Commentaries

Who’s afraid of deflation?

For most policymakers, deflation is the stuff of nightmares — scarier even than bank failures and stock market collapses. As the economy stumbled, deflation became Lords Voldemort and Sauron rolled into one.

In recent months, however, this economic supervillain seems to have lost its power to intimidate.

With growth reviving, many economists now believe that deflation is highly unlikely to materialize.

Another group suggests that deflation is not nearly as nefarious as often portrayed. Since falling prices are not generally associated with depression, we were wrong to be frightened in the first place.

Sadly, both of these reassuring premises are wrong. We should still be afraid of deflation.

First, the notion that deflation is a misunderstood and potentially benevolent economic force is only partially true. Supporters of this theory often cite research from the Federal Reserve Bank of Minneapolis, which showed that falling prices seldom coincide with depression.

Looking at data for 17 countries over more than a century, the Minneapolis Fed concluded that “nearly 90 percent of the episodes with deflation did not have depression.”

The government’s foreclosure flop

The Obama administration has attacked the problem of rising home foreclosures with a humanitarian zeal. Their program — the most ambitious in generations — was intended to save up to four million people from being thrown out of their homes.

A few months on, this $75 billion policy has been a humiliating flop. Only about 270,000 mortgages have been modified since the scheme was announced in February, according to government figures, and if past experience is anything to go by, half of those could be delinquent again within six months.

The root of the failure is that the Administration crafted its policy on a powerful narrative of banks hoodwinking borrowers into taking out exotic and extremely dangerous loans.

Instead, homeowners’ own reckless borrowing and unemployment have been far more important.

The Making Home Affordable plan aimed to help victims of bank sharp practice, offering various incentives to lenders to bring monthly payments back down to around a third of an owner’s income. It was not designed to aid families whose income had disappeared due to unemployment, those who had large debts beyond their primary mortgage, or those suffering from serious negative equity.

If the administration is serious about stemming foreclosures they need to go back to the drawing board and consider some politically perilous alternatives

A study of 4,000 foreclosures from 2006 to 2008 in Southern California by Michael LaCour-Little, a finance professor at California State University at Fullerton, found that many borrowers were not the hapless victims either of machinations by the banks or of an unlucky decision to buy at the top of the market.

Bernanke: Back to Clark Kent

Having averted a disaster, cartoon superheroes typically revert to their bland civilian identities. With the recession loosening its grip, Ben Bernanke is trying a similar trick.

After a period of heroic boldness and creativity, the Fed is determined to be dull. Wednesday’s statement from the Federal Open Market Committee may well be calculated to bore.

Yet Bernanke’s reversion to Clark Kent is premature given the dangers still posed by a fragile U.S. economy. The Fed’s more timorous approach in recent months seems due to an increasingly hostile political environment combined with an improving economic one.

But until the United States is well on the road to recovery Bernanke should try to hold on to his swashbuckling spirit.

The Fed has every reason to be politically intimidated. Relations between lawmakers and the Fed are close to an all-time low.

Much congressional ire has been focused on the Fed’s role in bank bailouts. There has been nervousness over its expanded balance sheet, which more than doubled during the crisis to around 14 percent of GDP.

For some Republican Senators such as Jim DeMint, the Fed’s purchase of U.S. Treasuries has been aiding and abetting “reckless” spending by Obama. DeMint is not alone in believing that credit easing is a covert means of devaluing the dollar. In the House an increasing number seem willing to listen to obsessively anti-Fed Congressman Ron Paul.

from Rolfe Winkler:

Beware the government’s job figures

In a phone conversation yesterday, John Williams at Shadow Government Statistics warned me not to read too much good news from the better-than-expected jobs figure.  The government's seasonal adjustments aren't, well, adjusting properly.  They're still keying off "typical" fluctuations in employment.  But of course today's economic climate is anything but typical.  Yesterday the official unemployment rate ticked down a tenth of a percent to 9.4%, but according to Williams it should have ticked up a tenth of a percent to 9.6%.

There are big seasonal changes in employment that the Bureau of Labor Statistics corrects for in order to reduce the volatility of the unemployment rate.  For instance, each year employment spikes ahead of the holidays as companies add workers, and then drops as those workers are let go.

July usually sees a regular pattern of planned automobile production line shutdowns to accommodate retooling for the new model year, but recent disruptions to the auto industry have changed pattern this year. Without the usual pattern of shutdowns, the government’s computers nonetheless responded by creating the usual offsetting boost in jobs, not only in the auto industry, but in supporting industries as well. The auto industry itself was alone among durable goods manufacturing industries in showing a reported, seasonally-adjusted monthly gain in July, up by 28,000 jobs.

Besides bad seasonal adjustments, Williams has problems with the so-called "birth-death" model, which "adds a fairly consistent upside bias to payroll levels each year, currently averaging 76,000 jobs per month."  The genesis of the birth-death model was after the early '80s recession, when employment figures didn't catch jobs being added by new small businesses.  However, when a company like Taylor Bean & Whitaker stops reporting its stats, say because all employees were fired en masse, BLS assumes the company is still in business.  (For how long, I'm not sure)  The bottom line is that, in recessions, you're losing more jobs from failing businesses than you're gaining from emerging ones.  Hence the upward bias of the model during recessions.

But according to Williams the biggest problem with the official unemployment rate---"U-3" in BLS parlance---is that it excludes both the underemployed and workers who have become "discouraged" and stopped looking for work:

During the Clinton Administration, "discouraged workers" -- those who had given up looking for a job because there were no jobs to be had -- were redefined so as to be counted only if they had been "discouraged" for less than a year.  This time qualification defined away the long-term discouraged workers.

Add all the underemployed and the disappeared and you have Williams "alternate" measure, which pegs unemployment at 20.6%, not 9.4%.

Bracing for a glut of leisure time

The United States has been labeled “no vacation nation.” Americans are notoriously diligent compared with citizens of other rich nations — putting in long hours and often not even using the skimpy vacations to which they are entitled.

Now more Americans are being forced to take it easy. Even for those who are keeping their jobs, many companies are cutting hours and imposing “shotgun” vacations in an effort to economize.

Government data have shown the length of the average working week plunging faster than in previous recessions. Time devoted to work has already fallen twice as much as during the slump of the early 1990s. No improvement is expected from the payrolls report on Friday.

This is likely to be a double-edged sword. Behavioral economists believe the respite from the rat race may be good news for those who are financially stable enough to enjoy more spare time. But it is further bad news for the unemployed and may delay the day when companies actually need to start hiring again.

The silver lining, though faint, is worth considering. Behavioral economists have long complained that Americans work too hard for their own good. People typically overestimate the boost to happiness from the extra consumption that longer hours permit, and understate the “hedonic” fillip from leisure time. Americans rank among the most hard-working folk in the rich world, laboring for an average of almost 1,800 hours a year. The Dutch, by comparison, put in a puny 1,400 hours, according to OECD figures — a difference that is equivalent to an extra 10 weeks of holiday for a full time employee.

“Americans who are not in chronic financial stress and can cope with the emotional blow of a lower salary, may find themselves better off for the spare time,” says Dan Ariely, author of “Predictably Irrational”, a book on behavioral economics. Obviously these are big provisos.

Take the American worker off the psychologist’s couch and the news is not so good. The figures are now indicating huge slack in the labor market. Economists are increasingly preoccupied by U6 — a broad measure of unemployment that includes those working part time because they can’t find a full time position. This is now 16.5 percent of the workforce.

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.

The danger of a lost generation

– Christopher Swann is a Reuters columnist. The views expressed are his own —

NEW YORK, July 24 (Reuters) – For the first time in three generations, Americans across the nation are facing the threat of long-term unemployment. Already more than one in four jobless Americans have now been out of work for more than six months, the highest level since records began in 1948.

For both individuals and national economies, long-term joblessness has proved to be extremely corrosive. Skills atrophy after extended periods of enforced indolence. Then, when an economy recovers, these workers are no longer in a position to fill new jobs.

As a result the potential maximum speed at which the economy can grow declines, and the workers themselves come to be seen as “damaged goods.” Those unlucky enough to be graduating in 2009 may find that their salaries never match those of similarly qualified peers who finished in 2006. To his great credit, President Obama has been quick to spot the danger. Under the administration’s stimulus package, the unemployed can now claim benefits well beyond the standard six months. In some badly afflicted states, insurance will last up to a year and a half.

The government is also offering $4 billion in funds to retrain workers. Tax breaks in the package aim to make it more affordable for young people to sit out the recession in school. Another $12 billion for community colleges has the same goal.

Yet even this heroic effort may be too little, too late for many Americans. The closest analogy to America’s current unemployment crisis is probably Japan. Here too was a nation accustomed to minimal long-term joblessness. In Japan the lost decade produced a lost generation.

Faced with a “hiring ice age,” graduates settled for lower status or temporary jobs. By the time companies were in the mood to hire again in bulk around 2007, they chose fresh graduates. Many of Japan’s thirtysomethings never caught up.

L-shaped housing market?

Economists seem willing to celebrate even the most tepid economic release these days. The National Association of Homebuilders’ Housing Market Index nudged up slightly to 17 in July, up from 15. Most economists had expected 16, so this is what passes for good news.

But the improvement is tepid indeed considering the record lows the index has hit. Even most dead cats bounce more vigorously than this.

The report pointed to an improvement in the low end of the market. Joshua Shapiro at MFR believes that this segment of the market at least may be nearing a bottom. He is less sanguine about the fortunes of middle and higher priced houses.

Many economists are assuming that a stabilization in the housing market is the inevitable first step towards a recovery. I would suggest gloomier possibility. The recent period of calm could simply be a pause for breath on the way down. The fact that this decline will probably be quite slow is cold comfort.

There is still an imposing inventory of unsold homes. Unemployment continues to rise. The interest rate of the 30-year mortgage is still well above its low point. As a suffering homeowner myself, it pains me to say that an L-shaped housing market may be the best we can hope for over the next few years.

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.