Has America become an “extractive economy”? The ‘tell’ of interest rates and inflation

 

 - by New Deal democrat

There is a quote, allegedly from Alexander Frazer Tytler over 200 years ago, but apparently actually originating in 1951 from a conservative columnist in Oklahoma, that “A democracy … can only exist until the majority discovers it can vote itself largess out of the public treasury.” But what if instead it is the wealthy who, by backing pliant politicians, are the ones who vote themselves money out of the treasury? 

That seems to sum up the fiscal state of the US in the 21st century, because three times in the past 25 years - in 2001, 2018, and last year - when the GOP has had complete control of government, there have been increasingly massive tax cuts favoring the wealthy.

Add in the incompetence and corruption of the current Administration, and the US appears to have begun a vicious cycle of inflation and interest rate increases.

 Let me begin with the fiscal situation. Below is a graph of of the annual gross federal deficit (blue, right scale), and the deficit as a percentage of GDP (red, left scale) since the turn of the Millennium:

The two emergency stimulus programs during the Great Recession and COVID stand out, as do the Bush tax cuts, and to a lesser extent the Trump 1.0 fiscal policies. Note that the graph ends in 2025, so the effect of last year’s tax bill do not appear yet.

Let’s compare this with the post-WW2 record until the turn of the Millennium:

Note that deficits were quite small until the late 1970s, typically no more than 2%, and then exploded during Reagan and George HW Bush’s terms to over 20%, until Clinton brought the situation (very briefly) back into surplus. But since W’s tax cuts in 2001, only in a few years have deficits been less than 2.5% of GDP, and they have worsened over time to about 6%, even during the post-pandemic Boom.

Decomposing the deficit situation shows that it is both an increase in outlays and a decrease in taxes collected:

As of last year - even before the Billionaire Bust-out Bill - only $3 were being taken in for every $4 being spent. And as the below graph of the 365 day moving average of the YoY% change in tax withholding payments shows, there has been a marked deceleration in tax payments that began last December and has continued this year:

Almost certainly, the fiscal situation will once again have been ratched further into negative territory.

The Bond Market has noticed, and it has not been amused. The trend in both the 10 year (red) and 30 year (blue) Treasury bonds has been higher ever since the pandemic:

With the exception of late 2023, the yields on both of these Treasuries is at levels not seen since before the Great Recession.

And there is every reason to suspect that this situation is going to worsen. First, here’s the diffusion index for prices paid from the most recent ISM manufacturing and services reports:

These are both near their worst post-pandemic inflationary levels.

And here are the averages of the prices paid (blue) and prices received (red) diffusion indexes from the NY and Philadelphia regional Fed reports:

With the exception of the post-pandemic surge, both of these are also near their highs since the turn of the Millennium.

Much of this has gone to the spending spree by the upper tiers of income, as indicated by the weekly Redbook reports:

And let’s not forget that the Iran situation shows no signs of ending, with gas prices on their way back up:

Let’s put this together. We have a widening deficit, and increasing interest rates, meaning that an increasing share of GDP is going to have to go to interest payments on deficit financing. And we have a corrupt Administration that has raided the treasury for the benefit of wealthy cronies. The Administration is also so incompetent that it has caused inflationary increases in consumer prices both from tariffs and from the results of its Iran fiasco. 

And there is no sign of this ending anytime soon. 

To return to the beginning theme of this post, about a decade ago economists Daron Acemoglu and James A. Robinson wrote “Why Nations Fail,” positing that countries with a strong rule of law and a widespread distribution of benefits, succeeded, while “extractive economies” typified by a ruler at the top who is above the law who along with his cronies siphons off as much created wealth as possible, fail. This is because in the former case innovation is incentivized, while in the latter case there is no point in being innovative since the ruler and his cronies will simply appropriate the wealth for themselves.

The US may well have passed the transition point into an extractive society, and the trends in interest rates and inflation are the first noticeable symptoms.

Is the disinflation in repeat home sales prices ending?

 

 - by New Deal democrat

There may be a new, slightly accelerating, trend developing in house prices — or it may just be noise. The former, of course, would not be good news for inflation. In any event, let’s take a look.

As per my usual preliminary comment, while existing home sales are about 90% of the market, new home construction is much more important for the economy. While the current cycle may have dispelled the notion that “housing *is* the economic cycle,” it is nevertheless an important component of the long leading indicators. But existing home sales are an important determinant of pricing equilibrium in housing, and the repeat home sales indexes, by S&P Case Shiller and the FHFA, are the best indicator of same.

The seasonally adjusted Case-Shiller National index (blue in the graphs below) declined once again, this month by less than -0.1% for the three month period ending in May, while the FHFA index (red) rose 0.3% [Note: FRED has not yet updated the Case Shiller data]:

Last month I noted that “there is something of a divergence showing in the YoY comparisons of the two national indexes,” as the Case Shiller national index had increased less than 1% YoY, while the (often slightly more leading) FHFA Index had accelerated to a 2.0% increase. This year the Case Shiller YoY comparison increased to 1.1%, and the FHFA increased to 2.2%:

As you can see, the red line has stopped declining and in the last few months has increased slightly. The blue line also appears to be ending its decline. As noted at the beginning of this post, this could be the sign of an incipient reversal of trend, but as of yet it could just be noise. 

Nevertheless, as shown in the graph below, by historical standards these are quite low increases. Additionally, while I haven’t shown it in the graph, last week existing home sales showed an increase of 1.8%. Given the lead time between house prices and the official CPI shelter component of owners’ equivalent rent (gold), here is an update of that historical comparison [Note: CPI*2.5 for scale]:

Keep in mind that the oficial CPI metric for shelter has been complicated by the “shelter kludge” that the Census Bureau performed last November as a result of the extended government shutdown. I concluded last month that  “I continue to believe that the repeat sales indexes point to continued slow deceleration in the shelter inflation in the CPI.” The increasing trend in YoY comparisons in the repeat sales indexes, if it is signal and not noise, calls that into question.

Finally, let’s take a look at how new and existing home prices as measured by repeat sales compare with households’ buying power (blue in the graph below), by adjusting for average hourly nonsupervisory earnings in the graphs below (median household income would be better, but is updated only once a year, and average wages are reasonably close for these purposes). I’ve also included the same metric for median new home prices, both monthly (thin, red) and quarterly (thick) to cut down on noise. Since the FHFA is reported as an index, I’ve used the most recent median price for existing homes as a substitute:

The bad news continues to be that existing houses remain more unaffordable than at any time before the pandemic, although they’ve backed off slightly from their highs; and indeed the median existing home is now more expensive than the median new home. Contrast that with new home prices, where builders have taken steps to meet the market. Until a lot more existing homes go on the market, this discrepancy is not going to be resolved.

Two cheers for increasing manufacturers’ new orders

 

 - by New Deal democrat

This is another one of those weeks when most of the important new data is crammed into one day, in this case Q2 GDP, personal income and spending, and jobless claims all will be released on Thursday.

Today we did get some further information on manufacturing, and the positive news in that sector continued, as new orders for durable goods (blue) increased 0.3% in June, and core capital goods orders (red) increased 0.9%. Since these are “official” (short) leading indicators, it is worth paying attention to them:

The former series in particular is noisy; hence the increased emphasis on the core. But it’s easy to see that both have been in an increasingly sharp positive trend since late 2024, interrupted somewhat in the months surrounding the T—-p Administration’s first imposition of widespread tariffs in April of last year.

This is in accord with what we have been seeing in the new orders components of the regional Fed manufacturing indexes. The average of the NY and Philadelphia indexes (gold, right scale) are shown below for comparison:

With the exception of early 2022, the regional Fed indexes have maintained a trend similar to the monthly durable goods orders reports.

The picture becomes more complicated, however, when we compare the durable and core capital goods orders metrics with the industrial (gray) and manufacturing (gold) production data (right scale):

Durable and core capital goods orders have risen over 35% since just before the pandemic, while production is up less than 1%, and manufacturing production slightly *below* their pre-pandemic level.

This brings up something that is important in the current environment, which is that the durable and capital goods orders metric are reported in nominal $ terms. Which means that, adjusted for inflation, the situation might be quite different. Below I show what both new orders metrics look like deflated by the PPI for finished goods, in comparison with manufacturing production:

Now the series look very similar, not only in terms of the trend, but also in their absolute values compared with just before the pandemic. Let me state right up front that there may be a better deflator or combination of deflators that may be better than the one I have used above, but it demonstrates that inflation has been distorting to the upside the positive trend in new orders. 

In other words, postive, but not so much. 

The NY Times finally tells its readers what I’ve been telling you for the last 6 months: wealth effect edition

 

 - by New Deal democrat

Via Ben Casselman, who authored the piece, here is the headline for a NYTimes article from last Wednesday:

As he summarizes it:

In other words, the Times finally got around to telling its readers what I’ve been telling you for about the last six months.

—-

And while I am at it, here is a link to the blog post I had to upload as an addition to the “Weekly Indicators” link one week ago, on the day when Blogger for some reason said I was unable to add a new post; on the pitfalls of mistaking the aggregate economy (and especially the stock market) as a proxy for the condition of average American working or middle class households:

 In which I defend the criticism of ‘bloodless quants’

Weekly Indicators for July 20 - 24 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

With the renewed warmaking in the Middle East, the price of oil and gas shot up, and interest rates across the board as well. It looks increasingly likely that the Fed will have to hike rates to fight inflation soon, maybe as early as next month.

As usual, clikcing over and reading will bring you up to the virtual moment as to all of the data on the economy, and reward me with a penny or two for collecting and organizing it for you.