- by New Deal democrat
You may have noticed, I haven’t posted much in the last couple of weeks. That is partly because real life sometimes intrudes, and when it does this must obviously take a back seat. Partly, however, it is also because for the first time in over a year, I have been seriously rethinking my outlook – but have come to no firm conclusions. So, better not to write anything, rather than write something that is half-baked and foolish.
Still, it is worthwhile to let you know what I am looking at. Consider this post nothing more than “thinking out loud” for your own consideration.
Looking at the economy, here are the good points:
Real retail sales still suggest strong hiring in the months ahead, and most likely decent advances in personal income.
The price of Oil has come down significantly, putting more money in consumers’ pockets to be spent domestically.
Coincident indicators, like payrolls, ISM manufacturing, and auto sales, are all continuing to show decent improvements (although we’d all like them to be stronger).
Bank loans, one of the last lagging indicators that was still declining, have turned up strongly in the last month.
Construction spending, also a big laggard, had a nice increase last month.
On the other hand, here are the bad points:
The Euro scare may affect exports substantially, as may any slowdown in growth in China.
Real M2 money supply is negative year-over-year. It has been declining since February, and is one big reason for the waning of the Index of Leading Indicators.
Real M1 money supply is still positive YoY, but it too has been declining on a monthly basis since February. Given Ben Bernanke’s fealty to Milton Friedman’s monetary explanation for the Great Depression, what on earth is Bernanke thinking?!?
The hiring index of the Chicago PMI turned negative for May.
Payments of withholding taxes came to something of a screeching halt in the last two weeks of May (the month just barely eaked out a YoY gain from May 2009, after a strong start).
The long end of the yield curve flattened in response to the Euro crisis.
The stock market has suffered a 10% plus correction (meaning a strong likelihood of the second consecutive monthly decline in the LEI).
One of the main reasons for my quandary is that economic indicators simply behave differently in periods of deflation vs. periods of inflation. The shape of the yield curve is an excellent prognostication device during inflation, but fails during deflation (except that an inverted yield curve in times of deflation is really, really, really bad). Similary, monetary indices are leading indicators during inflation, but seem to be coincident indicators during deflation (I did a detailed report on this about 18 months ago, looking at Economic Indicators during the Roaring Twenties and Great Depression).
Housing seems to operate similarly during both inflation and deflation, but we have only annual data until after World War 2.
Other leading indicators similarly weren’t published in the pre-World War 2 deflationary era.
And we are almost certainly going to have a brief bout of deflation, due mainly to oil prices. The $10+ decline in May is probably going to lead to a CPI of something like -0.5% for the month. April already showed a -0.1% decline. The best comparison periods are during the last decade (especially late 2006) and the Roaring Twenties, which similarly had a number of deflationary recessions.
Professor Hamilton’s studies on the effects of Oil prices suggest that the sharp percentage and $ per barrel increases in the price of Oil are probably having the maximum impact right about now, if I read them correctly.
One take on this data is that we are just beginning to enter a period of weakness which will intensify in the coming months. But another take is that to the extent there is weakness, it is happening more or less now and for the next couple of months, after which if Bernanke decides to reinflate, and the price of Oil cooperates, we will see renewed or expanded growth.
As you can see from the above, a fair amount of the answer to this question seems to depend on political rather than strictly economic decisions, coming out of Europe, the Congress (think: aid to the States, continued extended unemployment benefits), and the central banks.
Hence my quandary. In general, I am leaning towards the second scenario, where the relative weakness is happening right now. For example, the "shock" of $80 vs. $40 Oil from last year may be reflected in the plateauing - but not declining - auto sales now. If Europe stabilizes, the possible pause in hiring in late May might resume just as strongly as in March and April. As my thinking becomes clearer, I will post more.