Monday, August 23, 2010

Household leverage: what does the US have that the UK does not?

Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:
So generally, this simple analysis would suggest that Menzie Chinn's skepticism of a "status quo" of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture - certainly for the Eurozone, but possibly for the global economy as well.
The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

The chart above illustrates the total stock of household loans/debt (including non-profit organizations, which is small relative to the "household") as a share of personal disposable income.

In the UK, household leverage peaked above that of the US at 161% of personal disposable income in Q1 2008, having fallen to 149% by Q1 2010. Furthermore, recent deleveraging by UK households has occurred through income gains, rather than paying down debt: spanning the period Q2 2009 to Q1 2010, the UK household stock of loans increased 1.2%, while disposable income grew 3.1% (you can download the data here).

Given the remaining leverage on balance, the divergence in household saving rates across the US and UK is probably not sustainable. The UK household saving rate is likely to increase, or at the very minimum, hold steady.

The problem is: that according to the sectoral balances approach, it's impossible for the government and the private sector to increase saving simultaneously unless the UK is running epic current account surpluses (it's not). Therefore, the £6.2billion in public "savings" may push UK households farther into the red. However, the more likely outcome is that UK public deficits rise amid shrinking aggregate demand (and with it, tax revenue) and the increasing household desire to save.

The punchline: the US household has something that the UK household does not: (still) expansionary fiscal policy ($26 billion in state aid and extending unemployment benefits, for example).

Rebecca Wilder

Friday, August 20, 2010

Household saving rates in the US, UK, and Germany: (possibly) light at the end of the tunnel

Menzie Chinn at Econbrowser breaks down US import data by sector to argue the following (see entire article here):
What is clear is that consumer goods do not vary that much; now, part of auto and auto parts is going to satisfy consumer demand as well, and here we do have some evidence in support of the hypothesis of the consumer going back to his/her old ways of sucking in imports.
Consumption hardly seems resurgent, so attributing the increase in imports to consumers means that one is assuming a very high share of imports to incremental consumption -- something I'm not sure makes sense. So, I think the book is still open on whether the consumer is going to drive the US back into a rapidly expanding trade deficit.
Another way to look at this is by comparing global household saving rates. Specifically, I look at the household saving rates across the US (the world's largest economy in 2007, as measured in PPP dollars - download the data at the IMF World Economic Outlook database), UK (6th largest economy), Canada, and Germany (5th largest economy). The household saving ratio is calculated as gross household saving divided by personal disposable income, as reported in country National Accounts.

If the global economy is indeed "rebalancing", then relative to disposable income the big spenders (US, UK) raise saving, while the big savers (Germany) increase spending. In contrast, if the global economy is returning to the pre-crisis "status quo", then relative to disposable income household saving rate would:
  • fall in the US and UK
  • rise in Germany
(Using IMF data, here's a chart that I put together last year of consumption shares across economies to illustrate the big spenders and big savers.)

The German household saving rate is rising, while the UK households saving rate is falling. In the US, we're seeing the household saving rate stabilizing above pre-crisis levels, even increasing at the margin.

The table below lists average household savings rates for the pre- and post-crisis periods. Notably, the average US saving rate more than doubled to 4.8% since the previous 2005-2007 period, while that in the UK increased a much smaller 36% to 4.6%. Notably, German households increased average saving above an already elevated 10.6% average during the business cycle.

So generally, this simple analysis would suggest that Menzie Chinn's skepticism of a "status quo" of US consumer imports is worthy. But with the status quo firmly in place in Germany, the household saving data paint a foreboding picture - certainly for the Eurozone, but possibly for the global economy as well.

I'm in no way "blaming" this on the Germans - the banking system there will eventually contend with the crappy Greek and Portuguese assets they hold on balance. But didn't they learn their lesson? Relying on exports makes the economy highly susceptible to external demand shocks.

More on the UK vs US in my next post.

Rebecca Wilder

Note: Clearly, an analysis of this sort would require a much larger cross-section of household saving data. But differing measurement methodologies and data limitations make the comparison too arduous for a simple blog post. For example, Japan is not part of the analysis because only the expenditure approach to national income is available on a quarterly basis.

Tuesday, August 17, 2010

Nope, it's not enough for the weakest of the "Zone"

Spanning the period April 14, 2010 to June 7, 2010, the euro lost 12.5% in value against the $US (this is not a trade-weighted measure of the currency value, but it'll do). As the currency tumbled, Q2 nominal export income grew quickly over the quarter for the top 5 economies in the Eurozone:
  • Germany, 6%
  • France, 4.6%
  • Italy, 8.3%
  • Spain, 0.8% (definitely the exception to the rule)
  • Netherlands, 7.2%
The export income is welcome in Italy's economy, one of the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). But what about Greece, or the rest of the PIIGS countries that desperately need the external income?

Well, Greece actually did quite well in Q2: nominal export income was up 5.8% over the quarter compared to a 0.1% decline in Q1. Perfect - that's the point, right? Nominal depreciation begets external economic support via exports?

It's not enough. The problem is, that the external support generated by a euro depreciation is too evenly distributed across the "Zone". The result: those economies with both external and domestic demand posted record growth rates (i.e., Germany), while those with an overwhelming contraction in domestic demand posted further GDP declines amid reasonable external demand growth.

The chart below illustrates the pattern in GDP quarterly growth for Eurostat's reporting countries, ranked by Q2 2010 growth rates in order of smallest (Greece, -1.5%) to largest (Germany, +2.2%).

It should be noted here that the Eurostat data is a "Flash" report of Eurozone GDP only. The breakdown by spending category will not be reported until the second GDP release, which is scheduled for September 2, 2010. Therefore, the nominal export numbers, which are seasonally and working day adjusted through June 2010 (the volume indexes are only available through May 2010), proxy the strength of external demand.

The interesting thing is that export growth is likely strong enough to keep the third largest (as of Q2 2010) Eurozone economy, Italy, afloat for now. However, oncoming austerity measures (I searched for a list of announced European austerity measures, but only came up with this - do you know a credible source/link?) will drive the positive feedback loop: rising deficits - raise taxes/cut spending - cut domestic demand - taxable income falls - deficits rise.

Rebecca Wilder

Note: I included export data only, although the trade balance, which is exports minus imports, data tells a very similar story: widespread improvement in the trade balance.

Thursday, August 12, 2010

The Fed didn't announce QE2

Fortune published an op-ed piece by Keith R. McCullough at Hedgeye (h/t to my Mom). He argues (not very well, I might add) that QE2 is the doomsday scenario for "markets".

I'd like to point out the following (mostly because this is a common mistake): what the Fed announced is NOT QE2. Furthermore, the Fed's been considering investing options for months now, why the shock and awe treatment from markets?

Here are the FOMC's announced investment intentions:
...the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.
The Fed announcement is NOT a second version of quantitative easing (QE2). Quantitative easing is a "super" policy response, where the Fed grows its balance through reserve creation and the purchase of (usually) government assets.

The Fed is reinvesting the principal of maturing securities into longer-dated Treasuries from reserves already created. Therefore, the Fed is simply shifting the asset side of the balance sheet toward a Treasury-only portfolio. Reinvesting maturing Treasuries is regular practice for the Fed. No new quantitative easing.

The announcement should not have been a surprise; it wasn't to me. According to the FOMC minutes, the Fed has been considering investment options regarding the principal of the maturing securities for months now. From the June 22-23 FOMC minutes:
First, the Committee could consider halting all reinvestment of the proceeds of maturing securities. Such a strategy would shrink the size of the Federal Reserve's balance sheet and reduce the quantity of reserve balances in the banking system gradually over time. Second, the Committee could reinvest the proceeds of maturing securities only in new issues of Treasury securities with relatively short maturities--bills only, or bills as well as coupon issues with terms of three years or less. This strategy would maintain the size of the Federal Reserve's balance sheet but would reduce somewhat the average maturity of the portfolio and increase its liquidity.
The Committee decided to go with the second strategy, but in an altered form: reinvest the proceeds of maturing securities to maintain both the size of the balance sheet and the average maturity of the portfolio. And a few members favored the Fed's August announcement:
A few participants suggested selling MBS and using the proceeds to purchase Treasury securities of comparable duration, arguing that doing so would hasten the move toward a Treasury-securities-only portfolio without tightening financial conditions.
So you see, the FOMC announcement to buy longer-dated Treasuries is not QE2; is not a surprise; and for reasons that I did not describe here, doesn't portend economic collapse (see this policy brief, or the working paper, by Randy Wray and Yeva Nersisyan, where they refute the application of the Reinhart and Rogoff findings).

Rebecca Wilder

Wednesday, August 11, 2010

The compensationless recovery

New York Times David Leonhardt argues that real wages are rising, so those resilient workers that remain employed will benefit from the bounce-back in "effective pay". The problem with this insight is twofold: first, the expansion phase of real hourly compensation, a broader measure of total earnings, is falling; and second, sitting atop a mountain of consumer and mortgage debt, the aggregate economy cannot afford a compensationless recovery.
From the NY Times:
But since this recent recession began in December 2007, real average hourly pay has risen nearly 5 percent. Some employers, especially state and local governments, have cut wages. But many more employers have continued to increase pay.

Something similar happened during the Great Depression, notes Bruc
e Judson of the Yale School of Management. Falling prices meant that workers who held their jobs received a surprisingly strong effective pay raise.
Rebecca: The referenced "real wages" are the real average hourly earnings figures for production and nonsupervisory workers, 80% of the total nonfarm payroll. The broader measure of total earnings is real hourly compensation (see Table A and get the data from the Fred database). Real hourly compensation measures compensation for all workers, including wages, 401k contributions, stock options, tips, and self-employed business owner compensation. (You can see a comparison of the earnings/compensation series in Exhibit 1 here.)

Since December 2007, real hourly compensation has increased just 1.3%. Furthermore, the index declined four consecutive quarters through Q2 2010, a first since 1979-1980. If the NBER dates the onset of the expansion at Q3 2009 (the first quarter of positive GDP growth in 2009), real hourly compensation will have dropped .7% through Q2 2010! That's pathetic compared to the average 2.5% gain during the first 4 quarters of expansion spanning the previous 10 recessions.

The table lists the gain/loss of real hourly compensation, measured by the BLS, during the recession and early recovery for the business cycle as dated by the NBER.

Here's how I see it: the problem is not that real hourly compensation is falling during the the recovery, per se, it's that real hourly compensation is falling during the recovery of a balance sheet recession.

In the context of wage and compensation growth, the NY Times article was misleading in its comparison of the Great Depression to the '07-'09 Great Recession. Mass default during the Great Depression wiped private-sector balance sheets clean, no debt. But not this time around. We're going to need a lot of income growth (the BLS measure of real hourly compensation includes measures of income at the BEA) to increase saving enough to deleverage the aggregate household balance sheet.

I'll say it again: we can't afford a jobless recovery. Specifically, we can't afford a compensationless recovery.

Rebecca Wilder