Wednesday, April 20, 2011

Today's links

1--Extra Credit?, Paul Krugman, New York Times

One thing I see here and there — on blogs, in comments, etc. — is the claim that inflation is defined not by the rise in prices but by the expansion of money and credit, with prices just as a symptom.

Actually, no. Words mean what they are taken to mean, and if everyone uses the word “inflation” to refer to the CPI, then that’s what it’s about. If you have a theory that says that inflation in this sense is always the result of money expansion, fine — but that’s a theory, not the definition.

And do you really want to go there? After all, the data on money and credit doesn’t actually support your fears.

First of all, what is money? It’s not just pieces of green paper bearing pictures of dead presidents — that’s much too narrow a definition. Milton Friedman liked M2, which includes a wide range of bank deposits. In the modern world, there’s a strong case for adding in other forms of short-term funds placement, like repo. And measures like this have not shown rapid growth — in fact, they plunged in the financial crisis, and even now are growing at below historical rates.

What about credit? Here’s the rate of growth of nonfinancial credit liabilities in the United States — that’s business, consumers, and government combined: (see chart) We’re well below historical growth rates.

The only way to see dangerous inflationary pressures here is to see government debt as much more inflationary than private sector debt. Why?

2--Housing: Feeling the Hate, Calculated Risk

Excerpt: And from Bloomberg: Americans Shun Cheapest Homes in 40 Years as Ownership Fades

“I know people who have watched their home values get cut in half, and I know people who are losing their homes,” said [Victoria Pauli], 31, who works as a property manager for a real estate company. “It’s part of the American dream to want to own your own home, and I used to feel that way, but now I tell myself: Be careful what you wish for.”
At the end of 2010, the fourth year of the housing collapse, the share of people who said a home was a safe investment dropped to 64 percent from 70 percent in the first quarter. The December figure was the lowest in a survey that goes back to 2003, when it was 83 percent.

“The magnitude of the housing crash caused permanent changes in the way some people view home ownership,” said Michael Lea, a finance professor at San Diego State University. “Even as the economy improves, there are some who will never buy a home because their confidence in real estate is gone.”

3--Thoughts on Residential Investment Recovery, Calculated Risk

Excerpt: Residential investment (RI) is the best leading indicator for the economy. This isn't perfect - nothing is - but RI is usually a strong leading indicator for the business cycle. The slump in RI helped me call the 2007 recession correctly, and the lack of a recovery in residential investment is a key reason the recovery has been sluggish and choppy so far. Note: Residential investment, according to the Bureau of Economic Analysis (BEA), includes new single family structures, multifamily structures, home improvement, broker's commissions, and a few minor categories.

• In 2011, residential investment will make a positive contribution to the economy for the first time since 2005. The five years of drag on GDP from RI (2006 through 2010) is the longest period on record, breaking the previous record of four years from 1930 to 1933 (yeah, the Great Depression). The positive contribution this year will mostly be due to a pickup in multifamily construction (apartments) and in home improvement. However single family housing starts will continue to struggle.

• This positive contribution from residential investment suggests the economy will continue to grow all year and also in 2012 (point 1: RI is best leading indicator). There are plenty of downside risks, but I expect the expansion to continue.

• A record low number of housing units will be added to the housing stock this year. With more jobs, and more household formation in 2011, the number of excess housing units will be reduced substantially this year – perhaps by 600,000 to 700,000 units (or more).

Recently economist Tom Lawler took a long look at the 2010 Census data, and estimated there were about 2 to 3 million excess vacant housing units as of April 1, 2010. With the record low number of housing units delivered last year, Lawler estimated that as of April 1, 2011 the excess “would be somewhere in the range of 1.45 to 2.45 million units – with the latter almost certainly too high”. With another record low number of units added to the housing stock this year, the excess will be in the 750 thousand to 1.7 million range next April (with the latter “certainly too high"). This suggests the excess supply will be gone sometime between early 2014 and 2016.

As the excess supply is absorbed, new residential investment will increase in some areas – and will probably return to normal sometime in 2014 - or as late as 2017 - depending on the actual number of excess vacant housing units. I'm leaning more towards 2015 or 2016.

• “Normal” for housing starts will be the rate of household formation (probably averaging around 1.1 million per year in 2015), plus the net number of 2nd homes purchased, plus the number of demolitions. I think the 2nd home markets will be slow to recover, so "normal" will probably be around 1.3 million housing starts in 2015 or 2016 or 2017 (after the excess supply is absorbed) – up sharply from the current rate of around 550 thousand. For new home sales, normal will probably be in the 800 thousand to 850 thousand range – far above the recent 250 thousand to 300 thousand range, but also far below the 1.2 to 1.3 million range in 2004 and 2005.

4-- Big U.S. Firms Shift Hiring Abroad, David Wessel, Wall Street Journal via Economist's View

Excerpt: U.S. multinational corporations, the big brand-name companies that employ a fifth of all American workers, have been hiring abroad while cutting back at home, sharpening the debate over globalization's effect on the U.S. economy.

The companies cut their work forces in the U.S. by 2.9 million during the 2000s while increasing employment overseas by 2.4 million, new data from the U.S. Commerce Department show. That's a big switch from the 1990s, when they added jobs everywhere... [graph]

The data ... underscore the vulnerability of the U.S. economy, particularly at a time when unemployment is high and wages aren't rising. Jobs at multinationals tend to pay above-average wages and, for decades, sustained the American middle class. ...

While small, young companies are vital to U.S. economic growth, big multinationals remain a major force. A report by McKinsey Global Institute ... estimates that multinationals account for 23% of the nation's private-sector output and 48% of its exports of goods.

These companies are more exposed to global competition than many smaller ones, but also more capable of taking advantage of globalization by shifting production, and thus can be a harbinger of things to come.

5--Stocks, Flows, and Pimco, Paul Krugman, New York Times

Excerpt: On this view, the fact that the Fed is currently buying some large fraction of debt issuance is irrelevant; interest rates are determined by the willingness at the margin of private investors to hold the existing stock of debt, regardless.

This view could be wrong, or at least incomplete. Investor inertia – a tendency to leave funds where they are – could give flows an independent role. But how much of a role? If you believe that it is obvious that rates will spike as soon as QE2 ends, you have to ask why investors aren’t moving out of US debt now in anticipation; you don’t have to believe in efficient markets to believe that totally obvious gains or losses will be anticipated.

I’d also add that if flows matter a lot — if it’s hard to persuade investors to buy a suddenly increased quantity of newly issued Treasuries per month, as opposed to being willing to hold the total amount of Treasuries outstanding — the big shift into budget deficits and the corresponding increase in Treasury issuance should have led to sharply rising interest rates. And as you may recall, some people did predict just that — and ended up not just with egg on their faces, but losing a lot of money for their investors.

So I don’t buy the notion that rates are low only because the Fed is doing QE2; if there were really a problem with the marketability of US debt, rates would be high regardless. And so I don’t expect rates to spike when QE2 ends unless there’s good economic news that gives us a reason to believe that the zero-rate policy on short-term rates will end sooner than expected.

Update: Also, if you think that US interest rates are being held down by the fact that in some sense the Treasury hasn’t had to go to the market lately, since the Fed is buying debt — although the Fed isn’t actually buying it direct from Treasury — consider the case of Greece. Greece isn’t going to the market at all these days, since it’s getting all its funding from the bailout package. That hasn’t stopped the 10-year interest rate on its outstanding debt from reflecting investors’ perception of its underlying solvency.

6--BRICS credit: Local currencies to replace dollar, The Economic Times

Excerpt: Brazil, Russia, India, China and South Africa - the BRICS group of fastest growing economies - Thursday signed an agreement to use their own currencies instead of the predominant US dollar in issuing credit or grants to each other.

The agreement, the first-of-its-kind, was signed at the 3rd BRICS summit here attended by Indian Prime Minister Manmohan Singh, China's Hu Jintao, Brazil's Dilma Rousseff, Russia's Dmitry Medvedev and South Africa's Jacob Zuma.

"Our designated banks have signed a framework agreement on financial cooperation which envisages grant of credit in local currencies and cooperation in capital markets and other financial services," Manmohan Singh told reporters at a news conference with other BRICS leaders.

But the agreement is confined to credit and not trade. BRICS economies hold 40 percent of the world's currency reserves, the majority of which is still in US dollars.

7--G.D.P. Estimates Slide Further, New York Times

Excerpt: Earlier this week we wrote that several prominent economic forecasters had lowered their estimates of gross domestic product growth in the first quarter of this year. Today saw even further declines.

Macroeconomic Advisers, a forecasting firm, lowered its estimate to just 1.4 percent annualized, when just a few months ago they had pegged the number at 4.1 percent.

Capital Economics likewise brought its estimate down to 1 percent, writing in a client note:

Every data release last week seemed to necessitate a further downward revision to our first-quarter GDP growth forecast. By the end of the week when the dust had finally settled, that estimate was down to only 1% at an annualised pace. Indeed, there is now even a decent outside chance that the economy contracted outright.

The median estimate on Bloomberg is 1.8 percent annualized, although many of the usual forecasters have not yet submitted their numbers. We’ll get the Commerce Department’s preliminary number on April 28.

8---Euro vs. Invasion of the Zombie Banks, New York Times

Excerpt: At this late point there’s probably no way to escape the mess by cutting government spending in the troubled countries. This year Ireland has a budget deficit of more than 30 percent of G.D.P., whereas in Portugal it is 8.6 percent. Even the best economic reforms can take many years to pay off with concrete results, and with zombie banks a turnaround is even harder and perhaps impossible. Most important, immense government spending cuts are often unpopular and so investors wonder whether an ailing country’s political system will see it through. The confidence problem remains.

A second option is a giant write-down of current debts, combined with national bailouts to the creditor banks. For instance, taking this approach, the Merkel government in Germany might acknowledge the status quo isn’t working and speedily recapitalize the German banking system, while letting Ireland, Portugal and others off the hook for some of the money. It’s easy to see why this policy isn’t popular in Germany, and indeed, for years German politicians promised to their voters that such an outcome would never happen.

Another dramatic way out is for Ireland, Portugal or some other country to break from the euro and create a new and lesser-valued domestic currency, while also defaulting on some debts. Any such breakaway country would incur the wrath of the European Union and also might have trouble borrowing on international capital markets. There will be no easy exit path from the euro. Still, taking this approach, a resolution of some kind would be in place, no subsequent devaluation of bank deposits would be expected and the new lower-valued currency would improve growth. Also, the troubled countries already cannot borrow at workable interest rates.

There would be an associated problem, however: if any one euro zone country were to start exiting the euro, there would be bank runs on the other fiscally ailing countries. The richer European Union nations know this, and so they are toiling to keep everyone on board. But that conciliatory approach creates a new set of problems because any nation with an exit strategy suddenly has enormous leverage. Ireland or Portugal need only imply that without more aid it will be forced to leave the euro zone and bring down the proverbial house of cards.

9--Household Debt May Be Accelerating Again, Wall Street Journal

Excerpt: $822 billion: the amount defaults have lopped off U.S. household debt since mid-2008. U.S. consumers deserve some credit for getting their debts under control. But they still have a way to go.

One of the puzzles of the recovery has been how U.S. households have managed to shed some $658 billion in mortgage, credit-card and other consumer debt over the past two and a half years: Are they really paying it down, or are they just giving up and defaulting? The answer would say a lot about their ability to fuel an economic recovery, and help gauge the likelihood that they’ll get into trouble again.

The latest data from the Federal Reserve suggest defaults have played a big enough role that “paying down” would be a misnomer. By our own estimate, based on the Fed data, banks’ and investors’ charge-offs — the result of defaults — lopped $822 billion off households’ debt load from mid-2008 to the end of 2010. In other words, net of defaults, consumers actually borrowed an added $163 billion.

10--NYSE Margin Debt at Highest Since Crisis, Wall Street Journal

Excerpt: Margin debt jumped 7.2% in February, again rising to a new high since the 2008 financial crisis, according to the New York Stock Exchange.

At the end of February, margin debt totaled $310.27 billion, up from $289.55 billion at the end of January and the highest level since July 2008, according to Big Board data for customers of NYSE-member securities firms.

Market analysts track margin-debt activity as an indication of investors' appetite for speculative trading. The activity has risen nearly every month since the summer.

A potential pitfall for those trading "on margin" is a sharp decline in stock prices, which can expose investors to margin calls, requiring them to post additional collateral lest their brokers sell their securities to cover the debt. A wave of margin calls can worsen selling pressure on stocks and was seen as partly to blame for the market's woes during the financial crisis.

11--Neediest and sickest would pay the price under GOP budget plan, Los Angeles Times

Excerpt: The principal target of Ryan's plan is government healthcare spending — Medicare, Medicaid and the healthcare reform plan. That's a reasonable place to aim any deficit-reduction plan, because that's the area where costs are rising most sharply.

But his solutions are the antithesis of reasonable. They involve almost entirely throwing the neediest and sickest Americans out from under the government umbrella to fend for themselves. Medicare as we know it would be eradicated, the cost of Medicaid shifted largely to already hard-pressed state government, and a reform program designed to give tens of millions more Americans the protection of health insurance canceled outright.

Is this really the only path to deficit reduction?...

As for the health programs, the House passed Ryan's proposal to extinguish Medicare as a guaranteed coverage program and substitute healthcare vouchers, allowing seniors to buy private health insurance with a government subsidy.

12--Capitalism is failing the middle class, Reuters

Excerpt: Global capitalism isn’t working for the American middle class. That isn’t a headline from the left-leaning Huffington Post, or a comment on Glenn Beck’s right-wing populist blackboard. It is, instead, the conclusion of a rigorous analysis bearing the imprimatur of the U.S. establishment: the paper’s lead author is Michael Spence, recipient of the Nobel Prize in economic sciences, and it was published by the Council on Foreign Relations.

Spence and his co-author, Sandile Hlatshwayo, examined the changes in the structure of the U.S. economy, particularly employment trends, over the past 20 years. They found that value added per U.S. worker increased sharply during that period – 21 per cent for the economy as a whole, and 44 per cent in the “tradable” sector, which is geek-speak for those businesses integrated into the global economy. But even as productivity soared, wages and job opportunities stagnated.

The take-away is this: Globalization is making U.S. companies more productive, but the benefits are mostly being enjoyed by the C-suite. The middle class, meanwhile, is struggling to find work, and many of the jobs available are poorly paid....

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