Entries for January 2008

Initial jobless claims, just about the best real-time indicator of the health of the labor market, jumped last week by 69,000 to 375,000. That pushed the four-week moving average to 326,000. Is the labor market finally cracking? If so, I think even the biggest bulls would toss in the towel and predict a recession. But we may not be there yet. A few opinions from around Wall Street. From the econ team over at Action Economics:

Today's initial claims surge captured the attention of the markets, though the pop is likely part of the seasonal gyrations that have plagued these figures over the last three months, especially given the late MLK holiday. The gain leaves an average reading thus far in January of 326k that is still below what we continue to see as a 335k-340k trend-reading for these figures over this three month period.

One reason Democrats want to raise taxes on wealthier Americans is to combat the perceived problem of growing inequality. But that strategy hasn't worked in Britain. An interesting study from the Institute for Fiscal Studies in the U.K. looked at the rising of income inequality over there and found that high taxes have not stemmed the growing gap:

Even though the current Government has increased taxes on people with high incomes, this has not prevented them from racing further away from the average level of living standards across the country. In recent years, it is only in the wake of extended falls in the stock market that the incomes of the richest have fallen.

My take: I have argued this point for some time. Among the reasons for growing income inequality, though I have reason to doubt the gap is as severe as some make it out to be, are 1) rising—and nonlinear—rewards for high levels of education, 2) rising rewards for superstar performers—whether NBA stars or CEOs—who can capture economic benefits from a global presence, 3) the stock market. If you are not exposed to the market, whether as an investor, a financial professional, or someone whose salary is tied to the market performance of your company, you will fall behind.

Economic professor and Econbrowser blogger James Hamilton thinks the Fed's big rate cuts this month could result in a stronger housing market in a couple of months:

My research paper went on to demonstrate that although interest rates respond immediately to the anticipation of any change from the Fed, it takes a considerable amount of time for this to show up in something like new home sales, due to the substantial time lags involved for most people's home-purchasing decisions.... According to the historical correlations, we would expect the biggest effects of the January interest rate cuts to show up in home sales this April.

One of the interesting tidbits from the Florida GOP exit polls concerned the economy, with 45 percent of Republican voters, according to CNN, ranking it as their most important issue. And even though Mitt "I have the economy in my DNA" Romney stressed the economy as his key issue and promoted himself as an economic expert due to his private-equity—I mean, "venture capital"—background, John McCain won those voters by 40 percent to 32 percent. (And 63 percent, BTW, described the economy as "not so good/poor.") Moreover, exactly half of voters, according to CBS, said they would prefer that the next president place "a higher priority on reducing the budget deficit than on cutting taxes." With those voters, McCain crushed Romney 40 to 27. With that as context, a few observations:

1) I think many voters now equate deficits with fiscal mismanagement, probably not differentiating much among the budget deficit, national debt, and trade deficit. Candidates who propose tax cuts with no plan to "pay for them" will meet with great skepticism. And McCain's rep is "budget cutter" while Romney's is "tax cutter." Voters seemed to buy McCain's theory that lower spending "is the path to lower taxes." (And indeed, taxes tend to get raised when deficits are big.)

If today's surprisingly weak fourth-quarter gross domestic product report—the economy grew at a worse-than-expected 0.6 percent annual pace—is a sure recession harbinger, then why is the stock market not falling off the cliff? And why is the "recession in 2008" contract at the Intrade betting market down by 9 points to 60 percent, meaning a recession is now considered less likely? Three reasons:

1) The big negative for growth was a drawdown in inventories by business. That subtracted 1.3 percentage points from growth. But as Nigel Gault of Global Insight explains, "that suggests that companies are keeping their inventories lean, making it less likely that they will need to slash production in the future."

As regular readers know, I have been somewhat fixated on the low level of initial jobless claims—around 300,000 a week—as a positive sign for the economy. Employees may not be doing a whole heck of a lot of hiring, but they are not firing much either. Why so low? As Ed Yardeni explained to his Oak Associates clients yesterday:

While a recession could change their minds, employers are reluctant to institute mass layoffs, which can result in the loss of skilled workers who are costly to replace when the economy improves. I've previously observed that the U.S. is becoming increasingly a knowledge-based economy. It's hard to fire knowledge workers because they literally know too much about how to run your business. Furthermore, business managers may be more confident than investors seem to be that stimulative monetary and fiscal policies will work, as they have in the past to revive economic growth.

Whatever the reason, there is some new evidence that my instincts are correct on this one. According to a new economic forecasting model—one looking at the three-month change in the unemployment rate and initial jobless claims—developed by my old friend Tim Kane, chief labor economist for the Republican staff for the Joint Economic Committee of Congress, the odds of a recession are at just 36 percent or so—and probably dropping. Wall Street economists put the odds at 50 percent or better while the betting markets put the odds of a recession at 2 in 3.

The current value of this paper's [recession indicator] at this time (35.5 percent) should be taken with a grain of salt—it is based on simultaneous spikes in the two employment numbers utilized. Already in 2008, weekly jobless claims are declining dramatically (from 344,000 a month ago to 314,750 last week), and the RPI index will almost certainly decline as a result. The real economy may be robust, but the financial side of the economy faces serious challenges in the wake of the subprime mortgage crisis. A financial recession may well create duress into the real economy, causing a genuine contraction in output and employment. Whether this happens, the evidence provided in this paper hopefully gives observers of the U.S. economy a better sense of what numbers to watch.

Are we slipping into a recession or not? We may find out soon. It is tough to underestimate how closely economists will be watching Friday's jobs report and ISM report on manufacturing. Economist Mark Vitner of Wachovia will certainly be tuned in:

If we are right and the weather was a major factor in depressing the December economic data, we could be set for a monumental turnaround beginning in the next few days. The consensus forecast for January's ISM report ... calls for an additional 0.5 percentage point drop.... The combination of colder and wetter weather in December and a fairly mild to typical January could set us up for a surprisingly strong number. If the ISM rises back above 50, any talk of the U.S. economy already being in recession should subside considerably.... We will also get the January 2008 employment report on Friday morning. The consensus is calling for a modest gain of around 65,000 new jobs and no change in the unemployment rate. Our own forecast calls for a gain of 110,000 jobs, and there is plenty of potential for an upside surprise. First-time claims for unemployment insurance have fallen in each of the past four weeks and remain unusually low at just 301,000 in the most recent week. The latest claims data are consistent with strong job growth but have been summarily dismissed because they seem so out of sorts with everything else we heard about the month of January.... If the claims data prove accurate, however, and we get a stronger-than-consensus nonfarm job gain, the recession trade will begin to unwind, sending stock prices and bond yields notably higher.

As of 5:56 this morning, before the polls opened in Florida, the Intrade betting markets gave John McCain a 55 percent chance to win Florida and Mitt Romney 45 percent. Pretty close, though. Doesn't look like the networks will be calling this one early.

Which Democrat is carrying the torch of Clintonomics (or Rubinomics, if you prefer)? By that I mean which candidate believes economic growth is best served by 1) free trade and 2) lower budget deficits or surpluses leading to lower interest rates?

Sorry, trick question. It's none of them. The last Clintonista is Republican John McCain. While all the Democrats have shown a skeptical eye toward free trade and pushed for pricey fiscal stimulus packages, McCain remains an unabashed free trader (while supporting a radical transformation of unemployment benefits and worker retraining programs) and has clearly expressed a belief in the core tenet of Clinton economic policy: By lowering government deficits, bond yields fall as well. This is because of less competition for savings and lower inflation risk—as perceived by bond traders—due to controlled federal spending.

With Washington in full freakout mode over our economy—which doesn't yet appear to be in recession and has 5 percent unemployment (historically low)—these upbeat comments from James Owens, CEO of global heavy equipment maker Caterpillar, in an interview with Dow Jones at the World Economic Forum meeting in Davos, Switzerland, provide a nice counterpoint.

"I think I'm considerably more optimistic than the mood here in Davos," CEO James Owens said Friday.... Owens said he expects "either a mild recession or a soft landing" on tap for the U.S. economy.... Issues surrounding subprime mortgages "have been with us for a while," and the correction in the wake of the housing bubble is already under way, Owens said.... Owens said he expects to see "a bit of decoupling" between the world economy and the United States, pointing to extremely strong growth in the Middle East, Russia, and other emerging economies, where the commodity boom has fostered strong balance sheets.

Better late than never, GOP presidential candidate Ron Paul has released his economic plan. A few highlights:

Tax Reform: Reduce the tax burden and eliminate taxes that punish investment and savings, including job-killing corporate taxes.... Spending Reform: Eliminate wasteful spending. Reduce overseas commitments. Freeze all non-defense, non-entitlement spending at current levels.... Monetary Policy Reform: Expand openness at the Federal Reserve and require the Fed to televise its meetings. Return value to our money.... Regulatory Reform: Repeal Sarbanes/Oxley regulations that push companies to seek capital outside of US markets. Stop restricting community banks from fostering local economic growth.

1) John McCain seemed to have no idea what the President's Working Group in Financial Markets is—in response to a Ron Paul question—even though the "plunge protection team" has been in the news aplenty since last August's credit crisis and a fave topic for the more conspiracy-minded folks out there. (More to come on this.)

2) Again, no one seemed to notice that Mitt Romney's tax plan—eliminating investing taxes for the middle class, basically creating a progressive consumption tax—is really every bit as radical and sweeping as Mike Huckabee's Fair Tax. I'm sure the Democrats will notice and attack it for favoring capital income over labor income.

"I'm very well versed in economics" is how John McCain responded to a Tim Russert question at last night's GOP presidential debate that referred to a past, possibly self-deprecating statement McCain made about his lack of economic expertise. Yet McCain really seemed to have no clue what Ron Paul was talking about when Paul asked him a question about the President's Working Group on Financial Markets—the so-called Plunge Protection Team—consisting of the Treasury secretary, the Fed chairman, and government regulators—that meets at a principals level during times of financial crisis. Some have conspiratorially speculated that the team has nudged Wall Street banks to buy shares to prop up the U.S. stock market. Here is the exchange:

REP. PAUL: My—my question is for Senator McCain. This is an economic question that I wanted to ask. It has to do with the President's Working Group on Financial Markets. I'd like to know what your opinion is of this and whether you would keep it in place, what their role would be, or you would get rid of this group. And if you kept the group, would you make sure we would see some sunlight and know what they're doing and how they're being involved in our markets?

When this number tanks, then I really go to DEFCON 1. But initial jobless claims were essentially unchanged at 301,000 in the week ending January 19, and the four-week average dropped from 328,750 to 314,750, the lowest since early October. So far, according to Action Economics, initial claims are averaging 307,000 in January, well below prior averages of 344,000 in December, 339,000 in November, 327,000 in October, 313,000 in September, and 325,000 in August. The current phase of megapessimism really began with the weak December jobs number, a preliminary figure that is so unreliable that the Labor Department might really want to consider delaying its release until more complete data can be gathered.

Venture capitalist-blogger John Ellis offers up an original fiscal stimulus plan:

Well, it's not mine, actually. It's the brainchild of one Leonard Yablon, my neighbor and friend and the former CFO of Forbes. And it goes like this:

1. Allow individual 401K withdrawals of $12,000 for the next 100 days.

2. Individual withdrawals up to $12,000 will be tax free.

3. The result should be an immediate infusion of $120-$180 billion into the economy.

4. Which should stabilize the markets. There are other plans out there. But the Yablon Plan seems the easiest to get done fast.