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Thursday, May 31, 2007

The US Economy

It is still hard to say exactly where, or at least at what pace, the US is heading, as I argued in this post back in January. The big issue is of course the long run future of the construction sector in the US. Despite the fact that the short term outlook may be for a more protracted slowdown, I am by no means pessimistic in this regard in the mid-term: simply one glance at the US median age (plus my intuition that with so many structural savers out there interest rates are more likely to trawl the bottom than not despite the best efforts of the central bankers) suggests to me that the US housing market will have life, and for many years to come. Demographics seem to guarantee that.

The current housing market situation does not look at all positive:

Builders broke ground on more homes last month, but permits issued for future homes plunged to their lowest level in a decade, in a sign that the housing slump may not yet be over....Building permits, seen as an indication of the housing sector’s future prospects, fell 8.9 per cent to 1.43m, missing expectations of 1.52m and down from a revised level of 1.57m in March. This was the biggest monthly drop in building permits in 17 years.

Bloomberg reports this morning that the extent of the slowdown in the first quarter may have been worse than initially recognised:

First-quarter U.S. economic growth, already reported as the weakest in four years, will be revised even lower as the trade deficit widened and businesses reined in inventories, economists said before a government report today.

The world's largest economy grew at an annual rate of 0.8 percent from January through March, down from the 1.3 percent pace estimated last month, new figures from the Commerce Department may show. The forecast is based on the median of 78 forecasts in a Bloomberg News survey.

Now this is only an estimate, and we need to wait for the Commerce Department report to be published, but again, anecdotal reports like the data for remittances and migrant apprehensions cited yesterday do offer some confirmation that in the short run growth is unlikely to accelerate dramatically.

Really - as always in the US - spending seems to be the key:

A gain in consumer spending last quarter was one of the few things that kept the expansion alive. Spending, which accounts for about 70 percent of the economy, may be revised up to 4.1 percent in today's report, from an initial estimate of 3.8 percent, according to the median forecast in the Bloomberg survey.

and while we may not seen this rate of increase being sustained into the future, I see no good reason to anticipate a dramatic drop at this stage.

Another reason to be cautiously positive is the fact that the economy has been holding *without* the Fed taking recourse to rate reductions. Their ability to keep their hands off the tiller has certainly surprised me, but it should always be borne in mind that this capacity is still there, as and when the need arises. Indeed, at the present time they seem to be just as preoccupied by the US inflation path as they are about the likelihood of an imminent drop into recession:

Federal Reserve Chairman Ben S. Bernanke is pulled in opposite directions by worries over inflation and housing, leaving him little choice other than to keep interest rates unchanged.

Fed officials said they still expect a pickup in the economy this year and view inflation as their main concern, minutes of their May 9 meeting showed yesterday. They listed several caveats, including the risk that the housing recession may ``weigh heavily'' on growth.

Still, officials said the risks of a slowdown have ``diminished slightly.'' Futures trading indicates the chance of a rate cut by the end of December has dropped to 40 percent, the lowest this year. As recently as March, investors saw a half- point reduction as certain.

``If you don't quite understand how the economy's functioning, then there's a temptation to take the view that anything you do to interfere could turn out to be perverse,'' said Neal Soss, chief economist at Credit Suisse in New York, who was an adviser to former Fed Chairman Paul Volcker. ``Therefore, you're better off doing nothing.'

I cerainly like that last point: "If you don't quite understand how the economy's functioning, then there's a temptation to take the view that anything you do to interfere could turn out to be perverse". I think this is where we are, until we get a better measure of just why this present wave of global growth is so strong and so sustained it would, IMHO, be foolish to start jumping to any hasty, and possibly rash, conclusions. Thus - when in doubt "you're probably better off doing nothing". Would that other participants in the economic community could understand the force of this basic but subtle point.


In the end the Commerce Department report showed US first quarter growth to be slightly worse than expected this morning: a 0.6% annual rate.

The U.S. economy grew last quarter at a 0.6 percent annual rate, the weakest in more than four years, as housing slumped, the trade deficit widened and businesses reduced inventories.

In response to a question in comments I did some digging around, and came up with this chart from the Commerce Department.

Now basically this makes the position pretty clear, in the short run the decline in housing has been met by an increase in personal consumption, since the percentage changes in GDP (in opposite directions) more or less cancel out. What has happened is that growth has slowed and consumption maintained its path, so the % of GDP has naturally risen (at least that's my off the cuff reading).

Basically the consumer is hanging in, taking a longer view, and waiting for housing to pick up again. Will it? That is the big question, or better put, when will it? And can the consumer hold out till then?


Anonymous said...

since consumer spending is 70% of the economy (or GDP, pardon my ignorence i am not related to economics other than that it affects my life more than anything else :)

i was wondering if we can gauge the direction of it somehow, if someone knows the indicators used to gauge consumer spending please help me out.

i keep reading that most people are neck deep in debt, if that is the case how can they still keep spending at the same or better rate??

wages have stagnated since the last 5 years, and house is not longer the ATM since last 12-18 months, where are they getting the funds to spend on consumption?

is there any source to track how much debt is owned by americans? amd how much are they paying to service that debt?

Edward Hugh said...

Hello Techy2468

I don't know whether you realise it, but you have just entered into a very complex problem, where everyone has their own "narrative account", and it is damned hard to really test anything in any decisive way.

"since consumer spending is 70% of the economy"

well it does in the US, but in other G7 economies, it doesn't, it's nearer 60%, and just why there is this difference is one of the big headaches we have.

"i was wondering if we can gauge the direction of it somehow"

Quick answer, there aren't. If we could do what you ask we would know what happens next, but basically we don't. People have been talking about the "maxing out" of the US consumer for the last 3 or 4 years, yet on and on you go. Is it different now? It could be, but we would need to know why it should be?

"wages have stagnated since the last 5 years"

Yep, but as you rightly indicate, the US consumer has become increasingly credit driven, so current income doesn't seem to matter so much, as long as they will lend to you, which they won't now if you are "sub-prime" (I haven't seen too many definitions of this euphemism, does it mean - among other things - non-regularised migrant, here in Spain it certainly does, and the sub-prime market continues to kick here).

The real question is how much should you borrow (ie up to what sort of % of your future earnings and at what age): the answer to this obviously depends on what sorts of rates of economic growth you anticipate in the US over the next 10-20 years, and since this rate of increase depends in large part on how much people borrow the argument can become rather circular.

"and house is not longer the ATM since last 12-18 months"

Yes, but this is just the point, this has been going on for 12 months now, yet the show continues, or at least has continued sufficiently for the Fed not to reach for the lever and lower rates.

True growth in Q1 was very low. In fact you need to think about population growth here. Since the US population is growing rather rapidly there is an inbuilt dynamic to consumption which you don't find in some other countries.

Now that being said you could also take the view since in Q1 population rose more rapidly than GDP, then living standards per capita actually must have fallen during that quarter, and you could say (although not on official criteria) that this constitutes some sort of recession, but then what impresses you is the way the thing continues onwards ass if nothing had happened. My feeling is that for this to be the case the underlying dynamic - both in the US, and globally - must be pretty strong at this point.

The real question is why. And don't look at me for any clear answer, at least not right now. I amstill watching and scratching my head.

"and house is not longer the ATM since last 12-18 months"

Yes - one more time - but this doesn't mean it won't all start up again, maybe not as fast as before, but if the Fed drops rates to say 2%, you just watch what happens to house prices again.

You need to think about generations and cohorts here. People tend to take on large mortgages between 30 and 50, and pay them off between 50 and 70.

So as long as there are more people entering the 30-50 age group than there are people entering the 50-70 age group and the economy doesn't go into negative growth, then the quantity of indebtedness can keep going up and up.

Of course, in some societies - Germany and Japan say - the age pyrmaid has already inverted and this process cannot continue in this way, but in the US this won't happen for about 25 years (at least), so it all looks like a pretty safe bet for the time being.

At least that is my guess. Of course whether growth goes up or down in the next quarter is really anyones guess, but then as I say, if it turns down further the Fed will start to drop rates.

"is there any source to track how much debt is owned by americans?"

There probably is, but I don't have anything to hand, maybe a quick Google will bring something up.

"amd how much are they paying to service that debt?"

Well this brings us back to where we started, this depends on the fed, and on the future path of interest rates.

Actually it depends on more than the Fed, it depends on the levels of global liquidity we can expect, and for a variety of reasons my feeling is that things are going to remain pretty liquid, so the interest rate environment will probably stay low.

Is this a bad

Edward Hugh said...

"maybe a quick Google will bring something up."

It did. Here's something I found at the Federal reserve, and here's another one.

I also found a chart which I have put straight up on the post, with some brief explanation. I hope all this helps some.

Anonymous said...

Thanks for the reply.....but dang you also dont know....

below is household debt service data from http://www.federalreserve.gov/Releases/housedebt/

Qrter DSR
04q1 13.44
04q2 13.46
04q3 13.64
04q4 13.56
05q1 13.89
05q2 14.08
05q3 14.26
05q4 14.29
06q1 14.30
06q2 14.52
06q3 14.53
06q4 14.53

I am having trouble thinking in ratios.....does the above number (say 14.53) means debt is 14.53 percent of total disposable income.

* can you comment on the above trend (increasing DSR)

Edward Hugh said...

Hi again,

"does the above number (say 14.53) means debt is 14.53 percent of total disposable income."

Yep, that seems to be it.

"can you comment on the above trend"

Well, sort of. Clearly, as you are noting these levels have been rising - from the early 80s according to the time series they show.

And clearly there is a limit lying out there somewhere. But what is the limit? Aha. This is what no-one knows.

It is important to remember that this is aggregate data, so this is quite consistent with some people getting more in debt with others getting less. If this corresponds to some extent with changes in age structure, then it is not so pre-occupying.

Also remember, these payments from current income are to some extent influenced by the rate of interest set by the Fed. So a sustained reduction in rates would bring down these percentages a little.

I suppose the big worry would be the external deficit issue, and the rates of interest the US might need to pay in order to attract funds and balance the debt. If this meant high rates of interest then clearly this personal indebtedness would become a large problem.

Since I am not so sure about this, at least over the medium term, I am much more sanguine about sustainability.

Of course as we get up into the 2020s a lot of this may change, but 2020 is still quite a long way off, and a lot of other things can happen in the meanwhile.

"but dang you also don't know...."

No.I don't. And I'd be very careful with anyone who claims they do. None of this is obvious. We are learning something every day.

Edward Hugh said...

Hi again, you might be interested in this recent report on economic mobility in the US. Incomes for many groups certainly do not seem to be rising. People in their thirtees now will almost certainly work much longer than their parents, maybe this will give them the extra time to pay off all that debt :).

Anonymous said...

14.53 of disposable income(DI).
is this total Debt Service ratio to DI.

something is wrong with this data or my understanding of it.

or maybe since 1% of the population owns 70% of wealth (i hope i am right) the above data is getting corrupted with high income earners.

15% of DI is peanuts.....i think banks will lend upto 50% of DI....and i know people in india who pay upto 70% of DI only towards mortgage (they dont spend on anything else).

it would be interesting to get more data about the actual consumption of consumers.....and which income group drives it.

i have a hunch that the top 1% rich folks are not the actual consumers....they must be pretty much recycling their income into investment.

so right now it looks like the US economy is still alive because of low unemployment.

i have another hunch.....i feel that hiring was very low in service sector (particularly IT) during 2001-2004. since 2005 they are now expanding capacity hence the job market is doing great (filling the gap left void by manufacturing and construction).

and i feel that we are in a catch 22 situation......means that if the industry stops hiring in anticipation of a slow down........we are screwed because that definitely means we will go into a recession.
on top of that consumer will get hit hard in the next 2 years because of ARM mortgage reset to higher rates.

once again we may be self fulfulling our prophecy.

I think during the 1995-2000 boom, growth went hand in hand with hiring and come 2001 hiring completely froze in IT because stock market crash. In other words employment fell at the same time as market, unlike now.