When I saw the nice graph Curtis Miller created showing that productivity detached from wages in 1973, I was curious if I could duplicate it in FRED. Nothing against R but creating a graph in FRED is fast and easy since much of the Bureau of Labor Statistics data is available. After a little searching I found both series and indexed them to 1947.(Oops! I used the wrong series. I should have used the Business Sector: Real Output Per Hour of All Persons (OPHPBS) and Real Compensation Per Hour [RCPHBS].) The graph is similar to the one Curtis created except it pushes the date when productivity detached from wages back to the first quarter of 1970.
Although David Stockman argued in his book, The Great Deformation, that the era of sound money ended around this time, I am not comfortable with the idea that dumb spending policies should have an impact on real wages and productivity. I am not surprised but it does make me wonder. Is the adoption of fiat currencies and the expansion of the welfare state the reason we are seeing reduced real wages despite improving productivity?
US. Bureau of Labor Statistics, Nonfarm Business Sector: Real Output Per Hour of All Persons [OPHNFB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/OPHNFB, September 13, 2016.
US. Bureau of Labor Statistics, Nonfarm Business Sector: Real Compensation Per Hour [COMPRNFB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/COMPRNFB, September 13, 2016.
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?
I was looking at a debate between Mr. Davis and Mr. Perry over inflation. Mr. Davis started out the debate with this provocative article, American Families Are Right To Be Worried About Inflation, and Mr. Perry responded with his own chart showing that average hourly earnings grew faster than inflation. Since I do the grocery shopping for our family my gut feeling says we are experiencing mild inflation in excess of wage growth. So who is right? In almost all cases like this I go over to FRED and chart some data.
My first reaction to the debate was Mr. Perry’s selection of average wage earnings. The logical choice would have been real disposable income since it removes personal current taxes and inflation and is readily available at FRED. For the average person the only wage growth that matters is what they have after taxes.
If we look at a Fred graph of real disposable personal income versus the two CPI measurements, we can see that the graph confirms Mr. Davis’s statements who claims that “food inflation blows away wage growth” and “food prices have soared since 2009”. If we adjust the real disposable personal income for population growth, the difference is even more dramatic. So what is the best way to measure wage growth, average wage earnings or real disposable personal income per capita? They tell different stories.
I am puzzled why health spending had such a large impact on first quarter GDP report. I thought the Affordable Care Act impacted the health care expenditures for only a small part of the population. Other people are puzzled, too. The best article that I have found that partially explains the impact of health care spending on first quarter GDP is, “Health Spending and First Quarter GDP: What Happened?“, but it fails to explain why such a small component of the GDP had such a large effect.
When I get puzzled with economic data, I go over to FRED and plot some data. So if we follow Tyler Durden’s lead of plotting quarterly changes for health care expenditures and include the Real Gross Domestic Product series we get this graph. You can see that the quarterly change in GDP dwarfs the health care expenditures and it is hard to see much of a correlation between these two indices. Unless we are willing to believe that the tail can wag the dog, we have to conclude that the 2.9% decline in the economy was for economic reasons other than health care expenditures. The impact of changes in health care expenditures is still a minor factor in the GDP growth. The Affordable Care Act taxes are probably holding the economy back a little bit but if we want to grow the economy we have to do it the old fashion way by making things bigger, better, faster, or cheaper.
One concludes from this analysis that both year-to-year fluctuations in national health spending and the longer-term trend in that growth rate are driven primarily by current and prior-year changes in macroeconomic conditions.
I was curious about how he reached his conclusions since it reminded me of the John McDonough’s macroeconomic premise in the article, “Does Massachusetts Have the Nation’s Highest Health Insurance Premiums? It Depends.” In that article Mr. McDonough speculated that the reason Massachusetts has the highest health insurance premiums in the country is because they have the highest median income. In other words health insurance premiums migrated to the highest price the Massachusetts market would bare. In Mr. Reinhardt’s article, Controlling Health Care Spending, Revisited, I found a fascinating graph of the year to year growth in real per capita health care spending. My immediate question is what happened to real per capita income over the same time frame? Since I know how to get income data from FRED here is my version of the two indicators on the same graph. For those who are curious I estimated the year to year growth in real per capita health care spending from the NYT graph so I could put it into an Excel spreadsheet. It sure looks like the year to year increases are trending down to the increase in real disposable income. This would be a logical result in an environment where out of pocket costs are increasing and the country is increasingly sensitive to health care spending increases that exceed the general inflation level. If the large businesses and government entities that sponsor large group health insurance plans are unwilling to expand their contribution to health care spending, you have to wonder how we can expand our health care spending without a major increase in GDP and real per capita disposable income. If the predictions of slow GDP growth are correct then it looks like we are playing a game of musical chairs and the music is winding down. Even if there is no health care inflation then “someone” is being set up for a cost squeeze as we expand the health care system and its not likely to be the consumer. They look like they are tapped out. This reminds me of the typical problems faced by out of control entitlement systems. We have seen the future of health care and it looks a lot like Detroit.
So I went back to my old graph , added a line for corporate profits, adjusted it for inflation using the GDP deflator, and got the graph below. Since the Real GDP uses the GDP deflator(GDPDEF) as the inflation adjustment, I adjusted the other lines using the GDP deflator as the inflation adjustment. Maybe its just me but it sure looks like the blue line for corporate profits is following the green line for Federal Debt: Total Public Debt (GFDEBTN) since 2000.
When you look at my graph it sure looks like the current profitability is the result of the willingness of the federal government to issue debt. If businesses profits were primarily due to increases in sales then the corporate profits would be following the red line for the S&P 500. In this case it is above both the S&P 500 and the black line for the GDP. If we focus on the last 13 years we can see that corporate profitability trend line is more closely aligned with the debt line. Oops, there goes the narrative that the corporate profits are up because wages just hit an all time low! The corporate profit increase over the last 13 years was debt driven! Since several economists have described this recovery as a balance sheet recovery, it is no surprise that wage growth has been stagnant. Corporate profit increases without wage growth are inevitably fake profits and that explains the lack luster enthusiasm in the S&P 500 stocks. When your accountant is generating more earnings than the guy or gal working down on the floor, you have a troubled business. This is not complicated. Debt fueled corporate profits were fun but now we have the same tough job ahead of us. If we want higher wages and a growing S&P 500, then we must have real sales growth coupled with productivity increases. This quest is as American as baseball and apple pie. If higher wages and an increasing S&P 500 price is our goal, then our reliance on debt is a distraction and a hindrance. When we fail to create real corporate profits and rising wages it is because we took our eyes off of the ball.
A couple days after writing this post I was pondering the question of where did the corporate profits go and why the rising corporate profits were not lifting all ships. Rising corporate profits usually result in high factory utilization rates and labor shortages. This situation typically resolves itself with rising wages, strikes, and sometimes both. Without seeing rising wages in this recovery it seems like the rise in corporate profits was the result of a shell game rather than real economic gain. Then I saw the article written by Jeffrey Tucker on the Daily Reckoning, This Car Won’t Move. The cartoon I included below from his post explains both the corporate profitability and why we have not see rising wages problems quite well. It may be hard to see but if you look closely you will see the wage earners are out there swimming with the sharks.
There is a lot of talk about fairness and income inequality in the media as they try to make wealth redistribution policies more palatable to the public. Don’t get me wrong, I do not have a problem with taking more taxes from Warren Buffet or Bill Gates. The problem starts when they start taking money away from me and I do not believe this is helping anything! When they take money away from me, I have to cut expenses elsewhere. In my case I cut my savings rate. The extra money taken from my paycheck reduces my retirement money and more dependent on social security. It is that simple!
As a country we have long since passed the point where we have a balance between spending and saving. Our defined pension plans and 401K plans are woefully underfunded and our social security system is a sham. The problem with the middle class is not income inequality or fairness. We are stupid! We make dumb decisions with our money and how we save. You hear this all the time if you listen to Dave Ramsey. Here is a quote from a John Goodman post, Why There is Wealth Inequality.
The greatest inequality of wealth holdings is among the elderly and the primary reason for that inequality is the different saving rates of people when they are young. Here is Noah Smith:
If you do the math, you discover that in the long run, income levels and initial wealth…are not the main determinants of wealth. They are dwarfed by…savings rates and rates of return. The most potent way to get more wealth to the poor and middle-class is to get these people to save more of their income, and to invest in assets with higher average rates of return.
Unfortunately the key idea we get from Keynesian economics is that increased spending is good for the economy and deficits are not important. Although I am skeptical that this plan ever worked, we can see that since 2000 this plan has definitely not worked. Here is the chart I created a couple months ago to show that relationship. For those unfamiliar with Mitchell’s Golden Rule, “the private sector should grow faster than the government”. I still prefer the stronger form which states the private sector should grow faster than the growth in government debt if we want to grow out of our mess. As a country if our economic policies are working, the green line would be lower than both the red and blue lines. If we look at the country as an individual investor, we need a greater return on our investment and this dependence on debt is not working!
I just finished reading The Age of Deleveraging by A. Gary Shilling and I agree with his analysis and conclusions. I think that his book is the most important book on economics that I have read this year so I included some notes from the book for my future reference. Part of the reason I enthusiastically agree with his analysis is because it matches my own analysis. Over several posts I have been looking for signs that the consumer is actually deleveraging. Part of my curiosity stems from listening to Dave Ramsey try to convince people of the benefits of becoming debt free and wondering whether he is part of a larger trend. The other part is trying to figure out what the average American will do with their investments and disposable income in a slow growth environment. Mr. Shilling and I come up with the same conclusion. It is time for the American households to unwind the excess borrowing on credit cards and student loans that occurred over the last thirty years. Consumer spending as a driver for the economic growth is tapped out.
In a similar way I was fascinated with the problems that CALPERS and other pension plans are facing if our economy fails to grow at 4% per year. It seems many of the pensions plans are making big bets that the economy will grow at 4% and the stock market returns will grow much faster than that. The reality is that CALPERS recently announced that their 1-year return was 1%, their 10-year return was 5.7%, and they are spending about 6.4% of their portfolio on benefits. For kicks I charted the inflation adjusted returns for the GDP(blue line), S&P 500(red line), and our total debt(green line). From the chart you can see a pretty good correlation between the three indices from 1980 until 2000. For that time period I came to the conclusion that the growth in debt from was primarily responsible for the growth in the economy and the stock market. Traditional economic theory seems to be working. After 2000 the correlation falls apart. It is as if we passed a tipping point and the equation we use to describe the economy changed. Increased debt was no longer a good thing for the economy or the stock market. Debt soared but the economy hardly budged off of its long term trend line and stock prices went down on an inflation adjusted basis. For pension plans like CALPERS that really sucks! For those who think we can borrow our way to economic growth, you need a new plan. I was pleasantly surprised the Mr. Shilling noticed the same problem with inflation adjusted stock returns and debt.
Here are my cliff notes from the book and two posts about the book at BusinessInsider.
Slow Growth Ahead
Global slow growth in the next decade will result from the U. S. consumer retrenchment, financial deleveraging, increased government regulation and involvement in major economies, low commodity prices and the shift by advanced lands to fiscal restraint.
No Help from Anywhere
Four more reasons for slow global growth: Rising protectionism, continuing U. S. housing weakness, deflation and weak state and local government spending.
Chronic Worldwide Deflation
Deflation comes in several varieties, but is fundamentally driven by supply exceeding demand. Productivity-saturated new tech and globalization will drive the good deflation of excess supply while slow economic growth introduces the bad deflation of deficient demand. As the combine, I look for chronic price declines of 2 to 3 percent annually.
Twelve Investments to Sell or Avoid
#1 Big-ticket consumer purchases
Consumer discretionary spending is getting whacked as Americans grow debt shy. Moreover, consumers will have less money to spend.
Autos, appliances, airlines, cruise lines and leisure and hospitality providers will suffer.
#2 Consumer lenders
America could be finally, finally kicking the credit habit. Credit card companies, like Visa (V), and various financial firms will pay the price.
#3 Conventional home builders
Home prices are dropping (Shilling predicts a 20% drop). People are losing interest in giant McMansions. Add to that America’s newfound antipathy toward debt and you’ve got a bear market for home builders.
You might want to avoid PulteGroup (PHM), Beazer Homes (BZH), M/I Homes (MHO), Ryland Group (RYL) and KB Home (KBH).
Collectibles are another casualty of deflation. That Rembrandt could be worth less in a few years.
Home prices aren’t done crashing. When they do, banks will suffer from a wave of foreclosures. The financial system will be revived after the crisis with new profit-crushing regulations.
Mortgage heavyweight Bank of America faces the biggest liability.
Shilling also names Goldman Sachs as a potential target for CDO suits.
#6 Junk securities
Shilling calls this year’s rally in junk bonds overblown. Slow revenue and cash flow growth will make it impossible for many firms to service debts.
#7 Flailing companies
Companies with below-average revenue growth and high fixed costs and debt will be the first to drop in the coming era.
Shilling does not give any examples. We’re going with US Steel.
#8 Low tech equipment producers
US industrial production has stalled and won’t need many machine tools and parts. Besides, these products are made a lot cheaper abroad.
#9 Commercial real estate
Demand isn’t increasing as the US economy stalls. Moreover, loans made in the bubble come due in 2012, threatening a wave of foreclosures that will crater demand.
Slow global growth means there won’t be much supply pressure for oil and other commodities. Meanwhile, deflation will bring down prices.
#11 Chinese and other developing country stock and bonds
Emerging markets aren’t there yet, Shilling says, and won’t be able to pick up the slack from a languishing U.S. For overheating markets like China, this will lead to a sudden crash.
#12 Japanese securities
Shilling predicted the Japanese crash in 1988, and he says the slow-motion train wreck isn’t over yet. Bad demographics and lack of export growth are just now making their pretense felt.
Ten Investments to Buy
#1 Treasury bonds
Shilling says he has been a 30-year Treasury bull since 1981. The "bond rally of a lifetime" is going to continue as deleveraging causes deflation. Even Ben Bernanke won’t be able to stop that.
#2 Dividend payers
There won’t be much growth, so you might as well collect dividends. A few examples include Procter and Gamble (PG), Unilever (UN), Coca Cola (KO) and PepsiCo (PEP).
#3 Consumer staples
Consumer discretionary spending is getting whacked, but people still need to buy bread and socks. Stores like Walmart are well-positioned to grow.
#4 Small luxuries
People want to spend money on something. Shilling says items like snakeskin tote bags, five-blade razors and designer jeans could be the new type of conspicuous consumption, taking the place of big ticket items like sports cars.
#5 The dollar
With Europe and Japan drowning in debt and emerging markets verging on a crash, the dollar is going to start looking pretty good. Shilling says the dollar will remain the world’s currency, with no real competition from gold or the yuan.
Meanwhile, America will be mired in deflation.
#6 Investment managers and financial planners
Low investment returns will discourage day-traders and encourage the use of professionals.
#7 Factory-built houses and rental apartments
Cheap small homes are the order of the day, as old people look for a cheap retirement spot and young people look for a small mortgage.
Renting will be a more and more popular strategy.
#8 Health care companies
As America ages, the health care industry seems unstoppable. Even Obama’s health care reform ended up boosting earnings for many companies.
#9 Productivity enhancers
Anything that helps juice bottom lines will do well in the new era. This includes consulting groups, computers, internet, biotech and telecom.
#10 North American energy
Shilling is bullish on deepwater drilling and natural gas, as well as coal and nuclear. He has particularly high hopes for the massive Canadian oil sands.
Recently I have been thinking about The 4% Solution: Unleashing the Economic Growth America Needs advocated by the Bush Institute, the CALPERS report that said that they had 1-year return of only 1%, sequestration, and Mitchell’s Golden Rule. For those unfamiliar with Mitchell’s Golden Rule it states that “the private sector should grow faster than the government”. In this discussion I will use the stronger form which states the private sector should grow faster than the growth in government debt if we want to grow out of our mess.
The 4 percent solution is wonderful idea that appeals to both parties. It states that we should focus our economic planning on those plans that help us achieve a 4 percent growth in real GDP. The problem with this plan is that it is primarily aspirational and is not significantly different than the plans of our last four presidents. In fact it does not address the problem that has plagued our last two presidents, we spent money like we already had the 4 percent growth money in the bank. This has been readily apparent with the economies under the last two presidents. Two different plans were used, some political objectives were achieved but both plans failed to generate the job or GDP growth. We did achieve a fairly spectacular increase in public debt.
CALPERS is the poster child for pension problems in the United States. Like most pension plans they expect their portfolio to achieve a 7.25% return. This seems reasonable since they earned a 7.7% return over the last twenty years. The problem is that their 1-year return was 1%, their 10-year return is 5.7%, and they are spending about 6.4% of their portfolio on benefits. This doesn’t work. They look like they desperately need the government to be successful with their 4 percent growth plans or they might have to resort to Plan B.
Sequestration is not a plan but a veiled threat that becomes more unveiled as we get closer and closer to the spending cuts. The idea of sequestration is not to subtle hint that we would like to chain our legislators to the bargaining table until they made a budget deal that cuts spending. So far the threat has not worked. The Simpson-Bowles and Ryan Path to Prosperity plans are much better than sequestration. Both plans are much better at growing the economy while structurally reforming the spending than sequestration. In fact I think the end game is a budget deal will likely be some variation of one of those plans that partially satisfies both parties. I think it is interesting to speculate what the presidents over the last 100 years would do with the situation that President Obama has in front of him. I suspect all of them would see a budget deal as one of the most significant accomplishments of their administration. I can almost guarantee that the last four presidents would have done a deal before the end of the first term. In my life time all of the presidents except for the current president have been willing to reach across the aisle to get a deal done to pass major legislation.
The key to any successful budget plan will be how to grow the private sector faster than the government debt. This is really simple math. You get a better bang for your tax buck with an increased number of private sector employees. The less these employees are dependent on government spending, the greater the cash flow goes to the government. Adding private sector employees is more efficient at increasing tax revenues then via an equal number of number government employees. For at least the last twelve years growing the government debt does not appear to be helping the GDP or the private sector very much. Here is a graph I created to show that relationship. I am using the S&P 500 as a proxy for the wealth and health of the private sector. To paraphrase the old GM line, what is good for the private sector is good for the country and our pension plans, too. In this graph I deflated the S&P 500 and Total Public debt using the GDP Price deflator so that all three indicators reflect inflation adjusted values using the same deflator. In the graph it looks like the Total Public debt helped the S&P 500 in the 1980’s and 1990’s and significantly hurt it after 2000. I was somewhat surprised to see that an increased Total Public debt does not seem to have helped the GDP at any time on the graph. The GDP kept trucking along at the same pace with only a minor blip during the recessions. Here is an interesting question, “How did government spending let alone debt financed government spending became the preferred vehicle for growing the economy?”
A big leap in credit card debt in May. It surged by $8.0 billion, the biggest one month gain since November 2007.
Here is an updated graph from the Fed that shows both revolving and non-revolving credit from 2000 to the present. In the graph we can see that revolving credit(i.e. credit cards) is still depressed and growing slowly compared to non-revolving credit(i.e. auto loans). It is still down from its peak in 2008 while the non-revolving credit has already passed its 2008 peak. Using a one month change to describe a trend is misleading. Since last month’s G.19 report showed a decline in revolving credit and this month it shows a gain, I think it is a little early to make predictions on credit card debt growth.