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Looks like they are moving towards higher levels of domestic consumption to sustain output and employment.

(must be reading my blog…)

China’s Central Bank Pledges to Keep Money Flowing

China to Start Trial Rural Pension System to Boost Consumption

China’s Central Bank Pledges to Keep Money Flowing

June 25 (Bloomberg) — China’s central bank pledged to keep
pumping money into the financial system to support a recovery in
the world’s third-biggest economy.

The economy is in a “critical” stage and the central bank
will maintain a “moderately loose” monetary policy, the
People’s Bank of China reiterated in a statement on its Web site
today after a quarterly meeting.

The central bank triggered an explosion in credit by
scrapping quotas on lending in November to back the government’s
4 trillion yuan ($585 billion) stimulus plan. Record lending is
stoking concern that a recovery may come at the expense of asset
bubbles, bad debts for banks and inflation in the long term.

Banks are set to lend more in June than in May, the same
newspaper reported June 22, citing unidentified sources. Last
month, new loans more than doubled from a year earlier.

China to Start Trial Rural Pension System to Boost Consumption

June 25 (Bloomberg) —China, home to 700 million rural
residents, approved a pilot pension program as the government
tries to encourage farmers to spend more to help revive economic
growth.

The new system, which aims to cover 10 percent of rural
counties this year, will help narrow a wealth gap with cities
and spur domestic demand, according to a statement today from
the State Council, China’s cabinet.

China has expanded its social safety net to reduce
precautionary saving by citizens planning for ill health and old
age. Premier Wen Jiabao has pledged to boost domestic
consumption to help the world’s third-biggest economy recover
from its deepest slump in a decade and lessen dependence on
exports and investment.

“The rural pension system has been almost non-existent,”
said Kevin Lai, an economist with Daiwa Institute of Research in
Hong Kong. “Once you build a stronger social safety net, people
will be more inclined to spend without having to worry about the
future.”

The government in late January also announced it would
spend 850 billion yuan ($124 billion) over three years to ensure
that at least 90 percent of its 1.3 billion citizens have basic
health insurance by 2011.

China’s economy grew 6.1 percent in the first quarter, the
slowest pace in almost a decade.

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This is the exact same line Niall Ferguson is spewing.
He also says the two choices are inflating or defaulting.

The inflation would be from too much aggregate demand and a too small output gap.

That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.

Sounds like that’s the goal of deficit spending to me- so in faccct he’s saying deficit spending works with his rant on why it doesn’t.

And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders.

Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered.

In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990’s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happend shortly after y2k.

Feel free to pass this along to either.

The fiscal black hole in the US

June 12 (FT)—US budgetary prospects are dire, disastrous even. Without a major permanent fiscal tightening, starting as soon as cyclical considerations permit, and preferably sooner, the country is headed straight for a build up of public debt that will either have to be inflated away or that will be ‘resolved’ through sovereign default.

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(email exchange)

The latest noise is that today’s deficits mean higher taxes later.

Answer:

1. Taxes function to reduce aggregate demand.

2. A tax hike is never in order with a weak economy, no matter how high the deficit or how high the interest payments may be.

3. Future tax increases would be a consideration should demand rise to the point where unemployment fell ‘too far’- maybe below 4%.

4. That is a scenario of prosperity and an economy growing so fast that it might be causing inflation which might need a tax hike or spending cut to cool it down.

So when someone states that today’s high deficit mean higher taxes later, he is in fact saying that today’s high deficits might cause the economy to grow so fast that it will require tax increases or spending cuts to slow it down.

Sounds like a good thing to me — who can be against that?

And, of course, the government always has the option to tax interest income if interest on the debt is deemed a problem at that time.

>    On Fri, Jun 12, 2009 at 8:46 AM, James Galbraith wrote:
>   
>   A comment in the National Journal, on the ever-green deficit alarmism that so preoccupies
>   people in Washington, to no good effect.
>   
>   Also, my June 5 lecture in Dublin, at the Institute for International and European Affairs, on the
>   crisis.
>   
>   With Q&A
>   
>   And a small postscript, reprising the old story of Eliza in Cuba, which I’ve promised her I
>   will now retire
>   
>   Jamie

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What Is Fiscally — And Politically — ‘Sustainable’?

By James K. Galbraith
Professor of Economics, University of Texas

June 11th —Chairman Bernanke may, if he likes, try to define “fiscal sustainability” as a stable ratio of public debt to GDP. But this is, of course, nonsense. It is Ben Bernanke as Humpty-Dumpty, straight from Lewis Carroll, announcing that words mean whatever he chooses them to mean.

Now, we may admit that the power of the Chairman of the Board of Governors of the Federal Reserve System is very great. But would someone please point out to me, the section of the Federal Reserve Act, wherein that functionary is empowered to define phrases just as he likes?

A stable ratio of federal debt to GDP may or may not be the right policy objective. But it is neither more nor less “sustainable,” under different economic conditions, than a rising or a falling ratio.

In World War II, from 1940 through 1945, the ratio of US federal debt to GDP rose to about 125 percent. Was this unsustainable? Evidently not. The country won the war, and went on to 30 years of prosperity, during which the debt/GDP ratio gradually fell. Then, beginning in the early 1980s, the ratio started rising again, peaked around 1993, and fell once more.

Thus, a stable ratio of debt to GDP is not a normal feature of modern history. Gradual drift in one direction or the other is normal. There seems no great reason to fear drift in one direction or the other, so long as it is appropriate to the underlying economic conditions.

History has a second lesson. In a crisis, the ratio of public debt to GDP must rise. Why? Because a crisis – and this really is by definition – is a national emergency, and national emergencies demand government action. That was true of the Great Depression, true of war, and true of the Great Crisis we’re now in. Moreover, we’ve designed the system to do much of this work automatically. As income falls and unemployment rises, we have an automatic system of progressive taxation and relief, which generates large budget deficits and rising deficits. Hooray! This is precisely what puts dollars in the pockets of households and private businesses, and stabilizes the economy. Then, when the private economy recovers, the same mechanisms go to work in the opposite direction.

For this reason, a sharp rise in the ratio of debt to GDP, reflecting the strong fiscal response to the crisis, was necessary, desirable, and a good thing. It is not a hidden evil. It is not a secret shame, or even an embarrassment. It does not need to be reversed in the near or even the medium term. If and as the private economy recovers, the ratio will begin again to drift down. And if the private economy does not recover, we will have much bigger problems to worry about, than the debt-to-GDP ratio.

It is therefore a big mistake to argue that the next thing the administration and Congress should do, is focus on stabilizing the debt-to- GDP ratio or bringing it back to some “desired” value. Instead, the ratio should go to whatever value is consistent with a policy of economic recovery and a return to high employment. The primary test of the policy is not what happens to the debt ratio, but what happens to the economy.

*****

Now, what about those frightening budget projections? My friend Bob Reischauer has a scary scenario, in which a very high public-debt-to-GDP ratio leaves the US vulnerable to “pressure from foreign creditors” – a euphemism, one presumes, for the very scary Chinese. Under that pressure, interest rates rise, and interest payments crowd out other spending, forcing draconian cuts down the line. To avert this, Bob has persuaded himself that cuts are required now, not less draconian but implemented gradually. Thus the frog should be cooked bit by bit, to avoid an unpleasant scene later on when the water is really boiling hot.

With due respect, Bob’s argument displays a very vague view of monetary operations and the determination of interest rates. The reality is in front of our noses: Ben Bernanke sets whatever short term interest rate he likes. And Treasury can and does issue whatever short-term securities it likes at a rate pretty close to Bernanke’s fed funds rate. If the Treasury doesn’t like the long term rate, it doesn’t need to issue long-term securities: it can always fund itself at very close to whatever short rate Ben Bernanke chooses to set.

The Chinese can do nothing about this. If they choose not to renew their T-bills as they mature, what does the Federal Reserve do? It debits the securities account, and credits the reserve account! This is like moving funds from a savings account to a checking account. Pretty soon, a Beijing bureaucrat will have to answer why he isn’t earning the tiny bit of extra interest available on the T-bills. End of story.

The only thing the scary foreign creditors can do, if they really do not like the returns available from the US, is sell their dollar assets for some other currency. This will cause a decline in the dollar, some rise in US inflation, and an improvement in our exports. (It will also cause shrieks of pain from European exporters, who will urge their central bank to buy the dollars that the foreigners choose to sell.) The rise in inflation will bring up nominal GDP relative to the debt, and lower the debt-to-GDP ratio. Thus, the crowding-out scenario Bob sketches will not occur.

I’m not particularly in favor of this outcome. But unlike Bob Reischauer’s scenario, this one could possibly occur. And if it did, it would lower real living standards across the board. This is unpleasant, but it would be much fairer than focusing preemptive cuts on the low-income and vulnerable elderly, as those who keep talking about Social Security and Medicare would do.

****

Now, it is true, of course, that you can run a model in which some part of the budget – say, health care – is projected to grow more rapidly than GDP for, say, 50 years, thus blowing itself up to some fantastic proportion of total income and blowing the public finances to smithereens. But this ignores Stein’s Law, which states that when a trend cannot continue it will stop, and Galbraith’s Corollary, which states that when something is impossible, it will not happen.

Why can’t health care rise to 50 percent of GDP? Because, obviously, such a cost inflation would show up in – the inflation statistics! – which are part of GDP. So the assumption of gross, uncontrolled inflation in health care costs contradicts the assumption of stable nominal GDP growth. Again, the consequence of uncontrolled inflation is… inflation! And this increases GDP relative to the debt, so that the ratio of debt to GDP does not, in fact, explode as predicted.

I do not know why the CBO and OMB continue to issue blatantly inconsistent forecasts, but someone should ask them.

Further confusion in this area stems from treating Social Security alongside Medicare as part of some common “entitlement problem.” In reality, health care costs and haphazard health insurance coverage are genuine problems, and should be dealt with. Social Security is just a transfer program. It merely rearranges income. For this reason it cannot be inflationary; the only issue posed is whether the elderly population as a whole deserves to kept out of poverty, or not.

Paying the expenses of the elderly through a public insurance program has the enormous advantage of spreading the burden over all other citizens, whether they have living parents or not, and of ensuring that all the elderly are covered, whether they have living children or not. A public system is also low-cost and efficient, and this too is a big advantage. Apart from that, whether the identical revenue streams are passed through public or private budgets obviously has no implications whatever for the fiscal sustainability of the country as a whole.

****

What is politically sustainable is nothing more than what the political community agrees to at any given time. I have been surprised, and pleased, by the political community’s acquiescence in the working of the automatic stabilizers and expansion program so far. The deficits are bigger, and therefore more effective, than many economists thought would be tolerated. That’s a good sign. But it would be a tragedy if alarmist arguments now prevailed, grossly undermining job prospects for millions of the unemployed.

Let me note, in passing, that Chairman Bernanke should please read the Federal Reserve Act, and focus on the objectives actually specified in it, including “maximum employment, stable prices and moderate long-term interest rates.” He does not have a remit to add stable debt-to-GDP ratios or other transient academic ideas to the list. One might think that the embarrassing experience with inflation targeting would be enough to warn the Chairman against bringing too much of his academic baggage to the day job.

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With productivity up more than expected Q2 GDP can be flat with hours declining.

Karim writes:

• Rate of decline definitely slowing overall and across a number of industries
• But to put the ‘blowout’ number (according to CNBC) in perspective: The -345k drop in employment was only exceeded 6 times since 1960 prior to the current recession
• NFP -345k and net revisions +82k

Details:

Good News

• Diffusion index 25.8 to 32.7
• Relative improvement despite 7k decline in govt jobs
• Consistent pattern of slower rate of contraction across several industries (retail, construction, temp, hospitality)

Bad News

• Unemployment rate up from 8.9% to 9.4%
• Duration of unemployment up from 21.4 weeks to 22.5 weeks
• Hours down 0.7%
• Total Unemployed and Underemployed up from 15.8% to 16.4%

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Someone needs to tell this guy the deficit spending IS the private savings. If any of you know him, please forward this, thanks.

Niall Ferguson jumped in with both feet. Calling the government’s growth forecasts ‘crazily optimistic’ he predicted federal debt would soon reach 140% of GDP and that private savings could not possibly absorb it all. “I hate to teach arithmetic to a Nobel laureate but it doesn’t quite add up,” he said.

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Real GDP

Can you find the recession? Year over year will be reasonable until last year’s large Q3 number drops out without similar sized q3 this year.

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Capacity Utilization, ISM Manufacturing

Down but not out as GDP muddles through.

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Philly Fed Index, Chicago PMI, ISM Non-Manufacturing, Empire Manufacturing Index

Limping along, but off the lows
The survey numbers seem to be depressed by inflation.

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Retail Sales, Retail Sales Ex Autos, Total Vehicle Sales, Redbook Retail Sales Growth

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Personal Spending, Personal Income

Apart from cars and trucks, retail muddling through, and getting some support from the fiscal package.

---

Non-farm Payrolls, Average Hourly Earnings, Average Weekly Hours, Unemployment Rate

Certainly on the soft side, but still positive year over year, earnings still increasing, and unemployment still relatively low (the last print was distorted a couple of tenths or so by technicals).

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Total Hours Worked, Labor Participation Rate, Duration of Unemployment, Household Job Growth

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Help Wanted Index, Chicago Unemployment, ISM Manufacturing Employment, ISM Non-Manufacturing Employment

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Philly Fed Employment, Challenger Layoffs

Most of the labor indicators are on the weak side, but not in a state of collapse. And GDP is picking up some from the fiscal package which should stabilize employment.

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NAHB Housing Index, NAHB Future Sales Index

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Housing Starts, Building Permits, Housing Affordability, Pending Home Sales

Leveling off to improving a touch.
Housing is still way down and could bounce 35% at any time.
And still be at relatively low levels.

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MBA Mortgage Applications

Mortgage apps are down but they are still at levels previously associated with 1.5 million starts vs today’s approx 1 million starts (annual rate).

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Fiscal Balance, Govt Public Debt, Govt Spending, Govt Revenue

It’s an election year, and here comes the Govt. spending which is already elevating GDP.

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CPI, Core CPI, PCE Price Index, Core PCE

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PPI, Core PPI, Import Prices, Import Prices Ex Petro

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Export Prices, U of Michigan Inflation Expectations, CRB Index, Saudi Oil Production

The ‘inflation’ is only going to work its way higher as it pours through the import and export channels.
And with Saudi production completely demand driven, there’s no sign of a fall off of world demand for crude at current prices.
Yes, the world’s growing numbers of newly rich are outbidding America’s lower income consumers for gasoline, as US demand falls off and rest of world demand increases.

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Empire Prices Paid, Empire Prices Received, Philly Fed Prices Paid, Philly Prices Received

All the price surveys are pretty much the same as ‘inflation’ pours in.

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ABC Consumer Confidence, ABC Econ Component, ABC Finance Component, ABC Buying Component

And all the surveys look pretty much the same as ‘inflation’ eats into confidence

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10Y Tsy Yield

And with all the weakness rates have generally moved higher as it seems inflation is doing more harm than ultra low interest rates are helping, perhaps causing the Fed to reverse course.

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10Y Tips

The TIPS market has been discounting higher ‘real’ rates from the Fed.

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Dow Index

Even as stocks look to test the lows

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U.S. First Quarter Advance GDP: Statistical Summary (Table)

by Kristy Scheuble

(Bloomberg) Following is a summary of Gross Domestic Product from the Commerce Department.

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	1Q	4Q	3Q	2Q	1Q	4Q	3Q
	2008	2007	2007	2007	2007	2006	2006

Annualized Quarterly Change

Real GDP	0.6%	0.6%	4.9%	3.8%	0.6%	2.1%	1.1%
YOY percent	2.5%	2.5%	2.8%	1.9%	1.5%	2.6%	2.4%

Year over year looks fine.

Personal consumption

1.0%

2.3%

2.8%

1.4%

3.7%

3.9%

2.8%

Down, but holding positive as income continues to grow.

Durable goods	-6.1%	2.0%	4.5%	1.7%	8.8%	3.9%	5.6%
Nondurable goods	-1.3%	1.2%	2.2%	-0.5%	3.0%	4.3%	3.2%
Services	3.4%	2.8%	2.8%	2.3%	3.1%	3.7%	2.0%

Services picking up the slack from goods.

Gross private investment	-4.7%	-14.6%	5.0%	4.6%	-8.2%	-14.1%	-4.1%
Fixed investment	-9.7%	-4.0%	-0.7%	3.2%	-4.4%	-7.1%	-4.7%
Nonresidential	-2.5%	6.0%	9.3%	11.0%	2.1%	-1.4%	5.1%
Structures	-6.2%	12.4%	16.4%	26.2%	6.4%	7.4%	10.8%
Equipment & software	-0.7%	3.1%	6.2%	4.7%	0.3%	-4.9%	2.9%
Residential	-26.7%	-25.2%	-20.5%	-11.8%	-16.3%	-17.2%	-20.4%

Housing still subtracting quite a bit, has to taper off as it bottoms albeit at very low levels.

	1Q	4Q	3Q	2Q	1Q	4Q	3Q
	2008	2007	2007	2007	2007	2006	2006
Exports	5.5%	6.5%	19.1%	7.5%	1.1%	14.3%	5.7%
Goods	5.2%	3.9%	26.2%	6.6%	0.9%	9.6%	7.4%
Services	6.1%	13.2%	4.0%	9.6%	1.6%	26.0%	2.0%

March trade report could revise exports much higher…

Imports	2.5%	-1.4%	4.4%	-2.7%	3.9%	1.6%	5.4%
Goods	2.4%	-2.6%	4.8%	-2.9%	4.2%	-0.6%	6.2%
Services	3.5%	5.5%	1.7%	-1.7%	2.3%	14.2%	1.3%

and imports lower.

Government consumption	2.0%	2.0%	3.8%	4.1%	-0.5%	3.5%	0.8%
Federal	4.6%	0.5%	7.1%	6.0%	-6.3%	7.3%	0.9%
National defense	6.0%	-0.5%	10.1%	8.5%	-10.8%	16.9%	-1.5%
Nondefense	1.8%	2.8%	1.1%	0.9%	3.8%	-10.0%	6.0%

Federal government spending deferred from 2007 kicking in, especially defense..

State and local

0.5%

2.8%

1.9%

3.0%

3.0%

1.3%

0.7%

As state and local growth slows.

Other Measures

Change in inventories $B	$1.8	-$18.3	$30.6	$5.8	$0.1	$17.4	$53.9
Net exports $B	-$496	-$503	-$533	-$574	-$612	-$597	-$634
Real final sales	-0.2%	2.4%	4.0%	3.6%	1.3%	3.5%	1.0%
Gross domestic purchases	0.4%	-0.4%	3.3%	2.4%	1.1%	0.8%	1.3%
Final sales to dom purch	-0.4%	1.3%	2.5%	2.1%	1.7%	2.1%	1.2%

Contribution to Change in GDP

Real GDP

0.6%

0.6%

4.9%

3.8%

0.6%

2.1%

1.1%

If revised up with March trade numbers, Q4 would have been the bottom.

Personal consumption	0.68%	1.58%	2.01%	1.00%	2.56%	2.68%	1.88%
Durables	-0.48%	0.15%	0.35%	0.14%	0.67%	0.30%	0.43%
Motor Vehicle	-0.37%	0.09%	-0.17%	-0.10%	0.35%	0.00%	0.16%
Nondurables	-0.27%	0.25%	0.46%	-0.10%	0.61%	0.86%	0.64%
Services	1.43%	1.18%	1.20%	0.96%	1.28%	1.52%	0.81%
Housing	0.23%	0.34%	0.27%	0.29%	0.26%	0.20%	0.18%

Again, services picking up the slack.

Gross pvt dom invest	-0.70%	-2.40%	0.77%	0.71%	-1.36%	-2.50%	-0.70%
Fixed investment	-1.50%	-0.62%	-0.11%	0.49%	-0.70%	-1.19%	-0.80%
Nonresidential	-0.28%	0.63%	0.96%	1.12%	0.22%	-0.15%	0.53%
Structures	-0.23%	0.41%	0.52%	0.78%	0.20%	0.23%	0.31%
Equipment & software	-0.05%	0.22%	0.44%	0.34%	0.02%	-0.38%	0.21%
Info processing	0.23%	0.51%	0.24%	0.36%	0.56%	-0.06%	0.24%
Computers	0.12%	0.20%	0.08%	0.08%	0.25%	0.03%	0.09%
Software	0.13%	0.18%	0.07%	0.16%	0.14%	0.04%	0.05%
Residential	-1.23%	-1.25%	-1.08%	-0.62%	-0.93%	-1.04%	-1.33%

Soft quarter for investment at least partially due to the widespread recession psychology.

	1Q	4Q	3Q	2Q	1Q	4Q	3Q
	2008	2007	2007	2007	2007	2006	2006
Change in inventories	0.81%	-1.79%	0.89%	0.22%	-0.65%	-1.31%	0.10%
Nonfarm	0.93%	-1.69%	0.87%	0.27%	-0.69%	-1.56%	0.01%
Net exports	0.22%	1.02%	1.38%	1.32%	-0.51%	1.25%	-0.25%
Exports	0.67%	0.77%	2.10%	0.85%	0.13%	1.51%	0.62%
Goods	0.45%	0.33%	1.96%	0.53%	0.07%	0.73%	0.56%
Services	0.22%	0.45%	0.14%	0.33%	0.05%	0.78%	0.07%
Imports	-0.44%	0.24%	-0.72%	0.47%	-0.63%	-0.26%	-0.88%
Goods	-0.35%	0.39%	-0.67%	0.42%	-0.57%	0.09%	-0.84%
Services	-0.09%	-0.15%	-0.05%	0.05%	-0.06%	-0.35%	-0.03%
Govt. consumption	0.39%	0.38%	0.74%	0.79%	-0.09%	0.66%	0.14%
Federal	0.32%	0.04%	0.50%	0.41%	-0.46%	0.50%	0.06%
National defense	0.28%	-0.03%	0.47%	0.39%	-0.54%	0.74%	-0.07%
Nondefense	0.04%	0.06%	0.03%	0.02%	0.08%	-0.24%	0.14%
State and local	0.07%	0.34%	0.24%	0.37%	0.36%	0.16%	0.08%

Implicit Price Deflators

GDP

2.6%

2.4%

1.0%

2.6%

4.2%

1.7%

2.4%

And higher numbers are in the pipeline as per the PPI and CPI reports.

Gross domestic purchases

3.5%

3.7%

1.7%

3.8%

3.8%

0.1%

2.5%

Not bad.

	1Q	4Q	3Q	2Q	1Q	4Q	3Q
	2008	2007	2007	2007	2007	2006	2006

Price Indexes

GDP	2.6%	2.4%	1.0%	2.6%	4.2%	1.7%	2.4%
YOY percent	2.2%	2.6%	2.4%	2.7%	2.9%	2.7%	3.2%
Personal consumption	3.5%	3.9%	1.8%	4.3%	3.5%	-0.9%	2.6%
YOY percent	3.4%	3.4%	2.1%	2.3%	2.3%	1.9%	2.9%

Moving up.

ex food and energy	2.2%	2.5%	2.0%	1.4%	2.4%	1.9%	2.3%
Real final sales	2.7%	2.4%	1.0%	2.7%	4.2%	1.7%	2.3%

Moving up.

Gross domestic purchases

3.5%

3.7%

1.8%

3.8%

3.8%

0.1%

2.5%

Unannualized Quarterly Change

Current GDP	0.8%	0.7%	1.5%	1.6%	1.2%	0.9%	0.9%
Real GDP	0.1%	0.1%	1.2%	0.9%	0.2%	0.5%	0.3%

Seen a lot worse..

Weakness but no recession and even some improvement on the horizon as government and exports pick up the slack from housing and the financial sector.

Employment softer but still reasonably firm by mainstream standards with unemployment at 5%.

Prices continue firm as Saudis continue to hike crude prices, even as other commodities settle down some.

Hence, I see a narrowing output gap and higher prices on the horizon, and Fed rate hikes at least as aggressive as currently priced by the FF futures market.

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Please excuse the mix of Bloomberg and Valance graphs.

Comments welcome.

Went blurry eyed trying to organize it all.

Markets reacted strongly to Friday’s -17,000 non-farm payroll number. Several sources called it the first negative payroll number in 4 years.

How quickly they forget the first negative number was the initial August number of
-4,000 that contributed heavily to the FOMC’s first rate cut. That number was revised upward the next month by close to 100,000 jobs and, if initially reported ‘correctly,’ might have changed the size of that rate cut. And, like the recent January number, the initial August number had a negative number for government workers that was subsequently revised upward and accounted for the majority of the revision.

Likewise, December’s initial report was weak, and the Fed reacted and markets traded accordingly, only to have it revised up to reasonably respectable 80,000 new jobs.

Clearly the initial numbers are far from reliable, and the initial revision is a far better indicator of the labor market conditions, with an eye out for second, third, and benchmark revisions that have also been meaningful.

So if the January number is completely disregarded and only the numbers revised at least once are considered, non-farm payrolls have been moderating but are far from levels that would indicate recession. In fact, non-farm payrolls have been reasonably steady for the second half of 07 where GDP averaged over 3% annualized, with upward revisions very possible as well, but that’s another story.

ADP

The ADP report of its near 400,000 payrolls has been a better indicator of the revised payroll numbers than of the initial payroll report. It’s also been showing the same gradual decline over the last few years as the (revised) payroll numbers due to the economy ‘using up slack’ and nearing full employment. But is has not dipped into negative territory or signaled a recession yet, further supporting the possibility of the Jan payroll number being revised up next month.

The unemployment numbers and household job growth numbers come from the household surveys, and the December jump in unemployment to 5% from 4.7% perhaps contributed even more heavily to the Fed’s latest decision to cut the fed funds rate a total of 1.25%. These are monthly survey numbers, so they are not subject to revision. The recent large fluctuations to both the upside and downside for the last 8 months are, however, on average, consistent with the above payroll reports of numbers revised at least once.

The labor force participation rate may also be an indicator of a reasonably firm labor market. At any point in time there are substantial numbers of people not actively seeking work and therefore technically not part of the labor force, but when firms make it know that they need more help some of these people are drawn back into the labor market and actively seek work. After what looks like a modest drop in the first half of 07 it seems to have recovered.

Additionally, the Fed anticipates this series to decline over time due to US demographics. That assumption would mean that over time lower payroll growth would be needed to sustain full employment, which is also consistent with what we saw for 07. In fact, Fed members (unofficially) consider a 4.75% unemployment rate to be ‘full employment.’ And anything below that risks elevating inflation expectations.

In fact, through August, the Fed’s policy was to allow unemployment to drift up to 5% to keep sufficient slack in the labor markets to keep the various inflation measures within its comfort zones.

Initial unemployment claims are also not yet indicating recession, but instead staying in a range expected with a mature economy that has reached full employment and has leveled off at what the Fed considers full employment levels.

Continuing claims have moved up some, but not to anything near recession levels, and are now hovering around a level approximately consistent with the Fed’s perceived full employment level of about a 4.75% rate of unemployment.

While moderating from previous levels of growth, taken together, the ISM numbers are hovering around 50. This too is consistent with an unemployment level just above the Fed’s 4.75% full employment estimate.

Duration of unemployment also continues to trade within a range consistent with current levels of unemployment.

This survey as well as the ‘jobs plentiful’ survey both continue to move within a narrow range over the last 18 months.

Real GDP also looks very firm. Since weak q4’s have been followed by stronger q1’s.

This year inventories were depleted by 1.4% in q4 and replenishing inventories from current very low levels should lend support to q1 growth. Low inventories are not indicative of a recession about to happen.

Personal income and spending are also consistent with current levels of employment and don’t yet show any sign of recession.

Durable goods are also not showing signs of recession yet.

Both the non defense durable goods and the government spending charts seem to indicate government spending, including defense, may be accelerating back to previous levels. It is not impossible that some 07 govt. spending got moved forward and is beginning to kick in. Deficit spending is projected to increase by $25 billion in q1 due to increased govt. spending.

Additionally the proposed fiscal package scheduled for implementation in May could add a further 1% to q3 GDP.

Housing remains weak, and continues to fall and subtract from GDP. And the risk that a wealth effect from falling home values could cut into consumer spending is pervasive.

Existing Home Sales Inventory

Absolute inventories of new and existing homes have been going down for several months, even as the supply measure in months of sales kept falling due to falling monthly sales rates.

An increase in the rate of sales from current low levels will quickly reduce the months of inventory.

Sales may have bottomed in October/November.

Lower prices, lower interest rates, and higher incomes all coming together.

This continues its modest, multi year decline. The Fed measures housing costs by calculating owner’s equivalent rent.

Refinance applications have spiked up indicating this market is functioning and credit worthy borrowers are able to obtain financing on favorable terms.

Purchase applications are also not showing signs of recession, assuming last week’s drop is not sustained.

Commercial Paper Outstanding SA

Looks like the commercial paper market may be on the mend. Watch for bank loans losing steam as cp regains market share.

The big story for the US economy has been the rapidly growing exports. The additional GDP attributable to rising exports has so far more than offset the reduced contribution of housing.

Prices have been rising at rates not seen since the great inflation of the 70’s began to wind down in the early 80’s, and the above numbers look a lot like those of the early 70’s. Additionally, it all started then and now with oil and other commodities trending sharply higher, and headline inflation indicators turning north for two or so years before core indicators followed.

The drop in prices the above charts show for the second half of 06 can be attributed to Goldman Sachs’ net reduction of the gasoline and crude oil weighting in its commodity index in Aug 06. This triggered substantial liquidations of long positions held by pension funds and other investors who were replicating the Goldman index for their investors, as well as the Goldman commodity fund itself selling gasoline and crude oil futures to reallocate to the new index. This had about run its course by year end, when at year end Goldman, and this time AIG as well, effectively further reduced the crude oil weighting in their indexes. This triggered yet another liquidation of positions. After prices bottomed and began rising again it was announced that control of the index had passed to S and P to avoid related party issues and conflicts of interest, and crude, gasoline, and other commodities resumed their former upward trends. Most have more than recovered and gone on to new highs.

Crude oil prices continue under the direct control of the Saudis, and probably the Russians as well. Saudis have been acting as ‘swing producer’ for several years, and Russia has now consolidated pricing so it can do the same. As any monopolist at the margin must do, they set price and then supply the quantity demanded at that price.
And as the Saudis have been posting ever higher prices (since the debacle of the second half of 06 previously described) the amount demanded at the higher prices has continued to increase. Last week OPEC announced that Saudi production was up to 9.2 million bpd, for example. Monthly production numbers are due out next week.

Meanwhile, the Fed has been aggressively cutting rates as what can most kindly be described as insurance against a recession. This has had an extreme effect on market expectations, as the 10 year tips are now discounting record low average ‘real rates’ by the Fed over the next 10 years, even as inflation continues to increase.

Equities remain at levels that look like very good value for long term investors.

The US trade balance is a function of the desire of non residents to accumulate $US financial assets.

That desire had been increasing for a long time, as evidenced by the growing US trade deficit. And foreign Central Banks were the largest entities desiring to accumulate $US financial assets, thereby supporting their domestic export industries. Additionally, there is evidence US pension funds have been diversifying out of $US financial assets as well into both passive commodity strategies and (unhedged) foreign equities.

Three things have altered the rest of world (and our own pension fund) desire to accumulate $US financial assets, which are also evidence of a ‘weak dollar’ US policy:

1. Treasury Secretary Paulson has labeled any Central Bank that adds to it’s holdings of $US financial assets a ‘currency manipulator’ and is deemed to be acting counter to US desires. This has led to reduced intervention in fx markets and curtailed the accumulation of $US financial assets by foreign CB’s.
2. American military intervention in Iraq, and sanctions against Iran have led to a reduced desire to hold $US net financial assets in many nations in the mid east.
3. The Fed chairman has pursued what looks like a pro inflation policy with aggressive interest cuts in the face of severe negative supply shocks and has also petitioned the President and Congress to increase the budget deficit with direct cash payments to tax payers.

This has triggered a general desire of non residents to decrease certain holding of $US financial assets. At the macro level, the way this happens is non residents first try to sell the $US in the market place, driving the price of the $US down. This continues until it reaches a level where the buyers of the $US are buying the currency because prices in the US are now low enough for them to buy US exports of goods and services, as well as US non financial assets including real estate.

Therefore I expect exports to continue to accelerate until non resident holdings of $US financial assets reach desired levels.

This is what export economies look like. Employment is high, but domestic prices are high enough so that domestic compensation (including government consumption) isn’t enough to buy the output, with the rest of the output being exported.

We are seeing that in the US. Domestic real consumption is moderating due to high energy and prices of other imports, while exports take up the slack in demand and support what the Fed considers near full employment levels.

The Eurozone is seeing much the same thing. Declining budget deficits contribute to relatively low domestic demand and domestic consumption, ..

..while high inflation indicators persist even as growth slows.

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Food, crude, metals up, dollar down, inflation up all over the world, well beyond CB ‘comfort levels.’

Nov new home sales continue weak, though there are probably fewer ‘desirable’ new homes priced to sell, and with starts are down the new supply will continue to be low for a while.

The December Chicago pmi was a bit higher than expected, probably due to export industries. Price index still high though off a touch from Nov highs.

So again it’s high inflation and soft gdp.

Markets continue to think the Fed doesn’t care about any level of inflation and subsequently discount larger rate cuts.

Mainstream theory says if inflation is rising demand is too high, no matter what level of gdp that happens to corresponds with. And by accommodating the headline cpi increases with low real interest rates, the theory says the Fed is losing it’s fight (and maybe its desire) to keep a relative value story from turning into an inflation story. This is also hurting long term output and employment, as low inflation is a necessary condition for optimal growth and employment long term.

A January fed funds cut with food and energy still rising and the $ still low will likely bring out a torrent of mainstream objections.

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