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PIIGS update


Greece continues to be the focal point of the world, with the other PIIGS not too far behind—since they are the other dominoes that could presumably fall if Greece defaults. Greek Credit Default Swaps are now trading around 6500 bps, which is about where they have been for almost two months now. In contrast, and to help put things in perspective, I offer this chart of CDS for the other PIIGS, all of which carry default risk that is orders of magnitude smaller than Greece. Italy and Spain are still trading near the low end of the range of what is termed "high-yield"—companies that have some risk of default, but are still very much ongoing businesses that more often than not succeed. Irish CDS are priced only slightly above the average CDS rate of high-yield companies, and there are a number of viable companies whose CDS trade around Portugal's levels. Markets have had over 18 months to digest the risks of a Eurozone sovereign default, and this chart tells me that the individual risks of defaults outside of Greece are not earth-shattering. If they all were to default that would be potentially catastrophic, but the chances of that are small. Yet the market (e.g., PE ratios of equities and the 10-yr Treasury yield) is priced to something close to Armageddon. Given market pricing, I think that the odds still favor being optimistic.

Weekly claims update


In response to the all-too-frequent lament that jobless claims haven't fallen decisively below 400K per week for a long time, I offer this chart, which compares the level of claims to the size of the workforce. Claims may not have fallen dramatically this year, but the workforce has been steadily increasing (payrolls are up 1.25 million year to date), with the result that the ratio of claims to the workforce (which I term "workforce disruption") has fallen by 6% since Dec. '10. The chart also shows that the ratio hasn't often been as low as it is today. The economy could be doing a lot better, but things could also be a lot worse.

Jobs report modestly positive


Although the change in private payrolls was less than expected (104K vs. 125K), upward revisions to recent months were unusually large, with the result that, according to the establishment survey, there are 188,000 more private sector jobs today than we thought there were last month. Moreover, the household survey turned up a gain of 346,000 jobs in October.


To smooth out the normal monthly volatility in all these series, it usually helps to look at what is happening over the last six months. As the chart above shows, both the establishment and the household surveys now agree that the economy has added private sector jobs at the annualized rate of 1.4%. That works out to an average of 120K new private sector jobs per month. All that does, however, is keep the unemployment rate from rising, since the labor force tends to grow about 1% per year on average, thus adding about 120K job seekers to the mix every month.



This report also showed that the decline in public sector jobs, which began almost three years ago, is still ongoing. From a macro perspective, that's a good thing, since it addresses one of our biggest problems: public sector bloat (which we share with many European countries, unfortunately). This had better continue, though, since the public sector workforce is still 1.5 million larger today than it was in early 2000 (for a gain of almost 7%). The private sector workforce, however, is still 0.6 million smaller (for a loss of 0.6%).

Overall, I would call the October jobs report modestly positive, especially since it soundly refutes the notion that the economy is struggling and on the verge of another recession. Instead, it clearly shows that the economy continues to grow, albeit at a frustratingly slow pace.

Service sector indices suggest continued moderate growth



The ISM service sector activity index fell about 4 points in October (top chart), but the more widely watched non-manufacturing composite index dipped only fractionally, from 53 to 52.9. Both continue to point to moderate growth. More encouraging, however, was the employment index, which jumped from 48.7 to 53.3. On balance, I'd say there's not a whole lot of news here, except that this is one more of a growing list of key indicators that point to continuing growth and no sign of another recession.

Capex revised upwards (again)


September factory orders beat expectations (+0.3% vs. -0.2%), and along with that news came yet another upward revision to capital goods orders. This proxy for business investment has not only reached a new all-time high, it is up 9.5% in the past year and up at a 12.2% annualized rate in the past six months. The underlying fundamentals of the economy continue  to improve. If this keeps up, the problems in Europe sooner or later will fade in importance.

Kina's new video


Kina Grannis is my niece. She's quite the singer and creative performer, and has just come out with this video, which I guarantee you will find enjoyable. If it doesn't display correctly, go to her website. To pique your interest, it took almost two years to film this short video, and they used 288,000 Jelly Belly jelly beans!

Fertility rates plunge, global population bust in sight


Here's a chart of the 2009 fertility rates of a selection of countries. Go here and you can play with the selections, courtesy of Google and the World Bank. Move the slider at the bottom to the left and watch how global fertility rates were much higher in the not-too-distant past. 20 years ago Brazil, for example, had a fertility rate of 2.9, and now it is less than 1.9. (Note: 2.1 is considered to be the replacement rate, below which a population will eventually shrink.) Currently, all countries to the right of the United States have fertility rates at or below replacement levels. The developed world population will be shrinking within a few decades, and the rate of population growth in the lesser developed countries will likely continue to decline dramatically for the foreseeable future.

When I was young, I remember all the dire warnings about the "population time bomb." Global population was careening out of control, projected to exceed 14 billion by the end of this century. Today the situation has completely reversed: now there are projections which say that global population will peak at 7.5 billion around 2040. Before you know it, the world's biggest problem will be a dearth of new babies and dramatically shrinking populations.

Already, Europe is losing about 700,000 people per year, a figure that will grow to about 3 million per year or more by mid-century. If fertility rates don't increase, the population of Europe will lose up to 100 million people by mid-century. Russia is losing about 1 million people per year, and it could lose 30% or more of its population by 2050. According to the IMF, Japan's population will peak this year and then begin an inexorable decline. Japan's labor force peaked in 1998, and has since fallen by over 2 million people. (Most of these statistics come from the fascinating book Fewer, by Ben Wattenberg.)

One implication: when speaking of developed countries, it will soon be necessary to specify real GDP in per capita or per worker terms. For example, Japan's relatively slow rate of reported GDP growth becomes healthier when taking into account a shrinking workforce and an aging population. An economy's population can shrink and the size of its economy can stagnate, while still growing in per-person terms.

HT: Instapundit

Fed on hold, and that's good

The FOMC met for two days this week and decided that no changes in policy were necessary. That's a relief, because it's hard to see how being more accommodative than they already are could make any difference.

Today's problems (e.g., Greek intransigence, bloated governments, oppressive regulatory burdens, threats of higher tax burdens, threats of trade wars, oversize debt burdens, threats of Eurozone bank failures, slow growth, high unemployment) have nothing to do with a scarcity of dollars or interest rates that are too high. It's all about fiscal policies in the majority of developed economies that have relied for too long on the Keynesian notion that borrowing money from Peter and giving it to Paul can stimulate an economy, and its close corollary, that governments can direct the course of economic activity to everyone's benefit. The best thing that can be said about this brand of Keynesianism is that it is rapidly headed for the dustbin of history. Good riddance!

All the shouting these days is coming from the recipients of government largess fighting to resist the inevitable cutbacks in their handouts and subsidies. It's going to be a long, drawn-out process that could last for years, but the important thing is that it is underway, finally.

A review of the monetary evidence supports my claim that monetary policy is plenty accommodative already, and that therefore the economy is not being held back in the slightest by a scarcity of dollars or interest rates that are too high.



Relative to other currencies, the dollar is trading at very weak levels, both nominally (top chart) and in inflation-adjusted terms (bottom chart above). If dollars were scarce relative to other currencies, it would be much stronger. Given how weak it is, we can safely assume that dollars are in relatively abundant supply relative to the supply of other currencies.



In absolute terms, the M2 measure of money supply (my favorite) has grown significantly in recent years, and is well above its long-term trend (top chart). M2 has grown relatively rapidly despite the huge slowdown in real and nominal GDP growth. As the bottom chart shows, M2 has grown by leaps and bounds relative to the economy, reflecting a huge increase in the world's demand for dollar liquidity. The Fed's efforts to be accommodative have more than met the public's demand for money, and that can also be seen in the fact that Excess Reserves today are approximately $1.5 trillion.



The Fed funds rate has been essentially zero for almost three years now, and in real terms, using the PCE Core deflator (the Fed's preferred measure of inflation, and one that is almost certainly not overstating inflation, being up only 1.7% in the past year), the real funds rate is -1.4% (top chart). That is about as low as it has ever been (it was only briefly lower in 1974). In real terms, 10-yr Treasury yields are also very low, at -1.9% (bottom chart), although they were lower in the inflationary 1970s. Low real yields have almost always occurred at times when monetary policy was accommodative and inflation was relatively high.


Gold and commodity prices have soared since 2002, which was the year that the Fed began lowering the funds rate from 6.5% to eventually zero. High real and nominal rates make it difficult to own commodities (because of the opportunity cost of tying up money in inventory, and because taking speculative positions in futures incur a high cost), but cheap money makes it much easier and more attractive. The tremendous rise in gold and commodity prices in the past 10 years is strong prima facie evidence that monetary policy has been very accommodative and continues to be.


Measured by the difference between 30-yr and 2-yr Treasury yields, the yield curve is still unusually steep. This is typical of the early years of a business cycle expansion, when the Fed reverses course from the tight money policies which contributed to the previous recession. Flat curves are a classic sign of tight money, but that is manifestly not the case today. Today's steep curve reflect's the market's strong belief that interest rates cannot stay at zero forever, and will have to rise in the future.



Comparing the nominal yield on Treasuries with the real yield on their TIPS counterpart is a reliable way of measuring the market's implicit inflation expectations. As the top chart shows, the market's 5-yr, 5-yr forward inflation expectations are about 2.25% today. The second chart shows that the market expects the CPI to average 2.1% over the next 10 years. Neither measure of expected inflation is particularly high, considering that CPI inflation has averaged 2.3% over the past 5 years, and 2.5% over the past 10 years. But they are both an order of magnitude higher than they were at the end of 2008, and that's key. With the benefit of hindsight, we now know that even though the Fed had launched its first quantitative easing program in late Sept. '08, there was still a severe shortage of dollar liquidity at the end of the year when everyone wanted safe-haven dollar cash. Late 2008 will go down in history as a classic example of a liquidity shortage that was so severe that even the Fed's extraordinary and unprecedented efforts to expand bank reserves were insufficient. Fortunately the shortage was resolved shortly after, and a recovery followed by mid-2009.

All of the charts above are based on sensitive, real-time market prices. No seasonal adjustments, no lags, no room for bias. The message of every one is the same: there is no sign of any shortage of dollar liquidity, nor any sign that interest rates are so high that they are depressing economic activity. Instead, there are abundant signs that monetary policy is very accommodative. Therefore there is no reason for the Fed to do more than it already has. If anything needs fixing, it's fiscal policy, and Greece is the poster boy for that claim.

Job market steady as she goes


As I noted last month, the huge spike in announced corporate layoffs was nothing to worry about (all of the outsized increase came from troop reductions), and today's announcement confirms that nothing unusual is going on. No deterioration in the job market, and no sign of any double-dip recession.


The ADP estimate of private sector jobs growth came in a bit stronger than expected, and last months' number was revised upwards. ADP seems to be doing a better job tracking the BLS jobs numbers, so today's ADP report suggests a strong likelihood that the jobs number released this Friday will be in line with, if not a bit stronger than, market expectations (+125K).

To be sure, while these charts show no deterioration in the jobs market, they do not come even close to suggesting a healthy economic outlook. Jobs growth of 125K per month is just about enough to keep pace with growth in the labor force, but not enough to bring down the unemployment rate, which remains very high. The economy is limping along at a pace much slower than it ordinarily would be, coming out of a deep and prolonged recession. But although the news is nothing to cheer about on its face, it is nevertheless better than what the market has been expecting (e.g., a renewed economic slump). Thus the equity market has enjoyed a 13% bounce in the past month. With markets, everything is relative; there are no absolutes.

California dreaming

News flash:

SACRAMENTO, Calif.—The new business plan for California's high-speed rail system shows the nation's most ambitious state rail project could cost nearly $100 billion in inflation-adjusted funding over a 20-year construction period, far above the amount originally projected.
The plan, which was shared late Monday with The Associated Press, also shows the system would be profitable even at the lowest ridership estimates and would not require public subsidies to operate.
The report estimates the actual cost at $98.5 billion if the route between San Francisco and Anaheim is completed in 2033. It assumes private investment will account for roughly 20 percent of the final cost.
The initial estimate to build the system when voters approved bond funding for it in 2008 was $43 billion in non-adjusted dollars.

Heaven help U.S. taxpayers (non-California residents are going to be on the hook for many billions of dollars) if this project ever gets off the ground. The projected costs have doubled, yet the planners still insist that the project will produce a profit. One train line is going to have enough riders to service a $100 billion debt, cover operating costs, and generate a profit to boot? The entire Amtrak system generated revenues of only $1.6 billion in FY '09, and that fell short of costs by $1 billion. I'll guess that the California line would have to at least quadruple or quintuple the current Amtrak ridership to break even. With one line? 

California: where dreams can become reality, no matter how much they cost.

More insights into the housing market collapse

It never hurts to learn from your mistakes, so here is a reminder of some of the mistakes that led to the great housing market crisis that precipitated the recent Great Recession. From Charles Calomiris' recent op-ed in the WSJ: "The Mortgage Crisis: Some Inside Views," a few excerpts:

There is no doubt that reductions in mortgage-underwriting standards were at the heart of the subprime crisis, and Fannie and Freddie's losses reflect those declining standards. Yet the decline in underwriting standards was largely a response to mandates, beginning in the Clinton administration, that required Fannie Mae and Freddie Mac to steadily increase their mortgages or mortgage-backed securities that targeted low-income or minority borrowers and "underserved" locations.
The turning point was the spring and summer of 2004. Fannie and Freddie had kept their exposures low to loans made with little or no documentation (no-doc and low-doc loans), owing to their internal risk-management guidelines that limited such lending. In early 2004, however, senior management realized that the only way to meet the political mandates was to massively cut underwriting standards.
The decision by Fannie and Freddie to embrace no-doc lending in 2004 opened the floodgates of bad credit. In 2003, for example, total subprime and Alt-A mortgage originations were $395 billion. In 2004, they rose to $715 billion. By 2006, they were more than $1 trillion.
... more than half of the mortgage losses that occurred in excess of the rosy forecasts of expected loss at the time of mortgage origination reflected the predictable consequences of low-doc and no-doc lending. In other words, if the mortgage-underwriting standards at Fannie and Freddie circa 2003 had remained in place, nothing like the magnitude of the subprime crisis would have occurred.

Read the whole thing. HT: Russell Redenbaugh

Auto sales still strong



U.S. sales of light vehicles posted a 13.2 million (saar) rate in October, slightly more than expected. These charts show the data from a long- and short-term perspective. Since the bottom in Feb. '09, and abstracting from the temporary boost from the "cash-for-clunkers" program and the disruptive impact of the Japanese tsunami earlier this year, vehicle sales have risen at a 14% annual rate. Although the level of sales is still depressed from an historical perspective, the recovery is proceeding at a fairly impressive pace. Nothing to worry about here.

Why is the Greek tail wagging the global dog?

Global financial markets seem to be convulsing over the financial fate of Greece, a country of 11 million people, with a GDP of about $320 billion, and government debt of $475 billion. The entire Greek population wouldn't fill up even half of Southern California. The annual output of the Greek economy is less than half the output of Los Angeles, and it represents only 2.5% of the economic output of the Eurozone countries.


Markets have known for awhile that Greece cannot possibly service its debt, which is why 2-yr Greek government bonds yield almost 90%, and the average Greek government bond has been trading at roughly 35 cents on the dollar for the past two months. If the holders of Greek debt were to mark their portfolios to market, they would realize a loss of about $300 billion on their Greek debt holdings. That would undoubtedly be painful for many, but in the great scheme of things it is less than 3 months' worth of U.S. federal budget deficits, and it would be the equivalent of a drop in the bucket (0.5%) of the $63 trillion global bond market (of which $42 trillion is investment grade and $21 trillion is high-yield, according to Merrill Lynch).

Even a total Greek default couldn't possibly matter much to the global economy. So why all the angst?

As Ed Lazear noted in an op-ed in yesterday's WSJ ("The Euro Crisis: Doubting the 'Domino' Effect"), it's not so much that markets fear a domino effect (e.g., if Greece defaults, then others will follow), it's that Greece's plight is symptomatic of a major fundamental problem that is cropping up in economies all over the world: governments that have grown too big to be supported by their economy. This problem can't be fixed by bailouts or haircuts or bank recapitalizations; it requires fundamental changes in the role and size of government in modern economies, because there is a tipping point beyond which a government that has grown too much begins to suffocate its economy. Too much deficit-financed spending must inevitably result in either higher tax burdens, default, or devaluation, none of which makes for a healthier economy. Greece is not alone in having a bloated public sector and too much debt, but it is the most immediately vulnerable since it cannot print its own currency (i.e., it lacks the traditional easy-out method of devaluation, which forces everyone to tighten their belts), it has no ability to increase tax collections, and its politicians have failed to inspire any confidence in their ability to straighten things out.

So the real reason that Greece is the focal point of market concerns these days is that Greece is the canary in the coal mine for a problem that afflicts many economies, including the U.S. If governments cannot be reined in, economic growth is going to be weaker than expected, because tax and debt burdens will rise. If there is a silver lining to the Greek crisis cloud, it is that markets have forced the issue to the fore, and markets will not be satisfied until there is a satisfactory (read: fundamental and lasting) solution. Either the Greek government tightens its belt, or Greece leaves the euro and devalues a resurrected drachma, or Greek debt is marked down to the point where the economy is able to service it going forward (or some combination thereof). There is no painless solution for Greece, and no painless solution for many other economies either. But solutions will have to be found, and that is the good news.

Construction spending remains in neutral


September construction spending (one of the least important of the economic indicators given its long lag time) was a bit weaker than expected, but there is no significant trend to be discerned here. Both components of the index have been moving sideways for months now, and the construction sector is now a fairly small part of the overall economy, so there is little of importance in today's news. If anything, it is just one more statistic that disproves the notion of an impending double-dip recession.

Anecdotally, I am seeing and hearing of a lot more remodeling activity than before. Plus, recently I drove past two relatively large housing developments that I had not seen before. And a contractor who earlier this year did an energy retrofit for us reports that he is now absolutely swamped with new business.

ISM index points to continued moderate growth


The October ISM manufacturing index was a bit weaker than expected (50.8 vs. 52), but it is still consistent with an economy that is growing at a 2-3% rate; it's not even close to what we would expect to see if the economy were entering a double-dip recession.


The employment index was roughly unchanged, and it too remains firmly in territory suggesting continued growth, not recession.


The export orders index declined, and is clearly weak and on the verge of suggesting contraction. However, this index does not have a particularly good record of predicting recessions or conditions in the general economy.


The prices paid index fell sharply and surprisingly, and is clearly in recessionary territory. This could be a reflection of the weakness in commodity prices we have seen in recent months, but otherwise I don't have a good explanation for this, especially since energy prices—and broad commodity indices—rose in October. Weakness in this index typically comes at the end of recessions, as downward price adjustments pave the way for a new period of business expansion.

Bank lending and money supply update


People continue to complain that banks are not lending money to small and medium-sized businesses (the ones too small to tap the credit markets directly), but the facts continue to say that is not the case. As this chart shows, Commercial & Industrial Loans at all U.S. banks have been rising for the past year, and the rate of growth has been accelerating of late.

Over the past year, C&I loans are up 8.9%. Over the past six months they are up at a 10.9% annualized pace, and over the past 3 months they are up at a blistering 14.5% annualized pace. At this rate, banks are expanding their business lending by about $3.4 billion every week. We're starting to talk about some serious money here.



Meanwhile, the broad money supply (M2) is up at an unprecedented annualized pace of 15.7% over the past three months. In recent years, despite the severe economic slump and the painfully slow recovery, M2 has greatly exceeded its 6% average annual growth rate since 1995, thanks to the Fed's willingness to accommodate the extraordinary demand for safe-haven cash in the wake of the Lehman and Eurozone panics. I would note that the "bulge" in M2 growth that began last June, when the Eurozone sovereign debt crisis really started to heat up, has stopped getting bigger. I estimate the extra demand for M2 was on the order of about $400 billion. That suggests that the panic flight out of Eurozone banks is not accelerating, and that is at least one bit of good news.

In any event, it's worthwhile noting that since just before the Lehman crisis and subsequent global financial panic, the M2 money supply has increased by $1.83 trillion. On average, that works out to $11.3 billion every week, or about $1.6 billion every day.

So far, all that new money has not had the impact on U.S. inflation that many would have expected, and that's due to the fact that the world's demand for money has expanded roughly in line with the Fed's willingness to supply additional money. But there continue to be important signs that the Fed's monetary policy is on balance accommodative (e.g., $1700 gold, the extremely weak dollar, and very strong commodity prices), and thus that higher inflation awaits us. That will especially be the case if and when the Eurozone panic subsides and the demand for safe-haven cash begins to decline. If the Fed doesn't soak up all the excess liquidity that will be the by-product of better economic times, then we could be looking at a significant rise in inflation even as economic growth picks up.

Bad policies create a scary economy