Wednesday, May 6, 2009

Bernanke's Happy Talk

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Ben was on the hill yesterday. He gave a generally happy talk. Personally, I think he's lying through his teeth. Here's why:

However, the recent data also suggest that the pace of contraction may be slowing, and they include some tentative signs that final demand, especially demand by households, may be stabilizing. Consumer spending, which dropped sharply in the second half of last year, grew in the first quarter. In coming months, households' spending power will be boosted by the fiscal stimulus program, and we have seen some improvement in consumer sentiment. Nonetheless, a number of factors are likely to continue to weigh on consumer spending, among them the weak labor market and the declines in equity and housing wealth that households have experienced over the past two years. In addition, credit conditions for consumers remain tight.

Yes, consumer spending increased 2.1% in the first quarter. But looking a bit deeper into the data we don't see a lot of strength. As I pointed out in this post the main reason for the first quarter increase was a jump in durable goods purchases in January. This total has decreased the last two months and is still far below the September/October levels of last year. In addition, wages are decreasing in a big way. In fact, disposable income increased only because of transfer payments and tax reductions. And consider this chart of total household debt as a percentage of GDP:

And combine that information with this chart of the savings rate:

So -- wages dropping, households area losing wealth, the job market is terrible, households are heavily in debt and are increasing their savings rate. There are the reasons I'm bearish about consumer spending.

Bernanke continued:

The housing market, which has been in decline for three years, has also shown some signs of bottoming. Sales of existing homes have been fairly stable since late last year, and sales of new homes have firmed a bit recently, though both remain at depressed levels. Although some of the boost to sales in the market for existing homes is likely coming from foreclosure-related transactions, the increased affordability of homes appears to be contributing more broadly to the steadying in the demand for housing. In particular, the average interest rate on conforming 30-year fixed-rate mortgages has dropped almost 1-3/4 percentage points since August, to about 4.8 percent. With sales of new homes up a bit and starts of single-family homes little changed from January through March, builders are seeing the backlog of unsold new homes decline--a precondition for any recovery in homebuilding.

Here is a chart from Martin Capital of new and existing home sales:

I dealt with the new home sales market in this post yesterday. Bottom line -- sales may be bottoming. But we only have two months of data to back that up making a prediction of a bottom seem premature.

As for the existing home sales market, he is correct that sales may have bottomed. Of course they may have bottomed last year as well. And again, remember the household debt chart from above? Who is going to buy these homes?

And all of that is before we get to the massive drop in home prices from the Case Shiller price index:

Ben goes on about business investment:

In contrast to the somewhat better news in the household sector, the available indicators of business investment remain extremely weak. Spending for equipment and software fell at an annual rate of about 30 percent in both the fourth and first quarters, and the level of new orders remains below the level of shipments, suggesting further near-term softness in business equipment spending. Recent business surveys have been a bit more positive, but surveyed firms are still reporting net declines in new orders and restrained capital spending plans. Our recent survey of bank loan officers reported further weakening of demand for commercial and industrial loans.1 The survey also showed that the net fraction of banks that tightened their business lending policies stayed elevated, although it has come down in the past two surveys.

Here is a chart of the percentage change in gross investment from the preceding quarter:

Investment has been weak for some time and was terrible last quarter.

I barely see the possibility of a recovery at this point. And I don't see a robust recovery in any way. On that Ben and I agree:

Even after a recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further. We expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.