ExRussian

In September 2008, as the worst of the financial crisis engulfed Wall Street, George W. Bush issued a warning: “This sucker could go down.” Around the same time, as Congress hashed out a bailout bill, New Hampshire Sen. Judd Gregg, the leading Republican negotiator of the bill, warned that “if we do not do this, the trauma, the chaos and the disruption to everyday Americans’ lives will be overwhelming, and that’s a price we can’t afford to risk paying.”

In less than a year, Wall Street was back. The five largest remaining banks are today larger, their executives and traders richer, their strategies of placing large bets with other people’s money no less bold than before the meltdown. The possibility of new regulations emanating from Congress has barely inhibited the Street’s exuberance.

But if Wall Street is back on top, the everyday lives of large numbers of Americans continue to be subject to overwhelming trauma, chaos and disruption.

It is commonplace among policymakers to fervently and sincerely believe that Wall Street’s financial health is not only a precondition for a prosperous real economy but that when the former thrives, the latter will necessarily follow. Few fictions of modern economic life are more assiduously defended than the central importance of the Street to the well-being of the rest of us, as has been proved in 2009.

Inhabitants of the real economy are dependent on the financial economy to borrow money. But their overwhelming reliance on Wall Street is a relatively recent phenomenon. Back when middle-class Americans earned enough to be able to save more of their incomes, they borrowed from one another, largely through local and regional banks. Small businesses also did.

It’s easy to understand economic policymakers being seduced by the great flows of wealth created among Wall Streeters, from whom they invariably seek advice. One of the basic assumptions of capitalism is that anyone paid huge sums of money must be very smart.

But if 2009 has proved anything, it’s that the bailout of Wall Street didn’t trickle down to Main Street. Mortgage delinquencies continue to rise. Small businesses can’t get credit. And people everywhere, it seems, are worried about losing their jobs. Wall Street is the only place where money is flowing and pay is escalating. Top executives and traders on the Street will soon be splitting about $25 billion in bonuses (despite Goldman Sachs’ decision, made with an eye toward public relations, to defer bonuses for its 30 top players).

The real locus of the problem was never the financial economy to begin with, and the bailout of Wall Street was a sideshow. The real problem was on Main Street, in the real economy. Before the crash, much of America had fallen deeply into unsustainable debt because it had no other way to maintain its standard of living. That’s because for so many years almost all the gains of economic growth had been going to a relatively small number of people at the top.

President Obama and his economic team have been telling Americans we’ll have to save more in future years, spend less and borrow less from the rest of the world, especially from China. This is necessary and inevitable, they say, in order to “rebalance” global financial flows. China has saved too much and consumed too little, while we have done the reverse.

In truth, most Americans did not spend too much in recent years, relative to the increasing size of the overall American economy. They spent too much only in relation to their declining portion of its gains. Had their portion kept up — had the people at the top of corporate America, Wall Street banks and hedge funds not taken a disproportionate share — most Americans would not have felt the necessity to borrow so much.

The year 2009 will be remembered as the year when Main Street got hit hard. Don’t expect 2010 to be much better — that is, if you live in the real economy. The administration is telling Americans that jobs will return next year, and we’ll be in a recovery. I hope they’re right. But I doubt it. Too many Americans have lost their jobs, incomes, homes and savings. That means most of us won’t have the purchasing power to buy nearly all the goods and services the economy is capable of producing. And without enough demand, the economy can’t get out of the doldrums.

As long as income and wealth keep concentrating at the top, and the great divide between America’s have-mores and have-lesses continues to widen, the Great Recession won’t end — at least not in the real economy.

The US dollar ($US) is on a roller coaster. And since S&P downgraded Greece to BBB+, the dollar has been on the rise. One can attribute the recent shift in the $US to many things – improving US economic conditions, return to risk, or relative weakness in other G7 countries, whatever. But what is clear, is that the dollar’s gaining some strength, 4.7% since the beginning of December on a trade-weighted basis.

But this is not sustainable. As economic recoveries diverge (i.e., the G7 recovery is expected to be slower than that in key emerging markets), the dollar will likely fall. That’s just gravity, and a necessary condition for sorting out global trade flows.

The chart illustrates the effective value of the $US, which is a composite index of the value of the $US against US trading partners (one source for this data is the Bank of England). As recently as November, the $US slid to its lowest value since March 2008. At that time – and really anytime the $US initiates a descent – Washington gets all worked up; but why? One of the necessary conditions for the re-balancing of trade flows between major trading partners is dollar depreciation.

Just look at the contribution to GDP growth from exports in 2006 and 2007, when not coincidentally the dollar was sliding.

The chart illustrates export growth and the contribution to GDP growth, as released by the Bureau of Economic Analysis. Note: an easy way to get this data is to simply download the excel file in the right sidebar of the release page.

A weak dollar can drive economic growth – especially as trade resumes, and emerging markets see a much quicker rebound than that expected for the G7. According to the Financial Times, its already happening – Asia ex-Japan is moving Japan’s export market:

Japanese exports continued to increase in November because of robust demand from Asia, easing concerns about the strength of the country’s economic recovery.

Real exports were up by 0.6 per cent on October, according to Bank of Japan data. This was the eighth consecutive monthly rise, although the pace of increase was the slowest since exports began to recover in April.

A weaker dollar is a big part of the story for a re-balancing of trade flows. And its not just a US and China problem. According to the IMF, the 2007 US current account deficit was $731 billion, while the value of China’s surplus was just half that, $372 billion. It’s much of Asia and the Middle East that are likewise driving imbalances (of course, the US is not an innocent bystander here). The dollar will see weakness again on a trade-weighted basis; that’s gravity.

Rebecca Wilder

Earlier this year, I compared US migration with that in Canada – one healthy, the other not so much. As a sequel to the story, the Census released its figures for migration into 2009, and the pattern in the US has worsened (you can download the data here).

The picture of American mobility is one of people/workers/households with essentially nowhere to go. Unemployment is ubiquitously high, and the housing market is lousy – can’t sell your home, can’t get a job. This Great Recession dragged net-domestic migration (moving within the US borders) down in all regions of the country.

Here are some of the headline results according to the Wall Street Journal:

The recession has had a profound effect on migration patterns in the U.S., reversing the flow of people to former housing-boom states such as Florida and Nevada, the latest data from the Census Bureau show.

In the year ending July 1, 2009, Florida — once the top draw for Americans in search of work and warmer climes — lost more than 31,000 residents to other states, the Census Bureau reported Wednesday. Nevada lost nearly 4,000. The numbers are small compared with the states’ populations, but they reflect a significant change in direction: In the year ending July 2006, Florida and Nevada attracted net inflows 141,448 and 41,640 people, respectively.

There’s no place to go. If you are in Michigan, for example, which state has the better prospects? And furthermore, homeowners are likely to find it very difficult to sell. It is worthwhile to compare the current experience with the cyclical downturn of 2001, when the unemployment rate increased for two years into 2003.

The chart below illustrates the net-domestic migration rate in 2003 and 2009 for each state, excluding the outliers which are listed in the text box. This is the state-level compliment of the first chart, which lists changes in migration patterns by region.

A 45-degree line is drawn: states above the line are seeing higher net-migration compared to 2003, while those below the line are posting lower net-migration than in 2003. Also, positive numbers indicate net-immigration (more people entering the state than leaving), while negative numbers indicate net-emigration (more people leaving the state than entering).

The first observation is that the “usual suspects”, Nevada, Florida, and Arizona, are the outliers. Nevada, for example, saw its net-domestic immigration rate of roughly 20% in 2003 turn negative by 2009, -1.5%. And compared to the previous recovery, which saw rising unemployment through the middle of 2003, states like Colorado, Oklahoma, Louisiana, and Utah are experiencing increased migration into their states. However, a larger share of states are seeing migration patterns slowing or even turning negative. And finally D.C., home to the US government, is experiencing large migration inflows compared to the last recession, -17.8% to +7.5% in 2009. Best to be near the spending.

In the first chart, there is clearly a negative correlation between years in which the unemployment rate is rising (2003) and net-domestic migration across regions. But this time around, the magnitude is much larger – the labor market was hit harder and the housing market is in shambles.

A more flexible migration pattern would further the structural shift that is underway in the labor market (generally out of manufacturing and financial services and into alternate industries). It will take some time for the migration clog to free up, and the structural re-balancing of production and jobs will likely take some time. There’s just no quick fix.

Rebecca Wilder

An article I wrote for Angry Bear: This week’s Greek Tragedy

Rebecca

I just can’t get over the run that the bond markets have had, especially in emerging and US high yield markets.

I indexed the four composites to 100 for comparability.

Rebecca

This year the US government is hiring for its 2010 Census. According to its job website, 2010 Census Jobs, “Hundreds of thousands of census takers are needed nationwide to help locate households and conduct brief personal interviews with residents”. And in response, Rebecca Blank at the Department of Commerce (via the NY Times), expects the monthly unemployment rate to drop about 1/2 of a percent. As I discuss below, the Census is not the economic boon that some will have you believe.

The NY Times article refers to the 2010 Census hiring as a $2.3 billion “injection into the economy”. Mark Zandi at Moody’s says:

“It’s a form of stimulus. It’s like infrastructure spending, or W.P.A. in the Depression. It effectively does the same thing. It’s not on the same scale, but it is large enough, and it will make a difference.”

I disagree. The $2.3 billion figure is misleading; it is simply earned income (about 800,000 jobs X $25/hour X 20 hours/week X 6 weeks), rather than direct spending. A worker that earns temporary income from a six-week job is more apt to save the income rather than spend it – that’s why rebates don’t work. Not much stimulus there.

And don’t forget the other side of the Census hiring story: the inevitable laying off of workers following the peak Census month.
The chart illustrates annual growth in government employment according to the establishment survey. Like clockwork, the Census survey grows government jobs to a peak 2.5%-4.5% annual pace in April or May of the census year. This means a peak impact of 800k-900k new jobs created in April or May 2010 (I use the average annual growth rate of 3.8% and a historical monthly average to forecast the payroll until April). All else equal, the unemployment rate will drop.

But consider this. It is likely that a very large share of the monthly 800,000 hires will simply be unemployed when the Census culminates – hence, the unemployment rate will rise in the early summer. And it’s very possible that the increase in the unemployment rate will be larger than its decrease. If any discouraged workers – those who have not searched for employment recently and are counted as “not in the labor force” – are hired and do not secure new employment after the six-week job is over, then they will join the ranks of “unemployed”.

We’ll see; but the economic impact of the 2010 Census, to me, is questionable.

ExRussian

“Don’t make the perfect the enemy of the better,” says the President and congressional insiders when confronted with the sorry spectacle of a health-care bill whose scope and ambition continue to shrink, and whose long-term costs to typical Americans continue to grow. They’re right, of course. But by the same logic, neither the White House nor congressional Democrats will be able to celebrate the emerging legislation as a “major overhaul” or “fundamental reform.” At best, it’s likely to be a small overhaul containing incremental reforms.

Real reform has moved from a Medicare-like public option open to all, to a public option open to 6 million without employer coverage (still in the House bill), to a public option open only to those same people in states that opt for it, or about 4 million (the original Harry Reid version of the Senate bill), to no public option but expanded Medicare (the Senate compromise) to no expanded Medicare at all (the deal with Joe “I love all the attention” Lieberman).

In other words, the private insurers are winning and the public is losing.

Pharmaceutical companies are winning as well. Yesterday, proposals to allow US pharmacies and wholesalers to import prescription drugs from Europe and Canada were defeated in the Senate. No matter that American consumers pay up to 55% more for their prescription drugs than Canadians, or that the measure would have saved the government at least $19.4 billion over ten years (according to the Congressional Budget Office). Big Pharma’s argument that the safety of such drugs couldn’t be assured was belied by the defeat of another proposed amendment that would have allowed drug imports only if their safety and economic benefits were certified by the Secretary of Health and Human Service.

Doctors and hospitals are also winning. More and more of the putative “savings” from health care reform (“savings” should really be understood as projected costs that are under the wildly-escalating costs projected without such savings) rely on contraints on future Medicare spending. But the details of such constraints keep vanishing, while ever more of the messy work of coming up with them is assigned to a so-called Medical Advisory Board that will supposedly recommend them later on. What no one wants to admit is that Congress never actually implements promised Medicare savings. When crunch time comes, it caves in to the AMA and the AARP. In a few years time, when boomers swell the ranks of seniors, and the political power of the AMA and AARP together rival that of Wall Street, the cave-ins will be boggling.

Meanwhile, opponents of abortion are winning, too. Ben Nelson (a Nebraska Democrat who enjoys being the spoiler even as much as Joe Lieberman) is holding out for even more restrictions.

The political reality right now is that Harry Reid will do anything to get sixty votes — which means Lieberman, Nelson, and even Olympia Snowe are able to use extortion on behalf of Big Insurance, Big Pharma, the AMA, and abortion foes. The President, meanwhile, remains eerily above the fray. Having closed deals months ago with Big Insurance, Big Pharma, and the AMA — in order to get their support in exchange for guaranteeing them big profits — his only apparent interest is keeping the deals going while helping Reid corral sixty votes for just about anything. (The deals have caused some awkwardness for the White House. Drug importation would have cost Big Pharma far more than the $80 billion price tag it agreed to, forcing the White House to oppose importation even though the President had publicly supported it during his presidential campaign last year, and even though John McCain supported yesterday’s amendment.)

Is the effort worth still worth it? Yes, but just. Private insurers will have to take anyone, regardless of preconditions. And some 30 million people who don’t now have health insurance will get it. But because Big Insurance, Big Pharma, and the AMA will come out way ahead, the legislation will cost taxpayers and premium-payers far more than it would otherwise. Cost controls are inadequate; in fact, they barely exist. If Wall Street’s top brass are “fat cats,” as the President described them last weekend, the top brass of Big Insurance, Big Pharma, and the AMA are even fatter. While they don’t earn as much, they’re squeezing the public for even more.

We are slouching toward health-care reform that’s better than nothing but far worse than we had imagined it would be. Even those of us who have seen legislative sausage-making up close, even those of us who never make the perfect the enemy of the better, are concerned. That two or three senators are able to extort as much as they have is appalling. Why hasn’t Reid forced much of the bill into reconciliation, requiring only 51 votes? Why has the President been so cowed? In all likelihood, the White House and the Dems eventually will get a bill they can call “reform,” but they will not be able to say with straight faces that the reform is a significant improvement over the terrible system we already have.

The precipitous drop in world trade is well documented (see one of my previous posts for a look at nose-diving exports in Asia); but the adverse effects on FDI is overlooked, in my view.

Foreign direct investment (FDI) is an important conduit to economic growth in the US and abroad. As an example, let’s look at what’s going on in Alabama, according the local paper Al.com (bold font by yours truly):

BAY MINETTE, Ala. — Things are quiet at a 3,000-acre industrial megasite northeast of town, but events in China are moving an eco-friendly auto plant closer to reality, a company executive and local economic recruiter said last week.

Charles Huang, vice chairman of Hybrid Kinetic Motors, said company leaders including Chairman Yung “Benjamin” Yeung, are finishing several agreements for design and production of components for the Alabama-built autos.

HK Motors announced in September that the $4.3 billion plant would employ about 5,800 at full capacity, producing 1 million vehicles annually by 2018.

If and when the HK Motors plant opens up, with the onset of production comes jobs, new income, and a growing capital stock (i.e., the machines and buildings). In the developing world, the effects are magnified since incomes and capital stocks start at a relatively low levels.

But this recession has dropped FDI markedly. According to the Q3 2009 Flow of Funds Accounts of the United States, outward FDI (US firms building plants in non-US economies) rebounded to a 3.8% annual pace, while inward FDI (foreign firms building plants in the US) slowed to a meager 1.7% rate.

In spite of the rebound in outward FDI, the growth rate of the stock of capital stemming from FDI is suffering.

The chart above illustrates the growth of the stock of capital resulting from FDI in and out of the US. The stock of capital is constructed using a simple dynamic equation, which includes investment each period (from the Flow of Funds Accounts, Table L.229) and the non-depreciated existing capital stock.

Since their peaks, capital formation stemming from outward FDI has slowed 40% to an 8.1% annual growth rate, while that stemming from inward FDI slowed 32% to a 9.2% annual rate. The global problem here is: even though US outward FDI rebounded in Q3, the production-generating FDI stock of capital growth is falling to its slowest annual pace since since 1995.

Going forward, the stock will depreciate further; and it will take new FDI to bring it back. This is critical for emerging markets that depend on FDI to foster economic growth.

ExRussian

Here is an article that I wrote today for Angry Bear: Sit back and relax: the US and China, this is gonna take awhile

Rebecca

This week the Federal Reserve reported the Q3 2009 Flow of Funds accounts. The headline indicators show household net worth improving and private debt burden falling.

The private sector – households and firms – is dropping leverage.

Either by default or by growing saving, the private sector is de-leveraging. According to the D.1 table, households and nonfinancial businesses dropped debt a further 2.6% q/q annualized, while financial sector debt fell another 9.3%. However, total debt (of the domestic nonfinancial sector) grew 2.8%, as the federal and state and local governments grew debt 20.1% and 5.1%, respectively.

Household wealth grew $2.7 billion for a cumulative gain of $4.9 billion since wealth hit a cyclical low in Q1 2009. To put this gain in perspective, household net-worth dropped $17.5 billion from Q3 2007 to Q1 2009, 3.5 x the recent gain. Wealth to disposable income, a statistically significant factor of the personal saving rate, rests right around it long-term (1952-1007) average, 4.9.

The chart illustrates the wealth-effect as the ratio of net-worth to disposable income. The direct and adverse impact of the wealth loss on consumption probably peaked last quarter; however, the lagged effects are ongoing.

Notice that the ratio shifted discretely in the 1990′s, not coincidentally when China’s current account surplus took off.

Most likely, the wealth to personal income ratio has mean-reverted, and will not rise back to its 5.7 1997-2007 average. A necessary condition is that global portfolio flows rebalance – i.e., China saves less and the US saves more. However, this will not happen tomorrow – de-leveraging is a process that takes years. The increase in international saving (i.e., falling current account deficits) will take some time, and by definition includes the general government eventually dropping its debt burden. Not to mention the political rhetoric and growing trade barriers suggest that a long-term economic shift is a ways off.

Rebecca Wilder