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Bank lending continues to pick up


Commercial & Industrial Loans (bank lending to small and medium-sized businesses) continue to demonstrate that we have passed an important advance in the business cycle. C&I Loans have risen at a 8.6% annualized rate over the past three months, a rate that begins to look pretty decent. That, after loans fell precipitously from late 2008 through late 2010.

Each time I post an update of this chart I get comments to the effect that it is still difficult for many businesses to get a loan. I don't doubt that at all, since total loans are still far below where they were just a few years ago. But it is nevertheless true that, on the margin, things are improving, and that's the most important.

The important thing about increased bank lending isn't that more lending will fuel economic growth; it's that more lending reflects increased confidence on the part of banks and businesses to take risks, and it's risk-taking that fuels growth. Government spending can't fuel growth, because the decision makers who direct the spending are not taking risks in the hopes of generating profit. They are simply agreeing to fund, with taxpayers' money, projects that sound important and will help them win votes in upcoming elections from favored groups. High-speed rail is a good example, since it sounds great, but if it were truly great (i.e., profitable), then there would be no shortage of private capital willing to undertake the task. As it is, profitable train lines are an endangered species.

The jobs situation is improving


The April establishment survey of jobs found a lot more than the market expected, but the household survey found a lot less. These two measures don't always agree every month, but over time they must. The household survey of private sector jobs is rising at a 1.4% annualized rate over the past six months, while the establishment survey is registering a 2% annualized growth rate. Both show that the private sector has added about 2 million new jobs since the low in late 2009/early 2010. Things are picking up and the outlook is getting slowly better, much as I anticipated last January.


Although painful for those affected, from an economist's point of view it's also good to see the ongoing reduction in public sector employment. Shrinking the size of our bloated government is an essential ingredient to boosting the economy's ability to grow. This is a process that is likely to be underway for a long time. A reduction in government spending frees up resources that can be better utilized by the private sector; it's that simple. Although it doesn't make sense to Keynesians, the best stimulus for our economy at this time is a reduction in government spending. It's happening, and it's ongoing, and that is good news.

The upward tick in the unemployment rate, from 8.8% to 9.0%, is essentially meaningless, since it comes from the household survey, and as you can see from the top chart, that survey produces erratic results from month to month. The thing to focus on is that fact that the pace of new job creation in the private sector is improving, and it has already improved enough to generate a gradual reduction in the unemployment rate over time.


I should add, of course, that today's employment report gives the lie to the weekly unemployment claims data. As I argued yesterday, the sudden and outsized gain in unemployment claims in April was most likely due to faulty seasonal adjustment factors, and today's employment report confirms that.

Something is happening with dollar currency


The amount of U.S. currency in circulation (most of which is in the form of $100 bills) is increasing at an historically rapid rate—almost 14% annualized over the past three months. As the chart above shows, currency has only grown this rapidly during times of crisis, when demand for dollars surged because the dollar was considered to be a safe haven currency. The world's demand for $100 bills surged in the wake of the Gulf War in the latter half of 1990, in the runup to Y2K in late 1999, when the dollar reached a multi-year peak against other currencies in early 2002, and during the financial/banking system crisis in late 2008. In all of those periods, the value of the dollar was relatively strong and/or rising against other currencies. In the past three months, currency demand has surged again, suggesting we may be in the midst of another crisis.


But there's an important difference this time. As this next chart shows, the growth rate of currency since mid-2010 is no longer correlating to dollar strength. In fact, currency demand has surged as the dollar has fallen. If currency demand were rising because the dollar is considered to be a safe haven during a time of crisis, why is the value of the dollar falling, and even hitting new all-time lows?

Could rapid currency growth over the past year be a precursor to a permanently higher inflation rate? I note that currency growth averaged about 10% per year during the high-inflation, 1974-1980 period, and the value of the dollar was declining throughout that period.  (Currency growth remained rapid in the early 1980s even as inflation plunged, because demand for dollars surged and the dollar rose dramatically against other currencies).

Meanwhile, the M2 measure of the money supply (of which currency circulation is a part) continues to grow at a very normal 5-6% annual rate. For some reason the world has a fairly intense desire to increase its holdings of U.S. currency at the expense of other forms of money.

I'm open to suggestions.

Silver sinks


The price of silver has plunged by more than 25% in just four trading sessions, as illustrated in this daily chart. Silver appears to be at the leading edge of the commodity price reversal that has blindsided many unlucky investors and speculators in the past week: gold is off by 5%, crude oil is down 13%, copper is down 6%, and gasoline is down 10%.

Those looking for an explanation for this point to signs that the U.S. economy is stumbling (e.g., the big jump in unemployment claims in recent weeks), since a weaker economy would reduce demand for commodities. I don't see convincing evidence of a material change in the economy's health (see my prior posts on claims and the ISM service sector), but the runup in commodity prices had all the looks of speculative excess (see my post on silver). We may discover what really triggered this commodity reversal in the fullness of time, but I doubt that it was any sudden change in the dynamics of the U.S. economy. Like the housing market, this could just be a speculative bubble that has burst.

Making claims out of thin air



The news that first time claims for unemployment surged by almost 90K during the month of April has rattled investors' confidence. But a look at the underlying data suggests that the source of the unexpected rise was most likely a faulty seasonal adjustment factor.

The top chart shows the level of non-seasonally adjusted (i.e., actual) claims. Here we see only a very modest uptick, nothing unusual. If that were all you knew, you would say that absolutely nothing happened in the labor markets in April. The second chart shows the level of seasonally adjusted claims, with a huge spike. Yikes! But the huge spike didn't occur in reality, it was entirely the result of applying seasonal adjustment factors to the raw data. Sometimes the seasonal factors can fail to anticipate the reality (i.e., the adjustment factor expected claims to fall meaningfully in April, but they didn't), and this is probably one of those times. If so, then we should see claims fall back down in the weeks to come, and I expect that will happen.

Update: Here's a chart of non-seasonally data showing how many people currently are receiving unemployment compensation of some sort. Once again, we see that there has been no sudden deterioration in the real world. All measures of those receiving insurance have been declining of late.

Things look great in Canada


Things are looking much better in Canada than in the U.S., and it shows. Once again the Canadian dollar has reached its highest level ever against the U.S. dollar, both on a nominal and inflation-adjusted basis. This chart compares the Can$ exchange rate vs. the U.S. with my estimation of Purchasing Power Parity, which is the exchange rate at which prices would be roughly equivalent in both countries. The loonie is strong, with the result that Canadians' purchasing power when traveling in the U.S. has never been greater (i.e., the positive gap between the actual exchange rate and PPP has never been larger).

Canada has just voted decisively in favor of a conservative government that will continue to pursue a pro-growth fiscal policy consisting of tax cuts and curbs on government spending. Canada's stock market is outperforming ours, its housing market has largely avoided the collapse we have suffered, its banks are doing well, its natural-resource-based economy is flourishing, taxes are being cut, and its budget deficit as a percent of GDP is less than half of what ours is (34% vs. 78%). What's not to like?

Going long the loonie is a tough decision, however, since it is pushing the limits of its valuation vis a vis the dollar. The news is great, but lots of good news is priced in. This leaves the loonie vulnerable to even the hint of commodity price weakness, and those fears are already stirring as gold and silver suffer from a bout of selling panic. Caveat emptor.

Full disclosure: I have no direct exposure to Canada or its currency at the time of this writing.

Weak ISM service report likely an outlier




The April ISM service sector surveys were much weaker than expected, but all components remained above 50, indicating that the sector is still expanding, only at a slower pace. The biggest decline came in the new orders sub-index, but the decline was so large and abrupt as to be suspicious. The economic data are not always consistent, and monthly fluctuations and aberrations do occur, and this is probably one of those times. Other indicators continue to reflect ongoing growth. The manufacturing sector is very strong, commodity prices are quite high, car sales are rising, financial conditions remain generally healthy, and there is no indication in either the Challenger survey or the ADP employment report (see charts below) to suggest that the economy is suddenly falling off a cliff.



The ADP report suggests that we are likely to see private sector job gains of around 200K in Friday's employment report, which in turn would mark a continuation of modest, unspectacular economic growth.

Car sales remain very strong


April auto sales weren't up much more than expected, but over the past six months they have registered an impressive 15% annualized gain, and over the past year they are up by 16.7%. Contrary to the overall economy, which seems mired in an unusually slow-growth recovery, the magnitude of the auto sector recovery is comparable to the strong recoveries coming out of the 1982 and 1990-91 recessions.

Reflections on the dollar's weakness


With the Fed's latest data release, it's official: in inflation-adjusted and trade-weighted terms (arguably the best way to measure the dollar's true purchasing power overseas), the dollar is now weaker than it has ever been.


Against a relatively small basket of major currencies (above chart), and not adjusted for inflation differentials, the dollar has yet to hit new all-time lows, but it's very close.

What does the dollar's unprecedented weakness mean? A lot of things:

It reflects the world's deep mistrust of our monetary and fiscal policies. In a sense, the dollar's value is akin to the price that foreigners are willing to pay to gain access and exposure to the U.S. economy. The very weak dollar is a sign that the U.S. is a very unattractive place to do business these days.

The Fed is supplying more dollars to the world than the world wants to hold. As a corollary, the Fed is setting U.S. interest rates at a level that is lower than they should be to balance the world's demand for dollars with the supply of dollars.

U.S. exporters may get a temporary boost, since a cheap dollar makes it easier for them to undercut foreign competitors. But the cheap dollar will tend to boost the price of all imported goods, and that in turn will increase the cost of living for everyone. Eventually, higher inflation will erode whatever advantage exporters might enjoy today. You can't devalue your way to prosperity.

U.S. tourists will find that most overseas destinations are extremely expensive; combined with expensive energy, this is likely to curtail many summer travel plans.

Foreign tourists will find that the U.S. is one of the cheapest destinations in the world; this is likely to boost the U.S. tourism industry.

Foreign holders of trillions of dollars of U.S. debt are losing money daily as the dollar declines against their currencies. Over the past year, for example, the Chinese yuan has appreciated by 5% against the dollar, thus reducing the value of China's Treasury holdings by 5%; that's roughly equivalent to two years' worth of interest payments. China doesn't have much of an alternative, though, since unloading a significant portion of its U.S. debt holdings would likely depress the dollar even more. Foreigners in aggregate have huge exposure to the dollar (the flip side of our multi-year trade deficits is a multi-year inflow of foreign capital); so huge, in fact, that they have little alternative but to grin and bear it.

If foreigners were to sell a significant portion of their U.S. holdings, they would not only lock in huge losses, but they would also have to find something here on which to spend the dollars they no longer want. Any net capital outflow would perforce require a net trade surplus. A mass liquidation of U.S. security holdings by foreigners could translate into a gigantic increase in U.S. exports. Alternatively, a significant portion of any mass liquidation of Treasuries by foreigners could find its way into our equity and property markets. Treasuries are trading a unusually high valuations (i.e., very low interest rates), while equities are not overvalued (e.g., PE ratios are below average), so swapping out of Treasuries and into stocks and real estate might make a lot of sense to many foreign investors. To the extent this happens, Treasury yields and equity prices might rise simultaneously.

Foreign investors are finding that U.S. real estate is very cheap. Since the peak of the housing market in early 2006, prices have fallen by about 30% according to the Case Shiller data, while the dollar has declined by about 15%. Combined, that has reduced the effective price of the typical U.S. home by 40% in the eyes of foreign investors. Foreign demand for U.S. real estate likely is playing an important role in stabilizing the U.S. property market.

With the dollar trading at all-time lows, a decision to sell the dollar here requires a firm conviction that the bad news that is already out there (e.g., trillion-dollar deficits, and a massive expansion of bank reserves that could fuel a huge increase in inflation) is going to get even worse—not only are things as bad as they've ever been, but we ain't seen nothin' yet.

With the dollar plumbing all-time lows almost daily, it is no secret that the outlook is grim. Dollar sentiment is extremely depressed. The dollar could therefore benefit from any indication that conditions are not as bad as everyone thinks. The mere absence of bad news could be very good news for the dollar. If the news turns positive (e.g., Congress finds a way to restore fiscal sanity without big tax hikes, and/or the Fed raises interest rates convincingly) then the dollar could have massive upside potential.

But as my mentor Art Laffer taught me, fiat currencies—unlike gold and real estate—have no intrinsic value. They can (and many do) decline forever.

Feel free to add more reflections in the comments.

Strong factory orders


March new orders for U.S. manufacturers jumped by 3%, substantially exceeding expectations for a 2% gain. As this chart shows, new orders have surged at a 25% annualized rate since last October, and are closing in on their previous highs. The economic recovery continues, and it looks like it's picking up speed, at least in some sectors of the economy.

Do rising oil prices threaten growth?


Arab Light crude is about $25 shy of its 2008 all-time high (both in nominal and real terms), and it has been rising steadily since last September. As this chart shows, every recession since 1970 has been preceded by a sharp spike in real oil prices. Does the recent spike mean the economy is headed for another recession? I think there are good reasons why oil prices will not necessarily precipitate a recession. 


To begin with, the aggravating factor that precipitated every recession on this chart was a significant tightening of monetary policy, as characterized by a pronounced rise in real interest rates and a very flat or inverted yield curve, as illustrated in the above chart. Today the monetary situation is completely different; real yields are very low and even negative, and the yield curve is quite steeply sloped. Rising energy prices can be problematic when the Fed is tight, because tight money puts the economy on a strict monetary budget: when you pay more for energy you have to pay less for other things. Thus expensive energy can really squeeze the economy when money is tight, and it is the shortage of money that results in a recession. Today the Fed is quite accommodative, which means that the Fed is essentially working hard to ensure that expensive energy prices don't result in a shortage of money to spend on other things. 


The other reason is that our economy has become much less dependent on energy over the years, thanks to technological advances and conservation initiatives. Energy expenditures represented about 9% of all personal consumption expenditures in 1981, but today energy only consumes about 6%. Even though energy prices today are higher in real terms than they were in 1981, we are spending about one-third less of our incomes on energy today than we did back then. 

Update: To clarify my position on higher oil prices: they are a drag on growth because they make economic activity more expensive/less profitable on the margin, but at the same time higher oil prices put more money into the pockets of oil producers, who must then spend it on something else. Higher oil prices do not cause money to go down a black hole; dollars spent on oil produced by OPEC countries never leave the U.S., they simply change hands. Higher oil prices will slow growth, but at these levels they don't threaten a recession.

David vs. Goliath update


I first posted on this subject in October '08 and then again about two years ago. In my original post I predicted that "we could see Apple surpass Microsoft's market cap within a few years." As it turns out, Apple's market cap eclipsed Microsoft's about one year ago.

Back in late 1999, Microsoft reached a peak capitalization of just under $600 billion, while Apple was worth a mere $17 billion at the time. Since then, AAPL investors have gained about $300 billion, compared to the $375 billion that MSFT investors have lost.

I've been an Apple fanboy ever since purchasing my first Mac in 1987, and I have used both Macs and PCs almost daily ever since, so I'm intimately familiar with both. I've owned AAPL stock for about 10 years now, and I haven't changed my mind: Apple makes better computers and a better OS than Microsoft—better than anyone else, for that matter. Apple also has become the most successful computer technology innovator the world has ever seen.

Apple was the first to commercialize the graphical user interface for personal computers, and it has since set the standard for music players, smartphones, laptops, and tablet computers. Microsoft and other would-be competitors have been reduced to copying and piggybacking on Apple's achievements. Apple leads, and others follow, in a market that now amounts to billions of potential consumers all over the world. This is heady stuff and I doubt the dynamics will change meaningfully in the foreseeable future.


Full disclosure: I am long AAPL at the time of this writing.

Profits update: stocks remain attractive


According to Bloomberg's data on trailing earnings per share ($88.15 as of April '11), corporate profits have risen at a 20.9% annualized rate over the past six months, and 27% over the past 12 months. As the chart above shows, corporate profits by this measure continue to track the growth of corporate profits as measured in the National Income and Product Accounts, with the latter tending to be a leading indicator of the former.


Despite the impressive growth in profits, which show no sign yet of turning down, the market has been assigning a PE ratio of just over 15 to after-tax earnings for the first four months of the year. The current PE ratio is below the average (16.6) of the past 55 years, which is a sign that, at the very least, the market is conservatively priced. However, given that risk-free Treasury yields are very low from an historical perspective (giving today's 10-yr Treasury yield of 3.3% a PE ratio of 30), today's below-average PE ratios could be taken as a sign of substantial caution regarding the outlook for corporate profits.


This caution is confirmed by this next chart, which compares the earnings yield on stocks (currently 6.5%) to the yield on BAA corporate bonds (currently 5.9%). Equity owners normally should be willing to accept a lower yield than bond owners, since they can benefit from higher equity prices and higher top-line growth. Yet earnings yields have exceeded corporate bond yields for the past 12 months: a rare event, and a sign that the market believes that the outlook for earnings is very uncertain.

Full disclosure: I am long equities of all sorts at the time of this writing.

Construction spending still weak


Not much news here: construction spending continues to be quite weak. Residential construction has been relatively flat and very low for over two years now. As the chart below shows, residential construction has now reached its smallest level ever relative to the overall economy. Nonresidential construction last year looked to be stabilizing, but in recent months has been declining again.

Manufacturing continues to be very strong


The ISM indices continues to reflect very healthy conditions in the manufacturing sector, with the April reading exceeding already-high expectations. The chart above suggests that with manufacturing this strong, the economy should be growing at a 5-6% annualized rate, much higher than the meager growth numbers we have seen in recent quarters. At the very least I think this suggests that economic growth should be accelerating over the course of this year.


Export orders have been volatile of late, but continue to reflect fairly robust conditions.


A clear majority of purchasing managers continue to report paying higher prices, which is not surprising given the rise in commodity and energy prices. This is bad to the degree that higher prices are being driven by accommodative monetary policy, but good to the degree that higher prices reflect generally strong global demand.


The employment index continues to run at very high levels, higher than anything we've seen since 1972.

Manufacturing and GDP


This chart is a complement to an excellent post by Mark Perry which shows and explains how manufacturing has been shrinking as a share of both U.S. and world GDP for decades, and another post of his which shows the dramatic gains in worker productivity that have enabled manufacturing to decline as a share of total economic activity, even as total manufacturing output, economic activity and living standards have boomed. The chart above highlights how China is an exception to the rule, since manufacturing as a share of China's GDP has been relatively stable for the past four decades.

In this same vein, I would add that agriculture was once about half of total US GDP, whereas now it is only a small fraction, yet we feed ourselves and are a net exporter of food. Here again we see how tremendous productivity gains have enabled us to devote fewer and fewer resources to the production of essential goods. This is as it should be.

There is no decline in US manufacturing, and China is not stealing jobs from us. Global trade is a win-win situation for all.