THE ECONOMY:
Exports top imports for the first time in 10 years, boosting GDP outlook.
There was a lot of hoopla about the trade deficit falling to $55B versus the $62B expected and the record $60.6B in February. It seems that finally the softer dollar is starting to spur exports and diminish the desire for now more expensive imports. No doubt that is part of what is happening. The reason it was cheered is because it is widely believed that the US consumes too much and thus the current account is too negative, and the theory is that will eventually make the US a bad risk, foreign investors will say 'no thanks', and our economy fades. Thus the lower gap was viewed as a positive.
No doubt you don't want a gap that is massive, but with the strongest economy in the world, it is very hard to apply rules of thumb. If the US goes most of the world goes with it. With other economies such as the EU fighting to stay off life support (see Tuesday commentary on UK retail sales), there are not a lot of alternatives for investment. Everyone says 'go East young man,' as they cavalierly advise to invest in China. The Chinese stock market is no place for even those with stout hearts. The economy is roaring, but the market is not. China still has major problems linking rule of law as the west applies it to its economy and markets. It is still the wild west (wild east?) as far as investing within country is concerned. That is why most who 'invest' in China do so by investing in what is shipped into China for consumption, e.g. oil, steel, etc. The point is, regardless of the talk about the trade gap and the relief shown that it shrank, we don't think it means a whole lot at these levels.
Moreover, the falling deficit brought about by a lower dollar is a double edged sword. Greenspan has discussed this before as we have, i.e. the self-correcting mechanism in trade gaps that are often caused by a strong currency. The currency gets too strong, an imbalance is created, the currency falls because of that imbalance, the gap starts to close because of the currency declines. Of course when the gap falls the currency starts to rise just as the dollar started to rise Wednesday on the news of the falling gap. US viewed as a less positive investment with a large gap, then viewed as a better investment with a falling gap. The cure can once again become the problem as the currency firms up on the better trade numbers. What helps ends up hurting.
It may even be a triple edged sword. Looking at the trade numbers you see a $1.2B decline in autos (primarily from Japan) and a $2.4B decline in consumer goods. The US/Canada gap fell 700M while the US/China gap fell by $900M (still $12.9B deficit), the second consecutive monthly drop with China. Energy imports, however, rose $3B (20%), and yet the gap still fell. What does this show? Less consumption by the US. Despite the groans about US overspending that causes the gap, it is a historical fact that when the US economy is in good shape we consume a lot of goods, both foreign and domestic. The fact that the gap declined even as energy imports jumped 20% shows a marked slowdown in US consumption. You an blame the dollar, and that certainly had something to do with it, but we are famous for desiring foreign autos and goods even with a weaker dollar. What this says to us is that there is some real slowing in US consumption.
Thus this great news about a shrinking trade gap that bucked up the dollar and raised some spirits on the street was not that positive of news for the economy. GDP will rise because of this, up to 3.7% or even 4% after the initial reading of 3.1% for Q1. This is the way domestic product is figured: imports deduct, exports add. Thus the first reading was really down because of rising oil imports. Now that we see exports were stronger given the weak imports, that is offsetting the higher energy costs and improving growth. In other words, it is still something of a shell game; we don't fell any better other than maybe saying 'hey it is not as bad as they said.'
Dollar rises on yuan report as well.
A quick comment on the dollar/yuan relationship. Lots of talk the past two weeks about China floating its currency versus the dollar or some graduated move to do that. The US has been on China's back to de-link from the dollar to supposedly help the trade gap. I remain somewhat ambivalent toward that; the US doesn't like anyone telling us what to do with our currency, and China is trying to keep its economy under control, something that is not as easy to do as we think. We see the big growth numbers and think running the country would be like quarterbacking the Steelers in the 1970's, i.e. anybody could to it. Yea, right. There are tremendous pressures in the country as it tries to keep a nascent free market going under communist rule. Talk about mixing your approaches.
Anyway, a Chinese newspaper reported China was going to try a 1% float, i.e. letting the currency float 1%. Hardly worth commenting on, but it is a step in a tricky process. If you think the Fed feels it is necessary to go slow with interest rates, imagine trying to tinker with something as volatile as a currency. The last thing China wants is a big jump in volatility with its currency. Its stock market already has a hard time attracting investment, and a wildly fluctuating currency would set them back a few years. All of the talk suggests it will happen, but we can bet it is going to be slow going.
Tax receipts continue to rise.
The new monthly figures are out, and for April the monthly surplus hit a 3 year high at $58B. That is on top of a $49B surplus in March. The surplus is directly attributable to higher income tax receipts.
The real conundrum in the economy is not that flattening bond yield curve even as the Fed hikes rates as Greenspan opines, but how tax revenues can be rising so fast given that taxes were cut. As with the yield curve it is really no conundrum, but some in DC act and talk as if it is a mystery as great as what happened to the ancient Mayans or how the great pyramids were built. There is no art to it, however, just mathematics. Income tax revenues are a factor of tax rate and income rate. We all know that tax rates were lowered, and thus those against tax cuts saw an immediate deficit being the difference between the higher tax rate times incomes and the lower tax rate times incomes. To them that money was gone and would never return.
That thinking does not take into account how reducing tax rates encourages more economic activity. How reduced tax rates raise our income levels. Thus if you reduce tax rates, once those rate cuts impact the economy, tax receipts don't drop off. Indeed, as seen now, they actually rise above those levels they were at higher tax rates. That means that there is a lot more economic activity generated at lower tax rates than at higher tax rates. That is the Laffer curve at work, i.e. where cutting taxes causes an expansion in tax revenues while raising them causes a contraction in revenues because higher taxes curtail economic investment. The risk/reward ratio declines to a point where those with the money find ways to hide it from taxes as opposed to putting it to work to make more money. Even Russia gets this; it went to a flat tax and undermined the black market because a cost/benefit analysis showed the black marketers it was more cost effective to pay the 12% tax than the cost of trying to avoid it.
The rising tax receipts are a continued indication that the economy is not really all that slow. Sure it hit a slower spot in Q1 after surging in 2003 and another fine year in 2004, but as we have noted, every cycle, up or down, has cycles within it. There are no straight up or straight down runs. Tax receipts are a very good indication of economic strength, and they are showing that current conditions are still solid.
Bonds versus inflation versus the Fed.
The key is always the future. With the bond market still rallying and thus the yield curve still flattening, it is showing two things. First, that inflation is in the eyes of the beholder or the Fed. There is inflation in healthcare, education, and commodities, but the issue is how much. The bond market is not showing much at all. That can mean we have a nice, low inflation expansion still underway. It can also mean the expansion is going to struggle (it is still not inverted which would mean a recession is ahead), or at least that the bond market is betting against the Fed.
The bond market is about the best predictor of economic activity, much better than the Fed or any other single indicator. To ignore the bond market or try to think you are smarter than it and classify it as a 'conundrum' that does not fit into your view of the world is to cavalierly ignore one of the most significant indicators in the economy. Once more, however, the Fed is doing that as it looks at its Phillips Curve indicators and puzzles over how there could be such low long term bond prices. It has raised rates, but the real action has been draining the liquidity pool once more. It has sucked up capital again, not to the extent in early 2000 when it recalled all of the Y2K money, but money supply has been declining rapidly for most of this year. It did this in early 2004, but it was long over by May of that year.
The Fed has a real problem ahead of it with commodity prices still surging and oil prices holding over $50/bbl. As we noted before, it cannot control the problem with interest rates. Rates need to be higher, but the economy does not need to have its life bled from it either. Fiscal stimulus to encourage additional supply side investment is what is needed to get inflation under control. In other words, more investment in the US so supply can catch up to demand along with some higher rates to keep inflation at bay until the supply can get to work. That is a pipe dream in this Congress, and thus the prospect of a Fed hiking rates to control inflation even as the bond curve flattens is the reality we face. That is the 'bleed them with leaches' approach to managing inflation, and its outcome is about as exact. |
