One of the standard family car trip experiences was children asking “How much longer?” Sometimes even before the car had left the driveway! If they waited for more than 30 minutes, it was a real sign they were growing up. Invariably, even a saint’s patience wears thin, and long before the destination was in sight, the question would be asked repeatedly, “How much longer?” A good parent would answer “Not much longer, sweetie”, no matter how many hours remained on the drive. As the trip progressed the question might be rephrased as “Are we there yet?” At least the rephrasing gave an indication that a significant part of the trip had probably passed.
Three Years Since Lehman
It’s been three years since Lehman Brothers failed, and to say the recovery has been a disappointment would be generous. The rebound since the recession that was officially proclaimed over in June 2009 has been weak, with a number of statistics suggesting the recession never truly ended. It’s been a difficult three years for the majority of Americans and most want one question answered, “How much longer?” Unfortunately, it is all too obvious that it is not yet time to start “Are we there yet?”
The Political Response
Most politicians (especially if they fear their own job is at risk) would look into the camera and say “Not much longer.” Those politicians seeking office, would boldly proclaim, “Not much longer, if I am elected!” Unfortunately for the current crop of politicians, their message is not being delivered to kids in the car’s backseat, but into family rooms throughout our country to millions of adults, who are simply disgusted with the leadership vacuum that promises more tough times. In the latest New York Times/CBS News Poll only 12% of respondents approved the way Congress is handling its job. The remarkable point is not that 88% of registered voters were unhappy with Congress, but that there were still 12% who approved! Only 33% felt their Congressperson deserved to be reelected.
We have stressed since mid 2009 that the myriad of structural imbalances we are facing took decades to build up, and, therefore, would not be unwound quickly. The interconnectedness between all the headwinds holding growth down suggests this trip is going to last years. (A short list includes weak job and income growth, lower home values, soft consumer spending, inadequate tax revenues at all levels of government, underfunded private and public pensions, historically low interest rates which punishes savers and pension actuaries, an aging population bulge, trillions in unfunded liabilities in the Medicare and Social Security programs, unsustainable safety net expenditures that prevented a deeper contraction, and the need to cut government spending in the not too distant future). We probably missed something, but this list is long enough to discourage even the most stalwart optimist.
Employment and Personal Income
Job and income growth are the two most important drivers of the economy, since they fund consumer spending and government spending through personal income taxes and sales taxes. More than 84% of those wanting a full time job have one, but their incomes are not growing. According to the Census Bureau, median household income is 7.1% below its peak in 1999. After falling for three consecutive years, it was $49,445 in 2010, and roughly equal to its 1996 level when adjusted for inflation. Even as middle class Americans have been squeezed for more than a decade by a lack of income growth, they have also been hurt by an imbalance of income disparity that has been gradually worsening since the late 1960s.
The Gini index measures the extent to which the distribution of income among individuals or a household within an economy deviates from a perfectly equal distribution. A Gini index of zero represents perfect equality and 1.00 equals perfect inequality. According to the Census Bureau, the Gini coefficient totaled .468 in 2009, the most recent calculation available. This suggests income disparity has risen by 20% over the last 40 years.
The Gini index measures the fairness of income distribution, and not the absolute income of a country. Despite all our troubles, the average American worker still earns more each year than other workers throughout the world. However, in terms of income distribution, the United States sports a Gini index that is comparable to Mexico and the Philippines.
As we wrote in our July letter,
“In the 1960s, the average CEO was paid 35 times the average workers’ income. Last year, the CEO of a public company was paid 350 times the average worker’s pay. We don’t believe anyone is worth that much money to run a company. But, if the Board of Directors of a public company believes they must pay that much in compensation to attract ‘talent’, and shareholders don’t object, we see nothing wrong with it. At the same time, the gap in wages between the average working stiff and a CEO is just too large to ignore. The income for the top 1% reached 23.5% of total income in 2007, which is just a hair below the level reached in 1928. These income figures include capital gains and income from stock options. Although raising taxes on this elite group won’t raise that much in taxes, it will serve as an appropriate symbol. The austerity that must be imposed on government spending will prove a hardship on almost half of the 300 million citizens in this country. For most of those in the top 1% of income, higher taxes will be more of an inconvenience than an actual hardship.”
No Jobs Created
In August, no jobs were created, and the unemployment rate remained unchanged at 9.1%. Another 8.8 million workers, or 6.7% of the labor force, are working part time, but would prefer a full time job. The number of hours worked fell as did hourly pay. Over the last year, the average worker’s pay increased 1.9%, well below the increase in the cost of living. Six million workers have been unemployed for more than 27 weeks. The US has not experienced anything like this since the 1930s. The longer someone is unemployed, the more their skills erode and they fall further behind the curve.Forty three months after the recession began in January 2008, almost 5% of the labor force remains unemployed. In 7 of the eleven recessions since World War II, all the jobs lost during the recession were filled within 24 months. What’s happening in this “recovery” is simply unprecedented.
Another way of measuring the depth of job losses and the quality of the recovery is to look at a 4 month change in non-farm payroll employment. Since 1960, the only recession that equates to the magnitude of job losses experienced in 2008-2009 occurred in the 1973-74 recession. In the wake of that recession, employment growth virtually exploded with the 4 month change exceeding 2.2%. The deep recession in 1981-81 was also followed by a significant snap back in employment 2.2%. Based on this metric, the rebound in jobs to .5% is less than 25% as strong as the 1975 and 1983 recoveries.
Home Sweet Home Casts a Long Shadow
In the last 40 years, the growth in home construction contributed significantly to the economic rebound that followed each recession. Despite record low mortgage rates and record affordability, housing starts hover at the lowest levels since 1963.
There are a number of reasons why there is no pent up demand as in prior cyclical recoveries. The lack of job growth has certainly played a role. However, the 30% decline in home prices may have improved affordability, but it has eroded current and future demand as never before. More than 25% of homeowners are underwater according to CoreLogic, which precludes them from refinancing and benefiting from the lowest mortgage rates in history. Even if they can afford their current mortgage, few can afford to sell since they would lose all their equity and most don’t have the savings for a new down payment. As long as home prices languish, more than 25% of future demand is gone. Higher lending standards have also shrunk the demand pool by another 5% to 10%, for at least another two years. This suggests that demand will be 35% lower or more for several years.
On the supply side, there is a substantial shadow inventory of foreclosed homes that will be disposed of over the next two years.
This forced selling will weigh on prices, especially in the states it is concentrated, Florida, California, Arizona and Nevada. In addition, an increasing number of baby boomers will be downsizing, either voluntarily or because they need their home equity to fund a portion of their retirement. With demand and supply so imbalanced, it is difficult to see home values rising before 2014, with a greater probability that prices will fall further.
Lack of GDP Recovery
The impact of weak income and job growth, along with no rebound in housing can be seen in how the overall economy has performed. In every recovery since 1948, as measured by Gross Domestic Product, it has never taken more than 3 quarters to recoup all the lost ground during the prior recession, until now. It has been 8 quarters since the recession ended in June 2009, and GDP is still below the level reached at the end of 2007.
This weak recovery is happening despite a record level of fiscal stimulus. According to the Congressional Budget Office, the federal government will spend $2.0 trillion in government social benefits in the fiscal year that ends on September 30. Income transfers will total 17% of total income, a record. Somewhat alarming, total personal income and social insurance taxes will total $1.9 trillion. This deficit of $100 billion contrasts with the $500 billion surplus in 2007 between social benefits and taxes. As we have noted previously, disposable income would be down 4% from 2007, rather than up 4% as a result of government safety programs, i.e. unemployment benefits, food stamps for 46 million Americans, and the unearned income and child tax credits. Clearly, the recession would have been deeper and the recovery even more feeble had these programs not been in place to support aggregate demand. However, this level of spending is unsustainable, and no replacement for healthy income and job growth.
Not Enough Job Creation Action
The focus of any job creation program must be on private sector jobs. We don’t think the President’s proposal goes far enough. And, to be meaningful, any viable program must offer incentives that last for more than one year. The fact that the President’s plan expires two months beyond the next election is a simple coincidence. Of that, we’re sure.
And Then There is Inflation
Over the last year, consumer inflation has climbed to 3.8%, while producer prices are up more than 6%, according to the Labor Department. Even core inflation has pushed up to 2% from 1%. The uptick in inflation complicates the Federal Reserve’s flexibility to provide more monetary accommodation, should the recent slowing in the economy persist or accelerate. When the Fed announced it was defining “extended period” to mean it would keep rates low for two years, three members of the FOMC voted against the change. Their primary concern was that inflation might intensify in coming months, and risk the Fed’s inflation credibility. Most FOMC votes are unanimous. Occasionally, one member might dissent. For three to dissent is truly rare. Given the recent inflation news, the doves on the FOMC will announced more accommodation at the September 20-21 meeting. The Fed’s statement emphasized emphasize that it has many tools it can use, if and when they are needed. That will lead to speculation about what the Fed will do at the November meeting.
In the meantime, we will be thinking “How much longer?” and yearning for the day when we can change that to “Are we there yet?”
U.S. Economic Review by Macrotides (September 2, 2011)
U.S. Macroeconomic Review by Macrotides (May 28, 2011)
About the Author
Macrotides is a monthly subscription newsletter written by a wealth manager associated with a major Wall Street investment bank. The author’s firm has requested that he not use his name to avoid any incorrect implication that his views might reflect those of the bank. The author has written investment advisory subscription newsletters based on macroeconomic analysis and market technicals for more than 20 years. Enquiries can be made at [email protected].