Global Economic Watch

Home Sprial

2011-05-20T13:00:00.000-04:00

The National Association of Realtors (NAR) reported today existing home sales slipped in April, although the market has managed six gains in the past nine months.

NAR chief economist Lawrence Yun observed that the market is underperforming and said, “Given the great affordability conditions, job creation and pent-up demand, home sales should be stronger.” As consequence, he remained cautious and forecasted, “existing-home sales are expected to trend up unevenly through next year.”

When asked why home sales continue to be stifled, Mr. Yun pointed to “unnecessary tight credit” and “a steady level of low appraisals that result in contract cancellations.” For example, another NAR survey shows “11 percent of Realtor’s report a contract was cancelled in April from an appraisal coming in below the price negotiated between a buyer and seller, 10 percent had a contract delayed, and 14 percent said a contract was renegotiated to a lower sales price as a result of a low appraisal.”

The much-followed Standard & Poor’s Case-Shiller Home Price Indices indeed show home prices through February 2011 for the 10- and 20-city composites are lower than a year ago. And “the 10-City Composite fell 2.6 percent and the 20-City Composite was down 3.3 percent from February 2010 levels.” Notably, Washington D.C. was the only market to post a year-over-year gain with an annual growth rate of 2.7 percent.

Underscoring the downward pricing trend, Chairman of the S&P Index Committee commented, “There is very little, if any, good news about housing. Prices continue to weaken, trends in sales and construction are disappointing.”

A textbook definition of deflation is a persistent fall in the general price level of goods and services. And deflation can be dangerous if it reflects a sharp slump in demand and excess capacity, and runaway deflation of this sort can be much more damaging to the economy than runaway inflation, because it creates vicious spiral that is hard to escape.

Following this logic, if the housing market participants expect home prices to continue to fall in the coming months then their expectation may materialize into yet more depressed demand resulting in even lower home prices. If so then this trend can develop into a vicious spiral that would be hard to stop.

Can this be stopped? Since 2008, the Federal government has been offering tax credits, up to $8,000, to first time home buyers to stimulate demand. And the Federal Reserve has kept its short term interest rates to hear zero and also bought mortgage backed securities to lower mortgage rates to their historical lows. And despite these efforts, home prices fell in February and home sales fell in April. Another approach is to bear the pain until let the market self-adjust itself to a stable equilibrium.

References & Additional Reading

National Association of Realtor, April Existing Home Sales – May 19, 2011
http://www.realtor.org/press_room/news_releases/2011/05/sales_ease

S & P Case-Shiller Home Price Indices – April 26, 2011
http://www.standardandpoors.com/servlet/BlobServer?blobheadername3=MDT-Type&blobcol=urldocumentfile&blobtable=SPComSecureDocument&blobheadervalue2=inline%3B+filename%3Ddownload.pdf&blobheadername2=Content-Disposition&blobheadervalue1=application%2Fpdf&blobkey=id&blobheadername1=content-type&blobwhere=1245303631555&blobheadervalue3=abinary%3B+charset%3DUTF-8&blobnocache=true

Social Security Out of Money 2036

2011-05-20T12:38:00.000-04:00

Adding to current debates on fiscal deficit and government spending in Washington, the Social Security Board of Trustees today released its annual report on the financial health of the Social Security Trust Funds.

The Trustees reported that the Old-Age and Survivors Insurance (OAS) Fund will be exhausted in 2036 which is one year earlier than what they projected last year. And the Disability Insurance (DI) Fund will be exhausted in 2018, “and legislative action will be needed soon” by Washington.

Following the report’s release, Commissioner of Social Security Michael Astrue said, “the current Trustees Report again reflects what we have long known to be true – we need changes to ensure the long-term solvency of Social Security and to restore younger workers’ confidence in the program.”

Under current law, the cost of Social Security is projected to increase faster than the program’s income because of the aging of the baby-boom generation. Based on the Trustee’s best estimate, program cost is expected to exceed tax received by the funds this year and remain higher throughout the remainder of the 75-year projection period.

As consequence, promised benefits of Social Security will not be able to continue beyond 2036, and those who receive benefits after 2036 will receive 77 percent of what was promised.

And if no substantial action is taken for several years, then changes necessary to maintain Social Security solvency will be concentrated on fewer years and younger workers will be forced to pay even higher prices in terms of lower benefits and/or higher taxes.

More specifically, doing nothing means younger workers who plan to receive Social Security payments after 2036 will have to accept 23 percent reduced benefits or raise their payroll tax rate to 16.4 percent from 6.2 percent today.

Therefore, implementing changes sooner would allow the needed revenue increases or benefit reductions to be spread over more generations. That said either political party has yet to offer a detail plan that would address the projected Social Security problem raised by its Trustees today.

References & Additional Reading

2011 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds – May 13, 2011
http://www.socialsecurity.gov/OACT/TR/2011/tr2011.pdf

Making Medicare, Medicaid and Social Security Sustainable for the Long Run, Alice M. Rivlin, Senior Fellow, The Brookings Institute – March 17, 2011
http://www.brookings.edu/testimony/2011/0317_house_budget_rivlin.aspx

Yellen: No Worries

2011-04-24T13:18:00.001-04:00

Vice Chair of the Federal Reserve Janet Yellen spoke at the Economic Club of New York today on recent increases in commodity prices and the effects of those developments on the outlook for inflation, the economic recovery now under way, and the appropriate stance of monetary policy.

Vice Chair Yellen first observed that “since early last summer, the prices of oil, agricultural products, and other raw materials have risen significantly.” And the price of Brent crude oil has risen more than 70 percent and the price of corn has more than doubled; more broadly, the Commodity Research Bureau's index of non-fuel commodity prices has risen roughly 40 percent.

As consequence, Vice Chair Yellen noted that inflation as measured by the price index for personal consumption expenditures (PCE) moved up to an annual rate of about 4 percent over the three months ending in February after having averaged less than 1-1/2 percent over the preceding two years. The Fed’s current inflation target is at 2 percent.

The Vice Chair defended the current monetary policy stance of the Federal Open Market Committee (FOMC) of maintaining the target federal funds rate at exceptionally low levels, despite commodity price increases, by making the case that recent development in commodity prices can be explained largely by rising global demand rather than by Federal Reserve policy.

According to the Vice Chair, the recent price increases have been mostly driven by a rapid pace of economic expansion of the emerging market economies (EMEs) like Brazil, India and China, as the financial conditions began to improve in 2009. For example, China alone has accounted for roughly half of global growth in oil consumption over the past few years.

That said, the Vice Chair evinced that “empirical analysis suggests that these developments, at least thus far, are unlikely to have persistent effects on consumer inflation or to derail the recovery.”

In other words, the FOMC concluded so far that “so long as longer-run inflation expectations remain stable, the increases seen thus far in commodity prices and headline consumer inflation are not likely…to become embedded in the wage and price setting process and therefore are not likely to warrant any substantial shift in the stance of monetary policy.”

Therefore, the Vice Chair reiterated her point that the continuation of the current accommodative monetary policy stance was appropriate since “unemployment remains elevated, and, even now, measures of underlying inflation are somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with our statutory mandate to promote maximum employment and price stability.”

References & Additional Reading

Vice Chair Janet Yellen at the Economic Club of New York – April 11, 2011
http://www.federalreserve.gov/newsevents/speech/yellen20110411a.htm

Federal Reserve Bank of San Francisco, FedViews – April 14, 2011
http://www.frbsf.org/publications/economics/fedviews/20110414/index.php?utm_source=home

Fed Critics: Exit Now

2011-04-09T11:38:00.000-04:00

The minutes of March 15^th Federal Open Market Committee (FOMC) meeting was released to the public today. Kicking off the meeting, the Manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets since the previous FOMC meeting.

The Manager reported since November, purchases by the Open Market Desk of the Federal Reserve Bank of New York had increased the SOMA's treasuries holdings by $310 billion. And achieving an increase of $600 billion in SOMA holdings by the end of June 2011 as authorized would require continuing to purchase additional securities at an unchanged pace of about $80 billion per month.

The FOMC first authorized the SOMA in November 2010 to purchase mortgage-backed securities (MBS) and mid to long term treasuries to increase the money supply and lower mid to long term treasury yields to support economic recovery. Since treasury yields are used as benchmark rates for many commercial rates such as auto loans, mortgages and capital leasing, lower yields will encourage consumer spending and business investment.

After five months, the monetary policy of buying mortgage-backed securities and treasuries has drawn many critics. Professor Allan Meltzer, the eminent monetary macroeconomist and chronicler of Federal Reserve history, publicly criticized the Fed’s monetary policy this week in a Wall Street Journal op-ed:

"One of the Fed's recent errors was increasing the money supply by buying more than $1 trillion of mortgage-backed securities as part of its 'quantitative easing' policy. Its hefty balance sheet now threatens to finance further inflationary increases in the money supply. How can it be unwound in an orderly way?"

And as follow up Professor Meltzer offered his exit strategy consisting of two parts. One is that the winding down of the mortgage-backed securities (MBS) and long-term Treasury securities on the Fed's balance sheet should be conducted in a way that avoids market disruption and distortion as much as possible.

The second is that the excess reserves held in the banking system—the liability side of the Federal Reserve’s balance sheet—have to be removed or "locked up" as needed to avoid an inflationary expansion of broad money and credit.

The March FOMC minutes showed that Fed is confident that it can gradually reduce the pace of the Federal Reserve's purchases of Treasury securities when the current asset purchase program nears completion with minimum disruptions to the economy. And this monetary policy is appropriate given “subdued” underlying inflation.

Of course, many Fed critics think otherwise.

References & Additional Reading

March 15, 2011 Minutes of the Federal Open Market Committee - April 5, 2011
http://www.federalreserve.gov/monetarypolicy/fomcminutes20110315.htm

Federal Reserve Bank of Atlanta, Monetary Policy Exit: Is a Bad Bank the Solution? – April 8, 2011
http://macroblog.typepad.com/macroblog/2011/04/monetary-policy-exit-is-bad-bank-solution.html

No Free Lunch Budget

2011-04-08T11:27:00.000-04:00

In response to House Budget Committee Chairman Paul Ryan’s request, the Congressional Budget Office (CBO) conducted a long-term analysis of the chairman proposal to substantially change federal payments under the Medicare and Medicare programs to help reduce their growing share of the federal budget and debt.

According to the CBO’s most recent projections, which were issued in June 2010 and were based on the assumption that then-current law would generally remain in place, spending on the government’s major mandatory health care programs—Medicare, Medicaid and newly enacted health insurance subsidies to be provided through insurance exchanges, combined with mandatory Social Security program—will increase from roughly 10 percent of gross domestic product (GDP) today to about 15 percent 20 years from now.

And if revenues and federal spending apart from those mandatory programs remain near their past levels relative to GDP, the increase in spending on health care programs and Social Security will lead to rapidly growing budget deficit and mounting federal debt.

Chairman Ryan’s proposed plan would convert the current Medicare program that makes payments directly to health care service providers to a system under which beneficiaries receive premium support payments. These payments then would be then used to help pay the premiums for a private health insurance policy and would only grow over time with overall consumer prices (e.g. CPI). Additionally, the proposed plan would convert the matching payments that the federal government makes to states for Medicaid costs under current law into block grants for fixed dollar amounts.

The central idea behind these proposed changes, as articulated in the House Fiscal Year 2012 Budget Resolution (The Path to Prosperity), is to end “an onerous, one-size-fits-all” approach by converting the federal share of Medicaid spending into a block grant that gives states the flexibility to tailor their Medicaid programs to the specific needs of their residents. And let private health insurance companies compete for Medicare payments by providing superior services at lower costs.

Would this approach work? According to CBO, “government payments for health care under the proposal would become significantly more predictable than under current law” since they would be anchored to overall changes in consumer prices. That said, under the proposal, “most elderly people would pay more for their health care than they would pay under the current Medicare system” assuming health care cost continues to rise faster than overall consumer prices.

And, federal payments for Medicaid under the proposal would be substantially smaller than currently projected amounts. Therefore, states would be required to provide less extensive coverage to beneficiaries.

In conclusion, the proposed health care programs would offer less, but they would also cost less. And this is no big surprise. Without strong growth, there has to be a trade-off.

References & Additional Reading

Congressional Budget Office, Long Term Analysis of a Budget Proposal by Chairman Ryan – April 5, 2011
http://www.cbo.gov/ftpdocs/121xx/doc12128/04-05-Ryan_Letter.pdf

Fiscal Year 2012 Budget Resolution, The Path to Prosperity – April 5, 2011
http://paulryan.house.gov/UploadedFiles/PathToProsperityFY2012.pdf

Stagflation, Really?

2011-03-26T12:55:00.000-04:00

The US Energy Information Administration (EIA) reported yesterday the retail gasoline prices for regular grade rose to $3.57 this week, up 4.7 percent from the previous week. And compared to a year ago, this gasoline price is up 78 percent.

Therefore, it was no surprise to see the Federal Open Market Committee (FOMC) note in their statement that was released today, “commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up prices in recent weeks.”

Many analysts and economists expect recent spikes in gasoline prices will add to production costs and force businesses to raise their prices resulting in a higher inflation. And this cost-push inflation may then get entrenched into expectations and push up mid and long term interest rates, since investors would require a higher inflation premium.

And higher mid and long term interest rates will negatively affect the economy particularly for housing and debt financing. Note that banks and other financial intermediaries benchmark their interest rates for auto and mortgage loans on US 10-year Treasury bond yields.

Compounding this problem, higher gasoline prices will also pull money out of the economy since the US imports 8.5 million barrels of crude per day. By some estimates, every $10 increase in crude oil prices reduces GDP by 0.2 percent.

Therefore, higher interest rates and lower domestic consumer spending may jeopardize economic recovery that is slowly gaining momentum. And some even now mention the possibility of stagflation around the corner. This happens when the economy experiences high inflation and slow growth.

That said, the Committee expects these effects to be “transitory” and anticipates a gradual return to higher levels of resource utilization in a context of “price stability.”

Consistent with this rosy view of the economy, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.

Furthermore, the Committee decided to the target range for the federal funds rate at 0 to 1/4 percent. And it expects to keep the federal funds rate at exceptionally low levels for an extended period to support the economic recovery.

Meanwhile, the price of gold climbed higher towards $1,440 per ounce.

References & Additional Reading

US Energy Information Administration, Gasoline and Diesel Fuel Update – March 14, 2011
http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_home_page.html

Federal Open Market Committee, Press Release – March 15, 2011
http://www.federalreserve.gov/newsevents/press/monetary/20110315a.htm

Will Economy Sink After QE2

2011-03-12T18:12:00.005-05:00

The founder and co-chief investment officer of one of largest money managing firms in the world, William Gross of PIMCO, shared his insights on Quantitative Easing (QE) programs and their effects on the economy and financial markets this week as part of his investment outlook series.

Mr. Gross, who oversees $1.2 trillion in investment reasons that the intent of the QE programs was obvious. It was designed to 1) pump public money into the financial system to replace private credit that was being destroyed in the process of deleveraging 2) lower interest rates on intermediate and long-term mortgages and Treasury bonds.

By replacing bad private credit that was held by many financial institutions and businesses with good government-backed credit, the Fed’s motive was to help troubled financial institutions and businesses in repairing their balance sheet. This way, more capital could be freed up so more lending could take place to help stimulate economic activity.

Moreover by lowering intermediate and long-term interest rates, the Fed was actively supporting the housing industry that was in a deep slump with falling prices.

Additionally, lower Treasury rates would incent investors to put more into stocks, in search of higher returns, and thus hope to generate a wealth effect to stimulate more spending and investment in the economy.

Since the implementation of QE 1 program in December, 2008 and QE 2 program in November, 2009, Mr. Gross observes that their cumulative effects of artificially low interest rates and doubling of stock market valuations have had intended outcomes.

The economy is now expected to expand nominally by 4 percent this year on the back of $1.5 trillion budget deficit. And the current 8.4 percent unemployment rate is expected to continue to fall as businesses gain more confidence and continue their hiring in the coming months.

That said Mr. Gross reflects that “many critics, including yours truly” now wonder whether the QE programs actually healed the economy, as opposed to simply covering up the underlying problems with trillions of public funds.

And Mr. Gross warns, “Washington, Main Street – and importantly from an investment perspective – Wall Street await the outcome.”

“Because QE has affected not only interest rates but stock prices and all risk spreads, the withdrawal of nearly $1.5 trillion in annualized check writing may have dramatic consequences in the reverse direction,” writes Mr. Gross. Hence, he is now anxious to see how the economy performs when the QE2 program ends in June, 2011.

References & Additional Reading

Federal Reserve Chairman Ben Bernanke, At the Stamp Lecture, London School of Economics – January 13, 2009
http://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm

William Gross Investment Outlook, PIMCO – March 2011
http://www.pimco.com/Pages/Two-Bits-Four-Bits-Six-Bits-a-Dollar.aspx

Record Food Prices & Unrests

2011-03-06T17:55:00.001-05:00

The United Nations Food and Agriculture Organization (FAO) reported today that global food prices rose for the eighth straight month in February.

The FAO Food Price Index which measures basic food prices at the international level averaged 236 points last month, up 2.2 percent from the previous month. And this was the highest record in real and nominal terms, since the index began measuring international food prices in 1990.

The index also showed the prices of all commodity groups monitored increased last month, except for sugar. The Cereal Price Index, which includes prices of main food staples such as wheat, rice and maize rose by 3.7 percent to the highest level since July 2008.

And the record food prices are putting more economic pressure on billions of people around the world who spend much of their income on food to feed their family. A United States Department Agriculture (USDA) survey shows that people who live in economies whose Private Consumption Expenditure (PCE) per capita is less than $10,000 spend on average 50 percent of their disposable income on food.

Therefore, the rising food prices affect low income countries more. And unexpected spikes in oil prices is now further exacerbating the current situation and causing social unrests in many countries.

So why food prices are going up? The standard supply and demand model shows that market prices will go up if either or both supply and demand shift accordingly.

Last year bad weather conditions such as draught in China and Russia reduced their cereal production. This means supply shifted to the left or a less quantity of cereal was supplied to markets.

This year emerging economies, who were less affected by recent global financial crises, are growing robustly and demanding more food. This means demand is shifting to the right or a more quantity of cereal is demanded.

Axiomatically, food prices must increase in this situation. Of course if supply can be increased then food prices could decrease. However, much of the available arable land is already in use. Therefore, with more demand, food prices are expected to continue to increase.

There is, however, another way to increase food supply. This can be done by improving productivity or food output per unit of input such as labor. This means – as we all know from studying the standard production possibilities model - countries need to continue to invest in technology and human capital and foster competition to help expand their production frontier.

References & Additional Reading

United Nations Food and Agriculture Organization, Global Food Price Monitor – March 3, 2011
http://www.fao.org/giews/english/gfpm/GFPM_03_2011.pdf

United Nations Food and Agriculture Organization, World Food Situation - March 2011
http://www.fao.org/worldfoodsituation/wfs-home/en/

United States Department of Agriculture, Economic Research, Food and Marketing – July 1997
http://www.ers.usda.gov/publications/agoutlook/jul1997/ao242e.pdf

Baffling Employment Report

2011-02-04T17:42:00.001-05:00

On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009. The Recovery Act provided $288 billion in tax cuts and benefits, increased funding by $224 billion for education, healthcare and unemployment benefits and made available $275 billion for federal contracts, grants and loans.

This stimulus injection of $787 billion into the economy was expected to deliver three immediate goals. First, create jobs. Second, spur economic activity. Third, foster accountability in government spending.

And two years after the Recovery Act and 18 months after the official end of the Great Recession, the Bureau of Labor Statistics (BLS) reported today the economy created only 36,000 jobs in January.

Being hopeful for a stronger recovery, investors and analysts were looking for 140,000 or more new jobs in today’s report. However instead of becoming troubled, they became baffled when learned that the BLS’s also reported the official unemployment rate dropped sharply in January from 9.4 percent to 9.0 percent.

So what is going on? Quickly many analysts discounted the accuracy of today’s reports by pointing out that many parts of the country were affected by severe winter weather in January. And severe weather may explain why the job creation, based on the establishment survey, was anemic last month. The survey reported that there was definitely a sharp drop in employment in transportation and warehouse and construction industries.

However drilling down into the “other” employment survey, based on households, some analysts were encouraged to learn that the absolute number of unemployed persons decreased by 600,000 in January to 13.9 million, while the labor force and the participation rate (64.2 percent) remain unchanged.

Given that there are 600,000 less unemployed, is it plausible that more than 36,000 jobs were created last month? This is plausible. The household survey has a more expansive scope than the establishment survey because it includes the self-employed, unpaid family workers, agricultural workers, and private household workers, who are excluded by the establishment survey.

Now investors and analysts are somewhat hopeful again, and they are waiting on the next month’s employment report and revisions for clarification on the strength of recovery. Meanwhile, policy and academic debates on the effectiveness $787 fiscal stimulus spending to create jobs and spur economic activity continue.

References & Additional Reading

The Recovery Act, Recovery.gov
http://www.recovery.gov/About/Pages/The_Act.aspx

Bureau of Economic Analysis, January Employment Situation – February 4, 2011
http://www.bls.gov/news.release/pdf/empsit.pdf

Fiscal Highway to Doom

2011-01-22T15:09:00.002-05:00

Senator Jeff Sessions (R-AL), incoming Ranking Member of the Senate Budget Committee, delivered an opening statement at today’s hearing, prior to the testimony of Federal Reserve Chairman Ben Bernanke, concerning current fiscal spending and growing debt.

Senator Sessions warned, “We are on a path that is unsustainable.” And he cited a recent newspaper editorial warning, a “break point occurs when a government borrows an amount equal to 40% of its expenditures for extended period of years.”

Politicizing his remarks, Senator Sessions reproached President Obama for adding another $250 billion to the debt when he agreed to maintain current taxes and new spending in December. “Instead of slowing down, President Obama hit the accelerator,” said Senator Sessions.

In conclusion Senator Sessions turned to Chairman Bernanke and said, I “looked forward to getting your thoughts on how you and the administration plan to put our nation on a sound financial path.”

Chairman Bernanke responded, “An important part of the federal budget deficit appears to be structural rather than cyclical; that is, the deficit is expected to remain unsustainably elevated even after economic conditions have returned to normal” in the next few years.

Therefore in subsequent years, Chairman Bernanke conjectured the budget situation to “deteriorate even more rapidly” as the aging of the population and continued growth in health spending boost federal outlays on entitlement programs.

Chairman Bernanke elaborated further that if the current fiscal policy is maintained, “federal debt held by the public is projected to reach 185 percent of GDP by 2035.”

This last statement is particularly disturbing since the IMF warned Greece that it was likely to face serious fiscal and debt problems when its public debt breached 100 percent of GDP in 2009.

Chairman Bernanke hoped in his testimony to the Senate Budget Committee that “in addressing our long-term fiscal challenges, the Congress will seek reforms to be the government’s tax policies and spending priorities that serve not only to reduce the deficit but also to enhance the long-term growth potential of our economy.”

In other words, Chairman Bernanke advocated that America needs to invest in physical and human capital. It is important to understand that “we cannot grow out of our fiscal imbalances.” However, a more productive economy would ease the tradeoffs that we face.

References & Additional Reading

Ranking Member of the Senate Budget Committee, Senator Jeff Sessions (R-AL) Opening Statement – January 7, 2011
http://budget.senate.gov/republican/hearingarchive/OpeningStatements/2011/2011-01-07Bernanke.pdf

Board of Governors of the Federal Reserve System, Chairman Ben Bernanke, The Economic Outlook and Monetary and Fiscal Policy Testimony – January 7, 2011
http://www.federalreserve.gov/newsevents/testimony/bernanke20110107a.htm