Commonality

What do Alaska, New Hampshire, and Vermont have in common?

They are the only states which do not have a bank listed on Calculated Risk’s unofficial Problem Bank List.

It’s not like there are no banks headquartered in those states– there certainly are, although not large ones. However many of the banks on the problem bank list are small.

An interesting factoid, at least.

 

Doctor Copper

There’s an old saying, that “Copper is the only metal with a PhD in economics.” This refers to the ability to use copper as a proxy for economic activity– the more economic activity going on, the more demand for copper. If copper’s current trend continues to hold true, maybe there’s hope for us yet!

Interestingly, the one year copper price chart clearly demonstrates this:

Note: These are live updating charts, so if you visit this site in a year or so and the charts make no sense, that’s why.

 

Putting the “G” in “GDP”

As I predicted a few posts ago, we’re starting to see some signs of life in the economy. Inventories are starting to clear out, initial unemployment claims seem to be peaking, and corporate profits were stronger than expected in Q1– all good. This tells us that the economy is probably bottoming, but not necessarily that a vigorous recovery is at hand.

Around July, you can expect to see a significant bump in reported GDP growth. Much more than you might expect, or even might seem to correspond with the view from your window. This is the result of stimulus spending passing through the system.

GDP, per the BEA definition, consists of Consumption + Investment + Government Spending + Exports – Imports.

If everything else is held constant, the increase in Government spending will cause GDP to increase. Even if the other components of GDP decline significantly, the Federal stimulus alone will insure increases in GDP in Q2 and Q3.

Of course, the bad news is that you can only increase once– so once that effect fades, the year over year comparison may not look so good in 2010. I guess we’ll cross that bridge when we get there…

 

Beige Book Update

Well, things seem to be turning up. The Federal Reserve issued their latest Beige Book, and we here at The Myth of Alpha found a decrease in the use of the words “decline” and “weak!”

Yes, that’s right– “decline” appeared only 131 times in various forms, while “weak” appeared only 41 times. An improvement over the last beige book, which had 127 instances of “weak” and 148 of “decline.”

 

Classical Economics

In classical economic theory, downturns plant the seeds for the next upturn, both by reducing price pressures and by reducing excess inventory, eliminating weak competitors, and most importantly providing a source of pent-up demand, as consumers and businesses defer purchases until times appear better.

So why didn’t this theory work in the Great Depression, as it has in most other down turns? I believe that the severity of the damage to the banking system, and hence to consumer savings and credit, caused such a disruption that recovery was severely impacted.

The destruction in the banking sector during 1930-31 is almost unimaginable in the present day. According to A Financial History of the United States, 1,300 banks failed in 1930 and over 2,000 banks failed in 1931! “By 1932, one in four banks in the United States had failed.”

And none of those banks had deposit insurance! So, as a depositor, when your bank failed, you were ruined– if your money was in the bank. Naturally, people took their money out of banks and hoarded it. The result was a huge reduction in the amount of capital available for productive use, and deflation on a massive scale. With deflation and the lack of capital availability to businesses and consumers, it’s no surprise that a serious downturn took place and that recovery was more difficult than normal.

Let us contrast that situation with early 2009. According to the FDIC, 2009 has seen 6 bank failures so far, and not one has cost insured depositors a penny. 25 banks failed in 2008, and again no insured depositors lost money. The Federal Government has reiterated it’s willingness to stand behind large banks– ultimately even if it means nationalizing them, which would be a disaster for shareholders and a non-event for depositors.

What about money market funds, you may be asking. Fair enough– in September 2008, one money market fund (The Reserve Primary Fund) was unable to maintain it’s $1.00/share net asset value. Investors lost around 3% of their principal. Not exactly financial armageddon.

At this point, many of the credit indicators are actually showing improvement. The Ted spread, for instance, which measures the difference in interest rates between inter-bank loans and short term treasuries, is below 100, a relatively normal indicator– actually, given the low rates for short term treasuries, it’s actually fairly low. The A2/P2 spread, an indicator of the perceived risk in commercial paper, is back to a more normal level.

Even a normal credit environment does not mean that recovery is imminent, unfortunately. First, the economy has to work off the excesses of the last expansion– and given the weakness of the 2001 recession, the last two expansions. If government action delays this process, then the recovery will come later– a prospect which would not surprise me, unfortunately.

Once we work through these excesses, and as the credit situation slowly improves, we should see a recovery, just as the classical theory predicts. Even if we don’t get a stimulus package from the government.

 

The More Things Change…

H.L. Mencken, writing in 1932 (emphasis mine):

“The psychic effect of the depression, it seems to me, is generally a good one. It has made multitudes distrust such charlatans as Hoover and [Secretary of the Treasury Andrew W.] Mellon who were quite willing, three years ago, to credit them with the magic of saints and archangels. It has busted a long line of popular wizards, running from Henry Ford to [head of Bethlehem Steel] Charlie Schwab, and from [economist] Irving Fisher to [newspaper editor] Arthur Brisbane, all of them as hollow as jugs. It has taught people the difference between speculative values and real values. It has hastened the death of sick industries, and proved the vigor of sound ones. It has blown up the old delusion that the amount of money in the world is unlimited, and that every American is entitled to a police captain’s share of it.

“Best of all, it has taught millions that there is really no earthly reason why there should be two cars in every garage, and a chicken in the pot every day. A few years back we were all leaping along after the pacemakers, and making shining fools of ourselves. Life in America had become an almost unanimous effort to keep up with the Joneses, and what the Joneses had to offer by way of example was chiefly no more than a puerile ostentation. So many luxuries became necessities that the line separating the one from the other almost vanished. People forgot altogether how to live well, and devoted themselves frantically to living gaudily.

“It seems to me that the depression will be well worth its cost if it brings Americans back to their senses. Once they rediscover the massive fact that hard thrift and not gambler’s luck is the only true basis of national wealth, they will discover simultaneously that a perfectly civilized and contented life is possible without the old fuss and display.”

 

Unprecedented!

I was chatting with a financial advisor yesterday who commented that her wish for 2009 was never to hear the word “unprecedented” again. I heartily agree!

 

New Deal II?

Many smart observers seem to think that President Obama should be looking to our 32nd President for inspiration– and there is plenty of evidence he is doing so. Indeed, our present economic situation does seem to have some valid parallels with the Great Depression, including a credit crisis, a period of deflation, and a deleveraging of consumers and businesses, leading to a significant drop in aggregate demand.

In 1933, Roosevelt’s answer, as we all know, was the New Deal. By replacing private consumption with public consumption, the theory goes, we should be able to reverse the decline in demand and get the economy growing again. The results were not an unqualified success, despite a rosy public perception when viewed through a telescope from 70 years distant.

However, while there are similarities in the economic situation, the Federal Government’s financial situation is completely different from the 1930s. This leads to more questions than answers, I’m afraid.

In 1930, the Federal Government spent around 3.4% of GDP. By the height of the New Deal, 1934, that had risen to 10.7%. In 2007, before any crisis or stimulus, Federal outlays were 20% of GDP! What is an appropriate maximum percentage of GDP for the Federal Government to spend?

Likewise, in 1930 US Government debt was around 16.6% of GDP. By 1940, it rose to 52% of GDP and by 2007 it was 65.5% of GDP. What would be the maximum amount of debt the US Government could sustain?

Incidentally, the EU provides some guidance on this. They require EU member countries to have debt of not more than 60% of GDP, and budget deficits of not more than 3% of GDP. Of course, they haven’t been able to enforce this, and some would argue that it improperly constrains individual countries from responding with fiscal stimulus, but it’s at least a data point.
Last edited by donv; Today at 02:17 PM.

 

The Fed Needs a Thesaurus

Perhaps the Federal Reserve could spend some newly created bank reserves on a few synonyms for “weak” and “decline.” There are 127 instances of “weak” and 148 of “decline” in the latest Beige Book.

Overall economic activity continued to weaken across almost all of the Federal Reserve Districts since the previous reporting period…

District reports indicate that retail sales were generally weak…

several Districts noted weaker conditions in transportation services…

Activity in the services sector declined throughout most Districts…

Residential real estate activity continued to weaken in nearly all Districts…

Most Districts that reported on lending activity indicated that it continued to decline or remained weak…

Credit quality declined or remained a concern…

Activity in the energy sector declined in several Districts…

And that’s just in the summary. Of course, they did make a few efforts:

Contacts in the Boston District described the commercial real estate market as grim and depressing…

In comparison, the March 2008 Beige Book contained only 76 and 71 instances, respectively, of “weak” and “decline.”

Not good…

 

Where Have all the Monetarists Gone?

I have been perusing the DecemberFOMC minutes lately, and I noticed a distinctly Keynesian flavor to the discussion. The key being almost a revival of the Phillips Curve, reflecting a tradeoff between unemployment and inflation, or in this case resource utilization and inflation:

Participants agreed that falling prices for energy and other commodities and diminished economic activity had resulted in an appreciable reduction in inflationary pressures. Those pressures were seen as likely to continue to abate because of the emergence of substantial slack in resource utilization and diminishing pricing power. Participants were uncertain about the extent to which inflation would fall. Some saw inflation leveling out near desired levels, while others expressed concern that inflation might decline below levels consistent with price stability in the medium term.

Certainly slack in resource utilization plays a part in inflation. I see first hand price reductions as companies try to win business, and reductions in raw material costs, driven by reduced demand, make this even more pronounced.

However, a look at the Fed’s Flow of Funds Report shows total indebtedness growing quickly in Q3 of 2008, after declining in the previous two quarters. This was sparked by a huge increase in Federal Government indebtedness. Furthermore, the monetary base, as shown in M1 and M2, have been growing quickly by every measure.

So, shouldn’t this lead to inflation? A monetarist would argue that more money chasing the same, or fewer, goods and services should lead to higher prices. A Keynesian would argue that as long as there are large measures of slack in labor and resources, higher prices are impossible.

Who is right?