Although a Fabius Maximus post, The online bubble is bursting, makes a good argument that we are probably witnessing a tech bubble bursting, I think that has more to do with irrational company valuations and a subset of social media problems rather than online advertising problems. If Facebook or Twitter collapses do we stop buying goods from Amazon? Even if all of the companies described in the Kalkis Research paper, End Of The Online Advertising Bubble, collapse does that mean we stop buying goods from Amazon or stop using Google for comparison shopping? I don’t think so. Online advertising is dominated by Google and Amazon is making many forms of online advertising less valuable. When you think about the history of the Internet and online advertising, the problems are evolutionary. The biggest problem facing online advertising is the creative destruction forced on the online shopping market by Amazon. I work for a small online retailer. A couple of years ago the shopping experience consisted of a customer searching for a product and then following one or more of the ads or links on the search results page to an online retailer. In a world dominated by the Google search engine, it is not surprising that our largest and most cost effective source for orders was Google AdWords. Despite the occasional abuse and fraud from pay per click vendors and the weirdness of search engine optimization strategies, this was a pretty good business model for an online retailer to drive traffic to their site.
Today the largest and most cost effective source for orders is Amazon. Amazon has two things going for it, customers are increasingly going to Amazon for their shopping experience and Amazon has a viable alternative to the pay per click business model for online retailers. Many Amazon customers expect Amazon to have the lowest price. Our web site analytics say our customers have dramatically reduced the number of times they are using Google for comparison shopping. The most important change for online retailers is that Amazon’s unique business model says that Amazon gets paid only when they process an order. This solves several problems for retailers. Retailers do not worry about Amazon orders causing pay per click abuse, credit card fraud, or payment processing problems. Since the percentage Amazon charged us for an order was less than our pay per click advertising budget, it was an easy decision for us. To increase sales and profit we listed more products on Amazon and cut down on our online advertising. In a flat retail market our Amazon sales have gone up, our Google sales have gone down, and our profitability has gone up slightly. We live to fight another day.
I struggle to explain the current economy. Gone are the days of inventory-driven booms and busts. We hated the layoffs but at least the economic boom was robust and benefited everyone. It was the rising tide that lifted all boats. Now it seems that neither good or bad economic news affects the economy. We have several years of lousy retail sales growth that does not seem to matter. We are “experiencing the strongest streak of employment growth since the 1990’s” but that does not seem to matter. Almost all of our economic and job growth comes the health care sector but that does not matter. Even lower prices for gasoline do not matter. This is not my father’s economy. The doldrums we are experiencing seems to have more in common the crisis of confidence that President Carter spoke about in his “Malaise” speech but with one significant difference. Based on recent history it looks like the traditional correlation between jobs and economic growth is considerably weaker than in President Carter’s economy. I am not alone in my confusion. Lance Roberts voices similar concerns in his article, Is There A Problem With The BLS Employment Reports?
IF we were truly experiencing the strongest streak of employment growth since the 1990’s, should we not be witnessing:
- Surging wage growth as a 4.9% unemployment rate gives employees pricing power?
- Economic growth well above 3% as 4.9% unemployment leads to stronger consumption?
- A rise in imports as rising consumption leads to demand for goods.
- Falling inventories as sales outpace production.
- Rising industrial production as demand for goods increases.
Obviously Mr. Roberts was expecting a much stronger correlation between job and economic growth than we are seeing. The more interesting question has to be, why are businesses hiring when it looks like that hiring more people does not translate into growing sales?
Charles Smith shows in this chart the growing disconnect between jobs and economic growth has been going on for a long time.
Over the last forty years we have chosen to become a country less dependent on labor. Part of this decline can be explained that global trade has encouraged countries like the United States to ship low wage jobs to countries with lower labor costs. A good portion of our textile business went over seas for this reason. Ironically this “land of opportunity” has less opportunities for low wage jobs than ever before and an even bigger problem with middle class jobs. Every developed country is desperately trying to hold on to its middle class jobs and, in some cases such as China, increase them. So if you believe financial engineering bubble is over then we are left with growing the economy in a way my father would be comfortable with, growing the middle class by encouraging product development at small and medium size businesses. The heavy hand of government regulations combined with increased cronyism seems to have been more advantageous to the firms that got most of their earnings from financial engineering rather than product development. The millennials and Hispanics need to start sifting through the policies that worked in the past and tweak them for this new generation. So if the health and wealth of America depends largely on the health and wealth of the middle class, what are the competitive advantages that will convince businesses to keep their middle class jobs in America?
One of the promises of the 2009 stimulus bill was that the government would start work on a large number of “shovel-ready” projects that would generate jobs. Probably the greatest disappointment with the bill is that most of the purported shovel-ready projects got tied up in the regulatory process and never generated any jobs. Since the border wall has been on the books since the 1980s you have to think that the regulatory process is complete. If the 2009 stimulus bill was screaming for any shovel-ready project that could generate jobs, why didn’t we build the wall?
There is something just not right about our economic malaise. Obviously this economy is different from my father’s economy but just because it is different does not mean it is better. When I went to college in the 1970s my middle class parents cash-flowed my education. Today it is nearly impossible for middle class parents to cash-flow their kid’s college education. Is this progress? The same is true about health insurance. It was such a non-issue in the 1970s that I can only remember that I had it and did not have to pay for it. As a healthy person I get no value from my current health insurance but it has grown to be one of my largest expenses and most of the increase occurred in the last couple of years. Is this progress? We seem to stuck in a loop where we keep spending more money to get the same results our parents got for much less. It is this value proposition that is frustrating and angering the middle class the most. Yesterday I was pleasantly surprised to read a Mauldin Economics newsletter describing “Dillian’s Loop“. Jared described it simply by giving the following example.
- If the regulations work, they are declared a success and they write more regulations.
- If they don’t work, it means they need to have more regulations.
In a way it reminds me of Albert Einstein’s quote, “Insanity: doing the same thing over and over again and expecting different results“. The subtle difference is that “Dillian’s Loop” makes fun of people who continue to propose single factor answers to multi-factor problems despite getting the wrong answer or in some cases the right answer for the wrong reason. In the developed world we still cling to the belief that there are simple solutions to complex problems and we are only one smart administrator away from eventual success. This belief permeates a lot of our policy making. Many of the Affordable Care Act supporters believe that because they expanded Medicaid it is working as intended and the act only needs a little tweaking to bring affordable health care back into the Affordable Care Act. If reforming health care costs was that simple why didn’t the Affordable Care Act supporters start off with that? Do they really believe a few more regulations will fix the health care cost problem? Even if this overly simplistic belief system leads us into making bad decisions on complex problems like the Affordable Care Act, regulations, or quantitative easing, we cling to another belief that there is still time to kick the problems down the road for the next generation to fix. The problem is that our faith in these two beliefs is waning and the clock is ticking on when our problems will spin out of control. If we cannot fake till we make it, we will be screwed.
Despite low gasoline prices and good employment numbers this economy is not my parent’s consumer driven economy. In my parent’s economy these factors would drive robust, broad based economic growth. In today’s economy it doesn’t. With economic gains focused almost exclusively on health care and auto sales it is fascinating that low gasoline price and good employment numbers have had almost no on the other sectors. This violates everything we have come to expect about America’s consumer driven economy. Since it is not my parent’s economy, what will trigger robust, broad base economic growth if low gasoline prices and good employment numbers will not do the job? With such a “meh” economy, why is the Federal Reserve raising interest rates? The economic fundamentals are still too weak to encourage inflation and higher interest rates traditionally slow down the economy. Despite the changed circumstances it is still reasonable to expect that an interest rate increase will drive the economy into a recession. What is the Federal Reserve worried about that is worse than a recession? Today I saw a quote from Stanley Druckenmiller that possibly explains the consumer driven economy dilemma facing the Federal Reserve.
“The problem with this is when you have zero money for so long, the marginal benefits you get through consumption greatly diminish, but there’s one thing that doesn’t diminish, which is unintended consequences.”
As a resident of Ohio I was intrigued by Cato’s article on Kasich’s fiscal record. The paragraph that caught my attention was:
Just 18 months after the expansion took effect, the costs have exploded. According to a recent report from the state’s Legislative Service Commission, costs are 63 percent, or $1.4 billion, over budget. The report says the overage is because of “higher than expected caseloads and per person costs.” The expansion population was 600,000 in June of 2015, compared to estimates of 366,000. Medicaid expenditures are 9.5 percent higher in fiscal year 2015 than they were in fiscal year 2014.
When you are $1.4 billion over budget it is kind of a big deal for states. What had me confused is why the local papers are so quiet about the budget overrun and who is the Legislative Service Commission? The second question was the easiest. The Legislative Service Commission is a nonpartisan agency providing the Ohio General Assembly with drafting, research, budget and fiscal analysis, training, and other services. They are the people who should know about budget overruns. Since Cato referenced their report, Status Of The GRF, I read it looking for references about Medicaid and the $1.4 billion dollar budget overrun. I did not find it. So I downloaded the tables for the report and looked for the budget overrun. I did not find it. So I went back to the original blog post and noticed that two of the three links refer to the LSC report. The other link refers to a post at OhioWatchdog.org called, “Ohio’s Obamacare expansion has cost $4 billion”. It is that article that says that “Kasich underestimated the cost of the first 18 months of his Obamacare expansion by roughly $1.5 billion” and the expansion population was 600,000 compared to estimates of 366,000. Both Affordable Care Act supporters and I would agree that was not surprising. The only question in my mind was whether the state was running deficits because they expanded Medicaid and who was paying for the overrun. If you look at the first page of the LSC report you will find that the FY2015 revenues for the state($31,473.1 millions) are approximately in balance with the expenditures($31,461.5 millions). Since the “budget overrun” was a federal obligation that was paid for by the federal government, the local papers did not care.
That got me suspicious about the statement that Medicaid expenditures were 9.5% higher in fiscal year 2015 than they were in fiscal year 2014. If we look at LSC table 2 we see that the FY2015 state’s share of Medicaid expenses grew 2.7% over FY2014. This is exactly the same growth as it was for the previous year. In FY2016 the state’s share of Medicaid expenses is expected to grow 4.4%. This number is inline with budget increases for education. When we look at LSC table 3 we see that FY2015 state and federal share of Medicaid expenses grew 9.7% over FY2014. This is worse than the previous year growth of 7.6%. The scariest number I saw was a 22% growth in the FY2016 Medicaid expense. From this data it looks like the state portion of Medicaid is in control and the federal portion is out of control. Since most Affordable Care Act supporters say the bill is working as intended, it is hard to blame Kasich for the out of control federal portion of the Medicaid mess. Is anyone surprised that Ohio has their act together and the federal government does not!
Most of the news pundits and central bankers are aghast with yesterday’s referendum vote in Greece. According to the pundits it was common sense for the Greek people to vote yes, take the money, and kick the can down the road again. On the other hand it is a sign of insanity to keep doing the same thing and expect different results. From that perspective it make perfect sense that the Greek people want a different resolution this time.
When the May Retail Sales report came out I was a little puzzled. With the economy doing so poor recently was the May retail sales report a mere parlor game in economic reporting? Somebody besides me must find It amusing that 1% unadjusted growth could generate 2.7% adjusted growth. Although both Bizzyblog and Zerohedge had already posted their analysis on the May report, there were two things in the Retail Sales chart on the Zerohedge blog that caught my attention.
- When the Retail Sales year to year growth drops below five percent for an extended period of time, the economy is generally sick.
- The trend over the last two to three years is remarkably similar to conditions preceding the last two recessions.
Rather than copying Zerohedge’s chart I reproduced the Retail Sales(RSAFSNA) chart below using data from FRED since it shows the US recessions.
Since I was curious whether there was something magical about the 5% line I ran some simple statistics on the last 61 months of Retail Sales percent changes(Not Seasonally Adjusted) and found that the mean was 4.720%. Then I divided the sample into five equally sized groups based on percent change. The breakpoints for the quintiles are 2.871%, 4.136%, 5.314%, and 6.823%. For illustration purposes I assigned a grade to these values. As an example for every month in which the retail sales growth was greater than 6.823% I gave it a grade of ‘A’. It should come as no surprise that there were 12 months in the sample in which growth exceeded 6.823%. Using this analogy the grades based on the Retail Sales growth for the first five months of 2015 was ‘D’, ‘F’, ‘F’, ‘F’, and ‘F’. Obviously the May Retail Sales increase looks more like a continuation of a bad trend and does not confirm the press’s enthusiasm for a retail sales recovery. Even the 2.7% seasonally adjusted growth the press was so happy about would be an ‘F’ grade. The 2015 grades are actually worse than the first five months of 2014 which had grades of ‘F’, ‘F’, ‘F’, ‘B’, and ‘C’. Most of the ‘D’ and ‘F’ grades occurred in the last two years and there were only two ‘B’ grades in 2014 and 2015. We have to go all the way back to July in 2013 to find an ‘A’ grade. Based on these statistics the 5% line looks like a pretty good indicator of healthy retail sales and a growing economy.
So now I am left with three questions:
- Has the Administration successfully transformed our consumer driven economy into a slow but not negative growth economy?
- Are we just one misstep from negative growth and an old fashioned recession?
- Since quantitative easing and zero interest rates have had less and less impact on the economy, what can the Fed do to avoid a recession in an election year?
For those folks fascinated by increased health care spending in a stalled economy there is a nice article, Health Spending Unscathed In Shrinking Economy, at the NCPA Health Policy Blog. John Fembup asked the question why is increased health care spending “bad” and increased spending at Wal-mart “good”? Here is my reply.
Historically only a few sectors of the economy have a multiplier effect on the rest of the economy. The two best examples of this is housing construction and the growth of the Goods sector. Most economic recoveries have been led by one or both of these sectors. So when major companies in these sectors report increased sales, this is important economic news. The logic is that if GM, Target, Costco, and Wal-Mart are having good years then it is possible that a broad based expansion is underway.
Historically health care spending had a weak correlation with Personal consumption expenditures(PCE) growth. Until 2014 the Goods sector had a strong correlation with PCE growth. In 2014 the positions changed. Health care spending became the leading contributor to PCE growth and the rest of the PCE sectors look like they were in a stalled economy. Based on this limited data you would have to conclude that increased health care spending does not have a multiplier effect on the economy.
Finally most of the increases in our standard of living can be attributed to innovation and productivity gains in the Goods sector. Health care has a poor record for innovation and productivity gains. The most interesting productivity gain that I have seen in health care was a county project to manage diabetes. It provided better care and lowered costs. If health care acted more like a business then they would adopt a more distributed decision-making organization structure to encourage this type of productivity gain. Health care is inherently a local service requiring local decisions. Instead the government and industry have embraced a more command and control organizational structure that generally gets its productivity gains from economies of scale. Since the Affordable Care Act has not generated any cost savings and has blown every budget, it looks like we got the worst of both worlds, increased centralization with no cost savings. We tried, we failed! It is both sad and exciting to think that if we want to increase our standard of living then it has become imperative that the health care industry innovate and focus on productivity gains. If we want to grow the economy then we have to be smarter about our down health care spending so the sectors that have a multiplier effect can grow.
Socialist governments traditionally do make a financial mess. They always run out of other people’s money.
While reading a Yahoo interview with Mr. Stiglitz in which he describes three steps to solve income inequality, I was struck with the thought that he remembers the 1980s much differently than I do. Here is a quote from the interview.
In his new book, “The Great Divide: Unequal Societies and What We Can Do About Them,” Stiglitz traces the modern divide of inequality back to the Reagan era. Though inequality was a huge problem at the turn of the last century and in the lead up to the Great Depression, Stiglitz says the income divide in the U.S. was reduced after World War II and that the country “grew at its fastest pace” and “grew together.” He says the turning point was the Reagan Administration and its rolling out of supply-side economics, deregulation, and lower tax rates. The goal of these policies was to spur economic growth overall and make everyone wealthier. Stiglitz says it caused a divide instead.
To refresh my memory about the Reagan years I went back and listened to the American Heritage podcast, “The Reagan Revolution”, by Professor Moore of Hillsdale College. I think there is a much stronger argument that the income divide was reduced after World War II because we won and they lost. There was very little foreign competition for our businesses until the mid 1960s. When the competiton heated up in the 1970s we were constantly reminded that the Japanese and Germans were making products that were not only better but cheaper and the cost for our social experiments with defined benefits and free health insurance were a burden our companies could no longer afford. I remember the early 1980s as a time filled with fear and despair. People in both the United States and Britain were concerned that the socialistic policies and practices of the past had failed to live up to their promise and were now viewed as the primary obstacle to improving competitiveness, employment, and wage growth. Desperate times call for desperate measures and the first idea to die was the idea of the paternalistic company in the United States and the state-owned company in Britain. The second idea to die was the cavalier attitude toward the importance foreign competition. The business sector needed to restructure with an emphasis on efficiency. It was a “we win, they lose” situation and America and Britain did remarkably well under pressure. The auto and steel industries in both countries started the long process of re-inventing their businesses for the new environment. Reganomics reversed the stagnant productivity during the Carter years with solid productivity gains. The Reagan Revolution is fondly remembered as the tide that lifted all ships and President Reagan was easily re-elected. Probably more amazing was the transformation of the British economy under Prime Minister Thatcher as it emphasized deregulation (particularly of the financial sector), flexible labor markets, the privatization of state-owned companies, and reducing the power and influence of trade unions. It was arguably the more difficult political task but the reforms has allowed Britain to be in a competitive position this century that is more like Germany than Italy.
When I look at the 2015 economic landscape I keep wondering whether we have become too financially efficient and complacent to innovate and grow sales. Our GDP growth is limping along primarily on gains in health care spending so is anyone surprised that wage growth has been stagnant? We need to get back to making things bigger, better, faster, or cheaper to get customers to keep coming back and arguably small and mid-size companies is the optimum organization structure to achieve it. The interesting part of this solution is that we probably fix both our middle class wage growth, income inequality, and GDP growth issues. The economic solution for today is the similar to the solution advocated by Reagan and Thatcher in the 1980s. What did the TARP bailout do besides protect bank executive paychecks? It sure looks like once again we are seeing that cronyism is the primary beneficiary of government fiddling. The most important question has always been how do you grow the economy after a liquidity crisis so how did quantitative easing become our best policy option for growth? We need to get smaller, agile, and more competitive if we want to compete in a world economy where it is likely that our the most feared world competitor is based next door in Indiana, Kentucky, or some other state with a similar attitude. It is time to unleash the animal spirits of entrepreneurs.