Economic Short Takes: Things I'm Worried About Right Now

I am running low on time these first few weeks of the term. Bits and pieces of things I am worried about right now:

On the employment situation report: Mark catalogued links to a host of insightful commentary that pours over the details of this decidedly negative report. The headline figures tell a brutal story, with ongoing steep declines in payrolls and aggregate hours worked pointing to a sharp contraction in economic activity in the fourth quarter. Internal details are even more painful, with the number of part time for economic reasons skyrocketing, one factor pushing the U-6 measure of unemployment up almost a full percentage point to 13.5%. Moreover, the diffusion indexes (for one month, 25.4 in December for all industries, just 11.3 for manufacturing) reveal the staggering breadth of this downturn; outside of health care, virtually no sector is spared some pain. Finally, further declines in the temporary employment sector point to more reports like this one in the months ahead.

On consumers: This coming Wednesday (January 14), we see retail sales numbers for December. It is not expected to be pretty; the holiday season is widely believed to have been the final straw for an array of retailers. A rough estimate based on confidence numbers suggests to me that real PCE continued to run at a rate of negative 1% or so in December, a swing of roughly 4 percentage points from spending growth prior to the recession. The positive impact of lower energy prices ran up against the forces of joblessness and increased saving rates (household deleveraging). The latter two dynamics will remain in play in the months ahead, whereas energy prices might not have much further to fall. To some extent, an increase in refinance activity should step up to compensate for any stagnation in energy prices, but I am not expecting any miracles, especially since, at least as of the third quarter, households had yet to significantly deleverage their balance sheets (click on chart to enlarge):

While tracking at a sustained 1% decline in real spending is bad enough, odds are for further deceleration – I suspect that household deleveraging in the years ahead will amount to more than a trillion dollars of foregone consumption. Business models that relied on consumer spending, particularly luxury spending (from RVs to $600 pairs of shoes) are going to suffer greatly in this environment.

On international trade: The sustained weakness in consumer spending points to a massive amount of import contraction, a supposition supported by Brad Setser’s article today on Asian export growth (or non-growth). This, however, might not yet show up significantly in today’s release of the US monthly trade accounts for November. Of course, if you were concerned that the trade deficit would eventually need to correct, you were likely looking for import compression as one mechanism supporting that correction. And the faster the adjustment, the greater the degree of import compression.

Unfortunately, the fastest way to get people to stop spending on imports is to put them out of work – which is where we are now. The dynamics have not played out as I expected, but the end result appears to be the same: There is no way out of this mess without a reduction in the standard of living for US households. Making the situation even worse is the inability of the world to break with the US dynamic, which means that rather than cushioning declining domestic growth, exports are likely aggravating domestic conditions. And the export decline is complicating predictions concerning the one potential silver lining – that at the end of this mess the US external accounts would be closer to balanced.

On fiscal stimulus: Lots of commentary on the incoming Administration’s spending plans; once again, Mark is keeping tabs. Given growing estimates of the output gap, there is substantial concern that the early numbers are woefully insufficient to meet the economic needs of the nation. The concern is accentuated by the large tax cut component of the package, which is widely expected to have little bang for the buck.

Menzie Chen argues that, contrary to concerns about enough shovel ready projects, there is plenty of room for infrastructure stimulus given the depth and duration of the expected output gap. And Nate Silver suggests that the early numbers are lowballing the expected final figure to gain a strategic negotiating advantage.

My take is that the current numbers, especially with a large tax cut component, are likely to pop the data in the second half of the year relative to the baseline. It is a lot of money. Behind that pop, however, the size of the package, and the timeline, are woefully insufficient to fix the economy. It took us almost three decades to get into this mess; it will take decades to get out.

While Menzie is right, there is plenty of scope for infrastructure projects, they need time and planning; if the Obama administration tries to rush such projects, they will be vulnerable to charges of waste, fraud, etc. But they need to do something to get a floor under the economy now to provide hope that they can get the job done over the long haul. Hence, we get a policy that is more of the same – tax cuts. Quick to implement with bipartisan support, but with, I suspect, few lasting effects – especially given the newfound predilection for saving. Why we don’t get more safety net expansions, however, is still a mystery to me. Seems like an easy way to use an existing program to quickly get money to those in need – and those who will spend.

On what should the little guy invest in or do with his 401(k): According to the Wall Street Journal, Americans are losing faith in the 401(k) system of retirement savings. I count myself in that group – the draw has not been good this decade for those following the rules:

Even if workers follow the golden rules of 401(k) investing -- saving early and diligently, holding a broadly diversified investment mix, never tapping their savings until retirement -- their success can still depend largely on the luck of the stock-market draw.

I would be willing to bet that the average person would sacrifice liquidity (money trapped in retirement accounts) to simply earn something like a 6% nominal return (assuming a real return closer to 4% or so) and avoid the headaches and stress of managing their own retirement portfolios. For the foreseeable future, however, if the Fed sees such a yield, they will want to snuff it out.

So what are your ideas? What should I tell people who ask this question? Assuming you stick with a base 401(k) contribution for the tax benefits, where do you put extra retirement money? My recent answer – feel free to offer alternatives – is to pay off your mortgage, which earns a guaranteed return (admittedly, there are some tax considerations, as well as the issue of walking away if you are seriously underwater). An interesting question – does a low interest rate environment really encourage taking on debt and spending, or the opposite? I recall in the 1980s people would take out high interest mortgages (the cost of housing was much lower, and as such still affordable), but then work to pay off the mortgage as quickly as possible. Under what conditions could a low interest rate environment create similar behavior?

Enjoy your week – good luck.

Comments

[Jason Rines...:]

"reveal the staggering breadth of this downturn; outside of health care, virtually no sector is spared some pain."

The pain is there too, 21% drop in Rx spending in 2008. On a personal level know a couple of Rn's. The hospitals they are working in are also cutting staff, hours and retirement benefits. But I do like Healthcare during this downturn compared to other sectors. What else will Boomers spend money on, more trinkets to clutter there homes? A bigger McMansion? I have a strong position in Consumer Healthcare and own a company in DTCA (direct-to-consumer-ad... Risk sharing models are the way to go to get real business done in this kind of economy to survive, then thrive.

Jan 12 10:14 AM

[Learning Curve:]

Thank you for writing a thoughtful article.
I'm looking with a jaundiced eye at the chosen members of the new economic team who –with the exception of Paul Volker—impress me as a bit out of touch with how to manage an economy in extreme recession.
(I have my view because I’m prejudiced to believe anything Paul Krugman says.)
Sighting Krugman's NYTimes article of January 11th and titled 'Ideas for Obama':

“First, Mr. Obama should scrap his proposal for $150 billion in business tax cuts, which would do little to help the economy. Ideally he’d scrap the proposed $150 billion payroll tax cut as well, though I’m aware that it was a campaign promise.
"Money not squandered on ineffective tax cuts could be used to provide further relief to Americans in distress — enhanced unemployment benefits, expanded Medicaid and more. And why not get an early start on the insurance subsidies — probably running at $100 billion or more per year — that will be essential if we’re going to achieve universal health care?”

My dream is that corporations will begin to welcome the prospect of relief from their obligations to provide health care insurance to employees. I’m dreaming that businesses will see that component of their budgets as burdensome (despite the fact that such costs provide a tax write off) and will, finally, support universal health care. What a relief for all of us if we were to join the rest of the ‘first world’ in taking this scary cost component out of people’s lives.

Jan 12 10:24 AM

[mc2406:]

Your point about Americans losing faith in the 401(k) system is playing right into the politicians hands. They can't wait to "save" all us poor Americans from having to think for ourselves by having the social security stystem take over control of 401(k)s and pension plans, offering a flat rate return. And, oh by the way, spending those trillions of dollars for more entitlement programs (spreading the wealth) that will ensure their continued reelections.

Jan 12 10:35 AM

[John Lounsbury:]

I was (a much younger) corporate professional in the 1970's. Those that were saving and investing through those terrible times are well-to-do (some wealthy) today. If you have a 401(k) plan, keep putting money into it. The minimum should be 5-10% or the corporate match, whichever is larger. You may have lost 40% or more in 2008. You may lose more in 2009. In 10, 20, or 30 years you will either be way ahead or no worse off than not saving at all. There is no downside except for the eventuality that the country and the economy do not recover from this downturn. In that event buy farmland and a couple of mules. (Or better still, horses - you can breed replacements.)

Jan 12 03:09 PM

[David Portnoy:]

Between the spending & the tax cuts being discussed, who will pay the future bill for the resulting deficits? I discuss the spending issue in my video blog at davidportnoy.blogspot.... which highlights my Top 10 predictions for 2009.

Jan 12 05:57 PM

[Urbane Gori...:]

You tell them that the market is like the 'Wild Wild West'... And they are on their own. I'd suggest having them buy Dr. Paul Schaap's book on his 50-50 system, available at this website : www.traderdoc.com/page...

jegan ;-)

Jan 12 07:35 PM

[Freedoms Truth:]

"I have my view because I’m prejudiced to believe anything Paul Krugman says."

Krugman is a charlatan and a partisan liar. He repeatedly twists and mis-stated things to make points that are, well, untrue. You are a fool to pay him any heed. Google Don Luskin "conspiracy to keep you poor and stupid" for more.

Jan 13 08:54 PM

[Freedoms Truth:]

Your point about Americans losing faith in the 401(k) system is playing right into the politicians hands. They can't wait to "save" all us poor Americans from having to think for ourselves by having the social security stystem take over control of 401(k)s and pension plans, offering a flat rate return."

That's right. the 401K is a good deal, far better than Social Security. I was worried about losing money in the 401K this year and a work colleague, a bit older and wiser, said "What are you retiring right now?" Nope. "So it doesnt matter what its worth right now." He's right. I wont tap it for 20 years. If I was worried about 'losing it all' 20 years ago, right after the 1987 wiped out a few years of gains - and quit saving and investing ... well, I wouldnt be worth 7 figures like I am today ...

So folks - DONT BUY THE BS about the stock market being a casino or the market being a terrible place to invest etc. If its out of favor now, it will likely get back in favor in the next 20 years. it might take a long time, especially if the Democrats are stupidly anti-market and anti-growth like they seem to be these days, but it will come back.

Jan 13 08:59 PM

[Freedoms Truth:]

“First, Mr. Obama should scrap his proposal for $150 billion in business tax cuts, which would do little to help the economy. Ideally he’d scrap the proposed $150 billion payroll tax cut as well, though I’m aware that it was a campaign promise. "

The OPPOSITE is true. The only good thing in the bill are the business tax cuts. The rest is useless pork that only adds to the deficit. We already have the biggest transportation bill signed last year and a trillion in govt bailout spending already. This bailout after bailout will not help, it will make things worse.
The reason is simple. The economy need *productive* activity. A recession occurs because *nonproductive* 'bubble' activity takes place that has to be bled out of the system. that retracement causes asset prices to fall, businesses that are untenable to go BK, and make economic activity shift or fall. To try to 'stem the bleeding' with MORE unproductive activity is nonsensical. Far better for the govt to give money to those to spend than to spend it themselves.
The best tax cuts are tax rate reductions. The rest are just gimmicks.

Infrastructure spending will not and cannot revive the economy, it just moves some economic activity into the govt sphere. Keynesianism has failed in US in 1930s, it failed in Japan in 1990s and it will not work here. It cant, and indeed the goals are all wrong - we dont need a short term stimulus, we need a plan for long-term economic growth.

Jan 13 09:04 PM