ExRussian

Across the OECD, the unemployment rate was unchanged at 8.5% in July 2010.

The chart illustrates the harmonised unemployment rates for 28 economies in July spanning 2008-2010 (based on data availability, the comparison month is June for Chile, Netherlands, Norway, and Turkey, and May for the UK). The countries are ranked by the percentage change in the unemployment rate from 2008 to 2010, where Denmark is the highest, 115% increase, and Germany is the lowest, -4.2%.

The story in this chart is obvious: the slack in global economic activity remains extreme in much of the developed world. More growth it needed; but apparently, we’re not going to get it.

The OECD released its index of composite leading indicators (CLI, where you can view the components of the index for each country here) for July. The pace of economic expansion is waning. (Click on chart to enlarge.)

From the release:

The CLI for the OECD area decreased by 0.1 point in July 2010. In Canada, France, Italy, the United Kingdom, China and India there are stronger signals of a slower pace of economic growth in coming months than was anticipated in last month’s release. Stronger signals that the expansion may lose momentum have emerged in Japan, the United States and Brazil. Tentative signals have also emerged that the expansion phases of Germany and Russia may soon peak.

According to the composite CLI, the OECD hit a cyclical trough in May 2009 (14 months before the July release). Since then, the unemployment rate has risen in 20 of the 28 listed economies.

The robust global restocking of inventories fueled world export income; but that cycle is now over (see the chart on page 8 of the OECD’s interim forecast). Furthermore, expansionary policy, which underpinned domestic demand around the world, is tightening.

Policy will turn expansionary again in several of these economies. The faltering sum of income will drag global growth further until stabilizing policy kicks in.

Rebecca Wilder

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What’s your answer? “Thinking about the past few decades… to the best of your knowledge, which ONE of the following U.S. Presidents do you think did the best job of managing the economy?“

• Bill Clinton
• Ronald Reagan
• Barack Obama
• Lyndon B. Johnson
• George W. Bush
• Richard Nixon

That’s question #11 of the the Allstate-National Journal Heartland poll. 42% of the 1201 adults polled last month answered Bill Clinton.

I wonder why near half of those polled think that Clinton did the best job of “managing the economy”. Using one simple metric, private-sector financial leverage (accumulated dissaving), Clinton ranks among the top three worst economic managers, behind George Bush (Jr.) and Ronald Reagan.

The chart illustrates private-sector leverage as a stock of debt to GDP indexed to the start of each Presidential term. Therefore, the numbers are not the debt ratios, rather the appreciation of the debt ratios since the onset of each President’s term. The data are from the Fed’s Flow of Funds Accounts.

The sector financial balances model of aggregate demand posits that fiscal policy must shift in order to normalize GDP amid deviations of the private-sector surplus (desire to save) and the current account (see Scott Fullwiler’s article on the sector financial balances model of aggregate demand, which references similar work by Bill Mitchell and Rob Parenteau; or you can see last week’s answers and discussion to Bill Mitchell’s quiz for a simple outline).

When the private sector is levering up, the public sector is not doing its job. Since the 1990’s, the private sector loaded up on debt (ran private-sector deficits) in order to maintain GDP closer to full employment in the face of shrinking government deficits relative to those of the current account (since 1991 the current account trended down as a % of GDP). Deregulation, of course, contributed as well.

According to this metric, Barack Obama ranks highest to date, thanks to the automatic stabilizers and the ARRA. But we’ll see what happens when 2011 rolls around: the waning stimulus will drag economic growth; the Congressional tides may turn; and the immediacy of the crisis continues to fade. Unless firms start to “dissave” and pass on profits to households via hiring and wage growth, we may be in for a rocky ride, since the household desire to save will hover at very high levels for years to come (see David Beckworth’s post on the growing mismatch between mortgage debt load and real estate valuations).

Rebecca Wilder

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Please hold on for just a bit more. I started a new position here in Boston and am waiting on compliance to clear my commentary online. I expect to be blogging regularly within the next week (or so).

Rebecca Wilder

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Earlier this week I compared household saving rates across the US, UK, Canada, and Germany. My conclusion was pretty simple:

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

The financial circumstances of US and UK households are very similar despite their diverging saving rates over the last two quarters (see saving rate chart here): leverage is high.

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

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

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

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

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

Rebecca Wilder

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Menzie Chinn at Econbrowser breaks down US import data by sector to argue the following (see entire article here):

What is clear is that consumer goods do not vary that much; now, part of auto and auto parts is going to satisfy consumer demand as well, and here we do have some evidence in support of the hypothesis of the consumer going back to his/her old ways of sucking in imports.
…
Consumption hardly seems resurgent, so attributing the increase in imports to consumers means that one is assuming a very high share of imports to incremental consumption — something I’m not sure makes sense. So, I think the book is still open on whether the consumer is going to drive the US back into a rapidly expanding trade deficit.

Another way to look at this is by comparing global household saving rates. Specifically, I look at the household saving rates across the US (the world’s largest economy in 2007, as measured in PPP dollars – download the data at the IMF World Economic Outlook database), UK (6th largest economy), Canada (a small-open economy), and Germany (5th largest economy). The household saving ratio is calculated as gross household saving divided by personal disposable income, as reported in country National Accounts.

If the global economy is indeed “rebalancing“, then relative to disposable income the big spenders (US, UK) raise saving, while the big savers (Germany) increase spending. In contrast, if the global economy is returning to the pre-crisis “status quo“, then relative to disposable income household saving rate would:

• fall in the US and UK
• rise in Germany

(Using IMF data, here’s a chart that I put together last year of consumption shares across economies to illustrate the big spenders and big savers.)

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

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

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

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

More on the UK vs US in my next post.

Rebecca Wilder

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

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Spanning the period April 14, 2010 to June 7, 2010, the euro lost 12.5% in value against the $US (this is not a trade-weighted measure of the currency value, but it’ll do). As the currency tumbled, Q2 nominal export income grew quickly over the quarter for the top 5 economies in the Eurozone:

• Germany, 6%
• France, 4.6%
• Italy, 8.3%
• Spain, 0.8% (definitely the exception to the rule)
• Netherlands, 7.2%

The export income is welcome in Italy’s economy, one of the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). But what about Greece, or the rest of the PIIGS countries that desperately need the external income?

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

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

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

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

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

Rebecca Wilder

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

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

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

Here are the FOMC‘s announced investment intentions:

…the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.

The Fed announcement is NOT a second version of quantitative easing (QE2). Quantitative easing is a “super” policy response, where the Fed grows its balance through reserve creation and the purchase of (usually) government assets.

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

The announcement should not have been a surprise; it wasn’t to me. According to the FOMC minutes, the Fed has been considering investment options regarding the principal of the maturing securities for months now. From the June 22-23 FOMC minutes:

First, the Committee could consider halting all reinvestment of the proceeds of maturing securities. Such a strategy would shrink the size of the Federal Reserve’s balance sheet and reduce the quantity of reserve balances in the banking system gradually over time. Second, the Committee could reinvest the proceeds of maturing securities only in new issues of Treasury securities with relatively short maturities–bills only, or bills as well as coupon issues with terms of three years or less. This strategy would maintain the size of the Federal Reserve’s balance sheet but would reduce somewhat the average maturity of the portfolio and increase its liquidity.

The Committee decided to go with the second strategy, but in an altered form: reinvest the proceeds of maturing securities to maintain both the size of the balance sheet and the average maturity of the portfolio. And a few members favored the Fed’s August announcement:

A few participants suggested selling MBS and using the proceeds to purchase Treasury securities of comparable duration, arguing that doing so would hasten the move toward a Treasury-securities-only portfolio without tightening financial conditions.

So you see, the FOMC announcement to buy longer-dated Treasuries is not QE2; is not a surprise; and for reasons that I did not describe here, doesn’t portend economic collapse (see this policy brief, or the working paper, by Randy Wray and Yeva Nersisyan, where they refute the application of the Reinhart and Rogoff findings).

Rebecca Wilder

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New York Times David Leonhardt argues that real wages are rising, so those resilient workers that remain employed will benefit from the bounce-back in “effective pay”. The problem with this insight is twofold: first, the expansion phase of real hourly compensation, a broader measure of total earnings, is falling; and second, atop a mountain of consumer and mortgage debt the aggregate economy cannot afford a compensationless recovery.

From the NY Times:

But since this recent recession began in December 2007, real average hourly pay has risen nearly 5 percent. Some employers, especially state and local governments, have cut wages. But many more employers have continued to increase pay.

Something similar happened during the Great Depression, notes Bruce Judson of the Yale School of Management. Falling prices meant that workers who held their jobs received a surprisingly strong effective pay raise.

Rebecca: The referenced “real wages” are the real average hourly earnings figures for production and nonsupervisory workers, 80% of the total nonfarm payroll. The broader measure of total earnings is real hourly compensation (see Table A and get the data from the Fred database). Real hourly compensation includes measures compensation for all workers, including wages, 401k contributions, stock options, tips, and self-employed business owner compensation. (You can see a comparison of the earnings/compensation series in Exhibit 1 here.)

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

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

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

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

Rebecca Wilder

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Consumer confidence: that extremely coincident, but often cited as leading consumer spending, indicator of really just jobs growth during recovery has struck again, down near four points to 50.4 in July.

During the recovery phase of the business cycle, confidence is highly correlated with jobs growth. The chart below illustrates the recession and recovery path of consumer confidence since 1973. The 2007-2009 recovery in confidence – I mark the technical end of the recession at June 2009 but the exact month is not important- is tracking earlier “jobless recoveries”: 1990-1991 and 2001.

The problem is, we can’t afford (economically, that is) a jobless recovery this time around!

Consumers are not feeling very good these days, with good reason! I like the way Dean Baker tersely puts it:

It is incredible that economists and economic reporters still focus on consumer confidence. Consumers are actually spending at a relatively high rate. (The savings rate is well below historic levels.) The problem is that they lost $8 trillion in housing wealth. The housing wealth effect on consumption is something that economists have known about for more than 60 years. It’s too bad that they seem to have forgotten and so have the reporters who cover this issue.

The problem is not confidence. It is a lack of money. That is why consumers are not spending more and will not anytime soon regardless of how happy they are.

Rebecca: In my view, it’s (more precisely) the lack of money during the recovery of a balance sheet recession (Richard Koo of Nomura developed this idea). In order to lower household leverage (i.e., pay down debt burden) the easy way, a significant increase in nominal income is needed, wage growth. And a significant increase in wage growth only occurs when the demand for labor is rising…precipitously. Only then will workers have enough pricing power (in aggregate) to demand sufficient wage gains in order to deleverage the safe way (not through default).

Recently, economists have been testing the theory that structural unemployment is rising (Economist.com post here). In my view, focusing on structural unemployment is just a policy excuse. It gives policymakers a reason to mitigate the large(r) policy impetus that is needed. Bad idea.

Richard Koo argues that structural unemployment is not rising:

When the deficit hawks manage to remove the fiscal stimulus while the private sector is still deleveraging, the economy collapses and re-enters the deflationary spiral. That weakness, in turn, prompts another fiscal stimulus, only to see it removed again by the deficit hawks once the economy stabilises. This unfortunate cycle can go on for years if the experience of post-1990 Japan is any guide. The net result is that the economy remains in the doldrums for years, and many unemployed workers will never find jobs in what appears to be structural unemployment even though there is nothing structural about their predicament. Japan took 15 years to come out of its balance sheet recession because of this unfortunate cycle where the necessary medicine was applied only intermittently.

Rebecca: Although this may appear to be a normal jobless recovery, recoveries from which consumers have prospered in the past through debt accumulation, it’s not. Jobs growth is key to the deleveraging cycle; and with forecasts of the unemployment rate in the 8%-10% range through 2012, still 7% in 2013, the prospect of sufficient private-sector income generation looks very gloomy.

Rebecca Wilder

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This recession caused a severe disruption in the labor market for teen employment. The chart below illustrates the unemployment rate alongside the employment-to-population ratio for those aged 16-19 years.

The visual is quite striking: at the peak of the business cycle, December 2007, the difference between the employment-to-population ratio over the unemployment rate was roughly 17.3 percentage points (pps). In June 2010, however, the difference narrowed fully to -0.3 pps.

This is a growing problem for our youngest workers. In April, the OECD issued a press release (featuring related research) calling for government support for “youth” unemployment across the member countries:

The report’s message is that governments need to do much more to help young people. Some have benefitted from broader efforts to help the unemployed. But more policies are needed that target young people, especially those with poor education and skills. These “at-risk” youngsters now account for between three and four out of ten of all young people in the OECD and are at risk of long-term joblessness and reduced earnings.

Back in June, the LA Times argued that young workers in the US, workers aged 16-19, are being displaced by college graduates and other skilled workers; in better times, these workers would not take jobs normally filled by teenagers.

The recession has been particularly cruel to those aged 16-19. However, the chart above illustrates that the downward trend is both secular and cyclical, as the employment-to-population ratio has trended down since 2000.

At the turn of the century, the employment to population ratio for teens aged 16-19 years was 45% (average over the year), and just 35% in 2007. There’s a problem here. Workers aged 16-19 generally earn low hourly wages (unless they invented Facebook, of course); and in some cases, even the small monthly sum supports family income. And as the OECD report suggests, often young workers do not qualify for unemployment insurance when displaced.

The Federal Reserve’s latest Survey of Consumer Finance (2004-2007) indicates that much of the mean income growth is accumulating at the top 10% of the income distribution (Table 1). Spanning 2004-2007, the bottom 20% experienced 3.4% income growth, while the top 10% saw near 20% gains. And every bracket in between saw either negative or near-zero income growth.

Here’s the bigger picture: teen income is likely becoming increasingly important to the families at the bottom of the income distribution, while the jobs are becoming increasingly scarce. Without entry level jobs, aggregate work experience starts to decline, which translates into lower skill overall; and then productivity declines. Bad stuff.

Rebecca wilder

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