Thursday morning radio: the economy on WREL

Mike Smitka

Well, I've gone through another week without a post on the auto industry, but Thursday has come and my WREL Lexington (VA) radio segment with it. Here's my latest.

First, our host Jim Bresnahan asks about the gyrations of global stock markets. China? – attributing a reason to what happens in the stock market is hard. As an economist I don't pay attention to the stock market, because how it does has no link to the economy in the short run, and little or no impact on the economy. Most trading now is computer to computer, operating faster than the blink of an eye, and opaque in details. So why things move in a particular direction, and how much, no one can explain. Now the reporter on CNN has to give a report every hour, and we as humans like things to have causes, and they'll attribute the up or down to something. So in the short run the market is random, and betting on it is a crap shoot, one where the house – Wall Street – wins. You have to pay a fee, and the computers can see your trade before it gets executed and (legally – there's no regulation) bet against you. As to the US, we're seen a strong rise in the market the past few years have seen; the US economy has after all been growing, and corporate profits are up. Stock prices ought to reflect that, but the link is loose so things will go up and down. Don't panic, invest for that long-run link and don't let yourself try to beat the house in the short run.

Low oil prices: not a Saudi conspiracy

Mike Smitka

Saudi Arabia is not what it used to be. Their petroleum and other liquids production in 2014, at 11.6 million barrels per day [mbd], is only about 1 mbd above what it was in 1981 (and is just shy of the peak over the period 1980-2013). But their market share is distinctly lower, falling from 17% (of global output of 60.6 mbd) to under 13% (of 93.0 mbd). That limits their pricing power.

Elasticities tell the story. The short-term price elasticity of demand is about -0.2, the medium-term one of course is more elastic at -0.5 or greater. [In most energy markets the income elasticity of demand is roughly 1, though recent work finds it is less in the OECD.] So if the Saudis cut output by 10%, global output falls about 1%. That means prices rise 5%. But with the quantity they sell down 10% and prices up only 5%, that means their income falls by 5%. With a population burgeoning in numbers and expectations, and as the ideological seat of the Wahhabi sect that fuels radical Islam – but so far has not seen cause to bite the Saudi hand that feeds them – well, the kingdom can't afford a large income hit. Oh, and they're consuming what to me is a surprising amount of oil.

One other bit of economic logic reinforces this argument: when interest rates are low and prices are low, it makes sense to leave oil in the ground rather than to pump and sell it. Selling turns oil into bank deposits, and those earn nothing. Leaving oil in the ground also provides the option to benefit from future price rises [though the option loses its value if prices fall further]. So do you want to store your oil in the ground, or store your oil in the bank? (Those with finance acumen can do the corresponding net present value calculation, and maybe even put a valuation on the option.) For the Saudis, pumping oil makes sense only if their focus is cash flow rather than maximizing national income.

Thursday Update (albeit posting late)

Mike Smitka

I do a weekly radio segment on the economy on WREL, the local Lexington Virgina AM radio station. Here are my notes from the Aug 20th show. These are not necessarily the order in which I presented them, and I avoid numbers when I can - radio is not the medium for conveying data – but I like to have them in front of me.

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Employment: I won't talk details, but job growth continued to trend somewhat above population growth, with no sign of acceleration. Projecting out, as I've mentioned periodically for the past two years, we won't return to normal levels of employment until 2017 and more likely 2018. I'll return to that topic later in the fall.

New Residential Construction: The latest data were out Tuesday [Aug 18]. The showed slow improvement, especially for multifamily units, the latter something we've seen all this year. For all the feel-good headlines, residential construction is still only level of January 1992 when the population was 20% smaller [321 mil today vs 255 mil then]. Corrected for population growth, the adjusted rate is still below any point of the last 60 years – we're at about the 1990 trough, but still below the level of the early 1980s housing bust. [If numbers are bad on radio, graphs are worse, but I can include here!] The recent peak was in January 2006. Today we're at half that level [49%] in per capita terms. Times are good only if you don't remember what things were like a decade ago, before the Greenspan-Bush bubble burst: relative to April 2009, well, housing starts are 2.4x that level! The bottom line is that housing continues to be a big drag on the economy.

China: yuan depreciation or dollar appreciation?

by Mike Smitka, Economics, Washington and Lee University

The coverage I've read focuses, implicitly or explicitly, on the RMB [yuan 元] / US$ rate, that is, the bilateral context. (An exception is the graph in the latest Economist article, The Devaluation of the Yuan: The Battle of Midpoint, 15 Aug 2015, 63). Their focus is however capital flows, which as I've blogged about before in "China's Pending Depreciation" [on this blog] and "Foreign Exchange Controls" [on my Econ 274 "China's Economy" class blog] will lead to a fall in the value of the yuan – exactly what's happened.

Ho, hum: the 3% change still leaves the yuan stronger than in September 2008