Posted by Karl Denninger
I am going to present for you my “deconstruction” of the current economic view – based on facts, not hype or “hope and dreams.”
We will begin with a couple of charts that should dispel one of the more-common myths that the goggle-eyed pundits like to express: the stock market is an accurate leading indicator of economic conditions.
First, mid-2006 into the first part of 2007, when the housing market had already peaked and the die had been cast for the housing and economic crash:
Next, the market from 1995 to the middle of 2000, when we had blown a tremendous bubble – and in point of fact, the Nasdaq had already collapsed at the right side this chart.
Or, if you prefer, this chart, showing that the economy was literally going to be in the toilet six months to a year later:
Those who claim that the stock market predicts the economy on a forward basis are pie-eyed idiots. They are cherry-picking their claims, using only those times when the market was in front of the economy, and ignoring those times when the market was in fact dead wrong about forward economic prospects.
In point of fact by the start of 2007 it was clear that we were headed for the economic cliff, yet the market kept rising for months, and ultimately peaked in October. In August of 2000 it was not only clear that the tech sector was going to fall apart it already had, with the Nasdaq 100 down roughly 30% while the broader market continued to rise, signaling that this was “just a blip.”
And in 2002, while the recession had already ended (according to the NBER it ended in November of 2001!) the market was prognosticating a continuing economic collapse and had been for more than half a year after the recession was over. The prediction was wrong.
If you take a dispassionate view of the equity markets as “leading economic indicators” you are forced to conclude that they are in fact no better at forecasting than a coin toss. That’s because the stock market isn’t a “profit forecaster” or a “prosperity forecaster” – it is the expression of opinion based not on current return but rather on the speculative belief that someone will (or won’t) pay more for a given security tomorrow than today.
So what can you look for in terms of forward economic expectations?
I have and continue to argue that there are three items that give us a short-to-intermediate view of the economic outlook. They are:
- Sales tax receipts. This is virtually the only economic “count” that is not subject to being gamed when it comes to the current picture for consumer spending. Since personal consumption accounts for 70% of the US economy, this is the most-accurate indicator we have. It is both timely reported (monthly) and reliable, as no business will report and remit taxes that were not collected on actual sales. At the same time under-reporting (that is, refusing to pay taxes that are actually due) is punitive enough and caught quickly enough that most businesses will not attempt to cheat. Non-discretionary items (food and medicine) in most jurisdictions are not taxed, so this indicator has reasonable accuracy when it comes to what matters in the economy – discretionary spending. Finally, the tax is proportional, not regressive or progressive, so changes are proportional to actual discretionary spending.
- Consumer credit. When it is expanding it is additive to GDP beyond actual output (wages, bonuses and other earnings.) When it is contracting it is subtractive to same. Note that as this number is not normed to population growth (that is, it is not “per-capita”) it should expand at a roughly 1% rate per year simply to accommodate growth in the number of people in the United States. Therefore, a “zero” rate is actually negative by about 1%.
- Civilian Employment Ratio. This is simply the percentage of all working-age people (16 to 65) that have a job and is derived from the household survey. This is arguably the most-important indicator of all in the intermediate (one to five years) term, as it provides the best view of the government’s revenue capacity on a forward basis (that is, the tax base upon which the government can levy to obtain revenue.)
So what are these indicators telling us?
First, let’s talk about “consumer spending” reports. These are predicated on same-store sales. The methodology is right in the government reports and on their web sites, but nobody reads beyond the first paragraph of the report.
A simple example will illustrate the problem with reporting methodology. Let us presume there are exactly two stores in the world. Each has $10,000 in sales a month. Same-store sales are reported as “flat” – that is, zero.
One month Store #2 goes out of business. It is deleted from the same-store sales report since it did not report both last month and this month. But Store #1 gets some of Store #2s former customers, and now sells $12,000 worth of goods.
The report will show a 20% gain, as that’s what “same store sales” shows, where in fact 40% of the sales literally disappeared and didn’t happen at all.
Likewise, if we had one store reporting $10,000 in sales and a new store opened, that new store would not be reported either. The old store might see its sales drop from $10,000 to $8,000, while the new store might have sold $5,000 in its first month.
The report will show a 20% decline, as again that’s what “same store sales” shows, where in fact there was a 30% increase in total sales!
Now of course these are extreme examples because there are many more than one or two stores – but the point remains valid – during times of economic contraction the government will materially overstate consumer spending, and during times of economic expansion it will understate spending. Bluntly, the reports are unreliable and do not show what “Tout TV” claims.
Sales tax receipts suffer no such deficiency. A new store must report and pay taxes immediately. A closed store stops reporting and paying on the date it closes. John Maudlin cites the same numbers I do in a recent article:
I called Philippa Dunne at The Liscio Report. They survey the various states about taxes, among other things. “Sales taxes are not up and the current survey we are doing is pretty bad.” She used the word “horrified” when commenting on some of the respondees’ replies at the various state tax offices.
That’s current economic activity folks, and it is why you keep hearing about states with horrifying budget problems.
The truth is that consumer spending is not advancing, it is contracting – still.
Now let’s look at consumer credit. Remember, this number is not normed to population growth. I will start with the long view, since we’re trying to do macro here:
The importance of this cannot be overstated. Notice that going all the way back to 1960 (the earliest we have data on the G.19 Fed release) the rate of growth in consumer credit has never been below -2% annualized, and only once dipped negative at all, in the early 1990s. If you want to know where the “great expansion” of our economy came from, you need look no further than here. We didn’t earn it, we borrowed it.
Note that at a 7% expansion rate credit outstanding doubles every 10 years. Note also that at a 3% wage growth rate (roughly about right) it takes about 24 years for income to double. The problem with trying to grow the economy with credit expansion at double or more the rate of income growth should be obvious.
On the shorter-term we have two other charts that drive home two far-more-critical points: that de-leveraging continues and it is far from over in the consumer sector. First, the total consumer credit outstanding:
Note that while the rate of decline is quite impressive we have only removed $117 billion from the total outstanding of $2,581 billion at the peak, or a decline of just 4.5% thus far.
Those who believe that removing 4.5% from the total amount of consumer credit outstanding is sufficient to return the consumer to “health” are delusional. The credit bubble was created over literal decades – a 4.5% contraction, while certainly moving in the right direction to re-establish stability, is nowhere near enough.
How do we know that the consumer isn’t done? Simple – he hasn’t stopped pulling back on the revolving debt – indeed, the rate of decline continues to accelerate!
While the rate of non-revolving credit acceptance appears to have stabilized just under flat (that is, with a slight continuing loss) the rate of decrease in outstanding amounts for revolving (charge card) credit continues to accelerate and is now approaching -10% annualized. On an annualized basis this would remove about $90 billion of spending a year where in early 2008 it was adding about the same – that is, this is a swing in actual consumer spending of approximately $180 billion dollars annually, or about 1.3% of GDP.
Next, I want to look at employment trends. These are some of the most important of all; we will first look at the ratio of employed to the population, found in this graph:
The importance of this cannot be overstated – it points out a stark reality that nobody wants to face – the number of people being added to “not in labor force” has been rising precipitously since the 2000 recession and still is!
We have spent a full decade without returning one net person on an annualized basis to the labor force – indeed, during most of the decade people were leaving the labor force on a strictly numerical basis, not being added to it!
This is in fact much worse than it first appears because the population has grown from 282 million in the year 2000 to approximately 307 million in 2009, a net gain of 25 million people.
Not only have we not returned anyone to the labor force who left on a net basis during the entire 2000-2009 decade but we also added 25 million more people to the population and none of them are working either!
So while the total employed count is back to roughly where we were in March of 2004 when adjusted for population growth we’re back where we were in the 1980s in terms of per-capita earnings capacity (ex-inflation of course), but with a spending appetite and debt load that more-correctly approximates 2007!
The following graph will illustrate the problem as it expresses debt as a percentage of GDP (as well as in raw numbers):
Note that in the early 1980s we had debt in the system of about 175% of GDP. Today it is about 370%.
In order to bring the system back into balance from a standpoint of the labor participation rate – that is, the percentage of people actually earning a living in regard to the population, we would have to cut the debt in the system by roughly HALF!
In short our nation’s bankrupt policies over the last two decades and more – both under Democrat and Republican administrations – has led to a monstrous twenty five trillion dollar debt imbalance – roughly the sum total of two years output in our economy!
So how is the government keeping the plates spinning in the air up to this point?
Government handouts are now close to 20% of personal income, up from about 14% in 2007, a forty percent increase.
If you wondered where all that government debt was coming from and why we have $1.6 trillion in deficit (and on track to be that or more this year!) now you know. Not only have the banksters been bailed out the government has literally been trying to prevent the collapse of its own bankrupt policies that stretch back more than two decades by handing out “free money” to the population – money the government doesn’t have!
It won’t – and can’t – work. PIMCO’s Bill Gross outlined the “strategy” for 2009 that was employed with temporary success and levitated both the bond and stock markets:
Here’s the problem that the U.S. Fed’s “exit” poses in simple English: Our fiscal 2009 deficit totaled nearly 12% of GDP and required over $1.5 trillion of new debt to finance it. The Chinese bought a little ($100 billion) of that, other sovereign wealth funds bought some more, but as shown in Chart 2, foreign investors as a group bought only 20% of the total – perhaps $300 billion or so. The balance over the past 12 months was substantially purchased by the Federal Reserve. Of course they purchased more 30-year Agency mortgages than Treasuries, but PIMCO and others sold them those mortgages and bought – you guessed it – Treasuries with the proceeds.
That’s right – the Federal Reserve effectively monetized (that is, they printed money backed by used dog food – that is, nothing) to cover 80% of a $1.5 trillion deficit, or $1.2 trillion worth. Some $500 billion of that went into handouts to the population (6% of roughly $27,000 in per-capita income times 307 million Americans) and the other $700 billion went to bail out Wall Street. Only 20% of the total was actually sold to investors worldwide.
Can this continue indefinitely?
Not a prayer in hell.
There are many who argue that we “had to” do all this to avoid an economic collapse. But have we really avoided anything, or have we simply made the problem worse by embedding $500 billion in additional “handouts” into the budget each and every year on a forward basis – roughly one sixth of the total federal budget – that will prove politically impossible to take back and yet which are not covered by improving labor participation?
More than two years ago I wrote a letter to all 535 members of Congress in which I implored them to find and set aside $200 billion in actual cash – not for “hand outs” in the traditional sense, but rather for the provision of emergency food, shelter and clothing, possibly to be provided on formerly-closed military facilities for up to 25% of the American population for a period of one year or more. They of course ignored that entreaty to the best of my ability to discern, but the reason for it was clear to me at the time and still is – a hungry and homeless population is a dangerous population, and “discontent” when married to an empty belly can easily turn to armed rebellion, especially if and when the “rabble” discern (and they eventually will) that they have been systematically robbed for decades by Wall Street, K Street and 1600 Pennsylvania Avenue.
Today we are $1.5 trillion poorer than we were a year ago and yet we’ve fixed exactly nothing. The banks have not been forced to write down their bad loans and/or jettison them, over-levered consumers have not been forced into bankruptcy where they could throw off the anvil around their necks and the structural employment and entitlement problems have not only been left un-addressed they have been made much worse. We are on the cusp of adding to the idiocy of Medicare Part “D” with so-called “Health Care Reform” that will impoverish more people and drive even more of our nation from the workforce. We continue to allow nations that abuse their working populations (such as China) to be the source of our “offshored” production and thus the destruction of our working class citizens, we demand “easy money” and bubble economics even when it has been proved over the space of two decades to result in fewer people working as a percentage of the population rather than more and we continue to pray at the altar of debt leverage even though it has resulted in two horrific crashes in the last decade and, should we not quit genuflecting before the bankster mob will result in a third that may bring down our government and economic ability to survive.
How long can the plates be kept spinning? Hell if I know. I didn’t think they’d get away with it for this long. The rest of the world figured it out almost immediately and stopped buying our debt on a net basis, but The Fed stepped in and played handmaiden to Congressional and Administration idiocy instead of administering a stern 2×4 to the head. I suspect that The Fed’s motivation stemmed from Bernanke’s belief that if he “just gave it a bit of time” things would turn around, but now we’ve had two years of “a bit of time” and yet consumer credit demand is through the floor and the labor participation rate shows that all we’ve done is shift more and more people as a percentage of the population to the dole. This inherently cannot continue or it will lead to the collapse of the government’s ability to fund itself via taxation, as these facts and figures are not hidden from view – policymakers and investors worldwide that have to buy our debt can see this and about six months ago they gave up.
Ben gave it another six months, but now it appears he has discerned that neither Congress or The White House will stop whoring around so long as he’s handing out $100 bills from an endless ATM machine.
Yet that path can’t work in the long term either. Not only does the risk of a super-spike in energy prices loom large but more importantly the structural damage done to the employment base through the printing of money and continued offshoring of jobs in response ultimately destroys the funding capacity of the government itself. While an energy price spike would provide the “shock and awe” to engender an immediate response the employment base deterioration is much more serious as this is a multi-decade trend that cannot be repaired quickly and yet if not addressed it will destroy the government’s ability to fund itself with certainty.
This is likely behind Bernanke’s announced end to money printing, but whether the resolve to quit mainlining the heroin will stick when the market is forced to either absorb $1.5 trillion in debt sales or Treasury is forced to whack half or more off the deficit is another matter.
Either way the claimed “restoration of balance” in the economy is a fraud until and unless we see structural changes in approach by Congress and The Administration – and neither, at this juncture, looks likely.