

Still, it's easy to remain complacent. Looking at positive short-term changes in economic measures that are cut in half over longer stretches is reassuring. But climbing out of this hole will take time and the task faces many pitfalls. It's only human to minimize the potential hazards, but strategic-minded investors can't afford such luxuries. As we've arguing in The Beta Investment Report, the time for aggressive portfolio decisions was in this year's first quarter. From here on out, the money game is about to get much tougher.

This post has been republished from James Picerno's blog, The Capital Spectator.

Things To Look For In An Economic Tipping Point

Economist Mark Thoma from Economist's View discusses what to look for in an economic tipping point. He describes the specific conditions that will need to occur that will demonstrate that the economy is on solid footing and has the legs to generate self-sustaining growth. However, if these conditions do not occur, we may be looking at a double-dip recession. Continue reading to learn more.
One question I am asked fairly often is how we will know when the economy turns the corner and we are on our way to a solid recovery. My answer is that we will be able to detect upticks in the data, though this may come with a bit of a lag, the important but harder task will be to understand why the data are showing improvement.

In order to be convinced that the economy is on solid footing and headed to better times, I will want to see several things. First, though not necessarily foremost, that banks are being recapitalized with private sector funds, and that this is happening without the aid of government guarantees or other such programs that encourage capital infusions (which is hard to determine while the government programs are in place). Second, I will want to see private sector non-residential investment improving, another sign that private sector funds are moving back into circulation. Presently, this hasn't even started heading back upward, though there are signs the decline is slowing:



And there are other important factors too, e.g. consumption rebounding (though not to pre-crisis debt sustained levels), stabilization in housing markets, and so on. The point is that a self-sustaining recovery will require that the private sector be the primary driver of new economic activity, and that is what I will be looking for.

Once the economy does start to recover, the hard but critical part will be to determine how much of the recovery is self-sustaining (as it will be if private sector funds are driving the activity), and how much is being driven by government stimulus programs. If the recovery is self-sustaining, and we are fairly certain of that, then we can begin to carefully wind down the government programs supporting the economy. But if the recovery is mostly due to government stimulus and there is little sign that the financial and real sectors are attracting robust levels of private sector funds, then pulling back on government programs could be disastrous and plunge the economy right back into recession. In fact, in such a case, we may need to provide even more stimulus to fully bridge the gap until the private sector can support the economy on its own.

So, in answer to the question, we will have a pretty good idea when the economy turns the corner, but it will take awhile to determine why, and we cannot risk pulling back on government programs until we are sufficiently certain that the private sector can support normal economic activity without the government's help.

Update: Nouriel Roubini:

A Phantom Economic Recovery, by Nouriel Roubini, Commentary, Project Syndicate: Where is the US and global economy headed? ... Data from the US ... suggests that the US recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close, but it has not yet been reached. ...

Moreover, for a number of reasons, growth in the advanced economies is likely to remain ... well below trend for at least a couple of years.

The first reason is...: Households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system ... is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending. Third, the corporate sector faces a glut of capacity... As a result, businesses are not likely to increase capital spending.

Fourth, the releveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth. ...

There are ... two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. ...

A second reason ... concerns the fact that oil, energy and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy... The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So, the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anemic rather than robust..., and there is a rising risk of a double-dip recession. ...

This article has been republished from Mark Thoma's blog, Economist's View.

Why A 'Jobless Recovery' Is Likely

Yesterday the World Bank warned of a long and painful recovery in most developed economies, echoing Bernanke's hints of a "Jobless Recovery". Martin Hutchinson from Money Morning gives 4 reasons that suggest a painfully slow economic recovery. See his argument below.

When the Labor Department recently reported that U.S. payrolls fell by 345,000 jobs in May - the lowest total in eight months - commentators were suddenly spotting “green shoots” of economic recovery virtually everywhere they looked.

Given that more than $800 billion of federal money has been earmarked for U.S. “stimulus” projects, one would actually expect that the frightening job losses of the past six months would quickly reverse, and that the U.S. economy would soon start creating the 3 million jobs that U.S. President Barack Obama has promised.

Unfortunately, that has not been the case.

That’s not to say that the outlook is for a Great Depression, an economic reversal in which a country’s output plummets by 25% or more from its peak level. While the current U.S. recession may well be the “worst since the Great Depression,” it’s becoming clear that the peak-to-trough output decline will be something like 5% - worse than the recessions of 1973-75 and 1980-82, both of which saw output declines of about 3.5%, but not all that much worse.

After all, the money supply has not been allowed to collapse as it did during the 1930s and there has been no repetition of the infamous Smoot-Hawley Tariff Act, though the “Buy America” provisions in the original stimulus outline and the corresponding “Buy China” provisions in China’s corresponding package indicate that “Smoot-Hawleyism” still lurks just beneath the surface.

However, the following four factors make it almost certain that the U.S. economy will be slow:

• Record-low interest rates make it impossible for the U.S. central bank to use rate cuts to jump-start growth.

• The huge U.S. budget deficit will force the federal government to continue its heavy borrowing - potentially “crowding out” private-sector players seeking loans to finance their own growth.

• The growing size and influence of the U.S. public sector.

• And an over-growth of government regulation.

Let’s consider each one.

First and foremost, the U.S. Federal Reserve has loosened money supply inordinately over the last year, with short-term interest rates at 0.00% and money supply growth at 15% per annum. Thus, there is no Fed loosening available to spur employment.

Interest-rate-sensitive sectors - especially housing and construction - are likely to remain depressed for years. These sectors are major employers of low-skilled and semi-skilled labor, which will not be picking up their normal slack.

A second adverse factor is the exceptionally large federal budget deficit - expected to reach $1.85 trillion, or 13% of the U.S. economy, in this year alone, according to the nonpartisan Congressional Budget Office (CBO). That deficit will stretch several years into the future, thanks to the stimulus package and various bailouts initiatives.

In the short term, these rescue-oriented provisions have helped U.S. employment, not the least by allowing federal and state governments to do some hiring. But in the longer term, the federal borrowing they have caused will restrict the private sector’s access to the capital markets. That will hinder small businesses in particular. Indeed, the private sector will find it difficult to fund capital expansion, and again the result is likely to be a dearth of hiring.

A third adverse factor is the expansion of the public sector itself. To some extent, it does not matter how budget deficits are financed; the important consideration is the transfer of resources from the private sector - allocated by the automatic optimization of the so-called “price mechanism” - into the public sector, where no such considerations apply.

It’s not just a question of government itself; it’s now clear, for example, that Chrysler LLC and General Motors Corp. (OTC: GMGMQ) are to be controlled by the government - with subsidies - at our expense.

When General Motors announces, as the company did Wednesday, that it will build automobiles on the basis of an assumed oil price of $100-$120 per barrel, one sees at once a politically motivated strategy; GM will cease making the large cars that in the past have been its principal source of profit. If oil prices average $50 or less, as is perfectly possible in a long period of sluggish global growth, General Motors will be a mess - and will need to be bailed out by us again.

The late William F. Buckley Jr. once claimed that 500 names chosen at random from the Boston telephone book could do a better job of running the country than Congress; I wouldn’t mind betting that such a random selection would also make a better job of running General Motors than the government.

Related to the growth in government is the growth in regulation. For example, President Obama’s “cap-and-trade” plan to address global warming will impose a new tranche of costs on the U.S. economy, without any great offsetting spurs to employment. In areas such as energy production and heavy industry, employment will be depressed by the additional cost burdens those areas bring, as well as by the simple difficulty of complying with the new regulations.

To see where a larger state sector and more regulation can lead, one need only look at the European Union (EU). Whereas U.S. unemployment was below 5% for much of the last decade, the lowest rate reached since 2000 was 8.8% in the EU. What’s more is that certain areas of the EU have much worse records than this.

In Spain, for example, unemployment was close to 20% for much of the 1980s and 1990s, and has now soared once again to no less than 18.2%. The EU is not ensconced in a Great Depression and Spain remains a relatively wealthy country; nevertheless, the rigidities in the European system are such that unemployment remains persistently high, with adverse social effect, such as the rioting in the Paris banlieus.

The European Commission (EC) recognized this problem as early as the 1980s, and has been gradually pushing Europe towards the more open U.S. labor market, with only moderate success.

Because of over-loose money, excessive budget deficits, growing government and impending regulation, it is thus unlikely that the U.S. economy and its job market will bounce back as quickly as it has in the past.

The investment “takeaway” from this is obvious, I fear: A substantial part of one’s money should be invested in the free-market economies of East Asia, where regulation and taxation are lower, so even though a recession has also hit, recovery is likely to be much more robust.

This article can also be viewed at Money Morning's investment news site.