Steven Hansen's  Instablog

Purpose:

To outline steps the government must take to export manufacturing jobs and industries. 

Methodology:

Increase the cost of manufacturing goods inside of America while reducing the barriers and costs to foreign produced goods for sale in the USA.

Procedure:

1. Raise taxes (payroll and income) on goods production industry
2. Increase Regulation on goods produced in America
3. Eliminate Import Duties
4. Strengthen collective bargaining legislation
5. Increase minimum wage.
6. Enhance liability legislation (non-US manufactures have no pockets)
7. Improve Anti-pollution laws / carbon taxes.
8. Increase fuel taxes (ships use untaxed fuel).

Conclusion:

At this point you may be wondering why this article belongs on a financial blog.  The trigger was the July 2009 jobs data when I realized that the manufacturing job losses of this Great Recession were probably permanent.

Even in the "good" economic times of 2004 through 2006, we were shedding manufacturing jobs.  To put some perspective on what is happening, 31% of all manufacturing jobs have disappeared since January 2001.

We have entered the New Normal.

Manufacturing was 12% of the non-farm private workforce at the end of our last recession in 2001.  It is currently 9% of the workforce today.  When you trend recessionary effects such as employment and unemployment from past recessions, you do not expect to find such a distortion in the underlying data occurring at such a rapid rate.

America is going through a rapid metamorphosis.  The underpinnings of our economy are based on manufacturing – tax structure, social laws / programs, education, and economic inner workings.  The effects of our rapid de-industrialization are adding to the chaos of this depression cycle. 

Have a good day.

Disclosures: None
 

The year-over-year (YoY) calculations soon will improve significantly beginning with August 2009 data.  The media will start reporting economic turning points which do not really exist.  Expect the economic clowns to spread a false message of recovery.  The clowns will ignore the month-over-month (MoM) calculations which help define the economic trend.

• The Commercial Real Estate Time Bomb
  
•  Employment Shows Economy Still in Crisis
  
•  Volume Increase in Home Sales
  
• Manufacturing Close to Bottom
  
•  Consumers Are Unwilling Unable Scared to Drive Recovery 

I purposely mixed the data between sources this week to demonstrate how many of our economic indicators are inconsistent.  There is no perfect economic indicator.  There are data-gathering errors, sampling errors, methodology errors, and analyst errors.  There is no economic indicator which does not have error.  All suffer from analysts and punters misusing or misrepresenting the message whispered in the data.

This does not make any of them a bad indicator.  My favorite “whipping boy”, the Institute of Supply Management (ISM) surveys, is still very useful – as long as you understand their shortcomings, and use it in conjunction with other data you are seeing, and then trend the results.

Even the jobs data this past week from the BLS had a certain aroma.  It is possible to pick the corn out of the crap develop useful data.

                                                        ~ ~ ~

There is little doubt we are close to the end of this recession’s decline.  Yet, the painful process of watching the data get less bad month after month continues.  The end of recession needs to have a data low point (trough) in at least jobs and manufacturing.  

 This did not happen in July 2009. 

                                                        ~ ~ ~

The Commercial Real Estate Time Bomb

San Francisco Fed President Yellen said commercial real estate could once again increase the downside risks to the economy.  Bank of Tokyo – Mitsubishi UFJ summarized the economic effect of Commercial real estate to date:

Residential construction has been a drag on real GDP since Q1 06, while commercial real estate just started to subtract from growth in Q4 08, 0.3 percentage points of the 5.4% real GDP decline, moving on to Q1 09, 2.3 percentage points of the -6.4% real GDP decline, and 0.3 percentage point of the -1.0% Q2 real GDP decline. This drag is a worry, but nominal GDP commercial construction has now declined 18.1% this cycle, similar in magnitude to past corrections in the 80s and 90s.  

Commercial real estate decline will not end in 2Q 2009, and most likely there will be another 3 to 5 quarters of decline.

The banks are full of non-performing paper.  We have never suffered a nationwide housing price decline, and this has bled the banking system of its reserves despite their recapitalization efforts.  And this crisis is still not over.  Combine this with the normal non-performing credit card debit defaults which accompany a severe recession.

Now add Commercial loan defaults.  The banking industry’s bacon has been saved in the past by “V” recoveries.  This takes the pressure off of the banks because the borrower’s business picks up and increases revenue, the commercial property values increase.

There will be no “V” recovery in the “new normal”. 

Employment Shows Economy Still in Crisis

The headline: The government announces Unemployment rate falls 0.1% in July 2009 to 9.4% - Recovery Begins. 

The reality is that non-farm civilian private jobs are still evaporating at the rate of over 4% per year, but this number is trending down from 8% earlier this year.  Employment is less bad.

It is impossible for a expanding population to have unemployment rate fall while the number of jobs also falls.  But it appears nothing is impossible in America.  There is a methodology error which I have questioned in the past as this unemployment data is extrapolated from a detailed telephone survey.  If it were my data I would have published it and disclaimed it as it did not make sense.

Trending the BLS employment data (“Chart 2” graph above) and the ADP employment data (graph below), job losses and job gains should equalize in 2 to 4 months if current trends hold.  This is an end of recession marker when this event occurs.

Our changing methodology in deriving the unemployment rate makes backward comparisons between past WWII recessions difficult – our current methods paint a rosier picture.  When you encounter a statistic where today’s situation is worse, you take notice.  Hat tip to Mish and Calculated Risk for the graph showing workers who have exhausted their regular unemployment benefits (and maybe even the extended benefits)

The 4 week moving average of advance initial unemployment claims decreased slightly to 555,250.  The use of unemployment insurance data to project total unemployed as some analysts are trying to do will yield erroneous results.  The use of this data is to trend initial claims only – it is a gauge of the rate people are becoming unemployed.  This rate continues to trend downward, and this is simply sending an economic signal that the highest rate of decline of employment for the Great Recession has past. 

The best explanation of unemployment initial claims recent volatility was given by Bank of Tokyo – Mitsubishi UFJ: 

A plunge in initial jobless claims occurred over the first half of July because the bankruptcy announcements of Chrysler and GM and the associated plant closings meant that the usual plant closings in July for retooling instead happened much earlier than is typical (pushing up claims to record highs in May and June). Historically, the BLS has always had difficulty seasonally adjusting the numbers surrounding the auto retooling each summer, and the early plant closings made the adjustment even more difficult this year. The weeks ending July 4^th and 11^th received a huge downward seasonal adjustment, while the weeks ending the 18^th and 25^th were bumped upward. Today’s data is the first that reflects the true underlying level of claims. 

For continuing unemployment claims, the huge drop in July that was also affected by seasonal adjustment issues suggests the unemployment rate will move down (temporarily) in July as well – even when you take into account the fact that much of the drop in continuing claims was due to benefit exhaustion (the current exhaustion rate lies around 50%) and not due to a pick-up in hiring.

Volume Increase in Home Sales?

Home sales volumes are in all probability increasing but precise data is not available.

The National Association of Realtors NAR says contracts signed for home sales in June 2009 are up 3.6% MoM, and up 6.7% YoY (seasonally adjusted).  This data is for contracts for sale, and not actual sales which potentially would occur one or two months later.  Normally, this type of data is ignored, but the markets are searching for green shoots.

In comparing the NAR pending home sales data to NAR’s home sales numbers last week, the data does not correlate.   Even if the existing home data is time shifted two months, the percentage changes over the preceding period and YoY do not match.  Users of this NAR data should not draw any conclusions except for confirmation of general trends.  The NAR needs to publish its range of error as its data gathering methodology appears ragged.

This pending home sales data also does not correlate to the June data of the Mortgage Bankers Association which show basically flat new mortgage application rate.  This difference could be explained by more cash buyers, either:

• Investors with cash looking for fixed income and not needing a mortgage; or, 
  
• Buyers’ down-sizing and not needing a mortgage.

The new mortgage application rate remain relatively unchanged.  The four week moving average of mortgage loan application volume (which includes refinancing) increased 1.2% WoW, and increased 4.1% compared with the same week one year earlier.  The refinance share of mortgage activity increased slightly to 54.2% of applications.  The average interest rate for 30-year fixed-rate mortgage decreased 19 basis points to 5.17%. 

Manufacturing Close to Bottom

The Institute of Supply Management (ISM) manufacturing index, considered a key economic indicator, was contracting less bad in July 2008 at 48.9 (50 being manufacturing is neither contracting nor expanding). 

Industrial production levels are at the lowest levels this decade – and industrial capacity utilization is at the lowest since WWII.  The good news is that manufacturing is close to the bottom, and the reality is we are in a very deep hole.  Both new orders and production now are growing according to this subjective index.

This index is an un-weighted average across all manufacturing sectors – it should be viewed as “bar room talk”.  Manufacturing now accounts for only 5% of our economy based on revenue and employment.  Because of the multiplier effect into the service industries we continue to view manufacturing as a cornerstone of our economy.  The American tragedy is that this may be no longer true.

But this ISM survey does confirm other manufacturing indicators which also paint a “less bad” and “close to a bottom” picture.  There is no indication that ISM manufacturers believe the economy is going to start growing soon.

A segment of manufacturing, auto sales had a nice bump up in July 2009. This is the fourth month of increasing sales which is confirmation of a bottom.  Light truck sales after having a bad month last month is up MoM – but not far above the Great Recession lows.  Surprisingly, both Toyota and Chrysler increased market share at the expense of GM, Ford and Honda.

Yet Ford had its first YoY sales growth.

Preliminary June 2009 Census data on manufacturing released this week confirms manufacturing was still falling in June.  The data remain confused as happens when manufacturing bottoms.  New orders up slightly, shipments up (but due entirely to the increase in value of petroleum products), unfilled orders decreased slightly, and inventories down slightly.  The good news in this data was that HVAC and electric generating equipment were the reason for the increase in unfilled orders – this is a definite end of recession activity.  The biggest drag was the transport sector which normally signals the end of a recession by beginning to expand.  Conflicting signals.

Consumers Are Unwilling Unable Scared to Drive Recovery

Economists believe that consumers who have confidence in economic conditions will spend more.  As consumer spending accounts for 70% of the economy, consumers are continuously fed unrealistic economic hope to trigger spending.  The latest ABC consumer confidence numbers show the brainwashing is not working:

Ninety-two percent say the economy is in bad shape, at or above the fearsome 90 percent mark since early October; 76 percent think it’s not a good time to buy things; and 56 percent rate their personal finances negatively.

I see no reason consumers should have confidence.  There is no apparent economic driver, and they have been misinformed about “green shoots”.  There is no data which indicates in any shape or form we will return to the economic good ‘ole days of the past.  Government spending is out of hand, and the consumers believe this is trapping them into a future of higher taxes and reduced economic growth.

Many of the economic indicators have the ability to recover relatively quickly, but personal income is not one.  With our consumer driven economy, the more income consumers receive, the more money they can potentially spend. Personal income fell 1.8% MoM in June 2008.  This decline raises more questions than answers as it backs out the gains of the previous month and puts personal income in 2009 into negative territory.  One more reason not to react to individual month data, and to monitor trends.

Last weeks GDP release showcased government’s failure to overcome consumer belief that the economy will remain bad indefinitely.  David A. Rosenberg opined in John Mauldin's “Outside the Box”:
 

Consumer spending came in at -1.2% annualized, twice the decline expected by the consensus. This occurred in the face of gargantuan fiscal stimulus and leaves wondering how this critical 70% chunk of the economy is going to perform as the cash-flow boost from Uncle Sam's generosity recedes in the second half of the year. Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms? What do we do for an encore? In the absence of the fiscal largesse, it is quite conceivable that consumer spending would have shrunk at a 10% annual rate last quarter! Nonresidential construction action sagged at an 8.9% annual rate and this was on top of a 44.0% detonation in the first quarter. Ditto for equipment & software 'capex' spending, also down at a 9.0% annual rate and this too followed a 36.0% collapse in the first quarter. Residential construction slumped sharply yet again, this time at a 29.0% annual rate. These are the guts of private sector spending and collectively, they contracted at a 3.3% annual rate -- the sixth decline in a row.

Consumer credit decreased at an annual rate of 5.25% in 2Q 2009. Revolving credit decreased at an annual rate of 8.25%, and nonrevolving credit decreased at an annual rate of 3.5%.  This is a continuation of the trend which began 4Q 2008 when consumer credit began contracting.  It was expanding at nearly 5% per year before 4Q 2008, and now is contracting at approximately 5% per year.

Chain store sales for July 2009 remained depressed.  Data is normally expressed as YoY declines, and the recession was beginning to be felt in retail sales in August 2008.  So expect a big improvement next month which is simply more smoke and mirrors.

As a reminder, these same store sales figures do not include Walmart which is 40% of the chain store sales.  Walmart has decided not to report monthly.

Additional Economic Data This Week

Shipping counts are a good validation of economic trends as goods must be shipped between users.  The West Coast sea container counts are not rising, but are flat or slightly declining.  There is no indication of recovery.  Although rail counts are currently slightly improving, they remain below recessionary highs of earlier this year.  

Construction spending had a slight bump up in June 2009.  The dirty little secret was that it was caused by government spending – and not the private sector.  Still, the decrease in private sector construction spending was a mere 0.1% MoM, and was the smallest decrease this year.  One month does not make a trend.

Filing for Bankruptcy: eNucleus (ENUI), NanoDynamics (NNDY), Cooper-Standard Holdings,  Security Bank (SBKC),  Cygnus Business Media,  Finlay Enterprises (FNLY).     Bank failures this week:

Economic Forecasts Published this Past Week

The Economic Cycle Research Institute (ECRI) released their Weekly Leading Index which continues its gain on this index’s fresh 5 year high.  Lakshman Achuthan, managing director at ECRI, provided the following statement:

With WLI growth soaring into the double-digit range, prospects for U.S. economic growth have brightened significantly. 

Hat tip to Steve at  MEMETICS & MARKETING for editing support.

Disclosures: long MMF's, AAPL, AMZN, ORCL, GOOG, EWZ, EWY, EWA, EWC, PIN,  Physical Gold

This definition of GDP is so hard to understand, and the methodology to quantify GDP so convoluted, it should come as no surprise the media and the politicians believe GDP is the gauge of the economy.

It does comes as a surprise that many economists also believe GDP is the economy.

GDP Explained

The concept of GDP was an attempt by economists to quantify the important core economic elements so that America’s economic activity could be gauged.   

GDP does not include many economic activities,

If you buy a new car this is in GDP, if you buy a used one it is not.  If you buy a new house it is included in GDP, a used house is not.  And interest income is also ignored in GDP as it is an intangible.  The point is the item or service must be produced – it cannot be pre-existing.  In fact, one half of all of our economic transactions are excluded from GDP.  And even this statement ignores the black markets of illegal drugs, flea markets, barter transactions, Federal Reserve transactions, etc.

Wikipedia definition:

GDP can be defined in three ways, all of which are conceptually identical. First, it is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time (usually a 365-day year). Second, it is equal to the sum of the value added at every stage of production (the intermediate stages) by all the industries within a country, plus taxes less subsidies on products, in the period. Third, it is equal to the sum of the income generated by production in the country in the period—that is, compensation of employees, taxes on production and imports less subsidies, and gross operating surplus (or profits).

The most common approach to measuring and quantifying GDP is the expenditure method:

GDP = private consumption + gross investment + government spending + (exports − imports), or, GDP = C + I + G + (X − M).

Using NIPA Data Directly without GDP Filters

GDP is derived from America’s financial transaction income statement – the National Income and Product Accounts Table (NIPA).  GDP filters the elements of these NIPA tables which meet the criteria for GDP.  

In essence, the NIPA tables together are similar to a detailed corporate income statement with supporting ledgers (tables).   Income = expenditure.  GDP is derived by using the expenditure side of the NIPA tables.

In the Wikipedia definition of GDP, the third method of determining GDP is to tally the income produced in a country (highlighted above).  Of course only specific income producing activities would be included in GDP.  As the income side of the NIPA is not detailed, it cannot be used to derive GDP.

To get a broad picture of the economy, the entire income side of the NIPA could be used - the total income of individuals, corporations and government.  A single dollar may flow many times between individuals, corporations and government in each period.  Nothing is excluded - interest used to finance the economy, profits from stock transactions, flipping houses, etc.

As the total NIPA income is $24 trillion (individual + corporations + government), it provides a broader view of the economy.  It could be argued that this total NIPA income is the economy. 

As GDP is a subset of the NIPA tables, it is expected that the movements of both should be similar.  The graph below illustrates the QoQ changes to both real GDP and the NIPA total income.  As the economy is being more broadly viewed with a larger sampling, there is much less volatility (noise).

A total income approach to viewing the economy creates a less volatile data set, it is easier to trend.  For instance, it is easy to see that since 2006 we have been in a cyclical down trend.   This is much closer to alignment with the start of the recession in December, 2007 than is the peak in GDP, which occurred in the middle of 2003.  GDP has been in a cyclical down trend (with considerable volatility noise) since then.   

There are two tables used to create this NIPA total income – Table 6.1D which tallies the income of business and government, and Table 2.1 which tallies personal income.  In both cases, the gross income was used without adjustment.

Unfortunately, Table 6.1D. National Income without Capital Consumption Adjustment by Industry has not been updated for 2Q 2009.  This table provides the corporate and government figures.   We will have to wait until 27 August 2009 to see 2Q results.

Table 2.1 provides personal income and was updated for 2Q 2009.  Personal income is ½ of the total NIPA income.  There was not much difference in personal income between 1Q and 2Q.  Personal income grew by only 0.07% from the first quarter to the second, while wages and salaries in the private sector declined by 1.48%.  Government paid wages and salaries grew by 1.02%.  Personal current taxes declined and disposable income increased.

Although this income data could be fine tuned (such as removing taxes), there was no noticeable effect on the interpretation of the data.  When data is not manipulated or adjusted, the results are easier to accept.  If the data is detailed, an analyst can always remove an element which is determined is not appropriate for a particular analysis.

Using Total NIPA Income to Plot Economic Cycles

As NIPA total income is now trapping more of the economy than GDP, velocity of money calculations are more precise.  Velocity of money analysis can be used to understand economic expansion and contraction cycles.

It is significant that using NIPA total income to determine velocity of money, we had a growth (expansion) cycle peak in 4Q 2007 – an exact marker for the beginning of our Great Recession.

It may be that velocity of money stopped declining at the end of 2008. However, 2Q 2009 results will not be published until later this month.   I will revisit this velocity of money analysis when data becomes available.

If the 2Q 2009 data confirms a cycle bottom, it does not conversely imply an expansion cycle has begun.  It confirms that the economy is no longer contracting.  There are two important points:

• We have become Pavlov’s dogs.  We are conditioned to thinking about jobs and manufacturing being the economy – like it or not, this is less than one half of the real economy.  The NBER marked the beginning of this recession using jobs and manufacturing.  Half of the economy is ignored.
• As we are travelers on this economic river, what happens today was set in motion many months ago.  Economic change manifests slowly.  It is almost certain that the events which will lead to the end of this recession sometime this year have already occurred.

Using Total NIPA Income to Calculate Real Economic Growth

Using NIPA total income data can be used to calculate real economic growth.  Real GDP is an attempt to make GDP comparable across many years by removing the effects of inflation and other phenomenon to facilitate comparison.  No one fully believes the BEA's real GDP number is correct.  

The objective is to calculate real economic growth.  Somehow the effects of inflation and population growth must be removed. 

Most analysis ignores population growth.  Consider that if your population grows by 1%, the economy needs to grow by 1% just to be operating at the same economic level per capita.

Inflation is a contentious subject as very few can agree on its specific determination.  Using QoQ comparisons, the actual amount of inflation will be insignificant between quarters unless we enter a high inflation or deflation cycle. 

As population is growing at over 1% per year – the data is given a 1% headwind to overcome.

If this graph is correct, we have had little real economic growth this century.

Summary

Use of NIPA income for economic modeling is transparent and straight forward.  Quarterly data does not go back far enough to test past economic cycles.  But use of this NIPA Income data provides an improved and more realistic picture of the economy.

Using total NIPA income as an economic indicator does not create a perfect solution.  It also is not the total economy, just more of the total than GDP.

Disclosures: None