January 31, 2005
Like The Personal Income Numbers? Thank Microsoft.
From today's report on December personal income growth (courtesy of the Commerce Department's Bureau of Economic Analysis):
Personal income increased $360.9 billion, or 3.7 percent, and disposable personal income (DPI) increased $354.4 billion, or 4.0 percent, in December, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $66.4 billion, or 0.8 percent. In November, personal income increased $41.4 billion, or 0.4 percent, DPI increased $36.9 billion, or 0.4 percent, and PCE increased $31.5 billion, or 0.4 percent, based on revised estimates.
The 3.7 percent increase in December personal income mainly reflected the payment of a special dividend by the Microsoft Corporation. Excluding this special factor, which is discussed more fully below, personal income increased $62.7 billion, or 0.6 percent, in December, after increasing $41.4 billion, or 0.4 percent, in November.
Forbes.com puts some perspective on the Microsoft contribution.
While it is rare for a single company's dividend payment to impact incomes so strongly, Microsoft is a rare firm. With one of the most widely held stocks in the U.S., the software colossus forked over $32 billion. Compare that to the $38 billion that Uncle Sam paid out in federal income tax rebates in the summer of 2001.
Recipients did not, however, rush out to spend their windfall. Again, from the Commerce Department:
Personal saving -- DPI less personal outlays -- was $308.0 billion in December, compared with $23.1 billion in November. Personal saving as a percentage of disposable personal income was 3.4 percent in December, compared with 0.3 percent in November.
That was enough to drive personal saving into positive territory for the year. But, of course, its national saving -- which includes businesses and the government -- that we really ought to focus on anyway.
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The End Is Near?
According to Fred Bergsten we will soon see that Nouriel Roubini and Brad Setser have been right, so right, about their dollar-disaster scenario (here and here, for example). Yesterday's article at David K. Smith's web site has this:
Fred Bergsten of the Washington-based Institute of International Economics argues, as do others, that America’s reluctance to confront its budget and trade deficits is the big danger facing the world economy. Bergsten said: “The US deficits are unsustainable in domestic-political and trade-policy terms, as well as in international financial terms"...
Stephen Roach at Morgan Stanley, who admittedly has built a reputation for being the most bearish analyst of the American economy, agrees — and more. The dollar’s fall, on its own, will not be enough to curb America’s current account deficit — now running at an annual rate of more than $700 billion (£370 billion). Austerity, caused by a sharper rise in interest rates than the markets are assuming, will be needed. American consumers, who have raised their spending to the equivalent of 71% of GDP against a long-term average of 67%, will have to cut back. So will the Bush administration, which last week added $80 billion to its Iraq spending and $855 billion to its projected budget deficits over the next decade.
Bergsten sees the possibility of a dollar crisis “within weeks”: a combination of dollar selling by the foreign-exchange markets, coupled with the abandonment by leading central banks of their policy of accumulating dollars. Who, after all, wants to hold a declining asset? A dollar crisis, a sudden drop of 20%, 30% or 40%, could force American interest rates up sharply — the Federal Reserve being unable to ignore the inflationary consequences. This, in turn, would reinforce the risks to US growth underlined by Roach.
And here, according to Smith, is the list of all the really bad things that will happen.
A combination of a dollar crisis and sharply rising American interest rates would, for a start, hit global stock markets hard. Investors are betting on the gradualism of the Federal Reserve — a quarter-point rise every six weeks — continuing. Any change in that pattern would go down like a lead balloon.
The second big effect would be on Europe... A dollar slide that pushed the euro to $1.50 or $1.70 would guarantee a recession in the eurozone....
A third effect will be on trade more generally... Currency turbulence is never good for world trade, which has been enjoying a good recovery. A dollar crisis would not only undermine that but would put at risk the important World Trade Organisation Doha trade round, on which progress needs to be made this year.
Fourth, a sharp dollar-related rise in American interest rates would change the global interest-rate climate. It would raise the spectre of inflation. here is no automatic read-across from the Fed to the Bank, but a rise in inflationary expectations would affect everybody. A sharp dollar decline, after all, marked the start of the great inflation of the 1970s.
At this point I just have to comment. That last statement -- that a sharp dollar decline marked the start of the great inflation of the 1970s -- is a complete red herring, confusing cause with effect. The dollar depreciated in the 1970s because the U.S. monetary authority was running an inflationary monetary policy -- and had, off and on, since that last half of the 1960s. That is what led to the depreciation of the dollar (and the breakdown of Bretton Woods), not vice versa.
And, once again, of course U.S. interest rates are going to rise. Real interest rates -- that is, interest rates adjusted for expected inflation -- have been at anomalously low levels for years now. (Here's my opinion why that has been so, in case you are interested.) Furthermore, when interest rates start heading north, they often do so at a pretty good clip. (Some examples: Between October 1993 and November 1994, ten-year treasury yields rose by about 250 basis points. Between October 1998 and January 2000 the same yield rose by over 200 basis -- while the government surplus was rapidly expanding!)
So all of these predictions about falling bond prices are not the least bit fearless. The real question, in my view, is why the process has taken so long.
As for the doomsday scenarios that seem so popular, I'm still not buying it. I will not, however, hold Nouriel and Brad to Bergsten's "within weeks" window.
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January 30, 2005
The Big Stuff
I won't be posting anything new today, because frankly most of the usual stuff we econbloggers obsess about pale in comparison to the history being made in Iraq. So I plan to spend the day checking out the links posted at Iraq Elections Newswire and all the other usual places.
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January 28, 2005
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Labor Compensation Beats Inflation (Barely)
Beside the 4th quarter GDP report, today's big economic news is the Bureau of Labor Statistics' release of the Employment Compensation Index for December. Here's the lowdown.
Total compensation costs for civilian workers increased 0.7 percent from September to December 2004, seasonally adjusted, moderating from the 0.9 percent gain from June to September, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Benefit costs rose 1.4 percent, while wage and salary costs increased 0.4 percent, the smallest quarterly increase in wage and salaries in 2004. The Employment Cos Index (ECI), a component of the National Compensation Survey, measures quarterly changes in compensation costs, which include wages, salaries, and employer costs for employee benefits for nonfarm private and State and local government workers
Rises in benefit costs accounted for more than 60 percent of the increase in compensation costs for civilian workers from September to December 2004. Among private industry workers, benefit costs contributed nearly two-thirds of compensation gains during the quarter, with defined benefit retirement costs accounting for nearly one-third of the gain in compensation costs. Among State and local government workers, benefit costs composed half of compensation gains during the September to December period, with health insurance costs accounting for one-fifth of the gain in compensation costs.
Here's a little more perspective on those numbers, from SmartMoney.com.
In the year through December, compensation costs were up 3.7%, compared with a 3.8% rate in the year through September.
In its report Friday, the Labor Department said wages and salaries grew at the slowest pace since March 1999 during the fourth quarter, climbing 0.4%% after a 0.7% increase in the third quarter. Those costs account for about 70% of the employment cost index. In year-on-year terms the increase was 2.4%, unchanged from that of the third quarter.
But benefit costs, which have grown more than twice as fast as wages over the last two years, climbed more rapidly in the fourth quarter. Those costs were up 1.4% after a 1.1% increase in the third quarter. In annual terms, benefits costs grew 6.9% in the fourth quarter, up from the 6.3% annual rate of the prior quarter. Many economists attribute the slow pace of hiring during recovery from the last recession in part to the rapid growth of benefits, especially health insurance.
I'm not convinced that last sentence should be taken at face value. After all, from an employer's point of view all that should matter is the total cost of labor, not the form in which payment is made. The difference, of course, might be that payments in the form of health care benefits are more open-ended and "sticky" than payments in wages. If that's so, perhaps its a wrinkle in this debate (with follow-ups here and here) that deserves some consideration.
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4th Quarter GDP: Less Than Expected
The Bureau of Economic Analysis released the advance data for 4th quarter Gross Domestic Product this morning, and the number came in lower than most people anticipated.
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.1 percent in the fourth quarter of 2004, according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 4.0 percent.
The increase in fourth-quarter gross domestic product... was the weakest since a 1.9 percent pace in the first quarter of 2003. It also was below Wall Street economists' forecasts for a 3.5 percent rate of fourth-quarter expansion.
This bit of information, on the other hand, isn't much of a surprise:
The Commerce Department report showed exports of goods and services fell at the steepest rate in two years during the October-December fourth quarter while imports rose.
While the real growth numbers were softer than expected, average prices jumped. Again from the BEA press release:
The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 2.7 percent in the fourth quarter, compared with an increase of 1.9 percent in the third.
Of course, a little perspective on all of this is always useful. While the overall price number was not great news, the "core" measure didn't look so bad.
Excluding food and energy prices, the price index for gross domestic purchases increased 1.9 percent in the fourth quarter, compared with an increase of 1.7 percent in the third.
Furthermore, there is this reminder from the Commerce department report:
The Bureau emphasized that the fourth-quarter "advance" estimates are based on source data that are incomplete or subject to further revision by the source agency ... The fourth-quarter "preliminary" estimates, based on more comprehensive data, will be released on February 25, 2005.
And the longer view from the Reuters story:
Despite the softer fourth quarter, GDP in 2004 advanced 4.4 percent, up from 3 percent in 2003 and the most robust since a 4.5 percent increase during 1999. Private-sector economists generally predict continued expansion in 2005 at around 3.5 percent, which is considered to represent the U.S. economy's long-term growth potential.
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China Just Keeps Going, And Going, And Going...
This news is a few days old, but worth noting in advance of next week's meeting of G-7 finance ministers, which will reportedly include some discussion of what the Chinese central bank should do about the yuan. From The Economist:
ON TUESDAY January 25th, the Chinese authorities sheepishly confessed that the economy beat expectations last year, growing by 9.5%. It finished the year particularly strongly, growing at an annual pace of almost 13% in the last three months, according to J.P. Morgan. Anywhere else, this would be cause for celebration. But in China, the firecrackers remain unlit. Instead, analysts and investors are trying to reassure themselves that this is not bad news.
Why would this be bad news?
But economists are anxious about the balance of China’s economy as much as its speed. China may or may not be growing too fast, but it is certainly investing too much. In the year to the first quarter of 2004, spending on fixed assets—plant, property and infrastructure—grew by 43%. Investment accounted for 42% of GDP in 2003, and perhaps a still greater share last year. No economy can sustain such a colossal rate of capital accumulation. At some point, China’s investment must run into rapidly diminishing returns.
On its face, that statement seems kind of silly. The most basic growth theory tells us that countries starting from a position of low capital and income should grow more rapidly than mature economies, and that investment will be higher than is sustainable in the long-run. While it may be true that "investment must run into... diminishing returns," I'm not sure what appeal to theory or empirical evidence would lead us to believe it should have happened in 2004.
But the real issue is this:
If investors were betting their own money, these redundant cement factories—not to mention steel mills, luxury flats and car plants—would probably never have been built. But China’s reckless investment owes a lot to the heedless lending of its banks. Chinese households still save about 45% of their income. They deposit about two-thirds of these savings in China’s four big state-owned banks, which lend about two-thirds of these deposits to state-run firms. The banks pay little attention to risk and do not expect much of a return: perhaps 40-50% of loans are non-performing. In fact, their lending is best seen as a form of state subsidy. If these subsidies were added to the government’s books, China’s budget deficit would balloon to 18% of GDP, reckons Diana Choyleva of Lombard Street Research, an economic consultancy.
Furthermore, there is suspicion that growth is currently being stimulated by the Chinese government's insistence on maintaining the yuan peg to the dollar, which has required an expansion of the domestic money supply. On this, the mixed signals in advance of next week's G-7 meeting just keep coming. From Forbes.com:
China's central bank denied Friday that Beijing plans to soon loosen the link between its currency and the U.S. dollar, though remarks by economists suggesting a change was imminent briefly shook financial markets.
A member of the monetary policy committee at the central bank, Yu Yongding, told journalists attending the World Economic Forum in Davos, Switzerland, that given the dollar's recent weakness, "now is the time to revalue ... We need more flexibility. That means revaluation."
However, an official in the People's Bank of China's information office said Friday that Yu was an academic adviser, not an official, and that his opinion did not reflect official policy.
"(Yu Yongding's) remarks are only his personal view, and the opinions of an academic. It does not represent the central bank's policy," an official in the central bank's information office said.
The noisy signals from the Chinese government notwithstanding , here's a prediction, from FXSTREET.com:
China will not undertake any sweeping revaluation of the yuan, but is likely to widen the trading band and gradually appreciate the unit over time to ensure an orderly transition to a more flexible currency regime, analysts said.
Maybe that prediction is not quite fearless, though.
Last year many market watchers wrote in their research reports and told the media that China, which has pegged the yuan at about 8.28 to the dollar since 1994, would revalue it upwards in 2004. But that did not happen. Now ahead of the meeting of finance chiefs of the Group of Seven nations on on February 4-5, analysts are more cautious, with the buzzwords being "possible", "mild" and "gradual".
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January 27, 2005
What Inflation Rate Do We Want? (And Should We Tell Anyone?)
Greg Ip provides the following information in today's Wall Street Journal:
As Federal Reserve officials prepare to raise interest rates to keep inflation from rising, they are grappling anew with an old question: Should they aim for a specific number.
On the agenda for next week's two-day meeting of Fed policy makers is a discussion of whether the Fed should set a numerical objective for inflation and, if so, what it should be, according to people familiar with the matter. The Fed ponders such long-term topics twice a year, and no formal decision is likely. Nor is an explicit, public inflation target on the table.
I wasn't aware that the agenda for FOMC meetings had become public information in advance, and it is completely inappropriate for any Federal Reserve official to comment one way or another on whether what Ip says is accurate. In any event, the minutes will be out soon enough, and at that point we will all find out how good his sources are.
That aside, it is no secret that Fed governors and presidents have been batting around this topic for quite awhile, and Ip does provide a nice summary of the positions, starting with my boss.
At 1.5% by the Fed's preferred measure, inflation is now "roughly consistent with a working definition of price stability," Federal Reserve Bank of Cleveland President Sandra Pianalto said last week, expressing a view shared by most of her colleagues on the 19-member Federal Open Market Committee, the central bank's policy panel.
I added the link. (One small point of order. Strictly speaking, the Federal Open Market Committee consists of the voting members in a particular year, represented by the seven governors and five of the district bank presidents. More accurately, the 19-member group is referred to as FOMC meeting participants.)
Ip goes on to run down the range of opinions that have been staked out by the various players.
FOMC members who have advocated a numerical objective or target have offered varying ranges. Governor Ben Bernanke has said 1% to 2%. Governor Ed Gramlich has suggested 1% to 2.5%. Philadelphia Fed President Anthony Santomero last October proposed 1% to 3%, and St. Louis Fed President William Poole advocates a target of zero, with some allowance for measurement error.
And the pros and cons:
Advocates believe a target would enable investors to better predict how the Fed will respond to changing economic circumstances and solidify its commitment to price stability under Mr. Greenspan's successor next year.
But opponents, who include governors Roger Ferguson and Donald Kohn, fret that targets would confer an obligation to change interest rates whenever inflation deviated from the target, even if unemployment or financial stability called for different actions.
It's an interesting article, worth tracking down to read the whole thing.
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January 26, 2005
China: Not Quitting On The Dollar Just Yet?
A Chinese official told Reuters in an interview that China, which has been under heavy pressure to relax the pegging of its currency to the dollar, needed more time to prepare for making the yuan more flexible.
The comments come ahead of a meeting of the Group of Seven finance ministers and central bankers on Feb. 4-5, with many in the market expecting exchange rate flexibility to be a focus of the discussions.
"Given the timing, this seems to be a pretty obvious message from China to 'lay off pressuring us on the yuan at the G7'," said Mitsuru Sahara, vice president of forex dealing at UFJ Bank.
"It's looking more and more like the G7 will be a non-event and the yuan revaluation is further away than we thought."
But then again, that was yesterday. The most recent Reuters report had this to say:
The yen jumped on Wednesday, retracing some of this week's losses, after China said it would discuss the yuan at an upcoming meeting of the Group of Seven economic powers, rekindling speculation of a yuan revaluation.
A Chinese official said that the country's finance minister would attend next week's G7 meeting in London and that there would be a "deep dialogue" on issues including the yuan.
This seems a fair statement:
"We've had some conflicting signals in the last 24 hours on China," said Daragh Maher, senior currency strategist at Calyon.
"Yuan revaluation will be a topic of discussion at G7, but whether we will actually get some change of language on the yuan is questionable."
Should be an interesting meeting.
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January 25, 2005
The CBO Charts The Bumpy Road Ahead
The bottom line from the Congressional Budget Office:
Things look like they are getting better, but the CBO doesn't quite want you to believe it (at least not in the short run).
The Congressional Budget Office (CBO) projects that if current laws and policies remained the same, the federal government would run budget deficits of $368 billion in 2005 and $295 billion in 2006 (see Summary Table 1). However, because of the statutory rules that govern such baseline projections, those estimates omit a significant amount of spending that will occur this year--and conceivably for some time in the future--for U.S. military operations in Iraq and Afghanistan and for other efforts in the war on terrorism.
This is also important information:
CBO's revenue projections rest on the assumption that current tax laws remain unaltered except for scheduled changes and expirations, which occur on time...
The assumption that tax provisions expire as scheduled can have a significant impact on CBO's estimates. Many expiring provisions are extended almost as a matter of course, and most of them reduce receipts. Thus, revenue projections that assumed the extension of those provisions would be lower than revenue estimates projected under current law...
Assuming that the expiring provisions enacted in [Economic Growth Tax Reconciliation Act of 2001], [Jobs and Growth Tax Reconciliation Act of 2003], and [Working Families Tax Relief Act of 2004] were extended, CBO and the Joint Committee on Taxation (JCT) estimate that revenues would be about $1.66 trillion lower through 2015. About six-sevenths of that reduction would occur from 2011 through 2015. However, extending the changes to estate and gift taxes, which expire at the end of 2010, could reduce revenues as early as 2006 because some taxpayers might postpone taxable gifts that they would otherwise have made during this decade if they knew that the repeal of the estate tax would become permanent in 2011...
In the opposite direction, six provisions that are set to expire over the next decade would increase revenues if they were extended. The provision with the largest effect is the Federal Unemployment Tax Act surcharge, which would boost revenues by about $11 billion between 2008 and 2015 if extended...Extending the mine reclamation fees would raise about $200 million per year. The other four provisions, if extended, would raise about $100 million altogether through 2015.
Even abstracting from these complications, lots of things can happen. I find this picture, summarizing the CBO's uncertainty about ultimate outcomes, interesting.
And the long-run budget picture? This will come as no surprise.
In the decades beyond CBO's projection period, the aging of the baby-boom generation, combined with rising health care costs, will cause a historic shift in the United States' fiscal situation. Over the next 30 years, the number of people age 65 or older will double, while the number of adults under age 65 will increase by less than 15 percent.(10) Moreover, health care costs are likely to continue to grow faster than the economy. (Between 1960 and 2001, the average annual growth rate of national health expenditures exceeded the growth rate of GDP by 2.5 percentage points.)
Driven by rising health care costs, spending for Medicare and Medicaid is increasing faster than can be explained by the growth of enrollment and general inflation alone. If excess cost growth continued to average 2.5 percentage points in the future, federal spending for Medicare and Medicaid would rise from 4.2 percent of GDP today to about 11.5 percent of GDP in 2030 (see Figure 1-4). The Medicare trustees assume that excess cost growth will decline to 1 percentage point, on average; however, even at that rate, federal spending for Medicare and Medicaid would double to 8.4 percent of GDP by 2030.(11)
Outlays for Social Security as a share of GDP are projected to grow by more than 40 percent in the next three decades under current law: from about 4.2 percent of GDP to more than 6 percent. Such costs are likely to creep up gradually thereafter. By contrast, federal revenues credited to Social Security are expected to remain close to their current level--around 5 percent of GDP--over that period.
Together, the growing resource demands of Social Security, Medicare, and Medicaid will exert pressure on the budget that economic growth alone is unlikely to alleviate. Consequently, policymakers face choices that involve reducing the growth of federal spending, increasing taxation, boosting federal borrowing, or some combination of those approaches.
UPDATE: Kash at Angry Bear shows you what the path of the debt and deficits might look like if the President is successful in making his tax policies permanent.
Also, in case you were wondering how to interpret the fan chart above, which summarizes the CBO's own assessment of budget outlook uncertainty, here is the description from the relevant section of the report:
Using the difference between past CBO baselines and actual budgetary results as a guide, Figure 1-3 displays a range of possible outcomes for the total deficit or surplus under current law (excluding the possible impact of future legislation). The current baseline projection of the deficit falls in the middle of the highest-probability area, shown as the darkest part of the figure. But nearby projections--other paths in the darkest part of the figure--have nearly the same probability of occurring that the baseline projection does. Projections that are increasingly different from the baseline are shown in lighter areas, but they also have a significant probability of coming to pass. For example, CBO projects a baseline deficit of 1.2 percent of GDP for 2010. However, under current law, there is roughly a 5 percent chance that the actual outcome that year will be a deficit greater than 6 percent of GDP. Similarly, in the absence of further legislative changes, there is a 35 percent chance that the budget will be in balance or surplus in 2010.
UPDATE II: Andrew Samwick expresses his disappointment.
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Tracked on Jan 31, 2005 12:23:38 AM