THE ECONOMY:
Non-farm payrolls surge past expectations.
Thursday we indicated that a 200K+ report might be in line, and April's 274K topped expectations by about 100K while February and March were revised up 93K (February revised to 300K from 243K). That puts the three month average at 240K and 211K year to date. Gains were solid across the board with no one sector overly dominating (though services was still far and away the leader). The average hourly workweek rose to 33.9 (+0.2 hours), 40.5 in manufacturing. Average weekly wages rose $4.88 (0.9%), the largest percentage gain since 1997. The average hourly wage rose 0.3% to $16. These are getting to levels indicating the current staff has been stretched about as far as they can go. In short, they appear to be 'productivitied' out.
Is the move sustainable? The upside revisions are always very positive, but there was another 3-month stretch early in 2004 where jobs grew at 240K per month, and that did not last. Moreover, oil prices are still stingily holding onto gains and the economic data remains mixed though showing some signs of improvement. One thing to remember: employment is a lagging indicator. Businesses may have finally started to hire, but did they do it just in time for the slow down? That would not be a first.
The Fed looks a lot at the jobs report and wages; it believes in wage-driven inflation no matter what the economic conditions. Thus even if supply is strong as it was back in the late 1990's and early 2000 and there is no hint of inflation, the Fed gets jumpy when it sees wage growth. It was wrong back then. Today there is a bit of inflation because demand has exceeded supply in this recovery. Thus we have a Fed pre-disposed to hiking rates in these situations, and this data gives it no reason to doubt its conclusions.
Tax revenues surging, deficit shrinking, yet tax rates are lower. Now just reign in spending.
It was a farcical argument made back when there was a push for the current tax cuts, i.e. that tax cuts were just another form of government spending. Spending? Where did the money come from? Taxpayers. It is their money, not the government's, yet that simple precept is glossed over daily in Washington DC. The Feds told us they needed a lot more money to pay for all of their spendthrift ways and hiked our taxes in the mid-1990's. Turns out they got a lot more money than they intended because the boom that started in the 1980's was not over. Yet when revenues surged past anyone's expectations, instead of giving the excess back they kept it. They took more of our money than they said they would need and the refused to give it back. The rhetoric regarding the tax cuts was incredibly bitter (e.g., 'welfare for the rich') when you consider who paid the money in the first place. It is the same as a contractor saying he will charge you actual costs and gives you an estimated amount for the job; if it is less you will get the excess back. It costs less but he blows you off and pockets the extra to pay for his own lifestyle.
Beyond being downright absurd the argument was wrong. If it was spending we would simply be further in debt with a few more boondoggle programs to show for it. What has happened, however, is that the money that was given back to the consumers and entrepreneurs was invested in the US and fueled the economic recovery. Some still deny the economy has recovered even as GDP has come in well above what the Fed views as its potential; at a minimum the critics find several faults with the recovery.
Sure it is not perfect, but we have been saying all along that the recovery was demand led, and that has given us the less than perfect inflation picture right now. Even with that, however, the economic and fiscal posture is vastly improved. Tax revenues are up 29% over 2004. In that year the deficit was 3.6% of GDP. This year the deficit has dropped to a projected $395B down from $427B in 2004. That is down to 3.2% of GDP. The oft referred to 'nonpartisan' Congressional Budget Office now projects the deficit will fall below 2% of GDP in 2007. That puts it below its 40 year average in relatively short order.
So much so that the April to June quarter is expected to turn an expected $12B deficit into a $42B surplus. That is on top of a $30B surplus for the first quarter. Lower tax rates = rising economic activity = higher tax revenues. The data shows that tax revenues related to the dividend tax reductions and cap gains tax reductions have leapfrogged tax receipts on those assets. Lower rates but more revenues. More dividends are being paid out because the rates are lower. The individual investor benefits in getting the dividend and at a lower tax rate. That money goes back into the economy as opposed to sitting in the corporate treasury. Lower capital gains taxes unlock money stashed away in investments hiding the money from being taxed. Lower rates pry open the wallets and get money circulating in the economy; that is the lifeblood for economic growth.
How this works: toss out the Phillps Curve and start 'Laffing.'
Tax revenues don't rise unless there is more money in the pockets of citizens and corporations. Moreover, a lot of the revenues are coming from dividend and capital gains taxes. But those were lowered along with income taxes. That can only mean that there is a lot more economic activity to generate more tax revenues than higher rates were able to do. That is the history of tax cuts.
The Laffer curve states that at lower tax rates economic activity expands to such an extent that tax revenues actually increase. Raise taxes too much and tax revenue falls because of lack of investment. You can also lower them too far and revenues will drop as well due to diminishing returns (you get less bang for each $1 taxes are lowered). Here in the US we have successfully shown what rates will lead to falling economic investment and lower tax revenues. We have yet to find how low they can go before tax revenues fall off. This last reduction has produced a surge in economic activity and jumped tax revenues, so it is clear we have not reached the equilibrium point where economic growth is maximized and tax rates are at the minimum levels. In other words, we can cut taxes further and still generate more economic growth.
Given that demand is still outpacing supply and thus causing the inflation we are seeing now, it would behoove our leaders to cut taxes more and thus generate more supply and fuel further economic growth. Tax revenues would rise further and go toward cutting the deficit. It is the best of both worlds, but in Washington political careers and indeed political parties are staked against this historical concept. Thus reality denial will continue.
Tax revenues, ECRI indicate economy is still solid
Higher tax revenues speak for themselves. When tax rates are lowered and tax revenues rise, there has to be a lot more economic activity to not only make up the difference but add to tax receipts.
This jibes with what the Economic Cycle Research Institute's (ECRI) weekly economic indicator. It is a very reliable leading indicator, ferreting out several recessions and recoveries. It suggests that the economy is closer to the end of the slowdown if not past it. The FIG (future inflation gauge) shows inflation trending slightly higher still, but it is not indicating the Fed needs to get really aggressive, i.e. start with the 50 BP rate hikes. While the FIG is at a 25 month high, ECRI indicates the rise is due to energy. ECRI says there needs to be more than just oil for a serious inflation rise. ECRI has a good track record; hope they are right. If only the Fed followed ECRI.
An improving economy leaves the Fed on pace to continue its rate hikes. No pause, no slowdown, just continued hiking at a 'measured' pace until the Fed feels it has got it right. As we have chronicled often of late, this more or less gut feeling by the Fed as to when it has things right is what puts fear into the market. Sometimes that is what the Fed wants; as we have said, the Fed has turned into more of a Phillips Curve watcher and that makes it fear prosperity. While this may not be raging, roaring twenties style prosperity, the economy is doing much better. Above trend growth scares this Fed, however, and that keeps us at risk of Fed intervention each time the economy recovers and expands. |
