Making Sense of Mixed Economic Signals: Part 1

Government file from the DoE website.

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We are in an economic funk trapped in a slow recovery that simply stretches out the pain and keeps our anxiety about the future high.  This penance for our economic excesses is slowly purging us of our false idols and forcing us to face reality.

Our Economic Realities

Jobs, Education and the American Dream: Job gains during the current recovery are much less than in past recoveries. In the build-up to WWII and the post-war baby boom period America turned its focus to the industrial re-growth of a nation ravaged by the depression and pulled out of it by the looming threat and then reality of a war-time economy.  The demand caused by the baby boomers fueled the American Dream fed by higher incomes, more manufacturing to build the car and homes we needed, stuff we wanted to put into them and the services we needed.

But since the 1980s, higher costs of domestic production encouraged the globalization of production.  The rise of China is explained largely by the search for low cost manufacturing combined with its surplus of labor to feed the demand.  As the US saw higher costs diminish its competitiveness in global markets we responded by increasing productivity to slow the job loss rate.

In today’s US economy we have many fewer manufacturing workers but they are more highly skilled and tech-savvy as is essential to run high-precision equipment.  Wells Fargo Economics says April’s unemployment rates for those without a high school diploma were 14.6 percent, for high school grads 9.7 percent and for college graduates 4.5 percent. Education is still driving employment.

It is time for America to bring the jobs we outsourced to globalization back home.  We are aided in such a policy by high energy prices that make transporting goods around the world much less profitable.  We help ourselves by the growth in domestic oil & natural gas from unconventional courses that gives America a competitive advantage in lowering energy prices as evidenced by the much lower natural gas prices caused by the growth in unconventional gas at home already.

We also need changes in our tax laws to accelerate the repatriation of jobs including ending the tax of up to 35% for corporations to bring foreign earnings home, reduce our corporate tax rates to global competitive levels, reduce taxes on capital gains and dividends to unlock the cash hoard companies are sitting on today and reducing the regulatory uncertainty and hassles that discourage companies from creating jobs.  Expect to hear more ideas on this during the election campaign.

Housing.  We built our housing strategy as a nation on the prospect of rising economic growth, ever rising incomes and low interest rates.  We made the forecasters worst mistake—taking current good conditions and forecasting them forward on a straight line up.  It would be easy to blame politicians and bankers for lending us money too cheap or with too few restrictions allowing us to get in over our heads.  But we gladly took that money and then re-financed to pull out equity we thought would never quit growing at those double digit rates while home values escalated.

POP!  The house bubble burst and a very large share of America’s homeowners are underwater.  In the current economic recovery there is very little recovery prospect in housing for a long time to come.

Our house is once again just a place to live. It still may be the biggest investment most families made but it is far from the best as we are learning again the hard way.  Time will resolve this problem but that solution requires squeezing everyone in the housing supply chain as America writes down its inflated home valuations to sustainable levels.

Getting the economy growing again creating jobs and housing demand will ease this structural transformation in housing but not cure it.  Housing has structural problems that require structural solutions that go beyond the end of the no money down adjustable rate mortgage.  Those who can hang on will surely do so since the stigma of strategic default is still a very sobering one, but expect housing markets to look a lot more like commercial real estate markets where owners make cold, hard business decisions that include throwing the keys on the lender’s desk and walking away.  Bankers faced with such a credible threat will hate that calculus but that is the only thing they understand and the only way they will begin to work with borrowers underwater to negotiate solutions that speed the structural changes we all need.  Otherwise bankers better get ready to share the pain with underwater homeowners.  In an economy where renting is looking better and better it could mean we will tolerate the end of the interest deduction on income taxes in exchange for lower permanent tax rates.

Looming Federal Deficits:  We are accustomed to our politicians promising us the stars during the heat of an election campaign and we have forgiven them by re-electing them when they can’t deliver on their promises.  In a growing economy politicians’ spent money borrowed from future tax revenues to keep us happy.  In today’s slow growth economy burdened by trillions in recession stimulus spending that old game no longer works.  We face a looming crisis of debt that, if left to grow, represents an existential threat to our country and way of life.  On top of the recent debt accumulation, growth in entitlements spending on retirement for baby boomers, Medicare and health costs are overwhelming gains from our meager economic growth.  The number of workers paying taxes is down and so is the current tax income to keep the debt monster at bay.

Worse, our deficit spending relies upon selling bonds to foreigners to create capital inflows. Our financial solvency and future prospects are beginning to look too much like Bernie Madoff has been running the treasury.  We know this must change but the consequences are tough to swallow.  But time has now run out—and we all know it.

The Ryan Plan is the first honest step taken by a serious politician to “stop digging the hole deeper.”  For that sin of truth telling he is being pummeled today.  Yet not even our president is willing to stick his neck out to present a credible alternative to it.  But the Ryan plan does not absolve our sins it merely tries to get us to quit sinning.

We need the 2012 election cycle to be a genuine national debate on fresh ideas for turning the ship of state around.  We need honest talk, clear proposals and heated debate that forces those who seek to lead us to talk straight to us about what needs to be done.

Energy Price Implications:  Higher energy prices are having a ripple effect across the economy.  Higher oil and gasoline costs get embedded at every stage of every supply chain fueling inflation. Higher gasoline prices makes consumers feel vulnerable and change our consumption patterns in material ways. Wells Fargo Economics says personal income rose 0.4 percent in April at a 5.2 percent annual rate for Q1:2011. This helped ease worries that we were backsliding. But higher inflation, taxes, and energy prices mostly erased those real after-tax income gains in April as they did in March on top of a 0.1 percent drop in February. For Q1:2011 real disposable income gained at 0.2 percent annual rate.   Slow growing income and the psychological impacts of higher energy prices caused consumers to cut back spending. Real personal consumption expenditures rose just 0.1 percent in both March and April and are up at just a 2.2 percent annual rate over the past three months. The modest increase is in sharp contrast with the rise in nominal outlays, which climbed at a 6.7 percent annual rate. The difference is inflation according to Wells Fargo Economics. The personal consumption deflator rose at a 4.4 percent pace over the past three months, with energy prices surging at a 46.1 percent pace and food prices climbing at an 8.1 percent pace. Excluding food and energy prices, the core PCE deflator rose 0.2 percent in April and rose at a 1.7 percent pace over the past three months.

Walmart confirmed this analysis with its quarterly earnings report.  While Walmart’s earning beat estimate by $.03 per share when fuel sales are taken out same-store sales at Walmart stores and Sam’s Club Warehouse stores were down a combined 1.4% for Q1:2011. For Q1:2011 Walmart expects same store sales to come in from +1% to -1%. The reason Walmart’s earnings beat estimate is international sales growth and currency differences with $1.3 billion of the $3 billion in international sales growth resulted from currency conversion.

There is no single solution to bring down energy prices but expanding domestic oil & gas production can profoundly change the psychology of markets and commodity traders.  Much of the risk premium in energy prices today is the fear factor caused by the current uncertainty over energy and environmental regulation and the perceived hostility of the current administration to energy growth.  Elections have consequences as our president has told us, and so they do.  That is why the language of energy strategy is changing in the administration even if the actual policy decisions are still stuck in “NO”.  This too will pass if we keep the pressure up.  The near term prospect of the voters not renewing the current lease on 1600 Pennsylvania Avenue in 2012 has a way of concentrating the mind.

Why We Work!

These are the core problems we face as a nation.  Even at its worst, this is the only nation on earth that people risk jail or death on the desert or at sea to break into.  They must know something about life everywhere else we have forgotten.

It’s time we get our mojo back. It’s time we take back our country and go back to work.