Consumers Are Beginning to Spend, But Where Is the Money Coming From?

Retail sales were up 1.6% in March and 10% year-over-year. These are not new highs but, the short-term trend offers some hope at least. However, faced with many and much talked about headwinds, the question really is: Where is the money coming from and is it sustainable?

This is very difficult to answer, on a fundamental basis, because the government is so involved in the economy that it’s hard to tell what is real and what is stimulus. None the less, following are the current positions of the three major branches of economic thought.

Keynesians (Demand-Side Economists)

Consumers are spending, and are being helped by government stimulus programs (the $800 billion dollar stimulus program plus cash for clunkers, mortgage modification, home purchase incentives, extended unemployment benefits, etc.) However, consumers are not spending enough and credit is too restricted for the economy to grow again without government help. The problem now is that stimulus money peaks in June 2010 and then trails off. Therefore, we need to keep interest rates low and we need additional stimulus spending to keep consumers and the economy “growing.”

Here is quote from the Cleveland Federal Reserve that I think sums up the Fed’s position,

“What does all of this bode for a recovery of consumption, the primary driver of the U.S. economy? The data shown here point to a long road ahead for a sustainable recovery. Consumers are paying down loans or defaulting, and those looking for new consumer loans are likely to find that banks are still pulling back on lending, though individuals who can secure a loan face historically low interest rates. Given the hangover of outstanding debt and recent memories of shrinking asset values, consumers may not be motivated to ramp up their expenditures. Rather, consumption will likely recover slowly as households save more and await the return of an improved labor market and the sustainable source of funding—disposable income—that it typically provides for consumption.”

Keynesian Light (Supply-Side Economists)

Consumers are spending more and that spending is becoming broad based. According to Brian Wesbury, Chief Economist at First Trust in Chicago,

“Economic data clearly traces out a V shaped recovery.”

He acknowledges that many headwinds do exist, but not right now --not until some time in the future. His reasons for increased consumer spending include: 1, the pace of debt reduction is slowing (if you pay off less, you have more of your income to spend) and 2, incomes are growing and recovering (a three month trend of incomes show a slight increase.) This is a very short-term view, but Keynesians are focused on the short-term.

Capitalists/Austrian Economists

Capitalists agree that on a short-term basis, consumer spending is increasing, at the margins, but for mostly the wrong reasons. Capitalists look at consumer spending differently. First, the short-term, aggregated numbers do not tell the real story. For example, gasoline prices have gone up about $1.00 over the past year increasing spending in this category. That will/could amount to a lot of consumers spending; but it certainly hasn’t helped the consumer or the economy.

Capitalists contend that it’s not government or consumer spending that is the problem, it’s the lack of investments. Investments and productivity are what generate job creation. That should be our concerned. Savings (ours or foreigners) are needed in order to have investment. Also, the consumer is still deeply in debt and needs time to reduce debt levels (and hopefully save) before meaningful spending can be sustained.

But, where are consumers getting the money?

Here are some other ideas:

1.One source is “strategic defaults.” These are people who are underwater on the value of their homes and can afford to pay their mortgages, but are chose to let their homes go into default and eventually foreclosure. There are currently about 6 million people in the process of foreclosure. These strategic defaults may be adding about $200 billion to annual household cash flows. (Per economist David Rosenberg.) Some of these people have not even been contacted by the bank in over a year.

2.Tax refunds which might be lower than previous years but do fuel consumer spending.

3.Savings rate has dropped from a recent high of 4.6% to 3.1%. That alone would explain a lot of spending.

4.Additional stimulus programs to come.

Short-term, it appears that consumers are spending more and adding to GDP (which certainly looks good ;) but long-term, we need to solve the problems that caused this recession in the first place and that will take time not money.

Comments always appreciated.

What is going on with the market?

As you know, I understand that stimulus money drives up the GDP numbers making it look like the economy is getting better, but I have been very concerned about 2010 because of many impending headwinds:

1. Mortgage delinquencies about to rise significantly. Note, we are now entering the 2005-07 period when the option-ARM’s made up the majority of mortgages (pay what you want to per month and we will add the unpaid balance of principal and interest due to your mortgage)
2. Banks will have to report, for the first time, off balance sheet assets in their first quarter reports,
3. Unemployment is high and probably getting worse (except for government census workers),
4. Mortgage resets have started to rise and with about 25% of homes underwater, there may be no way for most people to refinance,
5. Home inventories are high (over nine months supply at the current sales pace) plus significant shadow inventory (from banks and home owners) is waiting to come on the market when times improve,
6. Current taxes and fees are poised to increase significantly and new forms of taxes (like a national sales tax) may be required to fund our unsustainable spending,
7. State (and local) budgets are in trouble (estimates are from a $200 to $300 billion deficit) and Governors are asking for more help from the Federal Government (who has no money), and
8. Consumers still very over-leveraged.

That’s enough. I am not trying to get you depressed; I just wanted to make a point.

I am trying to understand why the market continues to rise and why traders are apparently throwing risk out the window again. Bears are down to a low 21%. Then I learned about Richard Russell’s latest newsletter. He publishes the DOW Theory Newsletter and is one of the most respected market analysts anywhere. Plus, almost “everyone” buys his newsletter including Goldman, hedge funds, the Bank of China, etc. In his latest newsletter, he explains that he expected the market to close below a critical number (10,750) last Friday which would have turned the market negative. However, during the final six minutes of trading, volume suddenly surged and lifted the DOW above the critical level of 10,750. This was very unusual and caused him to ask:

“Where did that very late buying come from? I have to think this was one of the most flagrant cases of manipulation that I have every seen. Was it the Fed; was it Goldman or Morgan Stanley buying futures on orders from the Fed?”

Note: he is not enamored with the Fed to begin with. But, it got me thinking.

Fiscal and monetary policy is being run by Keynesians (and has been since FDR.) Keynesians believe that in a crisis, you quickly lower rates, print money and then stimulate the economy to fill the drop or gap in spending. If you stimulate enough, the economy (GDP) will “climb” and soon consumers will believe the economy is coming back and will start growing again. The return of the consumer completes the circle and allows the government to hand off the economy, once again, to the private sector.

Now to complete this conspiracy theory, imagine the Fed and the Treasury sitting around wondering how they are going to get the economy going again when “the demand-side” or consumer is over leveraged and can’t buy or borrow money and the banks can’t lend because of impending asset losses and the capital asset requirements needed to remain solvent.

I am not a conspiracy theorist by nature, but I am having a difficult time understanding this market and continue to search for answers.

Are Our Economic Woes Behind Us Or Ahead Of Us?

The way the market has been performing (Dow hitting a high of 10,750 in September and now six months later, with volatility, it is almost flat at 10,550.) Does that mean our woes are behind us or still in front of us? Following are a Macro and Micro view of what is occurring and what might occur.

The Aggregated or Macro View of the Economy

There seems to be two overriding views of the economy. The first is that both demand-side and Supply-side economists (Keynesians) see the economy through the lens of an aggregated economic model or the GDP. When you look at the economy this way, you see the “big picture;” but you don’t see the depth or interrelationships among elements within the economy.

For example, you see the economy growing at 5.9% in the fourth quarter---exactly what, you as a Keynesian, expect. This gives you confidence that the government is doing the right things to fix the economy. First, monetary policy: lowering interest rates and expanding the money supply and than fiscal policy: providing stimulus to get the economy back to normal and subsequently growing.

Now, with the economy focused in Washington (where the money is) and the math looking better: 5.9% growth; you could see our woes as being behind us. Even though Q4 inventory adjustments contributed 3.4% of the 5.9% GDP growth and inventories actually fell $39 billion. That’s the way the GDP model works and you could say that since it fell at a slower pace, things are getting better.

I think the macro conclusion is that things are turning around and with some additional stimulus; the government can keep this economy growing.

The Capitalist or Micro View Of the Economy

The other view, the capitalist view, sees the economy as interactions between individuals (micro view) rather than as an aggregated model (macro view.) Therefore, they look at how the pieces of the economy work on a supply-demand basis with constantly adjusting prices to achieve equilibrium.

This view sees the 5.9% GDP growth but looks at the longer-term implications. For example, in 2010 we are going to get another peak in mortgage resets (July) at a very high level of about $97 billion and remain high through September of 2011. Once this second wave of resets begins (which was in November of 2009) it takes about three months to get delinquencies reported and another three months before we get foreclosure notices. How many mortgages actually go into foreclosure we can only guess? But it will be in the millions.

The government could forestall some of these foreclosures through various programs (loan modification, not letting homes go into foreclosure until they have been rejected by a loan modification program, continuing to allow buyers to make 4% down payments and subsidizing them with $8,000 cash, etc.)

Also, bank credit remains very tight. Banks are not only restricting loans, the Federal Reserve is telling them not to increase dividends or buy back stock so they can continue to build up reserves. If this doesn’t make it difficult to get loans, the a new accounting rule that goes into effect in the first quarter of 2010 which requires banks to disclose their off balance sheet investment vehicles, will make it even more difficult. The only company we’ve heard from so far is Freddie Mac and they said they may be considered insolvent when they report. They are however; going to continue buying mortgage backed securities that are at least four months delinquent (no worry, they are tax payer owned.)

Are our woes behind us or ahead of us?
We don’t know. If the government continues to kick the can down the road on mortgages and allows the banks to continue to increase assets, it could keep the economy going in the short term. But if mortgage foreclosures become a major problem (number of, no credit, continued unemployment, etc.) we could get another step down. Watch the GDP numbers, watch the delinquency filings, and watch the first-quarter bank results.

Do We Need Another Jobs Bill?

Most everyone agrees that the unemployment problem is bad (unemployment at 17%, black men at 25% and youth at 30%.) The problem is affordability. There is plenty of work to do; it is just too expensive to pay for the work to be done.

However, since the $800 billion stimulus package was passed, employment has deteriorated. Now, the President wants a new “Jobs Bill” using temporary tax credits of $13 billion to create jobs. The president wants this bill passed immediately, so I thought its time to take a look at the bill from all three points of view.

From the Keynesian (more government) point of view, they say the original stimulus bill was aimed at increasing GDP and from that growth, creating jobs. The problem was that the stimulus package was not big enough to fill drop off in consumer spending. Therefore, we need an even bigger stimulus bill this time. Unfortunately, that would be difficult to get through Congress at this time.

Paul Krugman, in an article in the NY Times, argues that government must help. It can’t just do nothing. He suggest that for a few hundred billion dollars, we could get things going by:

1. Transferring monies to state governments so they can continue to maintain and/or create new jobs,
2. Hiring people to work for the government directly like they did in the 1930’s with programs like the Workers Progress Administration (WPA),
3. Giving companies temporary tax credits (for example, pay employers share of payroll taxes up to $5,000 for each new hire.)

The Supply-Side (less government) economists have a different point of view. Brian Wesbury, Chief Economist at First Trust in Chicago, argues that the labor market is improving and will continue to improve in the year ahead. That unemployment is simply a lagging indicator. His argument is based on the following reasons:

1. Civilian employment, based on the household survey, shows that 785,000 jobs were created in December (second month of job creation.)
2. Hours worked increased over the past three months and increased hours are an early indicator of future employment.
3. Unemployment has fallen from a peak of 10.1% to 9.7%, and
4. Employment has expanded into more industries recently.

Therefore, I conclude from his argument that permanent tax reductions would help make companies more globally competitive, but more stimulus money at this time would only fuel inflation.


The third point of view, the Capitalist view, sees the unemployment problem differently, according to Henry Hazlitt, Austrian economist:

1. The goal should be maximizing production, not employment. With full production comes full employment. By separating production and employment, you make employment the goal. That’s what they did in the 1930’s with the WPA. Projects were selected by how unproductive they were or how much labor they required.
2. We need to help the unemployed get into other growing industries,
3. We need to eliminate as many barriers to employment as possible. Here are a few of Liewellyn Rockwell’s suggestions:
A. Get rid of the minimum wage,
B. Payroll taxes rob employers of resources,
C. Laws that threaten firms if they fire an employee,
D. Unemployment subsidies that pay people not to work.

Over the next few weeks as the debate begins in the House and Senate over the type of jobs bill we need and the amount of money (we need to borrow) to pay of the jobs bill, you may need to adjust your plans accordingly.

Some ideas to think about as we head into 2010

We all have ideas about what 2010 will bring. I have made a list of some ideas, some thoughts, and some possibilities that I think might happen in 2010. But rather than guess at where the S&P 500 will end up or how much analysts will trim their earnings estimates; I thought I would come up wit a list of things that could make 2010 better or worse than I envision now. But I also wanted possibilities that would make people think about key elements of the economy as we move through the year. Here is the list.

1.Unemployment will not get much better and could get worse in 2010 because consumers are now into saving and debt reduction rather than spending; and companies key their inventories and expansion off consumer demand.

2.Dollar could increase in value early in the year due to global uncertainties (risks) and what looks like an improving U.S. economy and then fade later in the year.

3.The number of “Tea Party” people will continue to grow and will shape the look of the Republican candidates in the 2010 primaries.

4.More burdensome and anti-competitive regulations will come out of Congress that will prove to be roadblocks to recovery.

5.Concerns about when the Fed and Bernanke will raise interest rates will become mute because the market will raise rates months before the Fed and Bernanke decide it is time to raise rates.

6.The central Bank will hold interest rates low and continue to print money causing the next bubble because of malinvestments.

7.Residential housing will get worse in 2010 due to millions more foreclosures and more “toxic assets” put on bank balance sheets. Commercial real estate will continue to decline into 2011 because of the need to refinance “underwater” properties. However, new investors with assets will begin to buy up these cheap properties.

8.Banks will have to build assets to cover the toxic assets they currently have on the books and to cover the new toxic assets to come in 2010 and 2011. Therefore, bank lending will remain tight (and credit worthy borrowers scarce.)

9.Corporate winners and losers (consumers and tax payers have already lost) in the health “care” legislation will begin to become apparent in 2010 and the health care CEO’s and Unions who made deals with the administration will be surprised when they find that their negotiated “deals” will not be honored by the government.

10.Congress will pass another stimulus package to again help create jobs. It will be large, but it will be passed in smaller packages so they can get the spending bills passed without attracting too much attention or outrage.

11.Climate change hysteria will begin to abate during 2010 and Congress will begin to work on a realistic energy plan that we have been waiting and paying for since 1975.

12.Corporate revenues will continue to be elusive so companies that can raise money (with low interest bonds) will buy revenues and earnings with more mergers and acquisitions.

13.Government debt levels, already very high, will get much higher and the Federal Reserve is funding this debt with short-term bonds. Therefore, the Fed will be reluctant to raise interest rates. Imagine a 50% increase in rates (or from just 0.25% to 0.5%) would due to your “costs” when you are already paying hundreds of billions of dollars in interest.

14.This is certainly a minority opinion, but corporate earnings for 2010 are too optimistic and will be revised downward beginning with the second quarter numbers.

15.New investment areas will emerge because where you have buyers you have sellers and vice versa.

Is that enough or have I missed some important ones. If you have some others that should be added, please e-mail me your idea.

If we could just spend more on interest, we could really stimulate GDP growth

This may not sound right, but give me a second and I’ll show you that this statement is true.

The economy, as defined by most politicians and economists, is a mathematical model called Gross Domestic Product or GDP. This model is based on consumption (spending by consumers, businesses and the government.) rather than wealth building or production. So every dollar spent is a dollar of GDP and every new dollar spent is GDP growth.

Now, if you are in Congress or the President, you could catch on to this real fast. The more you spend, the more GDP goes up and the better your chances for reelection. But it gets even better.

But, we have one speed bump to get over first. To spend a dollar you have to produce a dollar. But the government doesn’t produce anything so it has no money to spend. No problem, it just has to get its dollars from somewhere else.

The government has to take a dollar from producers in order to spend a dollar; or it has to borrow the money with interest from someone else. It doesn’t matter where the dollar came from in the GDP model because every additional dollar the government spends is counted as an increase in economic growth (GDP.)

Now, if the government takes a dollar in taxes from a producer to spend. You could argue that the net is the same; you subtract a dollar from the economy in taxes and then spend that dollar. This could hurt down the road when you have to increase taxes to pay for the dollars you are spending now; but who cares. Many think they will be out of office by then.

You would think tax payers would catch on to this, but remember you elected them because they were clever and great communicators. So they just change the meaning of the word spending to investment and everyone is happy. Long-term you try to convince tax payers that you are only doing this because the government can spend dollars more wisely than the producer or because the government can buy something the producer cannot.

Wait. I’m not done. Here is the BINGO. You borrow lots of the money because if you pay-as-you-go, tax payers could catch on. And you get to pay huge interest payments on the borrowed money—you got it. Every new dollar paid is an increase in GDP.

Now, think of the GDP growth we are going to get when our deficits go up by 10 trillion or more over the next few years. PLUS, if interest rates rise significantly because of all the debt, BINGO –even more GDP growth.

If you think this is a sane approach to our economy, do nothing. If not, support politicians who are sane.

Opinion: Why health care costs will be significantly higher than congress is projecting

The current House version of the “Healthcare Reform Bill” (H.R. 3962) is projected to cost about $900 billion which is the spending limit President Obama said he would place on the bill. President Obama also said the bill would have to be “revenue neutral” which translated means you can spend up to $900 billion but you cannot (directly) add to the deficit.

The house bill claims to meet these two requirements. It spends $900 billion (or more) and it is revenue neutral if you believe in fairy tales. Following are some reasons why:

1. Taxes paid in advance will be put into the same “lock box” used for Social Security

To get to revenue neutral, the bill provides for taxes to be collected immediately (about $600 billion over 10 years) but doesn’t start healthcare services until 2013. That’s one way to get the costs down to $900 billion: charge for the service for years in advance so you get 10 years of taxes but only have to deliver six or seven years of service.

But we’ve had enough experience with Congress to know that they will simply spend all the money they collect and then in 2013 make payments out of the general fund --.just like they did with Social Security.

2. The $400 billion dollar cuts to Medicare and Medicaid are vary unlikely to happen

They have not been able to cut 10 cents out of these entitlement programs since they were enacted in 1964. Now they are suddenly going to throw seniors under the bus. I don’t think so. Here are a couple of examples why:

Social Security recipients are not going to get an increase in their social security payments in 2010 because there is no inflation. And they are scheduled to get an increase of about $8 in their Medicare insurance payment. Unable to withstand the pressure for even an $8 cut in benefits, Congress is looking at a new program to pay each recipient $250 as part of a “stimulus” package.

Or, how about the $250 billion reduction in payments to doctors (part of the $400 billion overall Medicare reduction) to help pay for the health care program (and keep the total costs under $1 trillion.) But, they then introduced a separate bill to pay doctors $250 billion to replace the $250 billion they would lose in the Healthcare bill. Since this bill is not part of the healthcare bill, the costs don’t count. The bill was voted down but you know what their intent is and they will find a way to pass it or disguise it sooner or later.

3. Waste, fraud and abuse will be eliminated or severely reduced

There is no line item in the budget for waste, fraud and abuse. Therefore, politicians on both sides of the isle have been unable to find these unnecessary costs for the past 45 years. Now they expect us to believe they are going to find them next year.

It’s time for us to wake up and realize this is not a health care reform bill. It is a big government, big spending bill. We already have the best health care in the world and yes the most expensive because we like to eat cheeseburgers, get hip and knee replacements to make our lives better, and get the best and latest cancer treatment, etc.

If politicians were serious about reform, they would attack the real reasons healthcare cost are rising so quickly that many people can’t afford health care insurance like the aging population which is about half of the future rise in costs and federal and state government regulations that prevent us from having a consumer driven healthcare system.

If you would like to get more information on fiscal and monetary policy, you can go the non-partisan, web site of the Concord Coalition www.concordcoalition.org