Wayne. Paul Shread posted this article on SA II
Certainly a different look at the current economy that we see from other equally respected analysts. Not trying to be argumentative or shoot down anyone else's views here.
But do think a balanced thread discussion benefits from considering positive as well as negative analysis of the economy.
Isopatch
To view the 5 charts Kasriel included with the text please click on url:
investavenue.com
<US RECOVERY PROGNOSIS? EXCELLENT!
By Paul Kasriel from Northern Trust Company 05-14-2002
We are not typically known for our optimism. If there is half a glass out there, you can
usually count on us to see the empty half. But even we, pessimistic as we are wont to be,
just can't get behind the double-dip notion. Rather, we see the economy having entered a
solid growth path, especially so given Alan Greenspan's reluctance to raise the discount
rate.
Let's address some of the issues raised about the prospective short life of this recovery,
starting with inventories. If ever there was a classic inventories-correction recession, it
was the most recent one. As Chart 1 shows, this last recession was characterized by the
sharpest liquidation of inventories in the postwar period and the mildest slowing in
final-sales growth. If a sharp liquidation of inventories led us into the wilderness of
recession, might we not expect that a rebuilding of inventories, or a diminution in the rate
of their liquidation, would lead us into the promised land of recovery? After all, as shown in
Chart 2, inventories typically make a large positive contribution to GDP growth in the early
stages of economic recovery. So what's the big deal about the slower rate of inventories
liquidation adding 3.1 percentage points to first quarter GDP growth?
Yes, but how do we know that this inventories-induced boost to GDP won't be a one-off
event? Didn't the factory workweek lengthen in the first quarter? Didn't these folks toiling
the extra hours on the assembly line get paid extra for it? If they are paid, do not they spend
at Wal-Mart? Does not Wal-Mart have to place more orders with their suppliers to restock
the shelves? Do not these new orders represent new final demand? Furthermore, do not
these new orders lead to more factory work, implying a still longer workweek and
eventually the hiring of additional workers? And so on and so forth. Is this not the standard
self-perpetuating growth dynamic of economic recovery? Some analysts confuse GDP
accounting with the underlying economic; processes. It's a general equilibrium system,
folks. When one element gets "disturbed," that element sets off chain reactions in other
elements. So, this concern that the large first-quarter GDP contribution from inventories
will be a one-off event is the thinking of the economically challenged.
But let's talk about final demand. Final demand on the part of American domestics
increased at an annualized rate of 3.7% in the first quarter - a rounding error short of the
fourth quarter's 3.9% growth. So, what's all this talk about weakening final demand? Yes
consumer spending did slow, but residential investment spending grew faster and
business equipment spending did not contract nearly as much as in past quarters. And
although growth in government spending slowed, at 7.9% annualized, that's not very slow.
We can debate the economic merits, more accurately, the demerits of government
spending on the longer-run growth-inflation tradeoffs for the economy, but in the GDP
boxscore, a dollar of government demand counts as much as a dollar of household
demand. Get used to it - government is once again a growth industry in America. And
again, those folks working longer hours to restock the Pentagon's arsenal of cruise
missiles get paid for doing so. And they go shopping, too.
But we hear that the recovery won't be sustainable until corporate profits start increasing,
which, in turn, will lead to a rebound in capital spending. Hello?! Didn't before-tax
corporate economic profits (the Commerce Department's measure of profits from current
operations) increase at an annualized pace of 93% in the fourth quarter? And as
suggested in Charts 3 and 4, don't the first-quarter Productivity and Costs data point to
additional strong corporate profit growth? Doing a little algebraic re-arranging of terms, it
can be shown that growth in the implicit price deflator of business output minus growth in
unit labor costs is equivalent to growth in nominal business revenues minus growth in
total labor costs. Although there certainly are more costs to businesses than labor, labor
costs represent the biggest expense item. So, deflator growth minus unit labor cost
growth is an approximation of corporate profit growth. And judging by the correlation
coefficient shown in Chart 3 of 0.73 out of a possible 1.00, this is a pretty good
approximation for profit growth. Chart 4 shows that this profits proxy has grown in each of
the last two quarters - 1.8% in the fourth quarter of last year and 5.1% in the first quarter of
this year. Again, although there are more business expenses than labor costs, we would
be willing to wager that economic profits in the first quarter are going to be up again. And
as go corporate profits, so goes capital spending.
How long will we have to wait before we see an uptick in business capital spending?
Judging from first-quarter spending on business equipment and software, not long. Chart
5 shows that equipment and software spending excluding transportation did, in fact,
increase (by 5.3% annualized) after four consecutive quarters of contraction. Because of
the post-September 11th drop in travel, the airlines did not order as many planes and
Hertz did not order as many cars. With travel picking up again, soon more planes, trains
and automobiles will be purchased by those providing transportation services.
So, we don't agree with those nattering nabobs of negativism about the prospects for a
double-dip. Rather, we think the recovery's prognosis is excellent - especially because
Alan Greenspan clearly wants to operate monetary policy in a reactive mode rather than a
preemptive one. The natural inclination of an economy is to grow. Earlier in this
commentary, we described the internal dynamics of an economic recovery. It's economic
inertia. Once an economy starts growing, it tends to keep growing, at least in nominal
terms, unless disturbed by an external force. For the US economy, that external force
typically is the Federal Reserve. Mr. Greenspan has made it clear that he does not want to
be that external force anytime soon. We were amused by the following passage in the
March 19, 2002 FOMC minutes:
Members concluded that the Committee would be in a better position to assess the
appropriate timing of a policy change at the May meeting when it would have more
information to gauge the economy's performance in two critical areas, namely
developments relating to inventory investment and the implications of trends in sales and
profits for capital investment.
Well, by May 7, "members" had data suggesting that inventories, although being liquidated
at a slower pace, still were being liquidated. Deductions from GDP due to the behavior of
inventories were likely quarters away. And members had data showing that capital
investment outside of the transportation sector was rebounding. On March 28, members
had information that economic profits soared in the fourth quarter. And if the members'
staff was worth half of what it is paid, the members had information on April 26 with the
release of the advance GDP data that economic profits would be strong in the first quarter,
too. Yet, at the May 7 FOMC meeting, the members unanimously said, in effect: "We need
more information."
In last month's outlook, we argued that Fed Chairman Greenspan would raise rates this
year less aggressively than what was then priced into the market for reasons related to his
legacy and his political master, President Bush. His comments and policy passivity has
borne us out. But Greenspan appears even more inert than we had anticipated. We had
expected him to reluctantly start baby-stepping up the fed funds rate at the June 26 FOMC
meeting. But that looks like a long shot now, especially in light of the politically-charged
6% unemployment rate. We, therefore, have moved out our date of the first 25 basis point
funds rate hike to August 13. So, we now see a year-end fed funds target of 2.75% instead
of 3.00%. If Greenspan keeps coming up with reasons to hold off hiking the funds rate
even later than August 13, watch out after November 5, election day. At that point, at least
the political constraints on rate increases will have been lifted. And Greenspan's legacy as
the keeper of the price-stability flame might be in danger of burning up.> |
