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Mortgage delinquencies improve very slowly

This recovery has been slow, and agonizingly slow for all those exposed to the real estate market. The top chart shows mortgage delinquencies as a % of total loans, while the bottom chart shows foreclosures as a % of total loans. Both reached record-high levels early this year. There's been some progress since then, but we still have a long way to go before the real estate market gets back to anything that might be considered normal. Lots of pain and suffering out there, and it's going to be a hard slog for at least the next year or two, even though it is nice to see that we have turned the corner and are moving in the right direction.

If there is any consolation to be found here, it is that this problem (record-high delinquencies and foreclosures) has been with us for quite some time now, and the market has had plenty of time to adjust prices and take losses. It is very likely that all the losses that are going to come out of the real estate market have already been priced in, and all the bad news has been digested. Undoubtedly there are many homeowners who haven't yet accepted the fact that they have lost lots of equity in their homes, but the market has most likely figured it out by now. The worst is over, and now the economy and the market can slowly put things back together.

Unemployment claims looking a bit better

Seasonally adjusted unemployment claims (top chart) last week fell to a new 4-wk. moving average low for the year. Actual claims (second chart) have been flat since late April. In a typical year, actual claims would have been rising at this time of the year, but that is not happening, so adjusted claims are falling. Either way you look at it, the labor market is doing better on the margin, and that is good, even though progress is slow.

Meanwhile, the total number of people receiving unemployment benefits—about 7,750,000—has not changed much in recent weeks, and remains quite elevated.

Why the CPI is understating inflation

The big news on the inflation front today is that the 12-month change in the October Core CPI fell to 0.6%, the lowest rate of inflation in the history of the index, which began in 1957. Even the headline CPI was up only 1.2%, which ranks as among the lowest rates of inflation since the low-inflation, early 1960s. To add to the "inflation-is-very-low" news, the CPI index today is still lower than it was in July '08! Yikes, that means we've had over two years of deflation! This presumably makes the Fed governors feel more comfortable with their view that inflation is now "too low" and needs to be pumped up a bit. But with all due respect (a scarcer commodity these days among many reputable economists), I think they are mistaken.

This next chart shows the CPI index less energy, which represents a little less than 10% of the CPI. Since oil prices peaked in July '08, non-energy prices have increased 2.3%, and they have increased despite a wrenching recession and almost a year and a half of 9.5% unemployment. Thus, one big reason the overall CPI is so low is that, since Aug. '08, we've seen oil prices fall by almost half; natural gas prices fall by more than 80%, and gasoline prices fall by 30%. 

The other big reason for low CPI readings is the housing market. As Brian Wesbury has noted repeatedly, one of the key factors depressing the CPI over the past year or so has been the government's estimate of how much rent homeowners would be paying if instead of owning their house they were renting it. If you subtract owner's equivalent rent from the CPI and look just at things that people are actually spending money on, then the CPI would be up 1.5% in the past year. Since owners' equivalent rent is now beginning to increase, after falling from mid-2009 through mid-2010, an important source of lower inflation in the past year or two will begin to add to CPI inflation in the months and years to come. Consider: owners' equivalent rent makes up about 25% of the CPI, is currently unchanged over the past 12 months, and averaged about 3% per year for the 10 years prior to the housing market bubble. If it were to return to 3% a year, owners' equivalent rent could add 0.75% annually to the CPI. 

This next chart comes from a relatively new and very intriguing source, the Billion Prices Project @ MIT (HT: Mark Perry). The chart compares the year over year change in the CPI (blue line) with the year over year change in the price of a basket of millions of consumer-oriented items as priced daily by MIT via online sources. There are some key prices, however, that aren't included, such as energy, cars, transportation, and services such as education, health, and tourism, but those only account for about 40% of the CPI. Despite this, MIT reports a high correlation between their data and the CPI. In any event, the MIT project is reporting inflation of about 1.8% over the past 12 months, compared to the 1.2% gain in the CPI and the 0.6% gain in the core CPI. One more reason to think that the CPI may be under-reporting inflation.

If the MIT index were to include cars, it would be registering even higher inflation, as this next chart suggests. According to the folks at Manheim Consulting, used car prices rose 4.7% in the past year. Since the end of 2009, used car prices have rebounded over 25% to a new all-time high, despite the fact that the economy has not fully recovered, and the labor market is still struggling with 9.6% unemployment.

If there is any deflation out there, it can be found mainly in the energy and housing sectors, both of which experienced a huge runup in price in the years prior to 2008. In my book, that's not deflation, it's pay-back. Almost anywhere else you look, prices are rising.

Inflation still alive and well at the producer level

Producer prices rose 4.3% in the 12 months ending in October. Measured over the past 3 years—to eliminate the extreme volatility of 2008—producer prices are up at a 2.4% annual rate. Excluding food and energy prices, the producer price index is up 1.4% in the past year, and over the past three years, it's up at an annual rate of 2.2%. No sign of deflation here, and if anything I detect a gentle upward bias in the pace of producer inflation since 2003, which not coincidentally was when the Fed first began to adopt an aggressive accommodative policy stance.

You may see reports that highlight the fact that the rise in producer prices in October was much less than expected, but that needs to be taken with a grain of salt. As Brian Wesbury notes, the unexpectedly small gain in October prices (and the unexpectedly large drop in core prices) was likely due to a seasonal adjustment problem, since "this is the fourth time in the past six years that the core PPI has dropped in October ... and (it) may be due to how the government estimates prices of light trucks, which fell 4.3% in October."

Manufacturing output continues to expand

US October Industrial Production was unchanged, according to the Federal Reserve, disappointing market expectations of a 0.3% increase. This weakness, however, was mostly due to unusually mild weather which caused utility output to drop 3.4%. The above chart shows the index for manufacturing activity (a subset of the larger industrial production index), which rose 0.6% in October and is up 6.2% in the past year. Over the past six months, manufacturing activity has expanded at a 4.5% annual rate—no sign of any significant slowdown or double-dip here. I note that the rebound in manufacturing activity following the 2008-09 recession has been much stronger than the rebound following the 2001 recession, even though activity is still about 9% below its late 2007 peak. We've got a ways to go before breaking new high ground, but we're making progress at a decent rate.

A new direction for fiscal policy

This is impressive, and augurs well for real change in Congress.

(Today) Senate minority leader Mitch McConnell endorsed the proposed earmark moratorium that the GOP Senate caucus will vote on tomorrow:

Nearly every day that the Senate’s been in session for the past two years, I have come down to this spot and said that Democrats are ignoring the wishes of the American people. When it comes to earmarks, I won’t be guilty of the same thing. 
Make no mistake. I know the good that has come from the projects I have helped support throughout my state. I don’t apologize for them. But there is simply no doubt that the abuse of this practice has caused Americans to view it as a symbol of the waste and the out-of-control spending that every Republican in Washington is determined to fight. And unless people like me show the American people that we’re willing to follow through on small or even symbolic things, we risk losing them on our broader efforts to cut spending and rein in government. 
That’s why today I am announcing that I will join the Republican Leadership in the House in support of a moratorium on earmarks in the 112th Congress.
UPDATE: Even the Democrats are getting the message: Democrat Senator Mark Udall (OH) today called "for an end to the wasteful and influence-laden process of earmarking."

HT: Glenn Reynolds

Renewed strength in goods exports

After a year or so of relatively stagnant loaded outbound container shipments, the Ports of Los Angeles and Long Beach in October reported increases. (Together, the two ports account for about 40% of U.S. goods exports.) Long Beach, in particular, saw loaded outbound containers jump by 21% from September, and 26% from October '09. Moreover, this was the biggest October export figure ever for Long Beach, which suggests that exports are on track to eclipse their 2008 highs before too long. Since data on outbound container shipments tends to lead official U.S. export figures, this is a good indication that we will see stronger numbers on U.S. goods exports in coming months. And that, of course, feeds directly into stronger GDP.

Bye-bye QE2?

This chart of the yield on 10-yr Treasuries shows the rather dramatic rise in rates that has occurred in the past week. As I mentioned a few days ago ("Return of the bond market vigilantes") the market is not only protesting the Fed's decision to move ahead with QE2, but now appears to be thinking that it might be cancelled or significantly cut back. This coincides with mounting opposition from all quarters to the idea of QE2, culiminating in today's release of an open letter to Bernanke from a group of notable economists and investors.

As I've said before, QE2 is not only unnecessary but foolish. The sooner it is put out of its misery the better. And to the extent that calling off further QE2 disappoints the market, that is a great buying opportunity for investors who understand that too much money is not a good thing.

UPDATE: Here is a chart that compares the 10-30 Treasury spread with the market's forward-looking inflation expectations. The action in both is fully consistent with the market changing its expectations about QE2. Less QE2 means the 10-30 spread needs to return to more normal levels, and inflation expectations have to decline.

The problem with healthcare (cont.)

This post adds to yesterday's post on the fatal flaws of ObamaCare, and is an update of a post from a year ago. It's valuable information which deserves dissemination.

If you could only use one chart to illustrate the fundamental problem with healthcare in the U.S. today, this would be it.

As of the most recent data (2008), consumers paid for only 12% of their healthcare expenses out of their own pocket. Back in the days before WW II, consumers paid for the vast majority of their healthcare expenses out of pocket. That began to change in the early 1940s, when the government agreed to allow companies to circumvent war-time wage controls by giving their workers tax-free health insurance; companies could deduct the cost of the insurance, and it wasn't considered income to the workers. This significant feature of the tax code has finally taken us to its logical conclusion: consumers now get almost all of their healthcare paid for by an employer, since this is highly tax-efficient. The 12% that is still paid out of pocket likely consists mostly of payments by individuals not covered by employer policies, and co-pays by individuals that are covered.

Since the vast majority of healthcare expenditures are not paid for by those receiving healthcare services, but rather by a third party insurer or the government, there exists little or no incentive in aggregate for consumers to shop around. That explains the notorious lack of price transparency in the healthcare market, and helps explain why costs have risen at a rate much higher than inflation.

To fix most of what is wrong with healthcare, we simply need to fix the tax code. Either allow everyone to deduct the cost of healthcare, or no one. Without the distortion of tax incentives, companies would eventually turn the healthcare purchase decision over to employees. That in turn would restore the proper incentives to consumers, allowing market forces and competition to make healthcare more efficient and more affordable.

Strong retail sales growth

Say what you will about the sluggishness of the recovery, but it is ongoing. Retail sales in October were only 2% shy of a new all-time high, after posting sizable gains in recent months. Sales rose an impressive 7.3% in the past 12 months, and gains were widespread. In real terms, sales were up a strong 6% in the past year. No signs here of any threat to future growth.

As a supply-sider, I don't believe that retail sales (i.e., "demand") drive growth. Growth is driven by "supply:" by work, production, investment, and risk-taking. The strength of retail sales is a sign that the economy is getting back to work and recovering its confidence. This is what portends continued economic growth going forward. If Congress can see its way to extend the Bush tax cuts (in light of the recent election and the sluggish recovery, what politician would dare vote to allow taxes to rise?) then confidence in the future and the incentives to take risk and start new enterprises will increase, and that should provide a significant boost to growth—and jobs—in the coming year.

U.S. dollar once again at an all-time low

This chart is arguably the best measure of the dollar's value relative to other currencies. It compares the dollar to a large basket of trade-weighted currencies, and it is adjusted for relative inflation differentials. This eliminates the distortions which come from, for example, a large nominal rise in the dollar against a currency that is suffering from very high inflation: if the dollar's rise offsets the effects of that currency's inflation, then the dollar has not really risen at all. Similarly, it corrects for large depreciations of the dollar relative to currencies (in particular the yen) that have enjoyed lower rates of inflation than the U.S.

The latest data from the Fed show that the dollar has once again—for the fourth time since the early 1970s—hit bottom. It is now as effectively weak as it was in Oct. '78, Jul. '95, and Apr. '08. Put another way, a U.S. tourist traveling around the globe today would find that his dollar has never bought less. For that matter, a dollar today has never bought less gold, fewer industrial commodities, or a smaller basket of consumer goods and services.

To say that the U.S. economy is at risk of deflation, at a time when the dollar has never been weaker, is nothing short of cognitive dissonance. One wonders what, exactly, the Fed is looking at when they reason that a bold, risky, and unprecedented experiment in monetary expansion (i.e., QE2) is justified. When the dollar's value is at an all-time low, it follows that there has never been such an oversupply of dollars relative to the world's demand for dollars as there is today. There are more than enough dollars flooding the world already; we don't need even more.

The market is smart enough to figure this out, of course, and that is undoubtedly one of the reasons the dollar is so weak today. Given the prospect of more dollars being dumped into the system tomorrow, the market's demand for dollars has already declined, depressing its price. So the real key to the impact of QE2 will be how it compares to what the market has already priced in. It remains my belief that the reality of QE2 will prove to be less than the anticipation. The Fed will not remain oblivious to the monetary realities forever, and the U.S. economy is already stirring in anticipation of a positive course correction in fiscal policy.

We have survived similarly weak episodes in the dollar before without a devastating rise in inflation (with the notable exception of the late 1970s, when inflation rose to the low double-digits following the dollar's plunge in 1978), and there is no a priori reason we can't do it again.

The six fatal flaws of ObamaCare

In a series of posts earlier this year in which I discussed the growing list of fatal flaws in healthcare reform, I opined that "the defects of this legislation are so massive and pervasive that it will never see the light of day." Arguably, that's still true today, especially as we can now add one more fatal flaw to the list: you don't have to comply with the law because you can get a waiver! To date, 111 firms have been granted waivers by the Obama administration, and the list is sure to grow by leaps and bounds. The very fact that many firms need to apply for waivers is good evidence that ObamaCare is fatally flawed. To celebrate the increasing likelihood of ObamaCare's eventual demise, let me recap the fatal flaws as I see them:

Fatal flaw #1: The penalty imposed for not buying a policy is very likely to be less than the cost of insurance for a great many people. This, combined with the requirement that insurance companies may not deny coverage to anyone with a pre-existing condition, means that a large number of people will forgo signing up for a policy, knowing that they a) will save money and b) can always sign up for insurance if they turn out to develop a serious medical condition. Thus, the actual revenues will far way short of projections.

Fatal flaw #2: The government has no ability to enforce the penalty for noncompliance.

Fatal flaw #3: Mandating that people buy a health insurance policy simply because they are alive is arguably unconstitutional. It is also a way of hiding the fact that young people will effectively be paying a huge new tax in order to subsidize older people.

Fatal flaw #4: Regulating the price which insurance companies must charge for policies, coupled with a requirement that companies must rebate to their customers the amount by which their loss ratios fall below 90%, effectively turns these companies into government-run enterprises and would likely result in the effective nationalization of the healthcare industry. That is a violation of the Fifth Amendment, and of a Supreme Court requirement "that any firm in a regulated market be allowed to recover a risk-adjusted competitive rate of return on its accumulated capital investment."

Fatal flaw #5: A government-imposed restructuring of the healthcare industry can't possibly improve our healthcare system, and is extremely likely to make it worse. As Don Boudreaux has noted, "Trying to restructure an industry that constitutes one-sixth of the U.S. economy is ... so complicated that it's impossible to accomplish without risking catastrophic failure."

Fatal flaw #6: In cases wherein companies find that complying with the law would result in large increases in healthcare premiums that would threaten employees' access to a plan, the Dept. of Health and Human Services may grant a waiver to the company. As evidence of the first five fatal flaws accumulates, and as healthcare insurance companies continue to raise premiums to pay for the unintended consequences of government attempting to regulate an entire industry and hundreds of millions of people, more and more companies are likely to apply for waivers. At some point the whole edifice will come crashing down of its own weight. 

I have a more detailed discussion of each of these flaws here, here, here, here, and here.

UPDATE: Lest I be accused of offering only non-constructive criticism, I refer readers to previous posts about the right way to reform healthcare, here, here, and here.