Main menu

This is why stimulus spending is inefficient (and highly so)

According to an article in today's International Business Times, the City of Los Angeles received $111 million from the American Recovery and Reinvestment Act, yet created only 55 new jobs. That works out to a cool $2 million per job. Milton Friedman explained this long ago, when he said "you never spend other people's money as wisely as you would your own." It also casts serious doubt on whether the government spending multiplier is even remotely positive.

"I'm disappointed that we've only created or retained 55 jobs after receiving $111 million," says Wendy Greuel, the city's controller, while releasing an audit report.
"With our local unemployment rate over 12% we need to do a better job cutting red tape and putting Angelenos back to work,” she added.
According to the report, the Los Angeles Department of Public Works generated only 45.46 jobs (the fraction of a job created or retained correlates to the number of actual hours works) after receiving $70.65 million, while the target was 238 jobs.
Similarly, the city’s department of transportation, armed with a $40.8 million fund, created only 9 jobs in place of an expected 26 jobs.
This is a disgrace and an abomination. But if the information is put to good use, it might help send enough new and disciplined people to Congress come November to make a difference.

HT: Drudge

Household Balance Sheet update

Today the Fed released its Flow of Funds report, which includes their calculation of households' net worth (chart above). It doesn't reflect any significant improvement over the levels of last year, and indeed it shows that net worth in the second quarter declined by about $1.5 from the first quarter, largely due to the 12% decline in the stock market. It's interesting to note, however, that the value of households' real estate holdings has been increasing, albeit only modestly, since the first quarter of 2009, and that tracks with the modest increase in the Case-Shiller housing price index over the same period. Also of note is the ongoing modest deleveraging of the household sector, with liabilities in the second quarter of $13.9 trillion, down from $14.3 trillion at the end of 2008.

In addition, the report shows that the household sector has been an important source of financing for our exploding federal deficit: households increased their holdings of Treasury holdings by $820 billion between the end of 2008 and the end of Q2/10. I can't help but think that if it weren't for the huge, deficit-financed federal spending that has occurred over the past few years, households might well have put that money to more productive use. Instead, we have households today holding over $1 trillion of Treasury debt that is yielding a paltry 1.5% on average.

The equity/inflation connection

This chart compares the S&P 500 index (orange line) with Bloomberg's calculation of the market's 5-yr, 5-yr forward inflation expectations (white line; as derived from TIPS and Treasury prices). There's a pretty decent correlation (0.7) between the two, and that implies that whatever causes inflation expectations to rise (though I think it makes more sense to say whatever causes fears of deflation to fall) also causes equity prices to rise, and vice versa.

The correlation has been especially strong in the recent rally. Inflation expectations have risen (deflation fears have fallen), and that has been expressed via a rise in nominal 10-yr Treasury yields and relatively flat TIPS real yields. Rising inflation expectations have moved hand in hand with equity prices. As I mentioned in yesterday's post, the market really believes that weak growth and deflation risk go hand in hand. The news this month has not been as bad as the market had expected, so the market has revised up its outlook for the economy (which is good for stocks) and revised up its outlook for inflation (which is bad for Treasuries).

Deflation again a no-show

Once again deflation has failed to show up in the numbers—it's the dog that didn't bark. I think the equity rally we've seen so far this month has been all about deflation failing to show up and a double-dip recession failing to materialize. The market didn't need good news to rally, it just need the absence of bad news. In other words, the market was priced to the expectation that the news would be bad, and when it wasn't, the market had to reprice upwards. Imagine what might happen if the news were to actually turn positive ...

Then again, perhaps the market is up because the odds of Congress extending the Bush tax cuts are improving.

Whatever the case, it looks like the CPI numbers have seen the low, at least for now. On a 3-month annualized basis, both the headline and the core CPI measures are up more than the year over year numbers (1.7% and 1.4%, respectively).

Meanwhile, corporations continue to make money, and many of them continue to report surprisingly strong profits. Commodity prices are rising across the board. Global trade is expanding. Credit spreads have narrowed significantly and default rates are coming down. Monetary policy all over the world is accommodative. Not one central bank or government is trying to rein in growth, while nearly all are trying (whether intelligently or not) to stimulate growth. Yet despite all these positive signs—and the absence of policy negatives—investors are so afraid of a double-dip recession that they are willing to forego all gains in order to enjoy the safety of cash.

I remain very bullish.

AAPL update -- still looking good

Apple (AAPL) is on track to post a new closing high today, so I thought I would celebrate that and reiterate my view that AAPL is still an attractive stock to own. I've been recommending AAPL repeatedly since my first post on the subject in Oct. '08, and I've owned the stock for almost 10 years and still do.

Apple's success lies in its ability to innovate and to use industrial design to make complex computers easy to use. Its products are beautiful and reliable, and its software is well-thought-out. Apple is arguably the only computer electronics company that has the capability to innovate in more than one area, and it has expanded its product line impressively over the past several years. Its market share is very strong in smartphones and mp3 devices, and it is steadily gaining market share in the laptop and desktop area. Apple's market cap has surpassed that of Microsoft, and for good reason. Microsoft is a one-trick pony that long ago lost the ability to innovate, and it's products and software appear to be designed by engineers rather than by artists and industrial designers.

An article in today's WSJ reminded me of my recent trip to Best Buy (BBY), in which I took three Argentine friends there so they could buy some cameras and computers. Argentina has virtually no Macs—everyone uses PCs, and the great majority of the PCs run the now-obsolete Windows XP. I showed them the Macs we have at home, and encouraged them to upgrade to a Mac laptop. They were reluctant however, since none of them had much computer expertise. What would they do if they ran into a problem?

The one thing that piqued their curiosity, however, was the iPad. They were entranced by its magic and simplicity. I used the iPad to show them our photos of Africa, and then I pulled up a map of California so they could plan their trip to San Francisco. Scrolling around the map, zooming in on details, flipping through photos, all accomplished with a single finger. "Does this map program come with the iPad? Will it work in Argentina?" they asked. Yes, I replied. "Can I do email and internet on the iPad?" Yes, I replied, and it's quite easy. You really can't screw things up, because all you need is a finger. No file system, no launch commands, no ability to push the wrong button. There's only one button in fact, and it always takes you back to home base. No moving parts. Sold.

After almost three hours of haggling with a very patient and spanish-speaking Best Buy employee, they loaded up their shopping cart with two iPads, two Canon SLRs, and an assortment of lenses and accessories. To my surprise, they even negotiated a 20% discount on the accessories. While they were checking out (around 3pm on a weekday) I noticed that the store was unusually full of customers, and there were quite a few standing in line. It's purely subjective on my part, but I think that Best Buy has really filled out their product line and has learned how to sell things much better than it did just several months ago. Now, as the article mentions, they plan to sell iPads at all their stores, not just a select few. There's potential here for BBY to do quite well as the economy improves..

As the article also mentions, according to Best Buy's CEO Dunn, "internal estimates showed that the iPad had cannibalized sales from laptop PCs by as much as 50%." That's the thing that has always sustained my belief in a bright Apple future: Apple's ability to gain a significant share of the gigantic market of Windows-based computers.

Deflation still a no-show

August inflation at the producer level came in at or slightly higher than expectations. So far this year, both headline and core producer price inflation are running at about a 2% annual rate. At the very least, this continues to rule out deflation, especially when we look at the price action at the crude level, where prices over the past year are up almost 20%.

Why then are so many observers—and the press—still obsessed with deflation? My guess is that the collective mindset is dominated by a faulty understanding of how inflation works. Even the Fed is guilty. It's very easy for people to believe that rising prices are the result of very strong demand, and that therefore weak demand should result in falling prices. We obviously have a very weak housing market, for example, and we observe that prices have indeed fallen significantly—by as much as 50% or so in the formerly high-flying Inland Empire market, and about one-third on average in major metropolitan areas, according to the Case-Shiller data. With everyone saying that the recovery is miserably weak, and with so many defaulting on their obligations and so many trying to deleverage, it is easy to extrapolate and say that demand is weak and therefore deflation is a real threat.

But the decline in housing and housing-related prices is not deflation, it's a relative price shift. It's the market's way of signaling that we have an excess of housing inventory, and the only way to clear that inventory is to lower prices. Lower prices send a signal to producers that we don't need new houses, so workers migrate out of the construction sector and into other sectors.

It's perfectly normal, even during times of inflation, to have some prices rise while other prices fall. Deflation is when all prices fall. That can happen only when the amount of money available in an economy is less than the amount desired—when money is effectively in short supply. If there's a shortage of money, then prices have to fall. If demand is weak and there is a shortage of money, then you have the ingredients for something nasty like a deflationary depression.

But that's not what we have today. There are a number of market-based indicators that tell us that money is not in short supply, and that money is in fact in abundant supply. If the dollar is weak relative to other currencies, it's because there is an abundant supply of dollars relative to other currencies. If gold and commodity prices are rising, it's because there is an abundant supply of dollars—lots of dollars chasing a limited outstanding stock of gold. A steep yield curve also reflects abundant money, because it is the market's way of saying that short-term interest rates are going to have to rise by a lot at some point in order to reverse the Fed's current willingness to over-supply dollars to the world. Very low swap spreads are another way that abundant dollars show up, because when money is easy to come by, then counterparty risk goes down.

Commodities are on fire, and that's good

This index of spot industrial commodity prices is up over 50% from March '09, and it is only 2% below its all-time high of July '08. I think this is highly significant, for a number of reasons.

Global growth: where there is this much commodity "smoke," there is almost surely some economic growth fire. Commodity prices don't move up strongly in the absence of demand. That almost all commodity prices are rising (and rising against virtually all currencies) is a good indication that the global economy is growing, and exceeding the expectations of the world's commodity producers.

Inflation: The world's central banks are about as accommodative as they have ever been. They are all fighting deflation, and they are all bent on ensuring that monetary policy presents no obstacle to economic growth. Short-term interest rates in many parts of the globe are at or near zero. That gold and commodity prices are rising sharply is an excellent sign that money is in abundant supply. An oversupply of money tends to increase the demand for tangible assets, since they are ultimately a hedge against the loss of value of fiat currency. Thus, rising tangible asset prices are an excellent indicator of potentially inflationary monetary policy. At the very least, strong commodity prices virtually rule out the risk of deflation.

Risky assets: Risky asset prices (e.g., equities, corporate bonds, emerging market debt) are arguably priced to the expectation that growth will be meager at best, and many are priced to the expectation that deflation is a significant risk. The action in the commodity markets says those expectations are way too timid, and that therefore risky asset prices are generally quite attractive. If instead of meager growth and deflation we in fact have generally strong global growth and at least some inflation, then nominal corporate cash flows are going to be much stronger than is currently being discounted. Growth plus inflation is a fantastic recipe for owners of high-yield bonds, for example, since those ingredients combine to deliver low default rates.

It's the spending, stupid: downsizing government is the new agenda

My favorite think tank—The Cato Institute—has a new ad out that just appeared in the Wall Street Journal, Washington Post, New York Times, Los Angeles Times, Washington Examiner and Politico. Click on the image above to see the full-size version of the ad.

As Daniel Henninger writes in today's WSJ, "It's the Spending, Stupid." The biggest issue for the electorate today is out-of-control spending at the federal and state levels. We've got to start cutting back, and in a serious way. Cato has already identified hundreds of billions that could be saved annually by cutting or eliminating programs and departments that never should have been created in the first place. Read this and pass it along.

Unemployment claims could be the next bull story

The top chart shows seasonally-adjusted (reported) claims, while the bottom shows actual claims. The message from both charts is that the big swings in reported claims in recent months was due primarily to faulty seasonal adjustment. Actual claims didn't rise by as much as expected in early July, and they didn't fall by as much as expected in early August.

Meanwhile, actual claims have been falling steadily since early July, and have now reached a two-year low (see third chart). Claims are actually lower now than they were for the same week two years ago. If this keeps up, claims could prove to be a nasty surprise for the bears.

The Chinese "manipulate" their currency to our advantage

Politicians just can't leave well enough alone. Once again we hear the drumbeat of concern over the alleged fact that China's has "manipulated" its currency—by keeping it too weak—and how that harms the U.S. economy. Yet nothing could be further from the truth.

To begin with, the Chinese yuan has appreciated by 23% since China's central bank first decided to peg the yuan to the dollar at the beginning of 1994—almost seventeen years ago. The Chinese economy has had plenty of time to adjust to its current currency regime, and if that weren't enough, the currency has appreciated significantly in the interim. Moreover, the Chinese have recently committed to allowing the yuan to appreciate even further, as suggested in the above chart.

Leaving aside the issue of whether they have kept the yuan artificially weak or not, China's monetary policy (which is driven by pegging its exchange rate) has been successful at delivering relatively low and stable inflation: since 1996, in fact, Chinese inflation has been substantially similar to that of the U.S (actually, it has been a bit lower—2% vs. 2.5% per year). This fact alone is almost proof that they haven't been keeping the currency artificially weak. (I'm leaving out 1994-95 since inflation in those years was temporarily boosted due to the 50% devaluation of the yuan that preceded its being pegged to the dollar.)  In other words, our price level has risen about the same as the Chinese price level for the past 15 years. If the yuan had been chronically undervalued during that time, then Chinese inflation would most likely have been higher.

But let's suppose that the currency was "too weak" when they first pegged it in 1994. If that were the case, then it is certainly a lot less weak today, since it has appreciated by 23%. If the currency were just about right in 1994, when Chinese/U.S. trade was still in its infancy, then it is arguably "too strong" today. If the currency were too strong in 1994, then of course it is even stronger today. In short, it's difficult to make the case that the yuan has been kept artificially weak.

And even if the yuan were chronically "too weak", what's the problem anyway? If the Chinese want to sell us cheap goods, that's to our advantage. True, some manufacturers here might go out of business as a result, but all consumers would benefit. Why should we pursue a policy—forcing the Chinese to appreciate their currency even more than they already have—that would disadvantage every single one of us—because a stronger yuan/weaker dollar would make Chinese imports more expensive—in order to protect a small number of businesses that are forced to compete with Chinese imports?

Mark Perry has a wonderful way of "rewriting" incoherent and uninformed policyspeak coming out of our government and our mainstream media. Here's how he corrects an article in today's Washington Post. It's a jewel:

This week, committees on both sides of Capitol Hill will plumb the conundrum of Chinese currency manipulation. The conundrum isn't that -- or why -- China is manipulating its currency: By undervaluing it, China is systematically able to underprice its exports, putting American (and other nations') manufacturing consumers and businesses that purchase China's cheap imports at a significant disadvantage. The conundrum is why the hell the United States isn't doing thinks it should do anything about it. 

There are certainly plenty of senators and congressmen -- and Main Street Americans U.S. producers that compete with China -- who'd like to see the White House place some tariffs taxes on American consumers and businesses who purchase the underpriced low-priced Chinese imports. If the administration doesn't act, Congress may just consider mandating some tariffs punitive taxes against American consumers and businesses on its own.

Temporary tax cut is a bad idea

Amity Shlaes has a nice article in Bloomberg today, entitled "Reagan, Obama, Summers All Wrong on Tax Credit." She makes a lot of good points—read the whole thing—but the one that most strikes me is that a temporary tax credit such as Obama is proposing benefits only established firms that have accumulated profits to invest. It does nothing to help new firms get started. A much better approach would be a permanent, across-the-board reduction in the corporate tax rate. That would give all firms, even startups, an added incentive to expand, since it would increase the after-tax returns to new investment. It effectively lowers the hurdle rate for all investment. Plus, it would allow U.S. firms to better compete with foreign firms, since the U.S. corporate tax is among the highest anywhere.

The article also has nice little tidbits such as the fact that Summers and Goolsbee are on record as criticizing such a tax in the past.

HT: Russell Redenbaugh

Federal government finances continue to improve

First, let me be clear: the federal budget is in miserable shape, since expenditures have exploded in recent years and the deficit is a huge percentage of GDP. Nevertheless, on the margin things are improving. One of the most encouraging signs of improvement is the rise in federal revenues over the past five months (see the blue line in the above chart), since that is a sure sign that the economy is doing better. People don't pay more in taxes unless they are earning more.

As this next chart shows, revenues haven't increased much compared to GDP, but at least they are no longer falling. Spending, on the other hand, has not only declined in nominal terms but also relative to GDP, with the result that the federal deficit over the past 12 months is now "only" 9% of GDP. That's still gigantic, of course, equating to fully $1.3 trillion, or just over $100 billion per month

The challenge going forward will be to cut back government spending. Tax rates don't need to rise to fix the budget deficit. Extending the Bush tax cuts would most likely result in a stronger (than otherwise) economy, and that would lift tax receipts even as tax rates remained unchanged. The best way to deal with the deficit is through reductions in spending, since that would likely boost the economy even further (see previous post for an explanation as to why). Growth is the solution to our current problems, and the best way to achieve that is through no tax increase and a lot of spending reductions. The solution is in sight, and it's already working to some extent.

Industrial production continues to recover

Industrial production in the U.S. rose modestly in August, about in line with expectations. Production is up at an annualized rate of 6% in the past six months, and has rebounded 9% from the lows of June 2009. As the top chart shows, industrial production has also rebounded all over the world since early last year, with the most notable rebound occurring in Japan.

But as this next chart shows, capacity utilization rates remain unusually low, so we'll need to see a lot more in the way of rising industrial production before the economy returns to anything that might be termed "healthy." Still, we are making progress and that is the most important thing.

In this last chart, I've added the real Federal funds rate to the chart of capacity utilization. The Fed has believed for a long time that inflation is the by-product of a very strong economy, so it is not surprising to see the strong correlation between capacity utilization and the real funds rate. When capacity utilization rates are high, the Fed sees this as a good indication that "resource slack" is very low, and thus inflation risk is high, so it tightens by raising the funds rate relative to inflation. By the same token, low utilization rates reflect a lot of idle capacity and resource slack, and that means inflation risk is low, so easier monetary policy conditions are called for. The unprecedented degree of resource slack we've experienced in this recession has given rise to the widespread concern that deflation risk is high. I don't agree with that line of reasoning (inflation is a monetary phenomenon that has nothing to do with the strength of the economy), but that's what drives the Fed so we need to pay attention. In any event, the degree of slack is declining fairly rapidly, so that means that deflation concerns at the Fed should also be declining rapidly.

Interestingly, the last chart suggests that if capacity utilization rates continue to rise, then the Fed might end up raising rates a lot sooner than the market currently expects. Fed funds futures currently show almost no chance of a tightening until next summer at the earliest. I for one would be very happy to see higher rates, and for a number of reasons. For one, it would send a positive message that things were improving. Two, higher interest rates are a net benefit to households, since the average household has a lot more floating rate assets (e.g., money market funds and bank CDs) than floating rate debt (e.g., adjustable rate mortgages). Three, a tighter Fed would provide much-needed support to the dollar, which is near the bottom end of its historical valuation range these days. A strong dollar would in turn foster more investment (foreign investors are much more likely to invest here if they believe the dollar will retain its value).

Politics on the margin—very encouraging

Ronald Pestritto has an interesting article in today's WSJ entitled "Glenn Beck, Progressives, and Me." In it he gives the nod to Beck's view that liberals today—especially Obama—are continuing the progressive tradition which began with Woodrow Wilson and Theodore Roosevelt. He also agrees with Beck that "The progressive movement did indeed repudiate the principles of individual liberty and limited government that were the basis of the American republic." There is a lot at stake in the November elections, and the surprising victories of Tea Party candidates in yesterday's primaries is therefore quite encouraging. The people are increasingly concerned—and rightly so—that the federal government has become way too powerful and needs to be checked.

Also in today's WSJ you will find a great article by Alberto Alesina, "Tax Cuts vs. 'Stimulus': The Verdict Is In." He reviews the findings of his research that show that a reduction in government spending and a reduction in tax rates are far more likely to stimulate an economy than increased spending. In fact, "cutting spending in order to reduce deficits may be the key to promoting economic recovery," because reduced spending sends the message that tax burdens are likely to decline in the future, and this creates positive incentive effects to expand individual initiative and new investment.

I've been saying something similar since early last year. Obama's stimulus spending was very unlikely to stimulate the economy. Indeed, I thought the stimulus was most likely going to slow down the recovery, because government spends money less efficiently than the private sector, and because increased spending creates expectations of rising tax burdens and that discourages investment and work.

The best thing we can do for the future is to recall what is left of the stimulus, recall the healthcare bill, extend the Bush tax cuts, and vote in a new Congress. These are ideas that appear to have legs, and that's very encouraging.

Retail sales update

August retail sales came in a bit stronger than expected, but it's hard to look at this chart and find any impressive strength. Sales are up at a 5% annual pace since bottoming at the end of 2008, but they are still about 4% below their peak level of late 2007. This amounts to a relatively modest but ongoing recovery, and that's the same story that is reflected in a variety of economic indicators.

Credit spread update

Our six Argentine friends departed this morning for a drive up Highway 1 to San Francisco, so blogging should be getting back up to speed this week.

To begin, here's an update on credit spreads. Following the Greek default scare that rattled markets and pushed spreads up in May, credit spreads have since settled back down. They remain quite elevated, however, and are still at levels that have been associated with the onset of recessions in the past. Things have been slowly improving on the margin, but the market remains quite nervous and fearful that a double-dip recession is lurking around the corner. Investors are still worried about the prospects of rising tax rates, and businesses are concerned that they face a harsh regulatory environment.

In short, spreads tells us that the market is still quite fearful. There is nothing here to suggest unwarranted optimism or unattractive valuations. If the news doesn't deteriorate as the market seems to expect it will, then spreads are likely stabilize or narrow further. This creates an attractive proposition for those willing to take some risk, because yields on corporate bonds are significantly higher than the yield on cash. The huge yield pickup to be found in the corporate bond market provides a substantial cushion against bad news, and if the economy fails to deteriorate or even improves just a little, then the rewards to holders of corporate bonds will be large.

Fear subsides, prices rise

My interpretation of the equity rally that has occurred this month is a bit different from David Rosenberg's, who believes that the market is no longer worried about a double-dip recession (even though he remains pretty confident that there will be a double-dip). I think the market is still very worried about a double-dip, only now a bit less so. The yield on 10-yr Treasuries is still extraordinarily low, and to me that is a sign that investors are still very worried about the economy's ability to grow.

I've showed this chart many times in the past, and it remains the case that there is a strong inverse correlation between the Vix (a proxy for the market's level of fear, uncertainty and doubt), and the level of equity prices. At just under 22 today, the Vix is still historically elevated; 12-15 would be a level consistent with a relatively healthy economy. Similarly, credit spreads are still quite elevated. Both are thus signs of a market that is still quite worried about the economy. On the margin, things are getting better, as the Vix slowly subsides and credit spreads slowly narrow. But the level of the Vix and credit spreads is still indicative of a good deal of concern among market participants.