Commentaries

from Rolfe Winkler:

Lunchtime Links 12-31

Bankers get $4 trillion gift from Barney Frank (Reilly, Bloomberg) David pours over HR 4173, all 1,279 pages of it. He finds some interesting nuggets. One of the bigger problems I see is the proposed insurance fund that would pay for resolving systemically dangerous banks. Talk about moral hazard!

Show some balls (Saletan, Slate) A colorful take on new TSA security procedures.

New jobless claims hit 17-month low (Kaiser, Reuters) Good news for the economy but, paradoxically, bad news for stocks (and gold). If the economy improves, the Fed will have to raise rates. That will hit equity values and strengthen the dollar. But don't count on strength lasting very long. As soon as the Fed meaningfully tightens, we'll head right back into debt deflation.....which is why many think the Fed is trapped.

The land of the rising bearish wager (Zuckerman/Slater, WSJ) Betting on a "sudden stop" in Japan. (ht Walker Todd)

Shoplifters? Keen an eye on workers (Greenhouse, NYT)

UBS whistleblower asks why he's going to prison (Brown, Reuters) This will be an interesting 60 Minutes piece.

Europe's vast farm subsidies face challenges (Castle/Carvajal, NYT)

Can good numbers be bad news?

Barring any unexpected stumbles, and revisions aside, today will be the last time this year that Americans are told their economy is shrinking.

Indeed, the modest one percent decline in second-quarter gross domestic product could be followed by growth rates as high as three percent in the final six months of the year.

But good economic news can be dangerous, as the Great Depression showed. As growth bounced back after 1933, complacency set in, leading to premature demands for an unwinding of government stimulus and tighter monetary policy.

The result was a second downturn in 1937, as Depression scholar and Obama adviser Christina Romer has pointed out.

A repeat of this blunder becomes more likely the better the figures start to look. The U.S. economy is far from ready to walk without the crutch of government money, and won’t be for some time.

The dependence of the economy on government support was graphically illustrated by today’s GDP figures. The 10.9 percent jump in federal government spending was one of the few positives on the GDP ledger between April and June.

Support from Uncle Sam was invaluable in propping up ailing consumer finances. Real disposable income actually increased by 3.2 percent, despite the appalling state of the labor market. This government infusion will continue into the final six months of the year as the “cash for clunkers” program works its magic on auto sales and infrastructure spending picks up.

Running short on ammunition at the Fed?

Barring another serious economic stumble, it seems that the Fed is not going to offer much more credit easing than already planned. The minutes of the June meeting of the FOMC suggested a solid resistance to stepping up purchases of either mortgage backed securities or Treasury bonds.

On Treasuries, the committee argued that a small increase in Treasury purchases would do little to push down rates. Meanwhile a large increase could heighten fears that the Fed intended to monetize the government’s debt.

I have to admit to being a little disappointed. Even after completing its $300 billion of purchases the Fed will own just a small fraction of the more than $6 trillion market. They have enough credibility to push through more purchases without raising concerns. Another burst of sub-5 percent mortgage rates could provide much needed relief for the housing market and ease pressures on household budgets.

Under normal circumstances the Fed could afford to be cautious. But I suspect that the fiscal stimulus that has yet to percolate into the economy will have only minimal effect. Much will be offset by cutbacks at the state level.

This leaves the Fed on its own. They can afford to give the economy one last shot in the arm.

Gloomy employment milestones

There is normally something for both optimists and pessimists in the monthly employment report.

When the payroll figures are disappointing, the unemployment rate is frequently better than expected. This month is no exception. While payrolls plunged by nearly half a million, unemployment barely budged.

On closer inspection there is little comfort in this report even for the most dogged optimist. The fact that unemployment only rose slightly was chiefly a result of a 155,000 decline in the size of the labor force. This could be noise, or a sign that discouraged workers are abandoning their search.

For statistical connoisseurs there were two alarming milestones. Since the start of the recession in December 2007, 6.5 million jobs have been lost – more jobs than were created during the previous business cycle. According to Heidi Shierholz at the Economic Policy Institute, this is the first recession since the 1930s to erase all of the employment creation from the preceding cycle.

The second discouraging sign is that the proportion of those out of work for more than six months is at its highest level since 1948, when records begin. Almost a third of the jobless are now classified as long-term unemployed – up from about 19 percent last year. This is bad news for U.S. productivity. As people stew on benefits their skills tend to atrophy. With more highly educated workers losing their jobs, this problem could get worse.

The figures are bound to be used as evidence that Obama’s costly stimulus package has been a dud. This is unfair. The time lags in fiscal stimulus are long. Payroll deductions were scaled back only a few months ago and much of the infrastructure spending will take many months to filter through. In addition the president’s package was never likely to halt the rise in unemployment, merely to slow it.

The figures should send the loudest signal to the Federal Reserve, which is still on the front line. Its credit easing program has always offered the best hope of economic stabilization. Recently the Fed has become less active.

Just in case you were wondering, no exit yet

Earlier today the Fed announced that it would extend a number of programs slated to expire this year until February 1, 2010, making it clear for any of the doubters out there that the Fed is not ready to pull the plug on its patchwork of support for financial markets.  It probably would have made a bigger exclamation point if the Fed Board had made the announcement yesterday when the FOMC stood pat on its policy, but no matter.

I had argued earlier this week, that now would be a good time for the Fed to go for the low hanging fruit when it came to an exit strategy and commit to winding down, among its lending facilities, the Commercial Paper Funding Facility when it was due to expire this year. After all it would show that it was committed to the temporary nature of these programs and give those worrying about too much stimulus something to chew on.

I still believe that at some point this will become a credibility issue for the Fed. Investors, especially those overseas, want to know that the U.S. government isn’t planning on inflating its way out of its debt mess. I understand the difficulties of trying to time things just right so you don’t quash an emerging economic recovery by taking away the stimulus too soon.  But, what better test case than a program that is already winding down in an area that U.S. companies, and by extension the economy, has become less reliant on.

The commercial paper market, which froze on two separate occasions in the last two years, is just not what it once was. At $1.15 trillion, it’s nearly half the size it was at it’s peak in 2007. Companies have moved away from relying on it and the economic slowdown means there’s also less need to borrow in this short-term market.

But, policy makers obviously feel the timing still isn’t right.

Update: I should note that the Fed did ditch one program, the Money Market Investor Funding Facility but that doesn’t really count since no on ever used it in the first place. And it trimmed back two other programs.