Echo

Windfall oil taxes amount to a tax on future oil production

Sunday, August 31, 2008

Today, windfall profits are a popular subject in the blogosphere. Mark Perry over at Carpe Diem blogs a bit about Exxon shareholder losses here, and Dean Baker over at Beat the Press gives a non-convincing discussion of production and supply decisions when prices reach the “windfall” level. His article attempts to undermine Ben Stein’s article over at the NY Times, where he argues that Obama should not increase taxes faced by oil companies.

Obama and the Democratic Congress are certainly worried about dependence on foreign oil (I never really knew what this meant, isn’t it just dependence on oil?), so why tax domestic oil profits? Taxing oil corporations will indeed lead to less supply both now and going forward.

Current supply is arguably fixed in the short term, but windfall prices (price spikes caused by unforeseen economic shocks like those in the 1970’s) provide the incentive for oil companies to increase oil and gas investment and infrastructure. To be sure, the fixed costs of adding to the drilling and refining capacities are monstrous; this can only be done with revenues to spare. A windfall tax amounts to a tax on future oil production. If the government is not willing to save, then allow the oil companies to save in place of the government. Don’t interfere with the oil companies' business (market) decisions to invest in infrastructure – it’s not like they aren’t paying taxes already. See a related Carpe Diem article.


Windfall profits taxes can be sizeable and oil profits are highly cyclical.

The chart shows quarterly petroleum and coal profits spanning the years 1980:1-2008:1 converted into 2008 $US using the Petroleum price index. Also included are the windfall tax revenues from the Crude Oil Windfall Profits Tax Act of 1980, which was repealed in 1988. The tax was an excise, rather than profits, tax. Revenues were based on the difference between the market price of oil and a set 1979 base price. During 1980-1986 windfall tax era, the government raked in an average of 53% of the petroleum and coal sector’s profits in tax revenues.

That sounds more like windfall tax revenues to me!

I am close to the oil and gas industry and know the income cycles well. My father is a geologist who has drilled for crude oil and natural gas all along the Gulf of Mexico, and I remember well the struggles of the oil and gas industry in the ‘90s (see chart 1992-1995). He was unemployed for a while, and that was very difficult for my family. Oil and gas is a cyclical industry, and corporate taxes should not be adjusted for its cyclicalities.

Why is the term “windfall” always attached to the oil and gas industry? As you can see, profits are subject to strong downward trends as well. Why didn’t Congress attempt to tax windfall profits tied to the money engine that was mortgage backed securitization? I know why – because the wealth was shared among many, rather than just a few.

Please leave comments. Best, Nontruths

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Small businesses thrive in the US labor market

The Bureau of Labor Statistic’s (BLS) employment report is released on Friday. Economists and policy makers are rife with anxiety because the report is difficult to forecast, and more often than not, a surprise.


Another report, the ADP employment report, is released the Tuesday before the BLS employment report. The ADP reports on total private employment, excluding government workers, and is said to be a good predictor of the BLS report; however recently, the ADP report has overestimated the growth in private employment by about 100,000 jobs per month. The report has essentially been written off by market traders as having any predictive power for the BLS report, but trends in the ADP report are interesting.

This chart illustrates the shares of the ADP payroll by firm size: Small (1-49 employees), medium (50-499 employees), and large (>499 employees). Since 2000, the share of small firms (44% in July) in the total private payroll has been growing relative to large (16.5%) and medium (39.3%) firms. The share of large firms fell 2.5% since 2000. The share of medium firms remains relatively unchanged. Times are a changing, and so is firm size. According to the SurePayroll survey – an online payroll service for small businesses – the top 5 states best for a small business are Utah, Maryland, Nevada, Colorado, and Arizona. I can relate. My family used to live in Colorado, where it seemed that everybody had a car or van with their business logo written on its side.

So, why have smaller firms thrived and overshadowed the large firms? E-commerce and the falling cost of computers have played a large part.

This chart illustrates the relationship between the falling cost of computers and related equipment and the share of small firms in the total ADP survey spanning the years 2000 to 2008. There is a strong and positive correlation: As the cost of computers falls, the share of small firms rises. Specifically, for each 1% annual reduction in the cost of computers, the share of small firms rises by 0.1%. For such a simple model, the significance is rather large (R2 = 0.75). PC prices, especially, have fallen so dramatically that starting a business and getting up and running has is extremely affordable.

Most of you work for small or medium size firms. Me, I am the exception because I work at a large firm. Come November, issues related to firm size will likely emerge – especially with health care. According to SurePayroll, 56% of small businesses do not offer health care coverage to employees. Obama is pushing for tax breaks to small firms who offer health care coverage, but is that really the best way to go?

I tend to side with McCain’s plan, offering consumer tax credits for insurance coverage (on a sliding scale, of course, set according to age and predisposed health conditions). Small firms are already at a disadvantage in their bargaining powers with insurance companies, and the tax break would likely need to be sizeable to compensate. Going to the consumer level, as McCain suggests, would create more competition in the health care industry and cost the government less money. What do you think?


Please leave your comments. Best, Rebecca Wilder

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Gustav threatens an already weak labor market

Saturday, August 30, 2008

Gustav Dangerous Category 4 says the Weather Channel. Here is what the Census Bureau has to say about the US region where Gustav will hit:
- Over 11.5 million residents from Florida to Southern Texas may be affected by Gustav
- The storm’s 5-day track threatens 68,000 miles of Coastline.
- 20% of New Orleans is living in poverty and 17% of households have no access to a vehicle.
As the storm progresses, the Census Bureau will detail Emergency preparedness here (there is no mention of Gustav yet).

Gustav’s threat to halt domestic oil production is to blame for Friday’s losses in the US stock markets. At stake is 80% of the Gulf of Mexico’s oil and gas production and a surge in gas prices to $5/gallon if infrastructure takes a direct hit.

But also at risk are jobs and welfare. The economic slump has already created a very soft labor market, where 463,000 net-jobs have been shed since December 2007. If Gustav affects the 11.5 million residents (over 7% of the labor force), then initial claims are sure to spike above their already threatening level of 425,000 filed last week.

In the end, a hurricane the size of Katrina or Rita would likely throw this economy into a recession. Private domestic demand just can’t take another hit on gas prices and jobs. However, with the media’s penchant for reporting negative news, the worst-case scenario seems overly dire. But given that Gustav is now Category 4, we will just have to cross our fingers and hope that it dissipates before arriving at the US Coastline.

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My thoughts on carbon emissions

Emission reduction and climate change are controversial topics of discussion, and whether the US elects McCain or Obama, the next Presidency is sure to sign in some bill pertaining to the reduction of US carbon emissions.

Abatement is very difficult to coordinate internationally; the incentive structure is just not well-defined. Why should a developed country abate when the developing world won’t or can’t abait its share of emssions? To be sure, a Google search of “success emission reduction” gets 286,000 hits, while a search of “failure emission reduction” gets 2,140,000.

Why should we reduce emission levels? According to Green Peace, the easily identifiable college-aged person wearing a bright tee shirt, holding a notebook, and appropriately blocking your path in his/her troll-like stance until you look at their clipboard, “the time to stop global warming is now”….or, “the health of the planet lies in the balance.” But according to the National Center for Policy Analysis, a libertarian organization (I call it libertarian but don’t know how they would classify themselves) whose mission is to provide alternatives to government regulation on various topics, “the causes and consequences of the earth’s current warming trend is still unknown, the cost of actions to substantially reduce CO2 emissions would be quite high and result in economic decline, accelerated environmental destruction, and do little or nothing to prevent global warming regardless of its cause.”


Global warming or not, I am sure that I like cleaner, rather than dirtier, air. If I lived in Vietnam (I was riding on that bike and thought that I would die with all of the exhaust I was breathing in), I would be much more active about emission reduction because my health would eventually be at risk. However, I don’t live in Vietnam and already enjoy reduced emissions and cleaner air. Perhaps there is some marginal value to even cleaner air, but the costs to get it are likely too large. In the end, if I am somehow forced to change my behavior, then I will. But if I am not, then I won’t. Unless every person in every nation around to globe goes green at the same time, then global emission levels will not change. Hence, the classic “free rider” problem.

If policy makers want to figure out a way to reduce emissions, fine, just don’t set unreasonable goals and don’ use a cap and trade system. The cap and trade system is extremely complicated to design, and can even result in higher emission levels.

Hans Gersbach proposes an alternative to coordination efforts and complicated cap and trade systems: the Global Refunding System (GSR), and on the surface, it is encouraging. Here is a link to an article that highlights his points:
-Countries choose whether or not they want to be a part of a Global Refunding System (GSR) fund
-Each year, countries pay into the fund according to a self-determined carbon tax
-The fund earns interest, and each country contributing to the fund receives an appropriate refund based on their share of emission reductions – this defines the incentive to abate.
-If a country exits (which it can), it forfeits its right to refund.

Dr. Gersbach argues that the GSR plan is self-enforced with a well-defined incentive structure (sharing in the fund’s wealth accumulation) that will entice countries to set a tax rate that actually reduces carbon emissions. It’s kind of a cool idea, but the part about the developing nations is not properly addressed. The key to reducing global emissions is the developing world cutting its emissions (China, India, Vietnam, Mexico, etc.) levels, but these nations have neither the technology nor the funds available to participate in the GSR.

Dr. Gersbach suggests that “only rich countries pay an initial fee into the fund, thus increasing future refunds for all countries and benefiting developing countries” in this version of the paper, and that “wealth not refunded and accumulated can be used to support particular projects for reducing greenhouse gases in some countries” in this version of the paper.

Basically, those who cannot afford it will not have to pay in but receive refunds when the GRS fund is started, and countries can spend any excess revenue of the fund.

My conservative alarm goes off, ding, ding, ding, haven’t we learned our lesson from the infamous US Social Security Fund?

Yup, this is why DR. Gersbach’s GSR fund won’t work. The fund will pay out early to those who don’t pay in, and all along the way, the fund’s surplus can, AND WILL BE, spent. As with the US Social Security Fund, there will be nothing left but several trillion in fancy IOU’s (US Treasuries) in 73 years (1935, when the SS Act was passed to 2008).

I don’t envy the Economists and policy makers who must sort out this problem. The difficulties in coordinating emission reductions internationally are daunting. It is likely, however, a solution will present itself when the proper technologies are developed.

Have you seen Demolition Man? My years of watching Science Fiction has convinced me that technology will eventually catch up with our social goals.

Please leave your comments. Best, Rebecca

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Export growth: Not your grandpa's run-of-the-mill machine

Friday, August 29, 2008

The financial markets loved the durable goods report. Stocks traded up on the Census Bureau’s latest bit of news: New orders for manufactured durable goods in July increased $2.9 billion or 1.3 percent to $219.3 billion, the U.S. Census Bureau announced today.


Presumably much of the growth in new orders of manufactured goods is due to strong export demand spurred by a falling US dollar. Dean Baker runs a blog over at The American Prospect. He gives some interesting insight into the durable goods report: “The machinery orders are presumably associated with an increase in manufacturing capacity. Increased demand for manufacturing is in turn likely the result of the improved competitiveness of the United States due to the fall of the dollar.”

People are a bit unnerved about the prospect of depending on foreign demand and export growth to sustain the US economy. It will certainly take some getting used to, but in the long run, export driven growth is likely to spur new and exciting innovations.

Search for the word “manufacturing” using the google image search engine. On the first page, one sees several pictures of assembly line workers, a car being built (Subaru, I think), some sort of nut and bolt-looking hardware thing, fire and combustion in a factory. On the second page, something called “digital manufacturing” comes up that features a chart with words like calculation, simulations, computer-based, custom orders, technical data, etc.

My point is: the manufacturing we are talking about in the current US export sector is not like the manufacturing two or three generations ago. We are talking about the US specializing in the production of highly innovative and technically sound machinery. Export-driven growth indicates that the US is specializing in the goods that it is best suitable for producing, technologies and machines in manufacturing, resulting in strong economic growth going forward.

Let me use an example. Several months ago, the History Channel (I think) did a piece on aircraft carriers, and how the plant and animal growth on the hull of the boat was slowing down the carriers; the drag coming from the growth costs the US Navy at least $50 million of the $500 million in gas bills. A science team received a grant to figure out how to reduce the drag on the hull. It turns out that sharks have microscopic tears in their skins that prevent plant and animal life from growing on their exterior. The science team proposes that the Navy do the same. That sounds like a neat technology! See Shark Skin Inspires Ship Coating for more detail.

With strong export growth, the US will allocate more resources toward research and development of really cool machines and transportation equipment (aircraft carriers that burn less fuel because there is less plant and animal life on the hull). There may certainly be an economic transition along the way, but eventually, the higher revenues in the export sector will end up in workers’ pockets.

Please leave comments. Best, Nontruths

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What does Consumer Confidence really tell us about the US economy?

Thursday, August 28, 2008

The consumer confidence survey, published by the Conference Board, gets a lot of press. A Google search of consumer confidence gets 5,410,000 hits and the first media title is a Reuters article from the survey’s August release, where confidence rose 5 points to 56.9, Consumer confidence bounces.


My impression of the consumer confidence measure is that it is just a poor measure of gas and home prices.

Confidence dropped in the early 1980’s following the oil shocks of 1973 and 1979, in 1991 with the Gulf War, and again over the last year when oil topped $145/barrel in July. Notice how confidence turned up in August, just as oil and gas prices began to subside. Confidence also is very susceptible to the housing market (as it should be). Further, consumer confidence hit its lowest levels during the last two housing corrections, in 1992 and in 2008.

Upon first glance, consumers are very good at calling a recession. However, there are plenty of mid-cycle dips (circled areas) in consumer confidence, where the economy is not in a recession. So I have to ask myself, do consumers really know what they are talking about?

The Confidence Board surveys 5,000 individuals for the following purpose: “The Consumer Confidence Survey™ reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes and buying intentions, with data available by age, income, and region.”

Certainly it details consumer attitudes and intentions. The August report indicates that current business conditions have not changed, the labor market is worse, and the economy is now more likely to get better over the next 12 months (although consumers are still quite negative about the outlook). This is certainly consistent with the consensus outlook on Wall Street and not new information. But do these consumers really know anything about business conditions?

This graph reinforces the fact that consumers are really not the best judge of economic conditions. Standard banking practice sets interest rates according to inflation expectations. If banks expect inflation to rise over the next year, interest rates (mortgage, car loan, savings, etc) will rise with the expected supply of money. In order to maintain the same real return, nominal rates must rise.

Consumers are obviously unaware of this simple fact; there is absolutely no correlation between consumer inflation expectations and the interest rate.
  • During the 1990’s, consumers were fairly confident that inflation was going to be stable in the oncoming 12 months, while at the same time, interest rates were expected to be quite volatile.

  • Since October 2007, inflation expectations have surged and the number of people that believe interest rates will be higher over the next 12-months has been falling.

So what is driving interest rates? Apparently it is Fed policy.

Interest rate expectations appear to be highly correlated with Fed policy. Why wouldn’t they? That is the goal of Fed policy: target lower interest rates in order to drive down long-term interest rates (mortgage, car loan, savings, etc). However, long-term interest rates don’t always follow the Fed’s lead. Mortgage rates – which have stabilized over the last three weeks – have risen since May, but the Fed funds target fell 3.25% since last year.

If one wants data on gas prices, it is better to download it directly from the Energy Information Administration’s website, rather than use the Confidence Board’s faulty measure of consumer confidence.

Please leave comments. Best, Nontruths

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US growth to revise upward on trade

Wednesday, August 27, 2008

Globally, growth is decelerating, and in some cases, is negative. Preliminary estimates of the second quarter (Q2) Gross Domestic Product – GDP, which is the value of a country’s production of goods and services - show the Eurozone contracting 0.2% since the first quarter (Q1), which was dragged down by its biggest countries Germany (-0.5%) and France (-0.3%), the UK is stagnant at 0.0% since Q1, Japan contracted -0.6% since Q1, and even Chinese economic growth slowed to 10.1% (growth over the year, rather than a quarter) from 10.8% in Q1.

But the US grew 0.5% since Q1, or 1.9% on an annualized rate. If the stimulus plan did not work (see posts at Mish's Global Economic Trend Analysis website here and my previous post here), and consumption is growing close to snail speed, what is driving economic growth?

The chart below illustrates the contributions to growth (% change in GDP) for the US listed by type of expenditure (GDP= C+I+G+NX).

There are a few interesting trends here.

  1. The contribution coming from consumption has been deteriorating throughout 2008 and is well-below 2.2%, its average contribution spanning the years 2000-2007.
  2. Residential construction (housing market) has subtracted from economic growth dating back to 2006; it, along with a strong draw on inventories, is the primary reason that investment is the largest drag on economic growth in Q2 2008. Nonresidential investment is still a positive contributor to economic growth.

Net exports (exports – imports) is currently the largest contributor to economic growth. Further, its contribution has been robustly positive since Q1 2007; the USD has been depreciating on a broad basis since 2002, which finally flipped net exports in 2007.

Real exports (extracting the effects of rising prices) are currently 13% of GDP and growing around 5 times the speed of the overall economy. And as an added bonus, real imports are falling as well. All in all, net exports are propping up the American economy.

Tomorrow (August 28), the revised estimates of GDP will be released; the consensus is that GDP growth will be revised upward to 2.7% on an annualized rate from 1.9%. Recent reports on inventories and residential construction have been more positive than the Bureau of Economic Analysis (BEA) had expected. However, the trade numbers are the primary reason that the Street sees an upward revision.

For the Advanced release (the first of three), the BEA – the government agency in charge of national accounting – reports its assumptions for June data (the final month in Q2) that have not yet been released. The BEA assumed that net exports of goods would be -$911.1 billion (a deficit) on an annual rate, or -$75.93 billion for the month of June. The report came in at -$70.0 billion, which is a smaller deficit than the government had anticipated. This will add at least $71.1 billion (5.93*12) to the newest estimates of GDP.

How can one say that the economy is currently in a recession when GDP is growing at a 2.7% clip? The real risk going forward is the fourth quarter (October through December) of 2008 when negative growth may be on the horizon.

Will a stronger dollar and slowing global economy reduce net exports enough to let the US economy sink? I believe that the contraction in residential investment will have subsided by then, and thus will cease to be such a large drag on GDP. The real wild card is US consumption; even though inflation is set to abate, there is still a lot in the pipeline that may further depress consumption’s contribution to growth.

Will consumers hold on like they have so far? What do you think?

Please leave comments. Best, Nontruths

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The 2007 US Census Report: Poverty Same, Uninsured down, Income Up, and some other stuff

Tuesday, August 26, 2008

Okay, if you haven’t heard about this one, then you must be living in a cave, or maybe with the crowd from “Lost.”

Normally I do not write about purely political topics, but I could not help myself. If you want, you can just scroll on down to the last paragraph for the political punch line.

The media beefed up this report so much that I couldn’t wait to hear about the 2007 US census statistics on poverty, health insurance coverage, and the American community survey data. And it is the end of 2008! With the Democratic convention underway, it was widely speculated that the number of uninsured individuals would rise and Obama’s health care plan would gain some momentum; well, they fell.

The basics of the 2007 report that you have probably already read about are the following:

  • Real median household income rose 1.3%.
  • The official poverty rate was 12.5%, which is statistically unchanged from 2006 (meaning that their estimates could be off just a bit, resulting in the 2006 number).
  • The number of uninsured persons fell 1.3 million to 45.7 million, or 15.3%.

Some other interesting 2007 statistics that are not in the mass media:

  • Median household incomes rose in the Midwest ($50,277) and the South ($46,186), and fell in the Northeast ($52,274) and were unchanged in the West ($54,138).
  • Real median earnings for men who worked full time rose $1,653 to $45,113 while for women, they rose $1,665 to $35,102 (notice the differential – no, this is not a 1950’s statistic).
  • The number of seniors 65 and older in poverty increased 200,000 to 3.6 million; the CBO’s estimates on social security obligations will probably change based on this number.

The uninsured rates in the Northeast and Midwest, 11.4%, were lower than that in the West and South, 16.9% and 18.4%. For the Northeast, this is a direct product of Romney’s state-wide mandatory and subsidized health care coverage.

Also, did you know that the report was also published in Spanish? Enough said. I am a bit irked that the Census Bureau spent time, money, and resources publishing this report in Spanish.

Please leave comment. Best, Nontruths

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Tax receipts: Financial distress has not killed the US economy

The US economy is trudging around in the mud, where its primary drags are the housing and labor markets. Housing wealth is plummeting with the 16% drop in prices (new report to come out today). The labor market has shed 463,000 jobs since December. Both sectors signal a recession if other indicators like consumption, personal income, GDP, and industrial production follow… and that is a big if.

Another way to look at the health of the US economy is through US government tax receipts (federal and state, local). Individual and corporate tax receipts, where individual tax receipts were 6-times the size of corporate taxes receipts in July, are a neat coincident indicator of the state of the US economy.

The bottom line: Corporate tax receipts paint a much dimmer picture of the US economy than do individual tax receipts.

Corporate tax receipts have been falling on an annual basis since July 2007. This correlates perfectly with the timing of the sub-prime mortgage crisis that led to widespread capital losses in the global financial system. With the financial industry holding 33% of total profits in 2007 (as measured by the BEA), financials are likely the biggest drag on corporate profit tax receipts.

With one sector dragging down corporate profits, are individual tax receipts following? Individual taxes reeipts fell on an annual basis for just 3 non-consecutive months since July 2007. The data are not seasonally adjusted – which is why the chart presents the 3-month moving average – and on an average basis, income tax receipts have not fallen since August 2005.

The individual tax receipts show a US economy that has clearly slowed but not tumbled into an abyss, as corporate taxes would imply. This is consistent with the labor market data, which is certainly soft, but not plummeting as it did in previous recessions.

According to US tax receipts, it is the financial sector - undermined by assets tied to worthless subprime mortgages - that is feeling the brunt of the slump. Certainly, financial distress has seeped into the real economy, but consumers and nonfinancial firms remain resilient.

I still contend that the housing market is underscoring the problems in the US economy. If the housing market turns around, which will start this year, then related sectors will also improve. Specifically, the labor market, with its 600,000 construction jobs lost since last year, will show signs of revival or at least not be losing as many jobs.

Please leave comments. Best, Nontruths

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There’s still a lot of inflation in the pipeline to hurt global economies

Monday, August 25, 2008

There is a lot of talk about the oncoming deceleration in inflation across the world. Oil has dropped precipitously; currently, it is trading in the $115-$119/barrel range, which is well below its peak above $145/ barrel in July. US gas prices have dropped 9% since they peaked over $4/barrel in July. With energy dropping and global growth slumping, price pressures are set to subside in coming months.


That is a good thing, but it ain’t over yet. There is still a lot of inflation in the pipeline that will continue to squeeze consumers and firms over the next year.

Inflation has spiked in many countries, and many Asian countries have seen record inflation rates. For some of these countries, price pressures were already building under years of export growth, and the recent surges in oil prices launched inflation rates to unmanageable territories. Curbing inflation became a top priority, and for many like the People’s Bank of China, inflation is still a serious concern.

The chart illustrates annual inflation rates in various Asian countries and in the United States. In Asia, the latest data suggest that inflation is still accelerating in Japan, Malaysia, Philippines, South Korea, while it is decelerating in China and Singapore.

At the same time, global growth is slowing. On an annual basis, growth slowed in Japan 0.18% in the second quarter of 2008 (Q2), in Malaysia 0.16% in the first quarter of 2008 (Q1), in the Philippines 1.27% in Q1, in Singapore 4.8% in Q2, in South Korea 1.08% in Q2, in Taiwan 1.93% in Q2, and in the US 0.72% in Q2.

Energy and oil cost less, resulting in lower expected inflation. In the US, gas prices are falling, and in China, energy prices have risen for two consecutive months. A slowing global economy and decelerating energy prices will relieve inflation pressures across the world.

However, there is still a lot of inflation in the pipeline that will continue to plague consumers and firms. Gas prices have plummeted since July, but they are still 31% over their average level between 2005 and 2008, 2.82 $/gallon. Without a likewise increase in wages and incomes, consumers will continue to feel strapped for cash. The merits of wage pressures are not under scrutiny here, but the fact is that even though gas prices are falling, consumer spending will likely continue to slow. There is a similar story across the world, even where wages have started to rise.

Correction: the second column should read: "Average inflation 2000-2007."

Globally, inflation is also set to abate, but the 7-yr average inflation rate across China, Malaysia, Singapore, Taiwan, Japan, Philippines, South Korea, and the US is far below their current and expected inflation rates. This is problematic, and unless inflation falls precipitously further, Asian producers and consumers alike will feel the pressure. Cost pressures are in the pipeline for Asia’s strongest exporters, and no matter how resilient are firms to the wage and energy price pressures, production is likely to slow a through 2008 and into 2009.

The fall in oil and energy prices is very good news for the global economic outlook. However, there is still a lot of inflation in the pipeline; consumer spending and firm production across the globe are set to slow through 2009.

Please leave comments. Best, Nontruths

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Fannie Mae and Freddie Mac do not equal the US Treasury

Sunday, August 24, 2008

The saga surrounding Fannie Mae and Freddie Mac continues. Although most of it is just speculation, share values of the two giants did drop precipitously, again, this week. On Tuesday, shares plunged 22% on speculation that a government bailout is imminent.

The investment community is incensed. According to Reuters, [Warren] Buffett called them "too big to fail" and said "the game is over" for them as independent companies. "In a practical sense, as institutions, they don't have any net worth," he said.

So how did Fannie Mae and Freddie Mac become too big to fail? Simple: As government sponsored entities (GSE), Fannie Mae and Freddie Mac have been funding their operations (borrow) at rates ridiculously close to that of the US Treasury.

In 2006, the average spread between a Fannie Mae 10-year bond and a US Treasury 10-yr bond was just 0.37%. With the implicit (now explicit) government backing, Fannie Mae and Freddie Mac are seen as close to default as the US Treasury. Does that make sense to you?

Corporate debt yields should exceed significantly US debt yields because the expected default rate is much higher. In 2006, the average spread between a Moody’s BAA-rated firm and the US Treasury was 1.6%, and for a AAA-rated firm, it was 0.72%. Fannie Mae and Freddie Mac are highly leveraged, more so than most firms, and should be rated accordingly; the spread to US Treasuries should well-exceed 0.37%. Finally, Moody’s downgraded the two giants on Friday, and yields jumped.

Economists far and wide are outraged over the bail out of Fannie Mae and Freddie Mac. A Bloomberg report with Jeffrey Lacker, President of the Richmond Federal Reserve Bank reads:

"For my money I would prefer to see them credibly and demonstrably privatized,'' Lacker said today in an interview with Bloomberg Television. He agreed with former Fed Chairman Alan Greenspan's view that the two largest U.S. mortgage finance firms ought to be nationalized, then split up and sold off.

Why would an economist prefer nationalization? Bailing out the two mortgage giants involves the US Treasury extending loans financed by US taxpayers (you and I). The problem is that you and I (taxpayers) will then share the liabilities of Fannie Mae and Freddie Mac, but the shareholders still enjoy the assets and profits. However, if Fannie Mae and Freddie Mac are nationalized, then taxpayers share both the burden (liabilities) and the assets (mortgages) of the two giants; it is simply more equitable that way.

Nationalization is unlikely. The US government gave these two giants too much latitude, and someone (you and I) are being called to clean up the mess.

The arms of the speculation have a far reach; the bail out is now all but a foregone conclusion. Will Fannie Mae and Freddie Mac call in on the newly-extended lines of credit at the US Treasury in the upcoming week? What do you think?

Please leave comments. Best, Nontruths

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Census statistics determine Republican and Democrat convention cities

Saturday, August 23, 2008

The Republican and Democratic conventions are coming up. The Democrats are meeting August 25-28 in Denver, CO (DEN), while the Republicans will assemble Sept. 1-4 in Minneapolis.-St. Paul (MSP), MN. How did each Party decide where to hold their conventions?

One would think that the Grand Old Party (GOP, or Republicans) and the Democrats (DEMS) would choose states where they hold a comparative advantage; specifically, states in which they hold a majority of the Electoral College. Nope. According to Carl Rove, the pioneer of the Electoral College Map, Obama is favored in Minnesota and there is a toss-up in Colorado. So that’s not it.

One could then focus her attention away from the Electoral College, and toward the average GOP and DEM voter. Listed below are just a few adjectives (phrases) that are commonly used to describe Republicans and Democrats (Click on the table to enlarge):

Perhaps the GOP and DEMS chose their convention cities to appeal to the average voter? I think that we nailed it. Listed below are characteristics of each city, compiled by the U.S. Census Bureau (Click on the table to enlarge).

According to the Census:

- The average person in MSP is wealthier than in DEN and is older in MSP than in DEN.
- A larger percentage of the population holds a bachelor’s degree in MSP compared to DEN, is whiter in SPM compared to DEN, and is older in MSP compared to DEN.
- The annual payroll for Health Care and Social Assistance is greater in DEN than in MSP.

Admittedly, there are facts that don’t fit, the % of population that is veteran is larger in DEN than in MSP and the % of population that is female and not married is larger in MSP than in DEN. However, the number of characteristics that do fit outweigh the number that don’t.

It looks like the GOP made a good decision on Minneapolis-St.Paul. Not only does it describe well the characterized Republica, it also has a large share of registered voters. Minneapolis-St.Paul, with its 84.5% registered in the previous election is a better choice that Denver, where only 74.2% were registered.

Perhaps McCain can woo the SPM Electoral College; stranger things have happened.

Please leave comments. Best, Nontruths

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What were homebuilders thinking?

Friday, August 22, 2008

The housing market debacle started with the collapse of the sub-prime mortgage market in August 2007. Thankfully, the Fed and Congress rallied, putting expansionary policy in place. The 3.25% reduction in short-term interest rates and $100 billion in tax rebate checks helped to keep the economy afloat as the housing market sank quicker than the Titanic.

However, in retrospect, it is easy to see that it was a mix of problems, including irrational building projects. The chart below shows the 3-month average annual change of existing home sales spanning the years 2004 to 2008 across the four US census regions.

By December 2005, existing home sales in the Northeast, Midwest, and South marked 0% or negative growth. The South plummeted one year later.

By the beginning of 2006, sales were already declining.


But homebuilders were still building. The table below lists the 10 states with the highest growth in housing units, measured by the Census, for the years 2006 and 2007.

As existing home sales were turning negative for the West and Midwest, this area was a continued target of for strong growth in housing inventory. Nevada homebuilding was hot, 4.5% 2005-2006 and 3.5% 2006-2007, and well above the national average, 1.4% 2005-2006 and 1.3% 2006-2007. In fact, except for Delaware and Louisiana, the same states saw the strongest housing unit growth in both 2006 and 2007. No wonder the housing markets in Nevada, Arizona, and Florida have been hit so hard.

The irrational homebuilders were caught with their pants down. It doesn’t make sense to start new projects when you can’t get rid of the ones you already finished.

Please leave comments. Best, Nontruths

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Is Zambia the next China?

Thursday, August 21, 2008

In the article, The Rise of Africa’s “Frontier” Markets, the IMF reports that several African countries are set to become the newest generation of emerging markets. So move over 1980’s-style emerging China, India, and Taiwan, and make room for 2000’s-style emerging Botswana, Ghana, Kenya, Mozambique, Nigeria, Tanzania, Uganda, and Zambia. Investors are interested.

What is an emerging market? Well, in 1980, the International Finance Corporation defined it as:

“developing countries with stock markets that were beginning to demonstrate the features of the mature stock markets in industrial countries. Emerging markets—which afford the opportunity to participate in economies through financial investments—have been identified in all regions of the world. In Africa, only South Africa so far has been seen as an emerging market.”

According to the article, the wider use of the term refers to an economy that has attracted investor interest based on a set of macroeconomic and financial fundamentals. Some sub-Saharan economies may soon be called “emerging” since they have experienced a surge in economic growth, where growth is led by the private sector. Public policy has recognized and accommodated the growth. Further, there must be a financial system where investors can put their money.

Zambia, a sub-Saharan country that shares a border with Angola, Democratic Republic of the Congo, Malawi, Mozambique, Namibia, Tanzania, and Zimbabwe, is a country that may be one of these new-age emerging countries in Africa. First, it shares similar economic statistics as the ASEAN (Association of Southeast Asian Nations) countries did in the 1980’s, when they were classified as emerging markets. Second, the central bank of Zambia, the Bank of Zambia (BoZ), recognizes the need for financial stability and has incorporated this need into its central bank mandate.
Zambia has experienced a surge in growth, which is necessary for emerging market status. The table illustrates that Zambia’s economic statistics in 2007 are similar to those emerging markets in 1980. Zambia is already growing at a 5.3% rate annually, and with an inflow of funds from foreign investors, growth could really takeoff.

Zambia has a financial system in place that encourages public trading of stocks, valued at $4.5b in 2007, and the central bank incorporates financial stability into its policy making process; both factors add to Zambia’s potential for emerging market status.

The BoZ’s official mandate is the following: Formulate and implement monetary and supervisory policies that achieve and maintain price stability and promote financial system stability in the Republic of Zambia. This is in contrast to the US Fed mission, which is to promote price stability and maximum sustainable growth, but necessary for its economic status.

Dr. Denny H. Kalyalya, the Deputy Governor Operations of the Bank of Zambia (Zambia’s central bank), indicated that public policy is recognizing and accommodating the growth. First, the Government of the republic of Zambia launched a 5-year Financial Sector Development Plan (FSDP) in 2004. Second, and in support of the FCDP, the BoZ initiated its Strategic Plan for 2008-2011 that strengthens the bank’s role in promoting Zambia’s financial system.

Could Zambia be the next China? It certainly doesn’t seem so now, and only time will tell. In 2007, per-capita GDP (income per person) in Zambia was $1,300. If Zambia continues to grow at the rate of 5.3% for the next 28 years, then per-capita GDP will rise to $5,520. China’s 2007 GDP per-capita was $5,300; something to think about.

Please leave comments. Best, Nontruths

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Fed policy has worked: Mortgage rates still low

Wednesday, August 20, 2008

Recently, the banking sector has suffered major losses, originating from the collapse of the subprime mortgage market. The IMF reports that banks are having problems raising capital to cover their losses, and in response, the banking sector has tightened up.

Some call it a credit crunch, the Federal Reserve is certainly indicating that loan standards are freezing up, and recently, mortgage rates are on the rise. With inflation bearing its mean face, investors are worried that the housing sector will never stabilize under the so-called credit crunch.

Some of the recent rise in mortgage rates coincides with the financial troubles of Fannie Mae and Freddie Mac; investors and banks are becoming more certain that the two mortgage giants will be forced to call upon the US Treasury for help. Since Fannie Mae and Freddie Mac “guarantee” half of the US mortgage market, banks are weary to extend loans while there is any uncertainty surrounding the health of Fannie Mae and Freddie Mac; mortgage rates rise.

Inflation has also played its part. As inflation expectations rise, banks set higher rates. With consumer prices reported to have risen 5.6% since last year.

Recently, banks have driven up mortgage rates and consumers have reduced mortgage applications. In May, the 30-year mortgage rate was 6.0%, and as of August 8, it rose to 6.5%. Contemporaneously, mortgage applications on average have fallen 3 weeks in a row. Home sales may be in jeopardy, pushing back the recovery of the housing market.
However, the Fed is on our side. In spite of record turmoil in the banking sector, mortgage rates remain at all-time lows because of the Fed’s expansionary policy that began back in September 2007. The Fed has injected enough cash into the US economy to lower short-term interest rates by 3.25%. Mortgage rates fell slightly in repose to short-term rates, and have recently risen back to their September 2007 levels, but they would be a lot higher had the Fed not stepped in.

As a counter-example, look at the UK. The UK housing market is likewise in a slump; in August, UK home values dropped 11%. The Bank of England, the British central bank, reduced short-term interest rates by just 0.25%, and that was back in April 2008. Since the Bank of England has not been accommodative, mortgage rates are on the rise. Banks have not had the luxury of an injected cash flow, and are more apt to respond to the pressures of higher expected inflation rates.


It could be a lot worse. I still expect that the US housing market will turn around soon. Sales will start to recover (2008), prices will cease to fall further (2009), and eventually, broader optimism will drive new and healthy construction (2010). Thank goodness for that dual mandate that the Fed has, and the Bank of England does not: To promote maximum sustainable growth AND stable inflation.



Please leave comments. Best, Nontruths

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Housing will bottom in 2008, but will not start to rebound until 2009

Monday, August 18, 2008

The collapse of the housing market is the epicenter of the financial earthquake that has ripped through Wall Street over the last year. The S&P 500 is currently off its October 2007 high by 20%. Corporate credit spreads have widened back to levels not seen since the collapse of Bear Stearns in March. Bank lending has tightening substantially (according to the Senior Federal Loan Officer Survey conducted by the Federal Reserve Bank). Mortgage rates have risen from 6.0% in May to 6.5% in August. Mortgage applications are falling. Home prices continue their decent, and the housing market has failed to make a decided stabilization.


Today, shares of Fannie Mae and Freddie Mac, the two government mortgage entities, tumbled more than 22% each. The general consensus regarding the future of Fannie and Freddie now includes a necessary bailout; a recent Barron’s article predicts that the US Treasury will need to inject funds to cover the (possibly) insolvent balance sheets of the two firms, resulting in a liquidation of shares and huge losses to shareholders. A.K.A., get out…and get out quick.

In some sense Fannie Mae’s and Freddie Mac’s problems will subside if the housing market stabilizes; the financial markets will rebound if the housing market stabilizes; the labor market (almost 600,000 construction jobs have been shed since last year) will rebound if the housing market stabilizes; consumer spending will improve if the housing market stabilizes; US growth will improve if the housing market stabilizes. The recovery of the US economy depends on the stabilization of the housing market.

The big question is: When will the housing market stabilize? The answer is that the housing market will have initiated its stabilization perhaps by July, but will not rebound until well into 2009. First, the market for home sales must find their bottoms, both on the primary (new home sales) and secondary (existing home sales) markets. This is likely imminent, and may have already begun. Second, home prices must find a trough. Alan Greenspan, the former Chairman of the Federal Reserve, believes that prices will not bottom until early 2009. Third, new construction will pave a path to a real recovery. Housing construction (new construction) may bottom in the next few months, but healthy construction will not likely emerge until 2009.

Sales may have reached a bottom

The housing market has not decidedly reached phase one of its recovery (sales finding a bottom). In June, the level of existing home sales (4.86 million) fell 2.6%, its biggest monthly drop since September 2007. Further, new single family homes plunged 33% since last year; however, new single family home sales (533,000) are just 11% the size of existing home sales (4.86million), so the effect on the economy is really negligible. For that matter, who really cares about new single family home sales?

On an annual basis, the rates of declines in sales are falling – June’s existing home sales, pending home sales, and new single family home sales fell to -15.5%, -12.2%, and -33% - so a bottom may have been found.
Prices have not yet bottomed

As home sales start to bottom out, the inventory of unsold homes - including vacant homes (currently 2.8% of all homes owned) - will be picked up, and prices can stabilize. We are already seeing evidence of this happening since average existing home prices rose 4 consecutive months to $257,500 in June, but other indicators paint a very different picture. The Case Shiller composite 20 index of home prices fell another 0.9% in May (the most recent statistic) for a grand total of 15.8%-off since this time last year.

It is good news that existing home prices are rising, and even that the Case Shiller index is lagged by one month (it’s latest release is May, while all of the other housing data released June statistics), so it may have risen by now, but home prices are going to stay low until a sure-fire stabilization in sales occurs; that may be a while.

Healthy construction will not occur for a while

And finally, we come to the merits of tomorrow’s release by the Census Bureau, new home construction (housing starts). As soon as the excess supply of housing is absorbed and home prices start to rise again, new construction will resume at a more-healthy pace.

Currently, new construction has fallen to just 3.2% of total economic production in a year (GDP), which is 2.2% lower than 3 years ago. How low can it go? In 1991, construction fell to under 0.8 million units per year, which is much lower than the current 1.07 million units started in June. It can go lower, but the upside is that starts rose quickly following their Jan 1991 bottom.
Tomorrow’s release is expected to bring further reductions in new construction, perhaps down to 0.90 million. As a technicality, the Census Bureau’ June report showed that many new homes were started that would not have been started if it weren’t for a new piece of New York City regulation. Thus, the 1.07million units started in June cannot be sustained, especially since existing home sales prices continued to decline.

Starts may bottom soon, but they will sit there until the rest of the housing market works itself out. To be sure, it does look like newly issued building permits have hit a bottom, so new construction may not be too far behind.
The glimmer of hope

There is a glimmer of hope that the US housing market is showing some signs of stabilization, but the verdict is still out. There is much excess inventory to work through, prices have to stabilize and rise, and finally, new construction must again gain some momentum. Until all three components occur, the US housing market, the US financial markets, and the US economy are to remain prisoners in their own homes.

Please leave comments. Best, Nontruths

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What matters to the US driver: gas prices and how much they drove yesterday

Sunday, August 17, 2008

Gas prices have finally changed the behavior of the insatiable American driver. As soon as gasoline hit $4 in July, Craigslist was flooded with the “dinosaur” SUV and lines were forming outside of the Toyota dealership with hopeful buyers of the now-it's-not-so-ugly Prius. I am from Houston and let me tell you that once those crazy Houstonians start selling off their shiny Hummers (yes, they love their Hummers), I knew that something was afoot.
Since January, gas prices have risen 33% and total vehicle miles driven has fallen 4.7% on an annual basis. Why are we driving less? Is it just the price gas? Firms have shed 463,000 jobs since January, real disposable income growth slowed to 3.4%, and since the rebate checks have now run out, income growth is set to slow further. Could these factors have contributed to the reduction in vehicle miles driven as well?

The answer is not really. In a short econometric test, I find that income is not a significant factor, employment is not a significant factor, but gas prices and previous driving habits are very significant factors in determining the driving behavior of Americans. People really don’t like to change their driving habits; it takes $4/gallon for gas and several months of reduced driving to get them to do that.

I use monthly data spanning the years 1993-2008 to test the effect that income, gas prices, unemployment, and previous driving habits have on a driver’s behavior. Total vehicle miles driven describe American driving behaviors, all variables are in log, and the table below lists the results.
Income and unemployment are not presented as results because they have no significant explanatory power in describing how many miles Americans choose to drive. Interesting that consumers will continue to drive even though they are losing jobs and incomes may be falling.

Current gas prices and previous driving behavior are the biggest determinants of driving behavior (vehicle miles driven). First, for each 1% increase in gas prices, consumers reduce their driving by 0.01%. I know that it doesn’t sound like much, but it’s something isn’t it?

Perhaps the most significant result of the test is how tough it is to change driving patterns; in fact, it takes months of practice. Drivers are relatively nonresponsive to gas prices (0.01%) compared to their miles driven in previous months (0.16% on average). If a consumer reduces his driving by 1% 6 months ago, then that translates into a reduction of 0.14% miles today; 1% fewer miles 5 months ago means 0.14% less miles now; 1% fewer miles 1 month ago means 0.16% fewer miles now.

Translation: we are really drivers of habit, and those habits are hard to break! It took gas prices surging quickly and peaking to over $4/gallon to get consumers to start changing their driving patterns.

It is certainly a relief that gas prices are falling, but to what end? Consumers finally started to drive less, but all that hard work is soon to go to waste. Gas prices will continue to abate, and the American driver will start to increase the number of miles that they drive. In just a few months, we will be right back where we started 6 months ago (a 5% annual increase in miles driven).

I am surprised that Nancy Pelosi and Co. do not complain about falling gas prices. It took a lot of hard work on the part of the American driver (and the markets), and emissions from driving are finally falling; isn’t that what Democrats have been pushing for all along?


Please leave comments. Best, Nontruths

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Release the employment report on Friday during Happy Hour

Friday, August 15, 2008

Macroeconomic data is notorious for difficulty in measurement and heavy revisions (for up to 5 years in some cases). The labor market data, compiled by the Bureau of Labor Statistics (BLS) is quite possible the worst of them all; any monthly report is likely to be revised up or down by up to 152,000 jobs.

This chart was published in the Wall Street Journal that accompanies an article about Economists’ predictions over the possibility of a Fannie and Freddie bailout (59% probability that the US Treasury will bailout the two mortgage giants). Not pertinent to the article, but what I found terribly interesting is the distributions of forecasts for GDP, inflation, and jobs (payroll).

Each block represents one forecaster’s prediction for GDP, inflation, and jobs over the next year. The GDP forecast distribution is tight, ranging from a little over 0% growth to around 2.5%. The economy will expand, but everyone agrees that the expansion is below the economic potential. The inflation forecast distribution is also rather tight, where most predictions range from 3%-5% annual inflation. Inflation will subside, but pressures are likely to remain.

On the very other hand lies the jobs forecast distribution, which is clearly wide and totally meaningless. According to the poll, the next 12 months will see an average change of jobs ranging from -100,000 to 120,000 jobs.

Nobody knows what the job market report is and nobody ever will. Further, and to a forecaster’s dismay, our previously solid predictor of the jobs report, the weekly unemployment claims report, has become tainted by needless government aid extensions.

The financial markets move big on labor reports because it is often a good indicator of the underlying macroeconomy. If the labor market is falling (growing) sharply, then consumer spending and sometimes the rest of the economy is also deteriorating. The employment situation is one of the biggest variables that the National Bureau of Economic Research uses in dating a recession. The 2001 recession saw 1.6 million jobs slashed, which dragged down economic activity enough to call a recession even without the famed 2 consecutive quarters of negative GDP growth.

So, to avoid any unnecessary confusion to financial markets (where volatility is already hot), I propose that the monthly labor report, which is always released on a Friday, be released at 5pm, rather than at 8:30am, because the report is inherently unpredictable and subject to heavy revisions.

Wouldn’t it be great if the BLS released the report outside of working hours? Portfolio managers can sit back and drink their martinis as the job losses are reported, rather than needlessly reallocating assets based on a unreliable report. The managers could take the whole weekend to realize that the job number may be revised up or down by 152,000 jobs, relieveing some of the current volatility in the S&P 500, the Nasdaq, corporate yields, or whatever your favorite asset class.


Please leave comments. Best, Nontruths

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The US economy is still plugging away: Industrial production expanded in July

Today’s industrial production surpassed market expectations with +0.2% monthly growth. Industrial production is represented by three sectors: manufacturing, mining, and utilities. The manufacturing and mining sectors expanded 0.4% and 0.9%, while utilities contracted -1.9%.

A closer look

This is a positive number for two reasons. First, industrial production is used by the recession dating committee at the National Bureau of Economic Research (NBER). The overall economy is expanding (Q2 growth 1.9%) and industrial production is essentially unchanged over the last six months (-0.07% average). As the chart illustrates, recession-level annual industrial contraction can hit the -3% to -7% range; this month, production is down just -0.14% since last year. A sure-fire contraction in the industrial sector has not been established since the beginning of the year.

Second, the utility sector, rather than the manufacturing or mining sectors, is contracting. Record energy prices are causing households and firms to reduce their consumption of water, heat, and electricity. If you care about the environment, then here is another indication that people are cutting back on energy usage.

Notes on revisions

The March-June 2008 reports were all revised downward slightly.

Report Details


Industrial Production (July)
Expectations: +0.0% since June
Previous (June): +0.4% since June
Today’s release: +0.2% since June


Capacity Utilization
Expectations: 79.8%
Previous (June): 79.9%
Today’s release: 79.9%

Please leave comments. Best, Nontruths

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Spending on the Emergency Unemployment Compensation program is excessive

Thursday, August 14, 2008

Today, the Department of Labor announced that unemployment claims fell 10k to 450,000 in the week ending August 9. The four-week average of newly filed unemployment claims is 440,500, which exceeds the average number of weekly claims filed spanning the 1992 and 2001 recessions.

On the surface, this number is daunting. 450,000 is 0.33% of the payroll, which exceeds the percentage of claims going into the 2001 recession, 0.29%. As it stands, 2008 has seen seven straight months of job loss, totaling 463,000 jobs shed, and the unemployment rate has risen 1% to 5.7% since last year.

However, job losses as reported in the establishment survey, 463,000, is small compared to the 1.6 million jobs shed in the 9 months of the 2001 recession. The unemployment rate, from the household survey that is statistically less meaningful than the establishment survey, was driven up by excess summertime (seasonally adjustments don’t account for this) workers looking for jobs to cover their shocking gas bills; as gas prices continue to fall, the unemployment rate should stabilize. All indications point to a soft and slightly deteriorating labor market, rather than one in a free fall like in previous recessions.

Congress obviously does not know this because it passed a new bill, "EUC 2008" or the Emergency Unemployment Compensation 2008 program, extending unemployment benefits up to 20 weeks to those who have exhausted theirs and increased individual benefits by $50. The bill stipulates that each state was required to notify all individuals who had previously exhausted their benefits that they may qualify for the EUC 2008 program.

So what happened? The state unemployment claims offices were overrun with individuals who may or may not qualify for the EUC 2008 benefits. Some individuals walked into the benefits office in order to see if they qualified for the EUC program, but were told (by the government of course, both times) that they actually qualified for the initial unemployment claims. This resulted in a 46,000 jump in initial claims for the week ending on July 26, 2008, and continued spikes two weeks thereafter.

Sure, the claims are deserved, but many of the new claimants would have never known that they qualified for the program had the States not told them. Congress is throwing money away, which seems excessively irresponsible when the labor market is not suffering as much as would be expected during an ongoing housing crisis, credit crunch, and surging oil prices.

Congress could save the cash that was spent on the EUC program and spend time (not money) informing workers that they may qualify for the program that was already in place. Why spend money on individuals who choose to be uninformed? Unemployment claims used to be a good predictor of the monthly employment report. Now there is so much noise that it is essentially useless.

Please leave comments. Best, Nontruths

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Higher unemployment or gas prices: Which would you prefer?

Wednesday, August 13, 2008

The national gas price rose 37% since last year and now sits at $3.86/gallon. The unemployment rate 1% since last year and now is 5.7%. If you had told me last year, when gas prices were $2.82/gallon and the unemployment rate was 4.7%, that prices and the unemployment rate would surge, then I would have been seriously worried for the economy. Transportation bills are 17% of average living costs, and such a surge in energy prices could cripple the economy (could being the operating word since the economy is currently growing at a 1.9% annual rate), especially when spending is falling with rising unemployment.

17% and 5.7% are just national averages. Labor dynamics and gas prices differ across the country. Drivers in New York City likely take public transportation and their transportation bills may be lower than in L.A., where people drive one house over to visit their neighbors (L.A. Story starring Steve Martin). The Midwest’s labor market, where the auto industry is dominant, may be harder hit than in other regions.

The chart shows the pattern of increases in gas prices and unemployment rates for the following regions: Boston, Chicago, Cleveland, New York City, and San Francisco. The data are the 1-year % change in gas prices in each city and the annual change in the unemployment for the Fed’s regional banks.

In June, Chicago has enjoyed the smallest hike in gas prices (16%), while Boston has been subject to the strongest surge in gas prices (29%). Cleveland has enjoyed the smallest rise in unemployment (0.8%), while San Francisco has experienced the biggest jump in unemployment (1.4%).

I would choose higher gas prices over rising unemployment. Drivers can substitute their methods of transportation from the car to a bus, bike (it’s summertime), walking, or taking the train. However, job creation is low (if positive at all), and nationally 463,000 net-jobs have been slashed since January. A rising unemployment rate by definition says that the number of people who want to find a job but can’t is rising; substituting toward new jobs has become more difficult.

Please leave comments. Best, Nontruths

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Exports outpace GDP: The US is back!

Tuesday, August 12, 2008

Today, the Census Bureau released its June report for exports of goods and services. The report indicates that real export growth outpaced GDP growth.

Let’s be clear on what this means: monthly real export growth is greater than quarterly GDP growth that is turned into an annual number. This is great news, and exports are keeping the US alive.

Some argue that export-driven growth does not have the same kind of effect as if the economy was being driven by consumption or investment (those sectors influenced by expansionary policy). The US, “may have just completed one of the most unsatisfying 3%-growth quarters ever.”

And another quote: “In a technical sense, [export and domestic demand] are created equal, but just in the sense of judging the health of the economy they’re not created equal,” said Abiel Reinhart, economist at J.P. Morgan Chase.”

How could strong export growth possibly be bad? In my book, this is leaving out a lot of positives regarding export growth (which you can see has not occurred at this rate at least since 2002). In a technical sense, both exports and domestic demand (investment, consumption, and government spending) are created equal in judging the health of the future economy.

As exports grow, the economy will invest in the most productive sectors, which will result in higher potential growth in the future. Stronger exports and higher productivity means increased growth and minimized inflation pressures; higher incomes; more jobs; more spending money. I am simply not seeing a the downside to export-driven growth today or in the future.

Please leave comments. Best, Nontruths

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Export growth is keeping the US alive: Q2 revisions will be upward!

International Trade

Trade Balance
Expectations: -$62.0 billion deficit
Previous (May): -$59.8 billion
Today’s release (June): -$56.8 billion


Today’s trade report was good. The trade deficit narrowed substantially, led by increased export growth. Recent US exports have been growing at a faster rate than the overall economy, which is keeping the US alive. Exports grew 4% on a monthly basis, and imports grew 1.8%. Export growth outpacing annual GDP growth (1.9% in Q2) on a monthly basis.

A closer look

The trade data, along with construction and inventory data imply an upward-revision of Q2 GDP estimates (the preliminary release).The Bureau of Economic Analysis, the government agency in charge of the national accounts, assumed that the June trade deficit on goods would be -$72.5 billion. The actual data revealed a goods deficit that was $2.5 billion lower, or -$70 billion, which will add to Q2 economic growth estimates.

The revised estimate of Q2 GDP will be in the 2.5%-3.0% range (on an annualized basis), up from 1.9%. The trade data is good – export growth is good – the US economy remains quite resilient.

Notes on revisions

The May number was revised up to -$59.2 billion, a $0.6 billion improvement over the last estimate. Again, this will add to the upward Q2 GDP revisions.

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Mortgage rates set to rise with inflation, Fannie Mae and Freddie Mac troubles

Recently, growth and stable prices have come under siege, and the Fed has performed a very precarious balancing act with the economy; growth has remained resilient and inflation mostly contained. Fannie Mae’s and Freddie Mac’s recent stress have pushed up interest rates further, and with already rising mortgages rates, the economy is certainly walking a tightrope.

The chart above shows three things. First, 30-year mortgage rates remain at record lows. In fact, since 1971, the current rate, 6.4% in July, is 12% lower than the 1981 high, 18.5%. Second, inflation and interest rates tend to move together. Inflation is on the move, and if left unchecked, will eventually bring mortgage rates with it. Third, mortgage rates have been rising since May 2008, roughly coinciding with Fannie Mae and Freddie Mac problems.

Inflation expectations affect interest rates, and have recently pushed up mortgage rates. Interest rates are set according to expectations over future inflation. If inflation expectations continue to rise (let’s say banks believe that inflation sit at 8% next year), then banks will raise interest rates. Saving rates, car loan rates, mortgage rates, CD rates, and all nominal interest rates, are set according to expected inflation and subject to upward pressure.

Banking sector stress affects interest rates, and recent troubles with Fannie Mae and Freddie Mac have pushed up mortgage rates. Congress passed a reforming housing bill that included provisions for Fannie Mae and Freddie Mac that seemed to calm the markets for a month, but another shoe is dropping. The S&P cut some of Fannie Mae and Freddie Mac’s debt ratings, and the firms may be forced to call on the U.S. Treasury for capital.

Two things are happening to put pressure on mortgage rates:


1. Inflation expectations are rising → mortgage rates rise → economic growth falls
2. Fannie Mae and Freddie Mac → mortgage rates rise → economic growth falls

Mortgage rates are rising with the banking sector’s fear of Fannie and Freddie failure; if this continues, the Fed may be forced to target lower interest rates. However, it is not clear that this would have any affect on actual mortgage rates until Fannie and Freddie sort out their balance sheets.

Please leave comments. Best, Nontruths

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China encourages US exports with currency intervention

Monday, August 11, 2008

I wanted to follow up a comment that I received on a previous post. Janie asked: “Isn't China still keeping its currency artificially low? What fun this all is!”

My answer is: Yes, China is keeping its currency artificially low relative to the US dollar (USD), and foreign exchange is always tons of fun!

There are many reasons why a government may want to peg its currency to another currency, let’s say the USD. One theoretical reason is to inherit the “good measures” of foreign monetary policy. Another is to target export growth, and enjoy capital flows into the economy and improved standards of living. The Chinese are driving big cars, drinking French wine, and hosting a memorable Olympic games. All this is thanks to the good old US of A.

China’s holy grail of growth is revenues stemming from US exports, and it has amassed $1.8 trillion in foreign exchange (lots of it in US dollars) by keeping its currency low in order to make its goods very affordable. In the first quarter of 2008, 11% of all US imports came from China. How much is 11%? A lot compared to the 12% of US imports that come from a country in which the US shares a border and has several free trade agreements, Canada.

China dropped its peg to the USD in 2005 for a peg against a wider basket of currencies (USD, Euros, pounds, Yen, etc.). Due to this change, the USD has been losing value relative to the Chinese Yuan since 2005. However, the People’s Bank of China (PBoC) still intervenes in the USD foreign exchange market to keep it strong relative to the Chinese Yuan. The Chinese Yuan would appreciate (gain value) much faster than it is currently doing if the PBoC was not intervening. China will not allow for its currency to appreciate much more, and will fight for its value against the USD. there is too much for China to lose.

The Hong Kong Monetary Authority (HKMA) maintains a tight peg to the USD. Again, it does this to generate export revenues from the US. As a omparison, notice how the UK pound floats freely in value with fluctuations in demand and supply.

Please leave comments. Best, Nontruths

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