Thursday, August 26, 2010

An updated look at the Stressors on the Recovery

- by New Deal democrat

In the last couple of weeks, I have updated my "Big Picture" look at the economy. In the long term, the Slow Motion Bust is continuing, and will continue until the huge excesses of debt are wrung out of the system and prices (of housing) are reset to levels that ordinary people can afford. In the short term, the KISS method of relying on the LEI shows an economy converging on zero -- GDP is likely to be somewhere near zero this quarter and next.

In this post I want to take a look at the current status of the reasons why the economy is "converging on zero." I have listed them before, they aren't a surprise. Some, most notably the BP oil catastrophe, have already worked themselves out (although their afteraffects will certainly linger). Several important others are due to the expiration of government assistance, in one leading sector of the economy (housing), and one lagging sector (government employment). The price of Oil is also important. Let's take a look at them:

1. The Euro Crisis

The Eurozone crisis was the trigger that provoked the current downturn. Measures of fear in the markets shot up from March through May as the crisis intensified (although, it is important to note, never anywhere near 2008 levels). This fear was measured through LIBOR rates. Here is a current look at the 3 month LIBOR:

It has returned by more than 75% to its pre-crisis levels. This doesn't mean that there can't be a new crisis (is Greece solvent?), but for now, that stressor has generally dissipated.

2. The Price of Oil

In April with the price of Oil briefly topping $90 on an intraday basis, both Bonddad and I noted that high-priced Oil would be one certain way to derail the recovery in a hurry. Prof. James Hamilton, who is an expert in the area, noted that Oil briefly approached (or touched) the 4% of GDP (or 6% of discretionary income) that in the past had triggered recessions. Since that time, Oil has retreated, most recently to $70 again, but has been very volatile.

Here is a graph that looks at the monthly price of Oil measured as a divergeance from $90/barrel over the last 5 years, and compares it with quarterly GDP. As you can see, the price of Oil so measured has an excellent track record for predicting GDP in the immediate future.

The graph isn't perfect, because I should measure the "real" inflation adjusted price of Oil, which would make the inflection point closer to $85 five years ago. Also, as Prof. Hamilton points out, the velocity of the price change is also important. The economy might be able to handle a smaller change of e.g., $5/barrel per quarter, but it takes longer to "digest" larger changes, both up and down.

Nevertheless, just as we and others have said, the price of Oil is indeed having an impact on the economy, and all things being equal, predicts zero GDP -- a complete stall, but not a significant downturn -- in the next quarter or two, after which there may be a mild rebound.

3. The expiration of the $8000 housing creditt

As I pointed out yesterday, the post-expiration collapse has taken place. I do not expect further significant deterioration. Here are housing permits and starts going back 5 years to the top of the bubble:

And here are new home sales updated through yesterday:

We may bounce along the bottom for awhile, but this is a case where reporting percentage declines (35% lower than last year!!!) masks that the absolute decline is much, much smaller than it was earlier in the housing bust. Housing leads the economy, and this will have a negative effect that will feed through for some months to come -- but it is going to be a much smaller negative effect than in the 2006-2008 period.

4. Census, state and local layoffs

Through the week ending August 14, about 500,000 census workers have been laid off. Only 80,000 remain. Depending on their local state laws, some unknown amount of them will be eligible for unemployment benefits. Due to the insane Congressional inaction/ lame action on renewing stimulus to the states (some of which has reportedly been hoarded for next year rather than being used for its intended purpose), it is quite likely that there are thousands of government employees, most notably teachers, who have been laid off this month.

While those layoffs suggest a headlong rush back into deep recession, they are totally contradicted by what is happening in the private sector. Here is a graph of the American Staffing Association's temporary help index, which has continued to rise through last week, to a level equal to August 2008:

Now here is a graph comparing government employment (blue) with private employment (red):

As you can see, private employment has continued to rise all through this year. It is government employment (not just census, but also state and local governments) which have given us our dismal job reports in the last couple of months.

In summary, Oil supports the notion of a stall in the recovery, exacerbated by layoffs sparked by the decline of 100,000 houses a year not being built, and further exacerbated by state and local government layoffs sparked by the loss or hoarding of federal aid. Essentially, both of these sectors have been "reset" to one year ago by the loss of stimulus. I fully expect the state and local losses to abate once current budgets are in place, while the construction losses, while small, as a leading sector will echo through the economy for some months to come.

Additionally, while the slow motion bust will continue, and while the renewed slowdown will mean more pain, I see nothing in the data causing me to change my opinion that the "Great Recession" bottomed out in the summer of 2009.