The Great Debate

That whole Age of Frugality thing didn’t last long, did it?

U.S. real personal consumption grew in February at a respectable 0.3 percent clip, the fifth straight such monthly rise, a fact widely greeted as news that the recovery is on course. The fly in this tasty soup, however, is income, which in real terms didn’t increase at all, not even by one tenth of a percent.

American’s did this neat trick — spending more while earning the same — the old fashioned way: they cut back on luxuries … like saving.

Savings as a percentage of disposable personal income fell to 3.1 percent from 3.4 percent the month before and down from a recent peak of 6.4 percent in May 2009. In fact, the last time the savings rate was lower was October 2008 when a market maelstrom was convincing so many people, apparently falsely, that something rather dangerous and important was wrong with the economy. In real terms, consumption is only very slightly below where it peaked in 2007.

Astounding.

What happened? Well, from a certain point of view the medicine of reflation worked. Low rates punished savings and also drove the stock market and other risk assets higher. The fall in housing prices abated, leaving many personal balance sheets in better shape. Given the shape of the job market, I think we have an answer to the question of whether asset price inflation drives spending. It did during the boom and it is again now.

Government transfers helped too. They hit $2 trillion for only the second time in history, as payments from the common coffers such as social security and unemployment insurance now comprise more than 18 percent of income.
This does not have to end terribly, but it most certainly does have to end.

Managing the rise of China’s vast economy and healing the U.S. trade deficit will require a new willingness and capacity to boost U.S. technology exports at affordable prices. More importantly it requires a new language from policymakers and a new mindset.

In a recent survey of American businesses, the proportion who felt unwelcome operating in China had risen sharply, amid tense stand offs involving Rio Tinto and Google. But with U.S. legislators in full flag-waving cry about China as a currency manipulator, is it really surprising China is looking to become more self-reliant?

At the heart of the trade problem is the difficulty the United States (and other western economies) are experiencing in adjusting to China’s rise to superpower status in the 21st century. It is causing the same problems the rise of Germany, Japan and the United States itself caused for Britain in the 19th and early 20th centuries.

Rather than inflation, it may turn out that economic volatility is the true test facing equities in the years to come.

Coming in the wake of an almost unprecedented set of circumstances and policies, the outlook for growth and inflation is extremely murky. For equity investors that means there is far less certainty over both the outlook for profits and how to value them than they had grown used to in the 25 years to the onset of the current crisis.

It is not simply that very low interest rates and bloated central bank balance sheets may cause inflation. That is true, but it is also possible that Japanese-style deflation takes hold. There is a higher chance now of wild swings in inflation, growth and monetary policy than any time in the post-World-War-Two period.

The rancorous argument about global payment imbalances and the yuan’s valuation is exposing a surprising and dangerous economic illiteracy among policymakers and commentators.

Before pressing China to allow a maxi-revaluation of the yuan, western commentators need to think through the consequences carefully. The idea that devaluing the dollar (and by extension euro and yen) will cause payment imbalances to disappear and boost employment in the West with little or no impact on inflation and living standards is a pipe dream.

MAXI-DEVALUATION
First some notes about terminology. Proponents generally phrase their argument in terms of an appreciation of the yuan (which keeps the focus on the alleged currency manipulators in China). But it could just as easily be recast as a depreciation of the dollar (which is a much more controversial formulation, highlighting the fact that the exchange rate problem reflects U.S. weakness as much as China’s strength).

For the growing number of Americans who see China heading for inevitable global dominance, nudging aside the United States, a brief walk down memory lane helps put long-term predictions into perspective.

Not so long ago, Japan was seen as the next (economic) number 1. American executives studied the 14 management principles of The Toyota Way, developed by the automobile manufacturer that grew into the world’s biggest car maker and is now recalling millions of defective vehicles.

Between the mid-1980s and early 1990s, books with titles such as Trading Places – How We Are Giving Our Future to Japan and How to Reclaim It (by Clyde Prestowitz) were required reading in Washington. Learned panelists expounded on the wondrous efficiency of “Japan Inc.”

This article originally appeared in the Business Insider.

By John Carney

Today’s bleak consumer confidence number is undoubtedly bad news for the economy. The bigger than expected drop suggests that consumers have lost confidence in the recovery, which will drive down home prices and consumer spending.

Consumer confidence is typically our “first look” at the state of the economy. While most government aggregated data come out with a two-month lag, or more, consumer confidence hits with just a one month lag. Studies have shown that consumer confidence is a good predictor of consumer spending numbers. Basically, people surveyed seem to be good at accurately reading their own economic situation, and those surveyed accurately reflect the broader economy. When consumer confidence drops to such deep unexpected levels–today’s were the worst in 27 years–then it is a flashing red-light about the economy.

There wasn’t anything good about today’s numbers. Every part of the survey was awful. On jobs, the optimistic folks who say jobs are plentiful fell to 3.6 percent from 4.4 percent. The pessimistic people who said jobs are hard to get increased to 47.7 percent from 46.5 percent. The gauge of expectations for the next six-months fell to 63.8, from 77.3 the prior month. The share of people who believe their incomes will increase over the next six months fell to 9.5 from 11 percent. The share of those expecting more jobs fell to 12.4 percent from 15.8 percent.

In these days of renewed gloom about the future of Europe, a quick test is in order. Who has the world’s biggest economy? A) The United States B) China/Asia C) Europe? Who has the most Fortune 500 companies? A) The United States B) China C) Europe. Who attracts most U.S. investment? A) Europe B) China C) Asia.

The correct answer in each case is Europe, short for the 27-member European Union (EU), a region with 500 million citizens. They produce an economy almost as large as the United States and China combined but have, so far, largely failed to make much of a dent in American perceptions that theirs is a collection of cradle-to-grave nanny states doomed to be left behind in a 21st century that will belong to China.

That China will rise to be a superpower in this century, overtaking the United States in terms of gross domestic product by 2035, is becoming conventional wisdom. But those who subscribe to that theory might do well to remember the fate of similar long-range forecasts in the past. At the turn of the 20th century, for example, eminent strategists predicted that Argentina would be a world power within 20 years. In the late 1980s, Japan was seen as the next global leader.

-Kully Samra is UK Branch Director at Charles Schwab. The opinions expressed are his own.-

There is no doubt that since the lows in March 2009 the U.S. market has rallied massively. However, at Charles Schwab we believe that whilst economic progress will continue, we must look to the months ahead with some caution.  We remain optimistic regarding the equity markets in the longer term and the economy in the short term, but recognise that increased volatility will likely characterise 2010.

Over the last month, we’ve certainly experienced a sense of this increase in volatility in the US markets and we would stress the importance of a diversified portfolio and an appropriate asset allocation that matches one’s risk tolerance in order to combat this. Investors should also ensure that they assess and rebalance their portfolios to fit the market conditions.

– John Kemp is a Reuters columnist. The views expressed are his own –

Unable to rely on the wounded consumer, the outlook for U.S. growth in the next three years depends on business investment and exports to take up the slack when stimulus programmes wind down.
Ultra-low interest rates will help. But with the economy struggling to work off a huge overhang of unused real estate assets, and not much sign of investment elsewhere, investment spending is set to remain sluggish, condemning the economy to a weak recovery in the medium term.

Federal Reserve Chairman Ben Bernanke and other senior U.S. officials have already warned the rest of the world can no longer rely on over-indebted U.S. consumers as the principal source of global growth. There is no choice but to rely on investment and exports to take up more of the burden.

– John Kemp is a Reuters columnist. The opinions expressed are his own. –

With clear signs the U.S. and world economies have returned to growth, investors are trying to guess when the Federal Reserve will begin to raise interest rates again.

Voting to maintain the federal funds target at 0.00-0.25 percent at this week’s meeting, the rate-setting Federal Open Market Committee (FOMC) reiterated that low rates of capacity utilisation, subdued inflation trends and stable inflation expectations were “likely to warrant exceptionally low levels of the federal funds rates for an extended period”.