Wednesday, August 31, 2011

Today's links

Today's Quote: "The rapid and marked deterioration in economic and financial conditions means that the risk of a serious disruption is now significant." Satyajit Das, "From Green to Red – Is Credit Crunch 2.0 Imminent?", The Big Picture

1--A Reprieve from Misguided Recklessness, John P. Hussman, Ph.D, Hussman Funds

Excerpt: It is now urgent for investors to recognize that the set of economic evidence we observe reflects a unique signature of recessions comprising deterioration in financial and economic measures that is always and only observed during or immediately prior to U.S. recessions. These include a widening of credit spreads on corporate debt versus 6 months prior, the S&P 500 below its level of 6 months prior, the Treasury yield curve flatter than 2.5% (10-year minus 3-month), year-over-year GDP growth below 2%, ISM Purchasing Managers Index below 54, year-over-year growth in total nonfarm payrolls below 1%, as well as important corroborating indicators such as plunging consumer confidence. There are certainly a great number of opinions about the prospect of recession, but the evidence we observe at present has 100% sensitivity (these conditions have always been observed during or just prior to each U.S. recession) and 100% specificity (the only time we observe the full set of these conditions is during or just prior to U.S. recessions). This doesn't mean that the U.S. economy cannot possibly avoid a recession, but to expect that outcome relies on the hope that "this time is different."
While the reduced set of options for monetary policy action may seem unfortunate, it is important to observe that each time the Fed has attempted to "backstop" the financial markets by distorting the set of investment opportunities that are available, the Fed has bought a temporary reprieve only at the cost of amplifying the later fallout....

The way to get out of this is to abandon the misguided belief that economic prosperity can be obtained by encouraging speculation and distorting the set of investment opportunities. Rather, we will eventually find, as was eventually also discovered in the post-Depression stagnation of the 1930's, that the way to get the economy moving again is to restructure hopelessly burdensome debt obligations.

Bernanke offered some of the only sound words of his tenure, stressing that "U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable, or, preferably, declining over time," and warning against excessive austerity by observing "Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery."

2--President Obama's job creation mirage, Dean Baker, Guardian

Excerpt: At the top of the list of job-creating measures is extending the 2 percentage-point reduction in the social security payroll tax. This provides no boost to the economy, since it just keeps in place a tax cut that was already there, but if the cut is allowed to end at the start of 2012, it will be a drag on growth....

A second item frequently mentioned is an infrastructure bank. This would allow the government to treat long-lived infrastructure investment as capital expenditures depreciated over their expected lifetimes, rather than expenditures to be paid for in full in the years the construction takes place. This is good policy and accounting (it is the same approach used by both private businesses and state governments), but it is not going to create many jobs and certainly not in the next couple of years.

The other items on the list are less clear. On bad days, we hear that President Obama is going to tout the trade agreements with Panama, South Korea and Colombia. These deals are all problematic at best, but even their supporters can't claim with a straight face that they will generate any noticeable number of jobs.

There are also reports that President Obama may propose some sort of tax subsidy for job creation. Such a subsidy can be bad or not so bad. One of the proposals, temporarily eliminating the employer side of the payroll tax, is a great plan – if your intention is to give still more money to business and undermine social security.

3--Mind the ($5.1 Trillion) Gap, VOX

Excerpt: The need for additional fiscal stimulus is based on the assumption that we are not in a normal year. If unemployment was at a normal level, if the output gap was zero (output was equal to potential), then there is no reason to postpone the necessary adjustment. But there is a dimension of economic policy (both monetary and fiscal) that works towards the stabilization of the business cycle. We do not expect monetary policy or fiscal policy to be the same in a recession than in an expansion. And while fiscal policy might require to show discipline over the coming decades, the amount of discipline should be different depending on the phase of the business cycle. Letting the economy be producing below potential for a long number of years is not only socially costly but it leads to a permanent loss in output which is a potential source of tax revenues. And the most recent projections from the CBO (Congressional Budget Office) in the US show that GDP will be significantly below potential output for about 8 years, from 2008 to 2015...

If we accumulate the output gap for all these years we are talking about a $5.1 Trillion gap that represents a permanent loss in output (and income, and tax revenues). Some might see this as a natural and unavoidable adjustment which almost amounts to claim that GDP and potential output are identical, the output gap is zero, unemployment is all structural. But given that the US economy has a strong tendency to return to its trend regardless of economic shocks, it is difficult to argue that there is no output gap to be filled in 2011 (or any other year before we get to 2015).

4--Arguments for Expansionary Fiscal Policy Watch, Grasping Reality with Both Hands

Excerpt: Poor Richard Koo talks sense. But his adversary in the pages of the Economist is… Allan Meltzer.

When the U.S. government can borrow at a real interest rate of -0.65%/year for five years, the case for larger deficits now--for pulling spending forward from the future into the present and pushing taxes back from the present into the future--is unanswerable: of course the government should borrow more on such terms: households value the taxes they will pay in the future if taxes are pushed back as much less painful than the taxes they would otherwise pay today, and a huge number of government spending programs offer at least a zero percent real rate of return via their effect on the productive capacity of the economy. Even if expansionary fiscal policy had no effect on capacity utilization and unemployment bigger deficits now while the government can borrow on such terms would be a no-brainer. And since expansionary fiscal policy does have such effects, it is something that you should advocate even if you have less than no brain at all--even if you have a negative brain.

5--A Former Clinton Official on How Obama Isn't Doing Enough for the Economy, Robert Schapiro, The New Republic

Excerpt: The results are now clear in the data. Financial institutions amassed trillions of dollars without expanding business lending, mainly because the financial-market distortions that brought on the crisis are still with us. These institutions are still holding trillions of dollars in wobbly asset-based securities, whose risks even now they cannot reasonably price. So they sit on most of their new capital (after paying out their bonuses) in hopes of avoiding another bout of bankruptcy from those assets, should another crisis erupt. Yet, the prospect of new legislation to sustainably resolve those weak assets by pulling them off the books—as Sweden did in its early-1990s banking crisis, and we did in the S&L crisis of 1989-1990—is nonexistent.

The prospect of another imminent crisis on the horizon ought to put the necessary policies into relief. One initiative that cannot wait: President Obama should call an emergency G-8 meeting to help head off a new financial meltdown in Europe. The sobering fact is that many of Europe’s largest banks are nearly insolvent. It’s a legacy from not only the 2008-2009 meltdown, but also the EU’s decision in 2007 to reduce bank capital requirements under the level set by the “Basel 2” accords. Americans benefited from the fact that our own banking regulators dawdled in making similar changes desired by the Bush administration, by which time even the Bush Treasury had doubts about cutting capital requirements. The result today is that the German and French banking systems in particular are in much worse shape than Wall Street.

Now these weak banks face additional, large-scale losses from the falling values of Italian and Spanish government bonds, a contagion from the now-anticipated defaults of Greek and Portuguese public sovereign debt. If this turmoil intensifies, it will probably pull down some of Europe’s largest banks. And if institutions such as BNP Paribas and Deutsche Bank (the world’s two largest banks) fail, the U.S. and global economies would probably follow.

Moreover, this time, the consequences would be even more dire than in 2008-2009, since governments have already exhausted their fiscal and monetary policy options.

We can still head off a 1931 scenario if Germany and France will accept the inevitable and obvious: A common Euro currency requires that every member pledge its full faith and credit for Eurobonds to support the full faith and credit of everybody else. Otherwise, the failure of a small member (today, Greece and/or Portugal) can destroy confidence in the economic sustainability of much larger members (Italy and Spain). And then, everybody’s goose is cooked....

The broad reach of these effects reflects how wealth is now distributed in the United States: According to Fed data for 2007, the bottom 80 percent of American households held 40 percent of the value of all real estate assets, compared to a miserable seven percent of the total value of all financial assets (and yes, that includes pensions). Home equity, in short, is very nearly the only real asset for more than half of all Americans. The decision to allow housing values to fall for four straight years—in contrast to the equity and bonds of large financial institutions—leaves the majority of American consumers growing poorer month after month. Just as people who grow richer spend more, people who find themselves poorer spend less. So, consumer demand and with it business investment will not recover until housing values stabilize....

Waiting for the markets to begin acting rationally again is a fool’s errand. The economy will only right itself when housing values stabilize and distortions in Wall Street’s and Europe’s financial systems have been addressed.

6--Have the Double-Dippers Been Dipping Too Much? Dean Baker, CEPR

Excerpt: The Commerce Department just released data showing that real consumption spending rose by 0.5 percent in July. This makes it highly unlikely that growth will turn negative in the current quarter. Consumption is 70 percent of GDP and this figure implies a 6.0 percent annual growth rate.
Of course consumption is not really growing that fast, more likely it is increasing at near a 2.0 percent annual rate, but maybe this number will shut up the arithmetic challenged economists who keep talking about a double-dip recession.

The economy's problem is pathetically slow growth. We should be seeing growth of 5-7 percent as the economy rebounds from the worst downturn of the post-war period. Instead, we will be lucky if growth just keep pace with the growth of the labor force, preventing unemployment rate from rising further.

The implication is that tens of millions of people will remain unemployed or underemployed because of the Wall Street sleazes and the incompetent economists who could not see an $8 trillion housing bubble and still don't know a damn thing about the economy. It's a crime that they still have their jobs.

7--From S&P: Nationally, Home Prices Went Up in the Second Quarter of 2011 According to the S&P/Case-Shiller Home Price Indices, Calculated Risk

Excerpt: Data through June 2011, released today by S&P Indices for its S&P/Case-Shiller Home Price Indices ... show that the U.S. National Home Price Index increased by 3.6% in the second quarter of 2011, after having fallen 4.1% in the first quarter of 2011. With the second quarter’s data, the National Index recovered from its first quarter low, but still posted an annual decline of 5.9% versus the second quarter of 2010. Nationally, home prices are back to their early 2003 levels.

As of June 2011, 19 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were up versus May – Portland was flat. However, they were all down compared to June 2010....
There could be some confusion between the SA and NSA numbers, but this increase was mostly seasonal. I'll have more later ...

8--Ben Bernanke’s Dream World, J. Bradford DeLong, Project Syndicate

Excerpt: ...Bernanke claimed that “the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years.”...

But let me focus on Bernanke’s fourth statement. Even if we project a relatively rapid economic recovery, by the time this lesser depression is over, the US will have experienced an investment shortfall of at least $4 trillion. Until that investment shortfall is made up, the missing capital will serve to depress the level of real GDP in the US by two full percentage points. America’s growth trajectory will be 2% below what it would have been had the financial crisis been successfully finessed and the lesser depression avoided.

There is more: state and local budget-cutting has slowed America’s pace of investment in human capital and infrastructure, adding a third percentage point to the downward shift in the country’s long-term growth trajectory....

Moreover, there is an additional source of drag. A powerful factor that diminished perceived risk and encouraged investment and enterprise in the post-WWII era was the so-called “Roosevelt put.” Industrial-country governments all around the world now took fighting depression to be their first and highest economic priority, so that savers and businesses had no reason to worry that the hard times that followed 1873, 1884, or 1929 would return.

That is no longer true. The world in the future will be a riskier place than we thought it was – not because government will no longer offer guarantees that it should never have offered in the first place, but rather because the real risk that one’s customers might vanish in a prolonged depression is back.

9--Vital Signs: Disposable Income Dips, Sudeep Reddy, WSJ

Excerpt: Consumers’ spending power failed to keep up with inflation and taxes in July. While overall personal income rose during the month, inflation-adjusted personal income after taxes fell 0.1%. It was the first drop since last September. Stronger incomes will be key to support continued gains in consumer spending. (See chart)

10--US economic indicators, Dr. Ed's blog

Excerpt: Hooray, we are still in the soft patch! That seemed to be the stock market’s reaction to yesterday’s personal income and consumption report for July. The 0.8% increase in personal consumption expenditures (PCE), which beat expectations, was led by a 10.0% increase in spending on new cars and a 5.2% increase in spending on household utilities. Excluding these two categories, spending rose 0.5%. It’s also up 0.5% excluding gasoline sales....

At the start of this month, real GDP growth reports for the US, the UK, Germany, and France during Q2 all were disappointingly close to zero. The plunge in stock prices during the first four weeks of the month suggested that investors no longer believed that the soft patch would be followed by better growth, but rather by a recession. We also gave up on better growth during Q4, but we remain in the soft patch camp. ...

There has been no soft patch in capital spending. That’s because capital spending is driven by corporate profits, which have been very strong, as discussed in yesterday’s Morning Briefing. Indeed, while Q2 real GDP growth was revised downwards slightly from 1.3% to 1.0% (saar), nonresidential fixed investment was revised upwards from 6.3% to 9.9%. Spending on equipment and software was revised higher from 5.7% to 7.9%, and structures rose 15.7% rather than the preliminary estimate of 8.1%. During July, nondefense capital goods shipments rose for the third straight month, up 0.2% and 12.9% over the past three months, at an annual rate. That’s the best pace in a year....

11--US. Consumer Confidence Falls to Two-Year Low, Bloomberg

Excerpt: Confidence among U.S. consumers plunged in August to the lowest in more than two years as Americans’ outlooks for employment, incomes and business conditions soured.

The Conference Board’s index slumped to 44.5, the weakest since April 2009, from a revised 59.2 reading in July, figures from the New York-based private research group showed today. It was the biggest point drop since October 2008. Economists predicted the August gauge would fall to 52, according to the median forecast in a Bloomberg News survey.
An unemployment rate above 9 percent, a downgrade of the country’s top credit rating, partisan squabbling over the budget deficit and a volatile stock market weighed on sentiment. Increased pessimism may make households less apt to open their wallets, a hurdle for the economy and retailers such as Gap Inc. (GPS)

“This paints a picture of underlying demand weakening,” said Bricklin Dwyer, an economist at BNP Paribas in New York, whose forecast of 45 was most accurate in the Bloomberg survey. “Consumers are seeing their wealth deteriorate. We’ve seen a huge decline continuing in the housing market. They’ve also been hit on the chin by the equity markets.”

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