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No Consensus About the Future

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As the election year progresses, we are exposed to wildly diverging predictions about the future of the American economy.  The Democrats are telling us that in President Obama’s capable hands, the American economy keeps improving every day – despite the constant efforts by Congressional Republicans to derail the Recovery Express.  On the other hand, the Republicans keep warning us that a second Obama term could crush the American economy with unrestrained spending on entitlement programs.  Meanwhile, in (what should be) the more sober arena of serious economics, there is a wide spectrum of expectations, motivated by concerns other than partisan politics.  Underlying all of these debates is a simple question:  How can one predict the future of the economy without an accurate understanding of what is happening in the present?  Before asking about where we are headed, it might be a good idea to get a grip on where we are now.  Nevertheless, exclusive fixation on past and present conditions can allow future developments to sneak up on us, if we are not watching.

Those who anticipate a less resilient economy consistently emphasize that the “rose-colored glasses crowd” has been basing its expectations on a review of lagging and concurrent economic indicators rather than an analysis of leading economic indicators.  One of the most prominent economists to emphasize this distinction is John Hussman of the Hussman Funds.  Hussman’s most recent Weekly Market Comment contains what has become a weekly reminder of the flawed analysis used by the optimists:

On the economy, our broad view is based on dozens of indicators and multiple methods, and the overall picture is much better described as a modest rebound within still-fragile conditions, rather than a recovery or a clear expansion.  The optimism of the economic consensus seems to largely reflect an over-extrapolation of weather-induced boosts to coincident and lagging economic indicators — particularly jobs data.  Recall that seasonal adjustments in the winter months presume significant layoffs in the retail sector and slow hiring elsewhere, and therefore add back “phantom” jobs to compensate.

Hussman’s kindred spirit, Lakshman Achuthan of the Economic Cycle Research Institute (ECRI), has been criticized for the predictiction he made last September that the United States would fall back into recession.  Nevertheless, the ECRI reaffirmed that position on March 15 with a website posting entitled, “Why Our Recession Call Stands”.  Again, note the emphasis on leading economic indicators – rather than concurrent and lagging economic indicators:

How about forward-looking indicators?  We find that year-over-year growth in ECRI’s Weekly Leading Index (WLI) remains in a cyclical downturn . . .  and, as of early March, is near its worst reading since July 2009.  Close observers of this index might be understandably surprised by this persistent weakness, since the WLI’s smoothed annualized growth rate, which is much better known, has turned decidedly less negative in recent months.

Unlike the partisan political rhetoric about the economy, prognostication expressed by economists can be a bit more subtle.  In fact, many of the recent, upbeat commentaries have quite restrained and cautious.  Consider this piece from The Economist:

A year ago total bank loans were shrinking.  Now they are growing.  Loans to consumers have risen by 5% in the past year, which has accompanied healthy gains in car sales (see chart).  Mortgage lending was still contracting as of late 2011 but although house prices are still edging lower both sales and construction are rising.

*   *   *

At present just four states are reporting mid-year budget gaps, according to the National Conference of State Legislatures; this time last year, 15 did; the year before that, 36. State and local employment, which declined by 655,000 between August 2008 and last December – a fall of 3.3% – has actually edged up since.

*   *   *

Manufacturing employment, which declined almost continuously from 1998 through 2009, has since risen by nearly 4%, and the average length of time factories work is as high as at any time since 1945.  Since the end of the recession exports have risen by 39%, much faster than overall GDP.  Neither is as impressive as it sounds:  manufacturing employment remains a smaller share of the private workforce than in 2007, and imports have recently grown even faster than exports as global growth has faltered and the dollar has climbed.  Trade, which was a contributor to economic growth in the first years of recovery, has lately been a drag.

But economic recovery doesn’t have to wait for all of America’s imbalances to be corrected.  It only needs the process to advance far enough for the normal cyclical forces of employment, income and spending to take hold.  And though their grip may be tenuous, and a shock might yet dislodge it, it now seems that, at last, they have.

A great deal of enthusiastic commentary was published in reaction to the results from the recent round of bank stress tests, released by the Federal Reserve.  The stress test results revealed that 15 of the 19 banks tested could survive a stress scenario which included a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a 21 percent decline in housing prices.  Time magazine published an important article on the Fed’s stress test results.  It was written by a gentleman named Christopher Matthews, who used to write for Forbes and the Financial Times.  (He is a bit younger than the host of Hardball.)  In a surprising departure from traditional, “mainstream media propaganda”, Mr. Matthews demonstrated a unique ability to look “behind the curtain” to give his readers a better idea of where we are now:

Christopher Whalen, a bank analyst and frequent critic of the big banks, penned an article in ZeroHedge questioning the assumptions, both by the Fed and the banks themselves, that went into the tests.  It’s well known that housing remains a thorn in the side of the big banks, and depressed real estate prices are the biggest risk to bank balance sheets.  The banks are making their own assumptions, however, with regards to the value of their real estate holdings, and Whalen is dubious of what the banks are reporting on their balance sheets. The Fed, he says, is happy to go along with this massaging of the data. He writes,

“The Fed does not want to believe that there is a problem with real estate. As my friend Tom Day wrote for PRMIA’s DC chapter yesterday:  ‘It remains hard to believe, on the face of it, that many of the more damaged balance sheets could, in fact, withstand another financial tsunami of the magnitude we have recenlty experienced and, to a large extent, continue to grapple with.’ ”

Even those that are more credulous are taking exception to the Fed’s decision to allow the banks to increase dividends and stock buybacks.  The Bloomberg editorial board wrote an opinion yesterday criticizing this decision:

 “Good as the stress tests were, they don’t mean the U.S. banking system is out of the woods.  Three major banks – Ally Financial Inc., Citigroup Inc. and SunTrust Banks Inc. – didn’t pass, and investors still don’t have much faith in the reported capital levels of many of the rest.  If the Fed wants the positive results of the stress tests to last, it should err on the side of caution in approving banks’ plans to pay dividends and buy back shares – moves that benefit shareholders but also deplete capital.”

So there’s still plenty for skeptics to read into Tuesday’s report.  For those who want to doubt the veracity of the banks’ bookkeeping, you can look to Whalen’s report.  For those who like to question the Fed’s decision making, Bloomberg’s argument is as good as any.  But at the same time, we all know from experience that things could be much worse, and Tuesday’s announcement appears to be another in a string of recent good news that, unfortunately, comes packaged with a few caveats.  When all is said and done, this most recent test may turn out to be another small, “I think I can” from the little recovery that could.

When mainstream publications such as Time and Bloomberg News present reasoned analysis about the economy, it should serve as reminder to political bloviators that the only audience for the partisan rhetoric consists of “low-information voters”.  The old paradigm – based on campaign funding payola from lobbyists combined with support from low-information voters – is being challenged by what Marshall McLuhan called “the electronic information environment”.  Let’s hope that sane economic policy prevails.


 

Morgenson Watch Continues

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I was recently reminded of the late Tanta (a/k/a Doris Dungey) of the Calculated Risk blog, who wrote the recurring “Morgenson Watch” for that site.

As soon as I saw the title of Gretchen Morgenson’s most recent article at the top of the Sunday link list at Real Clear Politics, I suspected there would be trouble:  “U.S. Has Binged.  Soon It’ll Be Time to Pay the Tab.”  After reading as far as the first sentence of the second paragraph, my concern was validated.  Here’s how the piece began:

SAY this about all the bickering over the federal debt ceiling:  at least people are talking openly about our nation’s growing debt load.  This $14.3 trillion issue is front and center – exactly where it should be.

Into the fray comes a thoughtful new paper by Joseph E. Gagnon, a senior fellow at the Peterson Institute for International Economics, which studies economic policy.

The Peterson Institute was formerly the Institute for International Economics, founded by C. Fred Bergsten.  It was subsequently taken over by the Peter G. Peterson Foundation, a foundation established and managed by Richard Nixon’s former Commerce Secretary (and co-founder of Blackstone Group), Pete Peterson.  The Peterson Institute is a “think tank” (i.e. propaganda mill) most recognized for its advocacy of “economic austerity” (which usually involves protecting the interests of the wealthy at the expense of the middle class and the impoverished).

Yves Smith of Naked Capitalism, is always quick to rebut the pronouncements of those economists, acting as “hired guns” to spread the gospel of the Peterson Institute.  Needless to say, once Gretchen Morgenson began to parrot the Peterson Institute dogma in her aforementioned article, Yves Smith didn’t hesitate to pounce:

I’m generally a Gretchen Morgenson fan, since she’s one of the few writers with a decent bully pulpit who regularly ferrets out misconduct in the corporate and finance arenas. But when she wanders off her regular terrain, the results are mixed, and her current piece is a prime example. She also sometimes pens articles based on a single source, which creates the risk of serving as a mouthpiece for a particular point of view.

(As an aside, a good example of this process has been Ms. Morgenson’s continuing fixation on “mortgage mania” as a cause of the financial crisis after having been upbraided by Barry Ritholtztwice – for “pushing the Fannie-Freddie CRA meme”.)

After pointing out Morgenson’s uncritical acceptance of the economic model used in the Peterson Institute report (by Gagnon and Hinterschweiger) Yves Smith directed our attention to the very large elephant in the room:  the proven fact that au-scare-ity doesn’t work in our post-financial crisis, anemic-growth milieu.  Ms. Smith focused on this aspect of the Peterson Institute report:

It also stunningly shows the howler of the Eurozone showing improvements in debt to GDP ratios as a result of the austerity programs being implemented. The examples of Latvia and Ireland have demonstrated that austerity measures have worsened debt to GDP ratios, dramatically in both cases, and the same deflationary dynamics look to be kicking in for Spain.

The article repeats the hoary cliche that deficit cuts must be made to “reassure the markets” as in appease the Bond Gods. Gee, how is that working out in Europe, the Peterson Institute’s obedient student?

Ms. Smith supported her argument with this report, which appeared in Bloomberg News on May 27:

European confidence in the economic outlook weakened for a third straight month in May as the region’s worsening debt crisis and surging commodity costs clouded growth prospects.

An index of executive and consumer sentiment in the 17- member euro region slipped to 105.5 from 106.1 in April, the European Commission in Brussels said today. Economists had forecast a drop to 105.7, the median of 27 estimates in a Bloomberg survey showed. The euro-area economy is showing signs of a slowdown as governments toughen austerity measures to lower budget gaps as investors grow increasingly concerned that Greece may default, while oil-driven inflation squeezes household incomes. European manufacturing growth slowed this month….

Be sure to read Yves Smith’s entire essay, which addressed the tired canard about those phantom “bond vigilantes”, etc.  Ms. Smith’s closing paragraph deserves repetition:

But the idea of government spending has become anathema in the US, despite plenty of targets (start with our crumbing infrastructure).  The banks got first dibs on the “fix the economy” money in the crisis, and continue to balk at measures that would shrink a bloated and highly leveraged banking sector down to a more reasonable size.  Evidence already shows the size of the banking sector is constraining growth, yet a full bore campaign is on to gut social spending out of a concern that sometime down the road the size of the government sector will serve as a drag on the economy.  In addition, the banksters need to preserve their ability to go back to the well the next time they crash the markets for fun and profit.  So the attack on deficits is financial services industry ideology, packaged to make it look like it’s good for the little guy. We have too many people who should know better like Morgenson enabling it.

The reader comments to Ms. Smith’s essay were quite interesting.  Many of the readers who have been outraged by Smith’s ongoing rebuttals to the Peterson Institute gospel and other Austerian dogma would do well to familiarize themselves with this bit of legalese:

EXCLUSION OF SOCIAL SECURITY FROM ALL BUDGETS Pub. L. 101-508, title XIII, Sec. 13301(a), Nov. 5, 1990, 104 Stat. 1388-623, provided that:  Notwithstanding any other provision of law, the receipts and disbursements of the Federal Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust Fund shall not be counted as new budget authority, outlays, receipts, or deficit or surplus for purposes of – (1) the budget of the United States Government as submitted by the President, (2) the congressional budget, or (3) the Balanced Budget and Emergency Deficit Control Act of 1985.

I include myself among those who are “generally” Gretchen Morgenson fans.  Nevertheless, it has become obvious that with Tanta gone, the spirit of “Morgenson Watch” shall endure for as long as the frailties of being a New York Times pundit continue to manifest themselves.


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