Icebergs Ahead

I've had it in mind to post a "__ reasons why the economy is still fucked" post for about a week and a half now, and then the unsurprisingly crappy consumer spending data came back today, and it's all fashionable to talk about the "death of green shoots", so I done got scooped by facts, and accordingly, everyone. Basically.

But because I'm not really in the econ blog circuit, and it still might be interesting to compile and talk about some other things than consumer spending, I'm going to go ahead with it anyway.

I can always judge the public sentiment by listening to what people whom I know have done little or no research on a particular matter think. I don't mean this as an insult. It is simply impossible to know everything about everything. I hear myself doing this as well. If someone brings up a topic I know nothing about, yet I might have caught a bit of something on the radio the other day about it, I find myself reciting that one factoid as if I wrote a book on the subject. I think it's a way of compensating, and to try to draw out information from other people to learn more.

So when I hear people, whom I know don't know what PCE stands for, saying things like "it seems like the economy is getting better recently," I know they don't necessarily think that, but they've heard it.

So when it starts to be spring time after our current winter of our consumer discontent, and all of a sudden you start hearing "green shoots" from administration officials, one must wonder, have they really been reading the economic reports, or just the Hallmark Easter cards?

Wouldn't it be lovely if spring time meant we were coming out of the recession, just like we come out of the cold weather into the sunshine? Wouldn't it be great if this recession lasted a season or two, like typical post-war dips in the GDP? Wouldn't it be nice if we were older, and we wouldn't have to wait so long?

Yes--I'm currently listening to Pet Sounds; No--we aren't getting out of this damn thing with metaphors.

Green shoots? What a stupid phrase. You know if people are resorting to gardening metaphors, we're all fucked.

And you know what they were getting all excited about? You know what the green shoots were? Second derivatives. For those who don't remember calculus, second derivatives are the rate of the change of the rate of change. For those who don't remember calculus, this is like when you take off from a green light, accelerate, and then after you hit third gear you continue to accelerate, but not quite as much. Only we're going in the other direction.

But we're not coming to a stop, we're coming to a... well, let me try these metaphors.

You're driving at a brick wall, with your foot on the gas. A second before you hit the wall, you think, "what the hell am I doing?" and you start to take your foot off the gas. For that split second, you aren't accelerating towards death quite as fast.

Or, you decide to go skydiving. You have a lovely time experiencing weightlessness, and then you decide to pull the cord. Nothing happens. You continue to plummet towards the earth, scared out of your mind. The houses and fields get bigger and bigger, as you fall faster and faster. Then, at a couple hundred feet from your death, you suddenly think to yourself, "Oh thank god, I'm almost back on the ground." And you feel much better, as your internal organs explode from the inertia force of meeting those lovely green shoots of grass covering the planet.

The economy is in fact showing no signs of recovery. It has stopped deteriorating quite at free fall, yet is still deteriorating. Does that make sense? The ship is still taking on water, but the iceberg is no longer lodged in its crotch.

The only sort of person who would think a slowing but continual deterioration is a sign of recovery is someone who thinks all recessions are those V-shaped graphs. Here's a little thing about graphs--if the X axis is Time, you can't draw a graph until its all in the past. You can't graph the future. So, you would only assume you know what the graph looks like if you think you can see the future, or if you are assuming the future will be just like some other past graph.

This recession is clearly different, in many ways. The downside of economics, I believe, is that because of its Cartesian dynamic, it loves to isolate for certain variables. You know this--you get some crazy graph, and solve for Y. Makes it all look easier to have one variable alone, and everything else a function for it. You can make nice graphs, and attribute correlations, and make predictions. This is all well and good, but the problem is that the economists seem to forget these are variables, and by considering a play of one variable, or at most a handful, they are ignoring the complex interplay of other factors. They start believing they can see the upswing as soon as they stop seeing a downswing.

The horrible part for us, is that it means they are going to cut stimulus, reform, and other action short, because it makes them think the trouble is over. What happened to the crisis of capitalism? Did we forget that? Well, they'll remember it next year when unemployment is above %10 all year.

There are still plenty of icebergs ahead. I don't know a lot about macro-economics, so I don't know which one's are really dangerous. But here are a few things I can see as potentially causing a lot of trouble over the next year.

A quick note to thank Calculated Risk for teaching me about half of what I know about economics. That ever exceedingly wonderful blog is my source for these statistics, mostly because he produces wonderful graphs. (Graphs can teach you an awful lot.) I highly encourage you to follow my links to look at the lovely graphs.

Consumer Spending

The big news today was consumer spending, which decreased 0.4% month over month. Consumer spending, calculated by the Census Bureau, makes 70% of the GDP.

After a major decrease over the holidays, sales haven't recovered. They haven't gotten much worse either, green shooters argue. Let's talk about that for a minute.

You could look at the lack of change as a pure number, developed out of, I don't know, nowhere, or we could think about American's spending habits. In 2007 we were spending out of control. More money than we had, almost. Only at the end of last year did Americans start saving again, and still, barely at this point. Here's a nice graph showing the personal savings rate.

Consumer culture reached its zenith at about this time. Credit cards, designer handbags, etc. You know the deal. This all came to a stop, but not a crashing stop. We have less credit now, and are getting a little smarter, but we are still Americans, for heaven's sake. People are still going to the mall, they just aren't biting people for a chance to get widescreen TVs.

Consumer spending still has a way to fall. Look at this graph, showing the change in inventory, and then the second, showing the inventory to sales ratio. The ratio is still at 1.44. It's dropped considerably, but people are still buying things, and there is still inventory. They are still accumulating consumer crap, just not quite as much.

Another green shoot I saw was this article from Bloomberg saying Walmart same-store sales are up 5%. Think about who shops at Walmart. Walmart is the bottom of the barrel, when it comes to retail. Shitty products at reel low prices. There are the people who live in small towns, in which Walmart is the only thing close, and there are the people who live in big towns, where there is nothing as cheap. If Walmart's sales increase at this point, its not a brilliant ad campaign. It's because those edges of the consumer envelope are widening. People who shop at Walmart are not buying more; more people are going to Walmart because they are being pushed that far.

There are still plenty of rich people in this country--as I keep repeating, this is America. There is still money out there, but with no source of regeneration for the wealth of the upper-middle class and the lower-upper class, we're looking at a horizon that is getting closer all the time. The money can't last forever, and with credit still drying up for most people, I see consumer purchasing continuing to shrink. Where is the money going to come from? Still losing 500K+ jobs a month here... And wages are dropping too.

Shit-backed Securities

Foreclosures are continuing.

Now credit card companies are having problems too. A small credit card issuer stopped new lending because charge-offs (money "defaulted" on a credit card) were reaching as high as 20%.

Those are business credit cards, which is a nice transition into commercial real estate. Commercial property values fell 21.5% from 10/2007 to Feb, and defaults on commercial real estate loans are beginning to increase.

Residential home sales may be picking up, but new homes are hardly being sold at all, and many sales are foreclosures sold at discount. Prices still have a long way to fall.

All of this means banks are continuing to tighten lending standards to consumers, despite how the money market interbank credit has softened since the crisis last October.

Like consumerism, and perhaps the root of that consumerism, America was out of control round about 2007. Credit fell off a cliff at the end of the year, but will still continue to get worse. A lot of people are going to default on their credit, both individuals and businesses. This leaves banks very exposed, and makes new loans very difficult. There are going to be a lot more problems with credit-backed securities of all kinds, and while the government continues to be concerned with the big banks and the securities themselves, has seemed to give up trying to fix mortgages for every day people.

All in all, not very green.

Systemic Banks

The stress tests were kind of a joke. Not only did the banks get to bargain with the government about how they were tested, (you remember that teacher in high school/college everyone knew you could get a better grade with if you just went and argued it?) but some of the figures used in the worst-case scenario were not worse than the current conditions. Furthermore, all these banks have to do is figure out how to report earnings more than the amount they will have to write down. The government basically said, just figure out how to break even. I mean, yeah, that's a start.

The government is clearly willing to do everything to keep these banks from being nationalized, including playing paddy-cake all day long. I mean, they've made the case for this themselves over and over again, so why would we think they are going to do anything different?

The part that really troubles me is that these banks aren't "learning anything." Not that they really would learn, but it seems like everyone is getting a free 1-up on this. Hey man, you lost, pass the controller on!

What is going to be different about investment banking in the future? Anything? Just an implicit backing of the federal government from now on? They keep everything. Where are the Chrysler and GM ultimatums for these assholes? How can we expect better regulation if we can't even get legitimate accounting out of these institutions?

The banking system may be saved by (or at least tied to, non-committally and without control, the fate of) the US government. But what does this mean for the future?

I predict another bubble in less than fifteen years.

Treasuries

Part of the trouble with tying the banking system to the Fed, without real control of the banking system, is that the Fed doesn't get to preserve its status as general OMC bellweather. They've got their hands dirty. The Fed balance sheet is huge, as it tries to cover every else's problems. And it's going to get even bigger as it buys more treasuries.

Treasuries are very strange. They are debt sold by the US Treasury (which is different than the Fed, by the way). A Treasury is a bond with a set interest rate, that matures at some time in the future. However, these bonds are sold back and forth all the time, for prices that vary. If you factor the selling price of a Treasury into the interest rate and the intital cost of the bond, you can get a yield that is higher or lower than the actual interest rate of the bond. So, for example, if the price of a bond is lower than its initial cost, you could have a yield higher than the interest rate, because you will end up making more money by "buying it on sale", so to speak.

People buy and sell Treasuries because they are very secure, being backed by the Treasury. You can earn some interest without any risk, really. And because there is always a market for them, you can sell them to someone else to get cash if you need it. You can even make money in selling them, if you play it right. It is still confusing, because when the yield of a bond is high, it actually means the selling price of it is low, and vice versa, but I assume the sort of people who work in this market have a clever mnemonic of something for remembering this.

But this is not all fun and games. Issuing Treasuries is how the US gets cash. We can have a deficit because we sell debt, and pocket the cash. We can still pay the bills by selling IOUs to the rest of the world.

Specifically, to China. I'm not going to even comment on how much of the US debt is owned, in Treasury bond form, by China because nobody is really sure, they just guess. China buys our debt because it is a good investment, and because by putting lots of their currency out into the world (the cash they are exchanging for the bonds) they keep their exchange rate low, which is good for their export economy. People send the world currencies into China, and China sends their currency out, buying it back cheap, and keeping some of the world currencies. (this isn't how it works, but the principle is about right).

But China, as the demand of cherries slows down, they can't be buying quite as much debt from us. Also, there is the fact that we are selling a lot of debt. With all these bonds out there, the demand is waning. The yields of the bonds start rising.

But the Fed wants the yields to stay low. When the yields are low, the incentive is not so great to buy Treasuries, and so banks put their money elsewhere, like into the money market, or keep the cash to invest somewhere. This is the essence of liquidity.

So the Fed and the Treasury are somewhat against each other here. The Treasury wants to stimulate the economy by spending lots of money through the government and charging it to its tab. The Fed wants to convince banks to invest in consumer debt and each other's debt, rather than the secure Treasury debt. So the Fed is buying up Treasuries, to make their yields decrease, adding to its giant balance sheet with all the debt they've been buying from corporations and banks as well, flooding the markets with cash. So far, the Fed has enough cash. But guess where they get their money (besides the banks, who must keep a bit deposited with the Fed as part of their charters)? From the full faith of the US Government!

There is a good amount of breathing room in the phrase, "the full faith of the US Government", but still, it is certainly not a good long-term plan. The dollar has already been weakening on this, because it appears that the Treasury is writing IOUs with one hand, and cashing them with the other. All of this debt will eventually become due as well. And while the US, for all intents and purposes, will always be able to issue more debt, it appears the systemic problems of our debt-oriented economy, which has just crashed, are now being shouldered on the currency. There are no magic bullets here, or a pit of Tartarus to fling the debt into. We can keep a lot of balls in the air, but for how long?