L. Randall Wray has a post up at New Deal 2.0 which puts forward an idea which is pretty innovative. I would label it a private sector replacement for unemployment insurance. It’s the kind of thinking that might bring Obama out of a policy cul-de-sac as the economy hemorrhages jobs.

Let me present an excerpted version and mention a few concerns one might have with this idea. The link to the full post is at the bottom:

The latest jobs report shows that the official unemployment took a huge jump to 10.2% –15.7 million jobless workers. If we add to those numbers involuntary part-time workers, plus those who have given up looking for work, the unemployment rate is 17.5%. Even that seriously undercounts those who would be willing to work if decent jobs at decent pay were readily available–a number I put at 25 to 30 million…

I am advocating… a universal job guarantee available through the thick and thin of the business cycle. The federal government would ensure a job offer to anyone ready and willing to work, at the established program compensation level (including wages and a healthy benefits package). To keep it simple, the program wage could be set at the current federal minimum wage ($7.25 an hour), and then adjusted periodically as that is raised. The usual benefits would be provided, including vacation and sick leave, and contributions to Social Security.

Let’s call this the Job Guarantee (JG) program.

… A permanent and universal JG program should be decentralized, with projects created and administered locally–where the workers are, and for the benefit of their communities. The federal government would provide the wages, plus a portion of capital and supervisory expenses (perhaps capped at 25% of total wages paid for each JG project). Local governments and nonprofits would propose projects and cover the rest of the expenses. State unemployment offices would be converted to employment offices, helping to match workers and projects.

Project proposals would be submitted to regional councils and, if approved, would be evaluated by state councils and then by a federal council. Wages and benefits would be paid directly to workers (using Social Security numbers and direct bank deposits) to minimize fraud. Organizations submitting proposals would be prevented from replacing paid workers with JG workers. For-profit business would be excluded, because the temptation to substitute would be too great. At the same time, businesses would be protected from unfair competition because all JG projects would have to demonstrate they’d fulfill unmet public purposes. If at some future date, a for-profit firm decided to provide services that a JG project is performing, the JG project could be phased out. There is neither need nor desire for the JG program to compete with the private for-profit sector.

…JG workers will be gaining useful work experience and training, making them more appealing to other employers. When firms hire, they will recruit from the JG program, offering a slightly higher wage.

At the same time, the program’s fluctuation allows it to act as an employed “buffer stock”-or “reserve army of the employed”-helping to attenuate the business cycle while maintaining full employment without setting off a wage-price spiral. An economic boom will shrink the size of the JG program; in a recession the program will grow.

Thus, an effort like the Job Guarantee program I am proposing would act as an automatic stabilizer — a feature most would agree is desperately needed in our current rollercoaster economy.

This is definitely outside the box thinking. It is basically a decentralized counter-cyclical works program to largely replace the unemployment insurance program we presently have.

The benefits I see are that it maintains full employment by putting to work those that would be idle and collecting unemployment insurance.  We have an enormous number of unemployed people who are drawing significant social welfare payments (five million are drawing unemployment insurance according to my latest post). Why not use a lot of that same money and deploy them.

This approach also would employ a huge slew of longtime unemployed workers that have benefits expire and skills languish, making them harder to employ and increasing structural unemployment.  The job guarantee could then reduce the level of structural unemployment that results from a steep downturn (see Mark Thoma’s recent piece on structural unemployment for a cogent explanation of that issue).

In my view, full employment is compatible with free market capitalism. In this approach, a job guarantee is there for anyone who wants it. Any structural unemployment will be largely voluntary.

Here are my questions. I am going to present what I consider the standard questions using the standard terminology – not because these are the exact questions I have but because these are the questions I would anticipate. I have run these same questions by a few economists to generate some answers. I have incorporated most of their answers. But, I still would like to hear your thoughts as well.

1. Isn’t this just an attempt to expand the state i.e. be a move toward big government? Why shouldn’t we expect ‘mission creep?’ Since the idea is designed to fluctuate with changes in the economy, it seems less of a concern. Yes, this is the not-for-profit private sector. But, we would still need to flesh out the safeguards to make sure that it didn’t crowd out investment in the for-profit sector. (You should expect this program to increase the pie and expand investment in aggregate, so that certainly mitigates these concerns as well.)
2. Won’t this misallocate resources and create malinvestment?  Since it is designed to be an automatic stabilizer i.e. countercyclical, it doesn’t necessarily appear so. But, it still might create misallocations by increasing the propensity to spend excessively on infrastructure. Infrastructure spending in the U.S. is probably too low at present.  But, at some point in the future, this will be a concern. The fact that much of it can be administered in the private sector locally is important in this regard.
3. How much will this cost? How do we pay for this? As I understand the idea, it is designed to replace unemployment insurance entirely – and that means we will recoup in taxes lost output from cyclical and structural unemployment. But, as the Federal Government is paying not just wages but benefits, it does not seem to be a deficit neutral strategy in a employer-provided health-insurance world. If health insurance became detached from employers that would be less of an issue. But, that’s not going to happen. (I should also point out criminality and imprisonment associated with lack of job opportunities would be reduced, so that certainly decreases any costs – both social and monetary).

Personally, I am not especially keen on the ‘New Deal’ terminology in the original piece.  That goes to political/philosophical predisposition. So I have stripped it of that language here.

As an aside, of 1920s and 1930s Democrats, I find Al Smith, the Governor of NY and 1928 Democratic Presidential candidate, far more interesting than FDR. Smith and Roosevelt had a very antagonistic relationship in no small part due to FDR’s co-opting of all of Smith’s 1928 ideas for FDR’s 1932 run. Al Smith was a first-generation Irish Catholic who grew up poor on the lower East Side of Manhattan and owed his rise to Tammany Hall. Prejudice is a big reason he lost to Hoover in 1928. Roosevelt was a blue-blooded Harvard-educated Aristocrat who was much more palatable to early 20th-century Americans. Try “Al Smith and His America,” or better yet “Empire Statesman,” for a good read on Smith.

I suspect Wray’s idea will gain more traction if it can be examined it in a politically-neutral frame.

Economists I have talked to who have studied this idea inform me all studies indicate the proposal has a 1-2% of GDP price tag.

Right now, President Obama seems like he is banking on a recovery that will bring unemployment down. But, this may not end up being so. From a purely political perspective, Wray’s suggestion is the direction Obama should go if he wants any traction on the unemployment issue should recovery not bring unemployment down.  But, Wray’s idea also deserves more discussion irrespective of the political ramifications because it keeps a buffer stock of skilled, employed people ready to hand for the for-profit private sector to employ.

Source

Navigating the Jobs Crisis: Time for a New ‘New Deal’ Jobs Program – L. Randall Wray

Related posts:

• Jobless claims dip in most recent week
• ADP Report: 697,000 jobs gone in February
• US unemployment hits 5-year high of 6.1%
• Irish unemployment gaps up by most in 40 years
• Spain: “we need to go back to 2000 wages and prices and start again”

The data released this morning by the U.S. Department of Commerce’s Bureau of Economic Analysis on personal income somehow managed to show weakness in income and consumption as well as savings.  I see this as proof that Americans are not saving and hence not deleveraging, but they are also so income constrained that their consumption should not be expected to increase markedly either. This points to a mild recovery.

The numbers from September show a significant decline in consumption from the cash-for-clunkers juiced August numbers.

Personal outlays — PCE, personal interest payments, and personal current transfer payments — decreased $48.8 billion in September, in contrast to an increase of $138.2 billion in August. PCE decreased $47.2 billion, in contrast to an increase of $139.8 billion.

If you take out August and cash-for-clunkers and look back at June and July, September’s consumption numbers are up a tick (annualized $10.53 trillion in personal outlays versus $10.44 trillion for July and $10.42 trillion for June).

So consumers are spending money. You can see this in the savings data as well.

Personal saving — DPI less personal outlays — was $355.6 billion in September, compared with $307.0 billion in August. Personal saving as a percentage of disposable personal income was 3.3 percent in September, compared with 2.8 percent in August.

3.3 percent is higher than 2.8 percent but it is a lot lower than 5.9 percent, which is where things were in May. I took this issue up at length in my post, “Americans are not increasing savings” earlier this month saying:

Savings rates averaged 9% through 1982. They were consistently above 7% through 1992. Since then, savings rates have collapsed. From Jan 1969 to November 1997 (comprising all monthly data since record-keeping began), the 10-year average savings rate was higher in every single month than the 5.9% savings rate achieved in May 2009.

So 2.8% is ridiculously low and inadequate to meet Americans’ needs in terms of reducing debt and Baby Boomers’ preparing for retirement. Absent asset-price appreciation as a source of savings, we are going to be in for some tough sledding in a few years. Clearly, record low interest rates are reducing the propensity to save.

On the other hand, incomes are still constrained. The BEA reports:

Personal income decreased $0.1 billion, or less than 0.1 percent, and disposable personal income (DPI) decreased $0.2 billion, or less than 0.1 percent, in September, according to the Bureau of Economic Analysis…

Real disposable income decreased 0.1 percent in September, compared with a decrease of 0.2 percent in August. Real PCE decreased 0.6 percent, in contrast to an increase of 1.0 percent.

This puts personal income on par with Aug 2007 levels, as income is being reduced by high unemployment.

My analysis says the data are pointing to a mild recovery on the back of consumer spending which is being spurred by low interest rates. As a result, savings are now going back down to dangerously low levels. This mix is a direct result of policy decisions made in Washington, which are designed to recreate the pre-crisis status quo ante. Thus far, they have been successful.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• Savings in America hit 5%, up from nil last year
• Third quarter GDP growth comes in at 3.5%
• Highlights from report with Q1 U.S. GDP down 6.1%
• Why the personal consumption data is important to the stock market

When it comes to the housing meltdowns in the richest economies, the US has been matched only by Spain, Ireland and the UK. All four countries have seen spectacular losses of wealth in the housing sector over the last two years.

The response by all four governments was to apply as much stimulus as they reasonably could to prevent their economies from descending into free fall. This has opened up gaping holes in each countries’ government accounts. However, in contrast to the United States or the UK, both Spain and Ireland have the Euro as an external constraint which limits their policy choices.  This has resulted in credit downgrades for the sovereign debt in Ireland and Spain.

Looking at Spain, there was massive over-building in the property sector, which attracted a lot of labor to Spain. Now that these jobs have been vaporized, the unemployment rate has soared to near 18%. The problem is quite acute and there are few policy solutions. Reinforcing this point for me was a discussion I had with Spain-expert Edward Hugh, who writes at the blogs Global Economy Matters and A Fistful of Euros, in the wake of some downbeat comments by Paul Krugman about the country.

Edward wrote:

The problem is Spain can only create jobs through exports. The problem is, with Brussels prices we cannot attract investment to build new factories to create high volume unskilled employment. At this stage in the game we are not in competition with Brussels, but with Bratislava. That may not be a pleasant truth, but it is simply like that. We have attracted a large quantity of people here to work in unskilled low-value employment. The industry that gave them work just permanently disappeared out of sight. We need, urgently to find alternatives since we cannot pay them all 420 euros a month for ever. This is more than a simple academic exercise, it is now a question of life and death for the Spanish economy.

Basically we need to go back to 2000 wages and prices and start again. Maybe you don’t like this idea, but can you point me to anyone who has an alternative?"

Obviously, a huge cut in nominal wages is never going to fly in any country because wage prices are sticky. Call it “money illusion” or call it a desire to maintain a decent standard of living, across-the-board nominal wage cuts are a political non-starter. But, this is what is needed in Spain.

Edward does address the standard-of-living problem this presents:

This is not simply about bringing down wages. It is about simulating a devaluation by bringing down prices AND wages together. So you as an employee should be in the same situation as before. The only realistic way to do this is through a pact between employers, unions and political parties, everyone.

The only real problem is with the debts, since they will also need adjusting down, but see another thread here on this.

But OK, I’m not saying this is going to be easy, just that we have no alternative. We shouldn’t have inflated the housing bubble in the first place.

Of course, being able to devalue the currency is one way to achieve this. But, Spain does not have that option. These are the very real policy cul-de-sacs faced in the aftermath of a debt-fueled asset bubble. And since another one seems to be inflating right now, I reckon the U.S. and the U.K. will be joining Ireland and Spain on this dead-end street in due course whether their currencies are weak or not.

Related posts:

• European House Prices are slowing
• Spain and Ireland ‘thrown to the wolves’ after ECB move
• Spain intervenes to save Caja Castilla La Mancha
• UK real wages falling
• Spain gets deflation

Last year at this time I posted “The Economy’s Four Horsemen,” which described macro cause and effect leading into and out of recessions.  When looking at income, spending, output and employment, it is income which is the steer variable going into a downturn.  Year-on-year changes in income precede changes in spending, output, employment and recession. So, in order to gauge what is likely to occur in any business cycle downturn and plan your business spending accordingly, you need to know what is happening to personal income.

To get a grip on this, I am going to look back at prior monthly data series on personal income dating to 1929.  What I am looking for is to pinpoint when in the economic cycle the change in personal income reverses course and whether this presages recoveries as well as recessions.

Here goes.

(click on image to enlarge)

*Note on data: I am using a six month average of the year-on-year change in inflation-adjusted personal income.

Top in personal income growth precedes recession. What I found is that a downturn in the change in personal income almost always precedes recession – and often by a large margin.  This proves that an individual business could look at the data on personal income and get a hint of an impending downturn – and react accordingly.

War used to stoke domestic income growth. There were a few false tops, however.  Most of them were war-related. For example, during World War II, there was a false top in 1941. But, by mid-1942, wartime production caused a renewed boom in personal income. the lag between the false top of Sep 1941 and the renewed turn in Jun 1942 was pretty significant. But, this was a clear aberration. As were the false tops in Dec 1950 associated with the Korean War and the ones in Feb 1966 and Nov 1968 associated with the Vietnam War. It seems post-depression, the ginning up of the military industrial complex was a significant factor in preventing economic bust.

Near-recessions in the mid-1970s and 1980s. After the Wars, a mid-1970s and mid-1980s dip were evident as well. However, in neither case did the change in inflation-adjusted personal income go negative.  Think of these as almost-recessions.  The markets went lower as well. In the mid-1970s, the near-recession personal income trough came in Jul 1977. The Dow peaked in Dec 1976 and kept falling until Feb 1978. In the mid-1980s, the numbers hit a trough of 1.9% in September 1987 when the stock market crashed. There were relapses in 1993 and 1996 as well. But, markets did not fall.

Recovery seems to precede uptick in income growth. While incomes suffer before recession on the way to recession, they lag on the way out, making recessions that much more painful. (See chart above). An increase in the change in personal income does not presage recovery.

Income-less recoveries in 1991, 2001, and 2009.  In each of the last three recessions, average year-on-year real income changes were negative. It is still negative now (-2.6% year-on-year, –2.5% average year-on-year, and –1.3% year-on-year adjusted for inflation).

So what does this say about the current cycle?

There are no false bottoms in the real income data. So,the data suggest that we are in recovery (maximum decline in personal income was November 2008), but that we are still in a very weak period in which a double dip is possible (average real personal income change is still –1.3%). Also, average real personal income losses have been less than they were in 1980 when we were in the first dip of the last double dip recession – one benefit of not having high inflation.

As far as I can ascertain, the data don’t really reveal any patterns between the stock market and personal income.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• US personal income data for September shows pullback
• Why the personal consumption data is important to the stock market
• Recession: How Long and How Deep?
• Data on past consumer deleveraging during recessions

My very first post on this blog was in March and it was titled “The Economy Is Definitely In Recession.”  Back then, this seemed like a stretch for a lot of people, but today the National Bureau of Economic Research (NBER), which makes the official recession call for the U.S., determined that the recession began in December 2007.

The U.S. economy entered a recession a year ago this month, the panel that dates American business expansions said today.

The declaration was made by the cycle-dating committee of the National Bureau of Economic Research, a private, nonprofit group of economists based in Cambridge, Massachusetts. The last time the U.S. was in a recession was from March through November 2001, according to NBER.

“The committee determined that the decline in economic activity in 2008 met the standard for a recession,” the group said in a statement on its Web site. The 1.2 million drop in payroll employment so far this year was the biggest factor in determining that start of the contraction, the group said.

Now, the only question is how long and how deep a recession we will have. I have long held that the U.S. will remain in recession until well into 2009. Let’s hope this is still the case. Given the recent sharpness of the downturn, we may have to wait until 2010 before we see any pickup.

How will we know the economy has turned?

The sequence goes from consumers’ real hourly earnings to consumer spending to industrial production to capital spending to corporate profits. Employment and capital (business) spending are lagging indicators and are not drivers of the business cycle at all.

So, when people start earning more money and industrial production picks up, we may be about to turn the corner. But, for now, that seems a long way off.

Source
Recession in U.S. Started in December 2007, NBER Says – Bloomberg

Related posts:

• The Economy Is Definitely In Recession
• US Recession Signals
• The Economy’s Four Horsemen
• Recession while GDP is growing?
• ISM Manufacturing Index plummets

Yesterday, I laid out some of my general thinking on the business cycle and the economy. Obviously, understanding the business cycle is important to economic forecasting and is, therefore, central to personal financial planning, general investing and business planning.

Over the next few weeks, I will chart out a panoply of data sets for the U.S. economy, which should give you a sense of where we are headed and how this compares to previous business cycles. But before I do, let me take this moment to give you a sense of how all of this ties in together.

The National Bureau of Economic Research (NBER) is the official arbiter of business cycles in the U.S. If you want to know when a recession occurs, it is the NBER which decides. The NBER relies on understanding four major economic data trends — the economy’s four horsemen:

• How much we spend: retail sales
• How much we earn: real earnings growth
• How much we make: industrial production
• How much we work: employment

But note, the NBER makes its analysis of these cycles to only determine when a business cycle peak has occurred and when a trough has occurred. Its recession call does not indicate when the rate of economic growth is slowing, which is the thing you want to know. Moreover, the NBER dates whether recession occurred only after the fact. That doesn’t do you much good if you are looking to act based upon where the economy is headed.

Never fear — there are ways to get to the bottom of all this. Joseph Ellis, in his book, “Ahead of the Curve,” does an amazing job of identifying cause and effect in the business cycle in a way that can be really helpful for anyone who wants to get a handle on where things are headed. Ellis was a Partner at Goldman Sachs and was ranked as the #1 industry analyst for eighteen consecutive years by Institutional Investor for the retail industry, a sector that desperately needs to know business cycle trends.

His basic findings bear repeating:

• Cause and effect relationships and the sequence in which they occur are pretty consistent throughout history.

• However, making sense of the data is complicated by two factors:
  • 1. Reliance on recession as the key measure of economic difficulty. In fact, recession is a lagging indicator which is completely useless for planning purposes because most of the damage to the economy and your portfolio is done by the time recession hits. In the future, we need to look for reliable early signs of weakening economic activity if we want to avoid getting caught in the headlights of a recession.
    2. As I indicated in my post on retail sales, the business press and most pundits have an annoying habit of focusing on month-to-month and quarter-to-quarter data. Doing so misses the underlying relationships in the data.

• Year-over-year rates of change are the critical factor. Don’t look at the absolute levels, focus in on the change — the delta, if you will.
• Consumer spending makes up two-thirds of the economy and drives the rate of economic change more than any other variable. Therefore, predicting key turning points in consumer spending patterns is going to be critical. Ellis says doing this will generally also predict turning points in the economy as a whole. The sequence goes: consumers’ real hourly earnings to consumer spending to industrial production to capital spending to corporate profits.
• Employment and business spending are lagging indicators and are not drivers of the business cycle at all. Companies cut investment in human and physical capital as a result of a slowdown in the rate of change in consumption.
• In order to forecast uptrends and downtrends in specific sectors and regions, you will need to drill down into sector- or location-specific data.

So, as we move forward and I report out on the major economic trends, keep this framework in mind, because it will give you a sense of how things are connected. I will be very focused on retail sales, real earnings growth, industrial production and employment. I also highly recommend Ellis’ book to anyone looking to make forecasts whether for personal investment or business forecasting and spending.

Related posts
Chart of the day: Retail Sales
Back to the real economy

Sources
Ahead of the Curve – Joseph Ellis

Related posts:

• US Recession Signals
• The U.S. has been in recession for one year
• ISM Manufacturing Index plummets
• Recession: How Long and How Deep?
• The Economy Is Definitely In Recession

Now that policy makers worldwide have finally stepped in to stop the bleeding, we have had a relief rally of monumental proportions. Most global indices were deep into oversold territory, meaning that there was lots of pent-up demand for a turn to the upside. A big rally to the upside was baked into the cards. However, these are purely technical factors and they have no relationship to the underlying fundamentals of the economy.

The coordinated actions this past week mark the end of the ‘acute’ phase of the credit crisis. This is now over. But, we will be left with the ‘chronic’ problems of slowing growth that include global rebalancing, increasing savings, purging excess debt and leverage and running out the clock on this recession. In this chronic phase, the question is how deep and how long the recession will be. And, I believe these questions will start to take center stage before long.

I was reading a blurb in the NY Times that reminded me of the so-called real economy that I anticipate will move center stage shortly. The article was about the home retailer Linens-n-Things, a company I see as a poster child for the deadweight loss we wish to avoid in this downturn.

The retailer, which initially struggled amid a housing slowdown and a decline in consumer discretionary spending, was finally taken down by a credit crisis that prevented possible buyers from getting the credit to fund a purchase.

“If capital markets weren’t so tight, I think this chain might possibly have survived,” Mr. Schaye told Reuters. “There’s just no financing to do these deals at all.”

The company had filed for bankruptcy protection in May and has already closed more than 100 stores. It had been under pressure from its creditors to rush closing its remaining 371 stores, according to court documents.

As of Dec. 31, the company was one of the largest purchasers of home furnishings in the United States, employed some 17,500 people and had a vendor base of about 1,000 suppliers, according to court documents. At that time, the company was operating 589 stores in 47 states and seven Canadian provinces.

But the sharp decline in the housing market and a slump in consumer discretionary spending undermined the company’s ability to pay its suppliers.

And though some investors were interested in buying the company, they were hindered by the lack of ability to borrow money, Mr. Schaye told Reuters.

“I actually thought there were going to be a couple of people who would (submit an offer) at the 11th hour, but they just didn’t get there,” he said.
-NY Times

You will notice that this is a company that could have and should have continued as going concern, even in a garden variety recession. However, excessive leverage and a credit crisis caused it to be liquidated, and now 17,500 people will be unemployed.

This scenario will be repeated in numerous places in North America, Europe, Japan, and ANZ — and will serve as notice that it is the real economy where we work and live that sustains the economy.

Undoubtedly, the United States is in recession. The likes of Paul Krugman and Paul Volcker have said so. But, I like to think of recession not as a state, but a change in state (and certainly not a state of mind as U.S. politician and McCain advisor Phil Gramm has offered).

Recession is like decelerating in your car from 100 to 40. But, it could easily be like going from 70 to 20. It is the change in economic growth that makes recession, not the absolute level of growth. When an economy slows from 7% growth to 2% growth, that is recession as much as slowing from 4% to -1%. In fact, when we talk about fast-growing emerging economies like China, we are talking about slowing down from 10% breakneck growth to a 5% amazing-for-us-but-not-for-China kind of growth. Five percent growth is a recession in China.

So, that begs the question, what clues should we be looking for to know how we’re doing going forward then? It’s the four horsemen of the economy:

1. How much we spend: retail sales
2. How much we earn: real earnings growth
3. How much we make: industrial production
4. How much we work: employment

Right now, the data for the U.S. and much of Central and Western Europe as well as for New Zealand, Singapore and Japan point to recession. However, that could always change. My analysis says that this global recession will last until at least late 2009 and this will be the deepest recession in post World War II history. Nevertheless, its depth and duration are still somewhat dependent on policy responses globally. Purging debt, increasing savings and bringing the shadow banking system to heal would all be positive developments in making this recession as quick as possible.

Now that the acute phase of the credit crisis is coming to an end, expect to see a lot of data here in the coming days and weeks on the four horsemen of the economy. The data should help us understand where things are headed.

Related posts:

• Fix the real economy first: lessons from James Montier
• Marc Faber says rate cuts won’t work
• Roubini: How to avoid the horrors of ‘stag-deflation’
• Three views of the global economy
• JPMorgan Chase: Large exposure to real economy downturn

Tom Toles is absolutely terrific. He captures the mood of the day so well in his cartoons, that it really puts paid to the aphorism that a picture is worth a thousand words.

Source
Tom Toles Cartoons, Washington Post

Related posts:

• Picture of the day: Tom Toles
• Picture of the day: Tom Toles on the Financial Crisis
• Picture of the day: Tom Toles on Wall Street
• Picture of the day: Planet ZIRP
• Picture of the day: waiting in line in LA

I caught this post in the paper version of the Washington Post over the weekend and have been meaning to send out a blurb on it. Apparently, a new market of peer-to-peer lending has popped up , where banks are no longer a part of the lending proposition. Loans are made directly peer-to-peer. Whether this is a reaction to tight credit or some weird new innovation due to the Internet, I don’t know. Call me conservative, but it doesn’t sound like an attractive proposition for individual lenders.

Below is a snippet from the article.

Steve Lubs was looking to get rid of his $8,000 in credit card debt, but his high interest rate had him bogged down. He tried getting a loan through a bank to pay off the balance but couldn’t find one with an interest rate lower than 12 percent.

That’s when he turned to Prosper, one of several peer-to-peer lending networks that connect people who need a cash infusion with those who have money to lend. About 70 people have pitched in with $100 to $300, totaling the sum he needs to get out of debt, at a rate of 8 percent.

“When it comes to borrowing, it’s a bargain,” said Lubs, an engineer who lives near Columbia.

Rather than turning to the traditional sources of loans — banks, mortgage lenders, credit unions — many cash-strapped consumers are borrowing from friends, family members and even strangers and are getting favorable terms and rates. And people with money to spare see lending it to others as a better investment than socking it away in a low-yield savings account or playing the volatile stock market.

“Worthy borrowers used to have lots of options, but those have dried up,” said Chris Larsen, chief executive of Prosper, where about 780,000 users have exchanged $160 million since the lending network launched 2 1/2 years ago.

Getting a loan isn’t as easy as it once was, as interest rates have climbed and credit standards have tightened. At the same time, demand for loans is rising. High gas and food prices make it harder to save and pay off existing debt. Home-equity lines of credit are harder to come by, leaving many people short on the costs of home improvement and other expenses. Some people also find it difficult to use traditional lending to finance a car or a graduate degree.

As a result, several peer-to-peer lending networks have sprung up, with names like Zopa, Virgin Money and Lending Club. Some, such as GreenNote and Fynanz, offer loans exclusively for students.

But using such networks can be a gamble for both lenders and borrowers. Loans made through some networks are not insured by the Federal Deposit Insurance Corp. Some networks are affiliated with credit unions or banks, which are regulated by the federal government.

Lenders run the risk losing their investment if people don’t pay them back.

The networks supervise the loan agreements by checking credit histories. But if a borrower defaults on a loan, a lender’s only recourse is to report the borrower to collection agencies. And not all networks are licensed to make loans in all states.

For borrowers, replacing existing debt with a new loan could lead to deeper financial problems. Personal-finance advisers say borrowers could find themselves in a worse financial hole if they use the networks like just another credit card.

Borrowers must be creditworthy, and both borrowers and lenders must divulge private information such as bank accounts and driver’s license numbers to get started, raising privacy concerns among some observers.

-From the Ground Up, Washington Post

Related posts:

• Lawsuit: steering mortgage applicants could mean more writedowns
• WaMu: Mr. Smith goes to Washington and turns predatory
• Home Equity Loans: Banks overzealous on cuts
• The fixed rate mortgage is king again
• Tapping the 401K and unrealized gains

Here’s an interesting statistic from the OCRegister in California. What are the twenty wealthiest cities in the United States? Pleasanton, CA tops the list with a median household income of $113,345. See the chart below for the other 19. I counted nine in California, five in Texas and two in the DC area.

Another interesting statistic was that Americans overall got richer in 2007, with the median income pushing up to $50,740. That was the first time that income topped $50,000.

Sources
Nation, state got bigger raises in ‘07 than O.C., OC Register
Three O.C. cities rank near top in U.S. income, OC Register

Related posts:

• Why the personal consumption data is important to the stock market
• Subprime, Alt-A Delinquencies Rise
• Savings in America hit 5%, up from nil last year
• Tapping the 401K and unrealized gains
• Personal income and recessions since 1929

I’ve been thinking a lot about unrealized gains and their effect on the global economy. if you remember, I wrote a few weeks ago about a new debit card that lets people tap the money from their 401(k) plan. I think these cards are a bad idea. I don’t like them because it is like margin trading where people tap unrealized gains that may artificially boost available credit to unsustainable levels. But, here’s the rub: these types of unrealized gains in wealth are helping sustain spending in difficult times.

During the Great Depression there were no HELOCs (Home Equity Lines of Credit), there were no 401(k) debit cards and there were no credit cards. As the economy in the U.S. and elsewhere worsens, people with substantial credit alternatives are beginning to feel pain. Those people would have added to the substantial negative feedback loop in the Great Depression. Today those same peopl have ways to tap into unralized gains in wealth in their homes, future income, and retirement savings in rder to sustain spending

While savings may need to go up over the long term in the US, it was negative during the most difficult years of the Great Depression as people tapped savings to sustain themselves. Without savings today, people are going to have to tap credit and unrealized gains. Is that a bad thing?

This is an issue I have yet to come to terms with. I think it is something to watch as ‘prime’ borrowers feel the real economy effects of the U.S. slowdown.

Related posts:

• Tapping the 401K and unrealized gains
• Japan does not demonstrate the failure of stimulus
• Chart of the day: household debt vs. savings
• We need humility
• Unemployment: U-6 data versus the Great Depression

I just picked up on a MarketWatch article about 401(k) debit cards through Tim Iacono’s blog. It marks a pretty astounding trend in financial innovation.

Debit cards are straightforward. You use them for purchases and money is deducted from your bank account. But when the debited account is your 401(k) retirement plan, critics angrily line up to take a swipe at that piece of plastic.

It’s not hard to see why. The 401(k) debit card lets you borrow from retirement savings and pay yourself back with interest over time, much as you would with a typical 401(k) loan. Only the card makes it much easier to crack your retirement nest egg; all you do is shop, swipe and sign.

Let’s cut to the chase here. A debit card used to draw down your 401(k) is a very bad idea and should be banned by regulators of the industry. Leave it to the financial services industry to come up with some innovative deal to get consumers to go out and spend money the don’t have. Hats off to the innovative genius who thought this one up. This is just the latest in a line of credit products used to tap unrealized gains — a great way to keep the party going.

Credit
The problem I have with these instruments is they represent the end game in a slippery slope of excessive credit. Credit is the basic mechanism we consumers use to tap into unrealized gains in income and wealth.

For example, a mortgage is a credit taken on under the assumption that one will have enough future income at each mortgage payment due date to pay off the mortgage over time in full. Essentially, it is borrowing against future income.

Likewise, credit cards allow people to borrow today ostensibly under the assumption that they will earn enough in future income to pay off the credit balance in full at some point in the future.

In a very real sense, we are consuming our future income by taking on these credits. Therefore, credit at its core allows one to ‘consume’ one’s future income before it is realized. Credit is like a short sale — borrowing against your future income before you earn the money or have legitimate access to it. That’s the purpose of credit and there is nothing inherently wrong with it as long as the agreement between lender and borrower is entered into prudently (which is not the case in predatory lending).

Unrealized gains
Where credit has become excessive is where it is has become like margin lending — borrowing against unrealized gains in wealth. The oldest form of lending on the margin is the stock market, where one owns shares and borrows against the value of those shares in order to consume the unrealized paper gains without having to sell the shares.

This is all fine and good while the asset is appreciating. But, if the asset falls in value, the owner faces the potential of negative equity where the loan is worth more than the asset. Margin loans are often seen as a contributing factor in the stock market crash which heralded the coming of the Great Depression.

Now, we have more financial innovations that allow us to lend on the margin against our assets. First, it was residential property and home equity lines of credit (HELOCs). This produced the famous housing ATM during the housing bubble and has left Americans with far less equity in their homes. In many cases, ‘homeowners’ are suffering from negative equity due to their having extracted unrealized gains using their HELOC.

With 401(k) debit cards here, we have people setting aside pre-tax dollars to use upon retirement. In this sense, those dollars don’t legitimately exist before retirement — at least as far as the future pensioner is concerned. So this is an asset supposedly accumulating unrealized gains until one hits retirement. Instead the 401(k) debit card allows consumers borrow on the margin against future wealth and consume those pre-tax dollars to the detriment of their future living standards.

Conclusion
What is clear to me is that human nature fixes most of our mental energy on the here and now. We aren’t thinking long-term enough to resist the temptations of margin lending. Allowing people to tap into unrealized gains in wealth this way is allowing us to collectively mortgage our future. I can offer only two solutions to the problem.

1. In the case of HELOCs and 401(k) debit cards, allow people to draw down only a certain percentage of their equity, say 20%.
2. Ban the instruments outright. We can’t handle the enticement.

Do we really want people borrowing against their 401(k) with a debit card?

Related posts:

• Unrealized gains in wealth
• Peer-to-Peer Lending
• Connecting Fed cuts with credit writedowns and quantitative easing
• What do Merrill’s financial results tell us?
• Consumer loan delinquencies paint bleak picture

You’ve probably heard the adage that the American consumer just won’t quit. And this last month’s retail sales numbers seems to follow that saying. However, if you look beneath the surface, American consumers are cutting back indeed. Paul Kasriel, the Chief Economist at Northern Trust, makes this point.

Don’t write off the U.S. consumer, right? Wrong. On a year-over-year basis there has been a sharp deceleration in nominal retail sales growth. On a year-over-year basis, there has been a sharp contraction in price-adjusted retail sales. The chart below using quarterly average data illustrates this. Growth in nominal retail sales peaked back in the first quarter of 2006 at 7.6% in this cycle. In the second quarter of this year, nominal retail sales growth had slowed to just 2.6%. Adjusted by the goods or commodities component of the CPI, retail sales on a year-over-year basis have been declining for three quarters running, contracting by 2.6% in the second quarter of this year. Notice that in the recession of 2001, although price-adjusted retail sales experienced slower year-over-year growth, they never outright contracted. In this recession – yes, despite all the happy talk, we are in a recession – real retail sales are contracting.

-Safe Haven, 18 Jul 2008

If you read my post on the recent consumer price inflation numbers, you’ll know that the CPI for Q2 2008 was running at a eye-popping 7.9%. So, 2.6% growth in nominal retail sales looks very poor indeed taken in that context. So much for the old adage.

Related posts:

• Chart of the day: Retail Sales
• Retail Sales: a belated look at Friday’s ugly numbers
• Germany: Inflation tames retail sales
• April U.S. retail sales: upside surprise?
• UK retail sales drop most in 22 years

As you know, the CPI registered a whopping 5% yesterday. Year-on-year inflation hasn’t been this high since the Gulf War. So much for the ‘Great Moderation.’ But the increase in inflation begs another question: why are interest rates so low?

The Fed Funds rate is 2%. While it is unlikely to hit the 1% level we saw after the last bubble popped under Alan Greenspan, it is certainly very low — 3% under the current level of inflation.

A few weeks ago, I showed a graph of savings and debt (on the right). Basically, this graph demonstrates as well as any the moral hazard and perverse incentive structure provided by the asymmetric policy response run by Alan Greenspan and Ben Bernanke. Raise rates slowly on the way up after the bubble has already happened; lower rates aggressively on the way down to prevent pain in the bubble’s aftermath.

Because of the ‘Greenspan/Bernanke Put,’ Americans know that they will not be rewarded for saving, but rather that they will have their debt eaten away by inflation during economic downturns. So when push comes to shove, Americans have not been willing to reduce debt levels during economic downturns. Why would you? If Fed Funds is 3% under inflation, it seems silly to park your money in a money market fund and have inflation eat away at your savings. So, as each downturn has occurred in the past 20 years, Americans have failed to cut back enough to shore up their personal balance sheets, banking on asset price increases to do the heavy lifting during the next upswing. This is one reason the relative size of the financial sector and its importance has continued to grow and grow.

This madness has got to stop. Yes, we have an economic downturn. Yes, the financial sector risks a systemic collapse. And, yes, inflation is eating away at all those debts. But, when will the U.S. become a country that rewards saving? With the Federal Funds Rate at 2%, this is unlikely to happen any time soon. One begins to think these policies are adopted to keep the gravy train going for the financial services sector, while average citizens are left to fend for themselves.

Related posts:

• Chart of the day: household debt vs. savings
• Savings in America hit 5%, up from nil last year
• Chart of the day: Savings Rate
• Americans are not increasing savings
• US personal income data for September shows pullback

Last month, in a post called ‘Chart of the day: real hourly earnings‘ I said that U.S. real wage rates were lower today than they were a generation ago on the eve of the first oil hock. hat’s pretty poor.

Today ‘UK Bubble‘ highlights the fact that real wages in the UK have been falling for 4 year, since before he bubble in housing burst.

She says:

In May real wages fell by almost 1 percent. In fact, wage growth has been stagnant for over a year.

The question as elsewhere in Europe is whether inflation will lead to pay rises. This has already happened in Germany and is one reason the ECB rightfully raised interest rates.

In contrast, the U.S. has interest rates at 2%, while inflation is running at well over 4% with more inflation in the pipeline. How can rates continue at 2%? The last time producer prices were as high as they are now, interest rates were at double-digit levels.

Producers paid 9.2 percent more for goods from June 2007, the biggest year-over-year increase since June 1981.
-Bloomberg News, 15 Jul 2008

It looks like the Fed wants to bail out its buddies on Wall Street and Fannie and Freddie at your expense. According to ex-Fed Governor William Poole, the Fed wants inflation.

Back in the UK, the same dynamic is underway. What will the BoE do in response? I’d wager they will do nothing. After all, they have the exact same problems as the Fed.

Recent wage settlements were based on expectations of lower inflation. Now that inflation is picking up, the UK is drifting towards a wage-price spiral. In January, a new round of wage negotiations begin.

You have to read the post a UK bubble to see the graph on real wages. It’s not pretty. With high debt, low savings, burst housing bubbles and economies in recession, the U.S. and the UK are two peas in a pod.

Related posts:

• ECB rate hike likely as wages in Germany spiral upward
• Spain: “we need to go back to 2000 wages and prices and start again”
• What’s a central bank to do?
• COLA: the real inflationary threat
• U.S. Consumer Prices Climb by the Most Since 2005

We knew that didn’t we? Well, in response to a questionnaire by Nationwide, the building society, consumers basically said savings is not important and that they don’t save as a result. I’m willing to bet UK consumers will change their tune after the housing slowdown, stock market fall and recession take hold. But, for now, it seems the current economic headwinds are actually deterring consumers from saving.

New research (source) from Nationwide Building Society reveals consumers increasingly think saving is less important than it once was. In June, just 26% of consumers thought saving was very important – this compares to 49% of people in May and 46% of consumers in April**. The Society’s research also reveals:

• Just over half (59%) of consumers think it is personally important for them to save – a decrease of 12% from May’s report;
• Less than half (46%) of consumers are saving regularly, with 33% saving occasionally, whilst a fifth (20%) are not saving at all;
• Nearly two thirds (61%) of people are saving less than they think they need to;
• However, 48% of consumers are optimistic that in six months’ time they’ll be saving what they need to – although a third (32%) think they won’t be saving enough.

Matthew Carter, director for savings at Nationwide, says: “Our latest research on consumers’ propensity to save is concerning. A sharp decrease has been seen in the store people put on saving and, if this decline continues, there will be trouble ahead if consumers do not put money aside.

“The increasing cost of living is clearly having an impact on household finances and consumers are prioritising bills over their savings. It is encouraging that half of consumers are still saving regularly, but nearly two thirds of people are not saving as much as they think they need to. If the economic situation gets more difficult, without the money put aside to fall back on, these consumers may find the going gets even tougher.”

-Nationwide press releases, 14 Jul 2008

* Data was collected between 19 May-22 June 2008 by TNS, a global market information and insight group. 1,000 people were questioned. Research is collected on a monthly basis and this is the third such release using the data collated.

**May’s data was collected between 30 May-1 June 2008 by TNS – 1,010 people were questioned. April’s data was collected between 18-20 April 2008 by TNS – 1,005 people were questioned.

Related posts:

• Nationwide: U.K. house prices resume their descent
• Savings in America hit 5%, up from nil last year
• We need humility
• UK house price falls are accelerating
• Nationwide: example of how UK recap scheme matters

From all accounts, it looks like Australia is set for a wicked slowdown. Four global industrial economies have been protected by commodity prices. They are Canada, New Zealand, South Africa and Australia. This Goldilocks scenario looks to be coming to an end across the board.

There are multiple data points indicating that trouble is brewing for Australia:

• The Westpac-Melbourne Institute consumer sentiment index fell 6.7 per cent in July to 79 points, its lowest point since January 1992. -Sydney Morning Herald
• Australian Bureau of Statistics data released on Wednesday showed growth in owner-occupied housing finance fell by a seasonally adjusted 7.9 per cent in May, its fourth consecutive monthly drop. -Sydney Morning Herald
• Home-loan approvals fell to an 8-year low in May as the Reserve Bank’s 7.25% interest rate turns consumers away from buying houses. – Sydney Morning Herald
• The nation’s largest mortgage broker last month sold 22 per cent fewer mortgages than it did in the same month a year ago. -The Australian

Does all of this spell recession? No. But, it does mean that a slowdown in Australia is underway.

Related posts:

• Australia: housing slowdown?
• Reserve Bank of Australia lifts rates again
• Australia: 40% chance of recession? Try 95%
• Australia guarantees bank deposits for three years
• B&B: Australia’s 2nd largest investment bank is bankrupt

The well-deserved euphoria over the European Championship in football has brought welcome relief to Spanish consumers, weighed down by a slow economy. However, global economies have not decoupled from the U.S. slowdown. European economies are suffering, Denmark having already declared recession.

In this piece I am going to take a look at the Spanish economy and make a prediction as to where it is headed.

I want to look at several factors in Spain’s economic outlook: housing, employment, inflation, interest rates, retail sales, production, and income.

Housing
Demand for housing in Spain is way down with the number of transactions collapsing, thus denting the municipal tax base in an economy where property transaction taxes had become a major source of income. Homes sales of 157,539 units were recorded in Q1 2008, representing a whopping decrease of 31.8% compared with the same period of 2007, according to data distributed by the Spanish Ministry of Housing. Existing home sales have suffered the most in the Spanish housing crash, with sales down 46.9% year-on-year. New home sales in Q1 2008 were still down 12.9% from the same period a year ago when 89,543 units were sold.

As yet, I have no data on prices, but all indications are that prices are down considerably from last year. Mortgage defaults are expected to hit 2% by year’s end, the highest rate in the eurozone, according to forecasts by the Spanish Mortgage Association (AHE). The AHE expects default rates to continue to grow in 2009.

Employment
The housing crash has had negative effects on employment. Unemployment in June rose to 2.39 million in Spain, an increase of 1.5% over the previous month. Since June 2007, unemployment in Spain has increased by 424,555 people, taking unemployment from under 2 million to its present levels.

As would be expected because of Spain’s housing bust, the construction sector has been hardest hit, having registered 21,080 new unemployed in June 2008. Now, immigrants in Spain have an unemployment rate of 23.8%. This is worrying as xenophobia and anti-immigrant feelings are on the rise in the country.

Unfortunately, this trend should continue unabated as the OECD expects Spain to have the highest unemployment rate of OECD countries in 2009 at 10.7%. This will be the major drag on consumption going forward and all but assures a recession in Spain.

Inflation
Meanwhile, prices in Spain are rising because of higher energy and food costs, just as they are across the globe. In the eurozone as a whole the annual consumer price inflation rate was 4% for June 2008, double the ECB’s target rate. That’s the highest since 1996 according to Eurostat. In Spain itself, inflation rose to 4.7% in June, according to the Spanish National Statistics Institute (INE).

At the wholesale level prices are now rising incredibly fast. According to the Spanish National Statistics Institute (INE), the Industrial Prices Index recorded an increase of 1.2% in May compared to April and was up 7.9% over the same month last year, boosted in particular by food and energy prices. These rises have not been passed on to consumers yet because of slack consumer demand.

Obviously, inflation was a major factor in the strikes in Spain last month and continues to weigh on consumer sentiment and demand.

Interest Rates
With inflation increasing around the globe and inflation in the Eurozone already uncomfortably high, the ECB will look to raise rates. The ECB has a single mandate toward inflation; therefore they have no other policy options.

Interest rates, therefore, will not help the Spanish consumer as Euribor continues to increase. As of yesterday, Euribor had risen to 5.361%, 0.856% more than a year ago when rates were 4.505%. That’s costing the average mortgage holder in Spain another 84 Euros per month (more than 1,000 euros per year). With less money to spend because of interest rates and inflation that is going to have to take a bite out of consumer demand.

Retail sales
Consumer sentiment in Spain is being negatively impacted by the housing downturn and the employment situation, not to mention interest rates and inflation. The 2008 Eurobarometer counts the Spanish as the most pessimistic of all of the European Union.

Retail sales are suffering as a result. A recent article in ABC pointed out that the Spanish spent 15% less in the May and June sales season than they did last year.

Auto sales, in particular have plummeted, falling 17.3% in the first six months of 2008 compared with the year ago period. This is the worst fall since 1993.

Overall, consumer trends in Spain are negative.

Production
Manufacturing activity has taken it on the chin in Spain, a big producer of automobiles. The Spanish purchasing managers index sank to its lowest level since records began in 1998, falling to 40.6 in June from 43.8 in May. 50 indicates recessionary levels. In June, the General Industrial Production Index (IPI) reported that production fell for the second month running, yet another sign that manufacturing is very weak in Spain.

Clearly, the manufacturing sector in Spain is in recession.

Income
Salaries have increased 5.1% over 2007 including overtime and arrears. Base salaries in Spain increased 5% year-on-year. But, to keep up with inflation and rises in interest rates, the Spanish worker will need to see annual increases in excess of 5% going forward as well. Will these increases last? It is hard to say. But, for now, salaries are just keeping pace with inflation.

Conclusion
Looking at the data on the Spanish economy was brutal. The data point to a softening worse than in the U.S. or in the UK. Clearly, the Spanish economy will be in recession soon, if it is not already. Given the predictions regarding interest rates and the housing and construction sectors in particular, one can only assume that this will be a long and deep recession for Spain and I don’t expect a pickup until the second half of 2009 at the earliest.

Sources
España será el país de la OCDE con mayor tasa de desempleo en 2009: 10,7%, El Mundo, 2 Jul 2008
El paro aumenta por primera vez en el mes de junio al incrementarse un 1,5%, El Mundo, 2 Jul 2008
Los españoles gastarán un 15% menos en las rebajas por el efecto de la crisis económica, ABC, 1 Jul 2008
Las ventas de coches se desploman un 17,6% en el primer semestre, la mayor caída desde 1993, ABC, 1 Jul 2008
Los limones, el aceite de girasol y la harina subieron entre un 29,3% y un 63,7% en junio, ABC, 1 Jul 2008
La luz es un 16,6% más cara desde hoy para los clientes domésticos, ABC, 1 Jul 2008
El alza del IPC al 4% en la Eurozona refuerza a Trichet para subir los tipos, ABC 1 Jul 2008
El Euribor se dispara al 5,361% y hace subir las hipotecas 84 euros mensuales, ABC, 1 Jul 2008
La Bolsa cae más de un 20% en el peor primer semestre de la historia del Ibex, ABC, 1 Jul 2008
La crisis económica en España amenaza el ’sueño europeo’ de los inmigrantes, El Tiempo, 30 Jun 2008
El precio de la vivienda nueva cayó el 1,2% hasta junio, ABC, 30 Jun 2008
La venta de viviendas nuevas sube un 12,3% en abril mientras la usada continúa desplomándose, El Pais, 26 Jun 2008
La construcción española se enfrenta a una severa recesión de al menos tres años, El Pais, 26 Jun 2008
La morosidad de los hogares se duplicará al 2% en 2008, ABC, 25 Jun 2008
La venta de viviendas se derrumba en 2008 y cae un 31% entre los meses de enero y marzo, El Mundo, 24 Jun 2008
Los españoles, los más pesimistas de la UE sobre la evolución económica, El Pais, 24 Jun 2008
La venta de viviendas cae un 31,8% en el primer trimestre, El Pais, 24 Jun 2008
Moderación salarial y aumento de las indemnizaciones en el sector de la construcción, EL Mundo, 17 Jun 2008
La producción industrial cae por segundo mes consecutivo, El Pais, 6 Jun 2008
La industria modera su caída en abril, El Pais, 5 Jun 2008La producción industrial se frena en seco, El Pais, 6 May 2008

Related posts:

• Spain panicked over possible rate hikes
• Spain: Next Stop – recession
• House price declines accelerate in Spain
• Spain begs to be at upcoming G-20, Brazil says no
• Spain: consumption drop four times as much as in ‘93

The news that income and spending in the U.S. economy has been resilient must be cheered as good (see news release here). It may result in our seeing a W-shaped recession as opposed to a U- or L-shaped one. The U.S. consumer is much more resilient than I could possibly have imagined.

Whether this ultimately proves prudent will be determined as the present financial crisis reaches resolution. Irrespective, those tax rebates are a much needed for those who want individuals to keep spending in order to cushion this downturn.

U.S. consumer spending rose more than forecast in May as tax rebates drove the biggest gain in incomes in almost three years, enabling households to at least temporarily overcome soaring fuel bills.

The 0.8 percent rise in purchases was the biggest since November, as Americans bought furniture, clothes and electronics after filling their autos’ gas tanks, the Commerce Department said today in Washington. Incomes grew 1.9 percent, the most since September 2005, and measures of inflation were lower than anticipated.

-Bloomberg News, 27 Jun 2008

Related posts:

• US GDP shrinks 0.3% in Q3
• Personal income and recessions since 1929
• U.S. CPI: Lowest since 1954 – deflation here we come
• Recession: How Long and How Deep?
• U.S. consumer spending down 1% in December

Hourly wages in the U.S. have not kept pace with inflation in the past 35-40 years. To the degree that U.S. households have been able to maintain higher real household earnings, it is all due to the influx of women into the workforce.

Real hourly earnings peaked at $20.30 per hour in January 1973, on the eve of the first oil shock. Over the next 22 years, it plummeted to $16.39. It now stands at $17.94, almost 12% lower than at its peak 35 years ago. In May 2008, hourly earnings growth y-o-y stood at -0.62%.

This unabated trend of wealth decline for the middle class during the last generation should give one pause about the macroeconomic policies in effect during that time period.

Related posts:

• UK real wages falling
• COLA: the real inflationary threat
• Chart of the day: Real GDP growth
• Chart of the day: Japanese Yen
• Chart of the day: Dow 1914-1929 vs. 1982-1999

If Mervyn King is right regarding comments he made in his letter to the Chancellor Alistair Darling, then we should expect interest rates to head down after peaking sometime before year’s end. I tend to agree with him that the deflationary forces of a recession, housing bust and credit crunch will take their toll on prices as well as the real economy. But, what if he’s wrong?

If he’s wrong it will be because workers demand and receive wages that will help them keep up with the spiraling food and energy costs. The spectre of looming strikes in order to maintain a cost of living adjustment (COLA) is the real threat. And just such a threat is what the Telegraph has found in its reporting on the inflation events today.

Hundreds of thousands of public sector workers are threatening to tear up agreements and demand higher pay as the cost of living surges.

Inflation figures released yesterday were worse than expected, prompting Unison, one of the biggest public sector unions, to call for the reopening of a pay deal for 500,000 health workers clinched only two weeks ago.

Other unions said that they wanted to revisit pay deals and gave warning of rolling strikes this autumn if Gordon Brown persisted in trying to cap pay rises at 2 per cent.

Soaring food, fuel, gas and electricity prices sent the official inflation rate surging last month, wrong-foot-ing policymakers and forcing the Governor of the Bank of England to write to the Chancellor to explain how it had failed to keep the lid on inflation.
-The Telegraph, 18 Jun 2008

The one event that can trigger ever higher prices is the adjustment of wages upwards. Economists had hoped the dreaded wage-price spiral of the 1970s was not a factor, and I certainly haven’t believed it to be a factor. The wage-price spiral is what ultimately led to an out-of-control inflation rate that peaked over 20% twice within 5 years. Let us hope this type of outcome is not a factor now in 2008.

But what if it is?

Then all bets are off. Gordon Brown had better read Stewart Liff’s book on managing government employees. As for us: be careful what you wish for because the UK would certainly be poised for a very hard landing.

Related posts:

• I was wrong on inflation
• UK real wages falling
• ECB rate hike likely as wages in Germany spiral upward
• Morgan Stanley warns of a new inflationary period
• Inflation is here to stay

Related posts:

• Chart of the day: Retail Sales
• Retail sales: don’t be fooled
• UK retail sales drop most in 22 years
• Germany: Inflation tames retail sales
• April U.S. retail sales: upside surprise?

UPDATE: The latest chart on U.S. consumer credit growth is here.

I have been focusing on debt as a primary contributor to the slump the U.S. is experiencing. We’ve seen skyrocketing Debt-to-GDP and Mortgage Debt. Now, I want to look at consumer credit. The Fed releases a monthly statement showing consumer credit, both revolving and non-revolving debt. These statistics date back to 1944, so they give a nice view of how debt is managed over the course of a business cycle

What you see in the chart is that debt growth (adjusted for inflation) always increases as the business cycle ramps up. Then as we near recession, it tails off, going negative in every recession since 1970 (1970, 1973-1975, 1980-1982, 190-1991).

What is peculiar about this particular cycle is that debt growth never bottomed in 2001. Instead it kept going and ultimately bottomed in Jun-Jul 2006 at -0.6% real growth y-o-y. It then actually rose again through to August 2007 and has since started back down. I don’t know what to make of this early bottoming and rise again, but there you have it.

I suspect the Fed rate interventions of 2001 caused this anomaly, suggesting we should have bottomed in 2001 and had a debt purge then that we are still waiting to have today.

This post is a part of my ‘chart of the day‘ series.

Related posts:

• Chart of the day: Mortgage to Growth Gap
• Data on past consumer deleveraging during recessions
• Why is everyone saying consumer credit is falling? It’s not.
• Consumer credit down, but does it show deleveraging?
• Consumer credit down a massive 33% in Spain

The U.S. has been flashing red regarding recession for some time despite the naysayers.
First, let me define recession because you usually hear that it’s two consecutive quarters of a decline in real GDP. Not exactly. The National Bureau of Economic Research (NBER), the official arbiter of recessions says:

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. For more information, see the latest announcement on how the NBER’s Business Cycle Dating Committee chooses turning points in the Economy and its latest memo, dated 07/17/03.
-NBER

So, you’ve got to look at:

• GDP
• income
• employment
• production and
• retail sales

to figure out where we are. To do that, I use a model from Joseph Ellis, a highly respected former partner and retail analyst at Goldman Sachs. In his book “Ahead of the Curve,” He says:

“It is intuitively clear to even the most casual business observer that uptrends and downtrends in consumer spending on goods and services drive more volatile cycles in the production of those goods and services. During an uptrend in consumer spending (i.e., after a period of flat demand) – when consumers are buying, say 5% more shirts at our Acme Shirts stores than a year earlier – we at Acme must for a while buy 8% or 10% more than we did a year ago to increase our inventories enough to support the new, higher level of demand.”
-Ahead of the Curve

Through this quote and his model from the book, Ellis is saying that a recession comes about from cause and effect that work in this order:

• Consumers buy less.
• Retailers, suppliers and manufacturers are not prepared for this slowdown.
• Inventories pile up.
• Makers of goods and services slow down production and business to meet falling demand AND to correct for the build-up in inventories.
• This reduces the capital spending
• The overall effect on GDP (which derives from actual production, not spending) is an exaggerated fall due to a cutback in both production and capital spending

Let’s look at the data.

GDP
In a blog entry last week, I critiqued the most recent GDP report. My conclusion was:

The economy is likely to have contracted in Q1 2008 and the recession likely began as early as Dec. 2007 or Jan. 2008 when the economy began to lose jobs.
-My Blog, 05 May 2008

Personal Income
The most recent Personal Income figures are from March 2008. Disposable Personal income in March 2008 was 4.1% higher in nominal terms than in March 2007, but only 0.9% higher in real terms when taking inflation into account. A year earlier in March 2007, the figures were 6.3% and 3.8% respectively. So, our disposable incomes are not going up as quickly, while inflation is increasing — a double whammy.

Clearly, we reached a peak in personal income somewhere between March and August 2007.

Employment
In April 2008, there were 7.6 million people in the U.S. who were officially counted as unemployed. The unemployment rate actually decreased to 5.0% from 5.1% the previous month because so many workers dropped out of the labor force. However, if you add in the 4.8 million people who are not counted in the labor force but do want a job, then you have 12.4 million people out of work for a 7.8% unemployment rate. These numbers are likely to be revised higher. See my blog entry from May 5th entitled “Last week’s employment numbers,” for more details on why.

As the official rate and the shadow rate hit lows of 4.4% and 7.2% respectively in March 2007, the employment trends have long since peaked.

It should be noted that weekly jobless claims identify the same trends as well. that average weekly jobless claims have increased nearly +60,000 in the past year to 365,750 from 306,000. A year ago in May 2007, they were down by over -20,000 from the year previously.

Industrial Production
The latest report to show recessionary tendencies is Industrial Production. The wall Street Journal says:

U.S. industrial production plunged in April, suffering a broad decline in output ranging from cars to furniture and business equipment.

Industrial production decreased 0.7%, following a revised 0.2% climb in March, the Federal Reserve said Thursday. Originally, production in March was seen up 0.3%.

Capacity utilization receded sharply to 79.7% in April, a sign of easing inflationary pressure. March capacity use was 80.4%, revised down from an originally reported 80.5%. The 1972-2007 average is 81.0%.
-Wall Street Journal

Retail Sales
April 2008 retail sales came out this week. The Blogger from “Calculated Risk” reported:

Although the Census Bureau reported that nominal retail sales increased 1.8% year-over-year (retail and food services increased 2.0%), real retail sales declined 1.3% (on a YoY basis).

This is a recessionary level for real retail sales.

-Calculated Risk, 13 May 2008

Real retail sales was last positive in Nov 2007. The change peaked in October 2006.

Conclusions
All of the major components that are tracked to indicate recession have long since peaked. Consumer spending increases actually peaked way back in August 2005 (using a rolling 12-month average real change). This led to production cutbacks. Industrial production also peaked in August 2005, with the rolling average yearly increase in production reaching 3.5%. As a result, this fed through to incomes. Disposable personal income growth peaked last year. Consumers then cut back with real retail sales going negative in December of last year. This fed through to GDP and jobs early this year.

First, GDP has likely already turned negative on a month-to-month basis (the official figures measure quarter-to-quarter). Second, real disposable personal income growth has not gone negative since the recession of 1973-1974. But, it is edging in that direction at only +0.9% over the last year. Third, we are losing jobs as employment peaked last year. Fourth, production growth peaked in 2005. Actual production peaked in January and has gone negative since then. Real retail sales went negative in December. The conclusion is that a
ll the major signs of recession are there. It probably began in Dec. 2007 or Jan. 2008. The question is how long and how deep.

Related posts:

• Personal income and recessions since 1929
• The U.S. has been in recession for one year
• US industrial production is very weak
• The Economy’s Four Horsemen
• Why the personal consumption data is important to the stock market

Today, as I write this blog entry, the U.S. Economy is in crisis. We have a massive consumer and mortgage debt problem. Gasoline and food prices are going through the roof. The U.S. dollar is plunging. People are losing their jobs and their homes. All of this is pretty nasty stuff. How do we get our economy back on its feet again? How do we sustain the rebound? What do we do? And what should we do?

The answer is simple; but, finding the political will is difficult. The answer is: we must save and invest in the future.

That one simple statement reflects the full measure of what we must do not only now in a time of crisis, but what we must always do in order to be economically secure and prosperous as individuals or a nation. Let me expand on this idea below.

SAVINGS
Let’s look at the first half of my simple statement: to save. As we discuss national savings, it may help to think about the U.S. economy as if it represented a family. So, when we talk about the collective saving of the United States, one could liken that to the savings of an individual and her family. Dictionary.com describes savings as “a reduction or lessening of expenditure or outlay.” This means that savings is the opposite of consumption. The best way to look at savings is as a transfer of purchasing power today to tomorrow because when we save we forgo purchases today so that we can purchase tomorrow.

So, if a worker received a paycheck of $1,000, that worker would have to buy less than $1,000 worth of goods in order to save. The rest would go into a bank account or a Certificate of Deposit (CD) or a Money Market fund or what have you. The percentage of that paycheck one saves is their personal savings rate. Now, a lot of people think they are saving money when they pay down their mortgage or when they invest in the stock market. This is not savings. From an economy-wide perspective, this is actually labeled consumption in the National Income and Product Accounts (NIPA). An individual might look at this as investment, but it is certainly not savings. Why not?

Savings means safely putting money away today in order to use it tomorrow. The money must be safe; it needs to be there when one is ready to spend it. When one invests in the stock market, the bond market or the housing market, one can lose money as well as gain money. This means the money is not safe. Therefore this does not qualify as saving.

We can also dis-save! Dis-saving means spending more than one earns. We accomplish this by spending everything we earn. We can then spend even more in one of three ways: selling off assets, withdrawing past savings or incurring debt in order to pay for consumption.

Now, if we take this concept to a national level, savings is represented in the NIPAs as “Personal saving.” One often hears that the U.S. has a low savings rate. What that statement means is that we, collectively as workers, have a low personal savings rate. What’s low and what’s high? Well, as recently as 1984, Americans saved more than 10% of their income (see table). Today that rate is under 1%. The Japanese, on the other hand, saved as much as 20% of their income in the 1970’s.

A low or negative personal savings rate is generally a sign that a family (or collectively, a nation) is either spending too much or earning so little that it cannot afford to save. One could get into a huge sociological discussion as to why one family saves and another does not — or why one culture saves and another does not. But, the fact is people save less in two instances: when boom times are so good that they over-consume or when bad times are so hard that they can’t make ends meet.

So, after World War II, the United States saved more than 7% of its income per year for nearly 40 years until 1984. Since then, there has been a steady decline to where we save less than 1% today.

INVESTMENT
That brings us to the other side of economic prosperity: investing. Dictionary.com defines investment as “the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value.” A good way to think about investing is using past accumulated savings in order to build future economic prosperity.

So, if a worker deposited $100 of saved wealth today in a bank or money market account or in a CD, the bank would invest the money in a company or project. A good investment might return $105 or $107 tomorrow. The bank would pay the worker interest and keep the rest for its profit.

Now, if we take this concept to a national level, investment is represented in the NIPAs as “Private Investment.” These investments in Physical Capital include things like homes, office buildings, factories, roads, bridges, computer equipment, software and so forth. Since World War II, the U.S. has invested 10-15% of its income per year.

For me, there is also an investment in Human Capital. That means, we can invest in our know-how, skills and knowledge through our schools and job training.

THE GAP
If you noticed, there seems to be a gap between savings and investment here. The question then is: how can the U.S. invest so much if it saves so little? The answer is it borrows the savings from abroad. Since America consumes more in foreign goods and services than it makes, it pays more to foreigners than it receives. This excess money is then invested back into the US. So, in a very real sense, trade imbalance is helping us to finance our investments.

This imbalance between savings and investment and between what we sell abroad and what we purchase from abroad cannot last. In so doing, we have dis-saved and sold off our assets to foreigners, reduced our home equity, raided our bank accounts and built up piles of debt. Our staggering debt load on an individual family level is matched by our national debt as a nation, which is now in the hands of the Chinese, the Japanese, the Saudis, Russians, and Brazilians.

The crisis we are now in is a direct result of our having saved too little and consumed too much as individual consumers and as a collective whole, as a nation.

So, again, the answer is clear. We need to save and invest in the future. To do that, we must first reduce our debt and then start saving. But, therein lies the biggest challenge we face: How do we face up to the fact that in order to move forward individually and as a nation we must tighten our belts, cut back on consumption and take the time to work our way back into prosperity? This will take humility and lots of it. And humility is something the American government and its citizens are sorely lacking today.

Related posts:

• Savings in America hit 5%, up from nil last year
• Chart of the day: household debt vs. savings
• Do the personal income data demonstrate unbalanced reflation?
• UK consumers don’t save
• Chart of the day: Savings Rate