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Saturday, August 22, 2015

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.

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.

CPI:  headline CPI for July was 0.2%, and for January - July [compounding the geometric average of 0.09%] it averaged an annual rate of 1.0%. Now there's the drop in gas prices, while food prices are falling despite the California drought. Those pull down the headline number; inflation less food & energy is higher at 2.3%, though for past 3 months that number has trended down. [A query for my students come September: how volatile are the data? – do 3 months a trend make?]

The standout: services excluding energy-related rose at 2.8% and shelter at 3.5%. But "medical care commodities" rose only 1.9% and "medical care services" only 2.2%, both below overall the "core" rate of inflation and both below the level for recent years, perhaps reflecting cost controls of Medicare.

Too many numbers to discuss but: 16% trimmed-mean CPI and median CPI are down a bit to 2%, sticky price CPI at 2.1% is up a bit. As noted, overall headline rate 0.2% from year ago, but headline inflation less food and energy was at 1.8%. All combined, the data don't indicate a trend, up or down.

Energy: I was in California recently, and saw gas prices well over $4. Returning to Virgina, I was surprised to see prices approaching $2. Lower oil prices have had a huge impact – though CA has more taxes and due to smog issues a more expensive type of basic gasoline, so their prices won't get as low.

Separately, the drill rig count is down 50% so far this year. Of course the half still drilling are doing so in the most productive geologies. Well output drops quickly in places such as North Dakota and Oklahoma (falling by half over two years – my recollection is the rate is faster). So total output won't keep rising, but with continued drilling neither will production collapse. Meanwhile the weak global economy means demand isn't strong.

Is this collapse due to a Saudi conspiracy, to preserve their market share? That misses the arithmetic of what output changes do: the Saudis are today a smaller part of global market and their behavior has less impact. If they cut output 10% or about 1 mb/d, it could – would! – drive up prices. However, my back-of-the envelope calculations suggest prices would rise by perhaps 5%, not by enough to increase their revenue. So this [-10%+5%] implies their income would drop 5%. With a burgeoning population (and an ever-bigger royal family!) that has high expectations, the Saudis need money to buy off their people. It's made worse by the royal family's dependence on the Wahhabi movement, which provides the religious foundation of (Sunni) Islamic fundamentalism. The Wahhabis helped the Ibn Saud gain power, and the House of Saud supports them today, bankrolling Wahhabi schools around the world. There's plenty of irony that our "good friends" the Saudis support the movement behind the ideology of terrorism. In contrast Iran's Sunni fundamentalism is more nationalist than terrorist – indeed they are quite effective in fighting ISIS and el Qaida. Why are they our enemies? That's a topic for Mark Rush (W&L politics) and Pat Mayerchak (retired VMI Intl Studies) on their WREL radio segments, as both are are knowledgeable about and have lived in and visited the region.

ACA: In California I attended a nursing conference along with my wife, and as part of a presentation on the Affordable Care Act. There I saw a video put together by a reporter who asked people on the street about ACA and Obamacare. What the reporter found was that most hated "socialist" Obamacare, but loved the Affordable Care Act. Of course they are one in the same thing. If the people on the street base what they say on their personal experience with ACA, they seem to understand that it does what the name suggests, the policy has been a success. But the average person is unable to connect that with what they hear on Fox news. Even media not dominated by preconceptions contributes to such confusion, as they hear "balanced" reporting that gives air to "the other side" – even when the facts show there is no other side!! Of course these healthcare professionals have to deal with patients who through the internet and advertising and talking heads "know" what ails them and which medications they need. It was (hopefully!) a sobering lesson for the healthcare professionals who comprised the audience, though the clip was shown because of survey data suggesting healthcare professional have very little understanding of the ACA.

This should serve as a caution as the Republican primary heats up. Most of what I've heard doesn't make sense, and some of what is coherent is either wrong or would be bad policy, not producing the results the candidates presume. The primary is about putting together sound bites, not putting together policy. As we approach next year we'll have platforms and position papers and issue speeches, but for the moment most of what is said on the hustings leaves me as an economist speechless, that is, I have nothing to analyze.

Interest Rates: the Fed has already been acting. The taper is over, and long-term assets are falling, from $2.09 trillion to $1.94 trillion or -9%. Most of the other special lending has been nil for 5 years. While 30-year rates not as low as early this year, they have been falling since June and are under 3%. As I claimed at the time, the taper in fact didn't lead to rising rates. Now the Fed is indicating it will likely boost short-term rates by the end of the year, which will surprise no one, most of all financial markets. Remember, too, that rates are 0% and thus "boosting" will be to raise short-term rates to 0.5% at most, which is still low! Anyway, in expectation of this increase 1-year rates have gradually risen to 0.4% and 3-year rates to 1%. Those rates are still extraordinarily low, and the implication of a fairly flat yield curve is that a 1-year bond in 2018 will yield only 2.5%.

The bottom line: markets expect interest rates and inflation to remain very low for years to come.

China: there's lots of talk of depreciation, but it's really a dollar appreciation. Indeed, once we recognize that China trades with the whole world – Europe is more important to them than North America – the RMB (the currency's official name, it's the yuan in common parlance) is in fact stronger than a year ago. Why? – because the dollar is stronger relative to the currencies of Europe, Japan, Korea and Southeast Asia as well as Canada and Mexico. The flip side is that it's a great time to be an American tourist abroad. Japan is cheap – my wife and I stayed in a home through Airbnb at $50 a night – and Paris was reasonable. London is still expensive, but they're not on the Euro. Anyway, to date the change is fairly small at 4%, well within the range of volatility of major currencies, and much less than the dollar has strenghthened against the bulk of China's trading partners. [See the previous post on this blog.]

The bottom line is that still leaves them with a stronger yuan relative to a year ago, and certainly relative to 3 years ago. If their intent was to boost their economy, they needed to push the yuan down a lot more!

Furthermore, China is doing what we're asking, liberalizing their markets. Chinese savers (which includes lots of companies that can no longer find investments equal to their cash flow) don't have diversified portfolios. All their assets are domestic, and they are heavy on stocks and real estate and bank deposits that pay 0%. So foreign assets appear very, very attractive, particularly as their stock market crashes. And we're poised to raise rates, while longer-maturity Chinese rates are falling (not that the average saver can tap longer-term markets). So if you were Chinese where would you park your savings? at home in yuan? No, overseas in dollars!! So with everyone wanting to buy dollars, of course the price of the dollar rises and that of the yuan falls. (Given the lack of experience of players in China's markets, that also gives rise to a trend of a falling yuan that gives all the more encouragement for trend-driven Chinese investors to buy dollars while the getting is good.)

For my Econ 398 students: Rudi Dornbush explored this in one of the early rational expectations macro models, though we'd have to devote a couple class days to and likely won't spend much time on open economy issues.