Continuing Unemployment and Hidden Cycles

Discussing the recent unemployment data with my most valuable Economics Major Summer Intern we decided that the statement that the current data is "better" or "worse" than the previous month's data does not make much sense in isolation. Unemployment is one of those factors that has strong cyclical seasonal and multidecadal components. To properly interpret the data to inform a prediction, all the data must be reviewed in context.

It turns out that this month's unemployment report, which also features continuing unemployment (CU), is a good illustration of this concept. Looking at the CU chart, you can see the cyclical seasonal and multidecadal components from the Backfit of our model. Notice that while there is a reasonable correspondence of the yellow line model fit with the actual data, shown in light blue, it now appears that the Gap between the prediction and the actual data has increased substantially, especially when compared to the previous "lack of fit." Ha! You say. That's because your model is flawed.



The predictive components of the model are heavily weighed by the historical cycles. The predictive line acts more like a chaotic attractor. Historically, the actual data is usually found to snap back in line with the actual data within a few months. This can be clearly seen from the Backfit.

Currently the Gap is rapidly increasing and has reached a historically high level. Should this continue for a few more months, reality wins as it always does, and then the model will indeed be considered flawed. It probably means that a new factor has entered into play that is not accounted for by the cycles in the historical data that were used to build the prediction. The flaw, then, still contains disturbing information.

Our model for CU is derived from data going back to January of 1967. It does not encompass the years of the last Great Depression. Therefore, it contains no cycle information for the years 1928 - 1966. My current hypothesis, should the Gap continue to expand, is that a much longer multidecadal business cycle may be unfolding on the downside. We may see much higher levels of CU reached than might be surmised from the relatively small data snapshot of the past which informs the current model.

Supporting the hypothesis are the model predictions we have for the Dow Jones Industrial Average (DJIA. Ths data set encompasses the Great Depression, as the data goes back to 1896. It is currently showing a large cyclical-variance based decrease which only bottoms out sometime after 2010. The DJIA model predictions, alas and alack, are reserved for our subscribers, who pay for the CPU time, hardware and wetware used for model development.

In summary, don't be caught extrapolating the future from a few months of economic data without knowing the bigger picture. Even if you obtain the picture by simply charting the values rather than investing the time to build a full structural model, the results are much more informative.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Inflation, Deflation and Other Bafflegab

This much is self-evident: living in the United States, paying my bills at the end of the month, life is more expensive compared to a year ago. The chatterings of academic and mainstream media economists have no relationship to how much time it costs to earn the dollar credits used to purchase various goods and services.

To illustrate this basic concept, we start off with a nice chart which shows the consumer price index for all goods and services, along with a breakdown of some goods and services that I would consider essential for achieving a bare minimum of the good life, as a participant in the grand economic game based in the united States.
Compare the salary you were making in 1985 to now. How does it compare to the cost of medical care, up about 400%? Or tuition and child care, up about 500% ? Or prices of food and energy, up almost 200%?

Realizing that my health insurance costs have just increased by 12% over last year, while the next set of tuition bills hits my desk in a year, I wanted to look at the data to validate my experience.

A good deal of my anxiety regarding this rather large rise in consumer prices of goods and services which I feel are basic to the good life is not due to the actual changes in price levels. It is due to the increasingly widespread invalidation of my experience of rising prices fomented by academic idiots spinning solipsistic sheets of data purporting to show that price levels that actually matter to ordinary citizens are actually quite stable.

So opines our Nobel Prize winning economist, Paul Krugman:

First things first. It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger.

The best line is "Consumer prices are lower now than they were a year ago." Really?

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Mirroring

The blog is now now mirrored at Wordpress.



For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Inflation or Deflation? Wrong Question. Futile Answer.

A business partner asked me to share my thoughts on a recent financial report which made the case for a long period of subdued price pressures as measured by the CPI. It was a great question since I have been doing some thinking about the issue given the various somersaults in the interest rate markets.

I came to my usual conclusion: purchased within the US, prices of discretionary items may remain stable or even decrease, but prices of non-discretionary stuff will tend to increase. While discretionary and non-discretionary usually refer to consumer purchases, I think we can also stretch that to groups and industries.

The monetary base in US dollars is increasing as a result of the Fed's quantitative easing (QE) policies. And while the Fed has massively increased "borrowable" reserves, so far, there hasn't been much borrowing by folks that would put that money into the economy, which would multiplicatively increase the 'credit money' supply.

I think we hit some kind of record for "excess reserves" which is a rough measure of monetary easing. Hence the QE policies - if Bernanke can't increase the money supply by inducing the borrowing of money into existence, he's simply going to 'print' it into the monetary base. Which also makes the insolvent banks look better than they are since the printed digits usually end up as a plus on their ledger with the Federal Reserve.

Trying to predict where that money will end up is difficult. The usual measure is the CPI, which has one advantage in that it's been around for a while even though it has been statistically degraded as far as information by various hedonic adjustments. For an alternate take on the real CPI, check out John William's page. I don't buy the timing of some of the conclusions, but I trust the data.

The CPI measures a defined basket of stuff, and in terms of actual money and velocity of money measures, it is a really small sampling of the effects of capital flows. It sometimes has no relationship at all to the elusive "general price level" which it is supposed to reflect. Sort of like a resistance meter attached to some inside circuit within a multidimensional Wheatstone bridge where the resistors are all variable and linked to one another through some set of nonlinear equations that change with time. If all the resistors go increase their resistance together, sometimes it reflects reality, otherwise, not. When the models don't work, whenever something 'unexpected' happens to price levels, someone coins a new word like stagflation. Or my favorite "conundrum."
Here are some some structural models of various financial time series that independently provide some support to the idea that some price levels, for commodities for example, will increase, and that this time around it may be reflected in CPI. With many thanks to my economics major summer intern for the nice graphs. The first figure shows a prediction for CPI for the next couple of years. The second figure is a longer term chart of the CPI in log form, where you can see a couple of inflection points, one around 1970, and another right about now, separating relative times of CPI disinflation and inflation.
In the world of real stuff, a good measure is the ISM Purchasing Manager's Index, which shows superimposed seasonal cyclical variations occurring on top of longer term economic cycle variations. We seem to be heading into a good Summer 'rally' which is going to reverse some time in the Fall. Priced in dollars, the CRB spot index looks like it is also in rally mode suggesting higher dollar prices for commodities in the future. It gets progressively strange because the US bond and bill interest rates are doing the opposite of what might be expected during a so-called recovery. The yield curve seems to be flattening out. The cyclical summer bump in employment does not look like it will last, supporting a further cool down of the US economy.


Taken together, I think commodity prices in dollars are going to increase most likely due to Asia's increased consumption as they successfully stimulate domestic demand. Because energy is a major input into production and distribution of commodities including itself, and is one of our major imports, I think the small basket of goods in the CPI will also increase priced in dollars.



Since we're not going to get Glass-Steagall in the near future, I also think once the commercial banks get sufficiently recapitalized, they will borrow from themselves and the Fed. Much of that capital will flow to higher growth markets like China, Brazil, and Europe's main energy provider, Russia, also raising foreign equity and bond prices.



Ironically, the current non-borrowed bank reserves that will get borrowed will therefore be invested in higher growth areas, which do not include, with certain sector exceptions like high tech software and electronics, Anglo-Europe and the US.


Here's the hedge. I have no idea how the crackup in the interest rate swaps OTC derivatives market is going to impact US banks like JPM that have $63 trillion notional value in outstanding bets. The increased volatility in interest rates is already bad enough since the derivative risk models used to price them are highly sensitive to volatility pricing. If any counterparties find themselves on the really wrong side of the fixed-rate, variable rate swap, it will be very bad. At that point, the rate of default may be higher than the Fed's ability to keep the money supply from decreasing, at least in the short term. Hence, we may actually see a drop in import prices due to one last rise in dollar purchasing power before it expires as a reserve currency.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

No Bell Rings at the Bottom

It's hard to argue with a Nobel Winner.

Nobel Winner Krugman Sees U.S. Recession Ending Soon

June 8 (Bloomberg) -- The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said.

“I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer,” he said in a lecture today at the London School of Economics. “Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilizing.”

So I'm going to let economic data argue with the Nobel Winner.

The US continuing unemployment data gives a beautiful representation of the cyclic nature of the economy, as we can see here. Along with the actual data, I have included the backfit data from one of our predictive econokinetic models.

You can see a cyclical pattern which not coincidentally has its lows anchored in some, but not all, election years. A cynic might speculate that the employment picture is adjusted by tweaking monetary policy so as to occasionally give the incumbent an advantage, or disadvantage. Or, it might be just chance. This issue is probably best discussed elsewhere.

What I want to show is that the cycle tends to reach an intermediate low in the Summer months, no matter what is happening with the total employment picture. This is best seen here, where I have also included a "freebie" which is a prediction of continuing unemployment based on our econokinetic model. Our subscribers who help keep the electrons flowing in the modeling CPUs have a much better idea of the long term trends in continuing unemployment. That information, coupled with other determinants, strongly suggests that a "recovery" is much farther away than Krugman believes.

We can also look forward to the usual happy talk about a recovery for the Summer of 2010, again when the continuing unemployment rate reaches an intermediate low. But it's what happens after that should be occupying our brain bank of economic advisers.

Krugman's thesis of trade where global capital flows would theoretically rebalance through the operations of the free market and result in a realignment of our current account have not been borne out by reality. We waited for the "New Economy" for over a decade while we exported whole industries overseas. For many American workers, it has been a complete disaster. For anyone interested in delving a bit more into this subject, a good starting point is Krugman's 1997 op-ed entitled In Praise of Cheap Labor. A review comparing and contrasting the philosophic approaches to economics of Stiglitz and Krugman written by Edward Fullbrook is also enlightening. Probably only a few remember Krugman's puff pieces on Enron whcih appeared in Fortune Magazine in 1999, when he was part of an Enron Corporation board that netted him $50,000.

When some of those workers receive paychecks from Obama's 600,000 job creation program they will use more of the money to buy foreign goods than US goods. When the infrastructure is built, they will be again unemployed. And just to repeat myself, it's what happens after that should be occupying our brain bank of economic advisers.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Summers to the Rescue - Hiring firebugs to douse fires

Der Spiegel reports on the deindustrialization of America. Apparently, the whole issue of structural deficiencies in the US economy has not gone unnoticed abroad.

America's economy is losing power and influence in the world. It's a creeping process and only becomes visible on days like yesterday: General Motors, a warhorse among the world's industrial companies, significantly bigger than the failed and scandal-ridden Enron and WorldCom, has filed for bankruptcy protection. A fat chapter has been added to the book on America's de-industrialization.


This process, which began with the relocation of textile production to Asia and then pushed steel producers, tire plants and many other industries out of the country, has plunged the country's political leaders into increasing despair. How else can one interpret the gigantic rescue operation for GM that will end in the nationalization of the biggest auto company in a country that has always hailed itself as the paragon of capitalism?

A scan of the American mainstream economic media, such as the WSJ and the business section of the NYT shows that the chatter has focused on the collapsing financial side of the economy, and how best to save it. But it has not addressed the root cause of the problem.

While in theory, free trade confers a lot of benefits which stem from optimization of production, in spite of all the verbiage and bafflegab of the current crop of economystic dirigistes, we never experienced it. It is not possible to have free trade when your trading partners are managing their currencies to assist their exports and to block your exports.

The way free trade is supposed to work is that countries that begin to run large current account deficits as a result of import-export imbalances undergo a drop in the purchasing power of their currency, while countries accumulating a large current account surplus see their currencies rise in relative value.

This feedback system assures that large trade imbalances are kept in check, since goods and services from countries with high current account deficits like the US drop in foreign currency price, helping exports, while imported goods rise in price, decreasing imports.

As our current account deficit ballooned in the 90's, the US dollar should have gradually adjusted to a lower level compared to the currencies of our trading partners. This would have helped American industries compete in world markets. The current crop of economystic idiots recently re-employed as civil servants to fix the economy watched the US current account deficit balloon in the 90's instead of addressing the issue via GATT as outlined in Article XII.

Instead, the exact opposite occurred. Export-oriented countries like Japan and China were encouraged to buy US dollars to weaken their own rising currencies. This was part of the infamous "strong dollar policy" which was executed by Robert Rubin.

Trade associations such as the National Association of Manufacturers (NAM) repeatedly petitioned Congress to review the effects of this policy on American industry. This is what Jerry J. Jasinowski, its President, had to tell Congress during oversight hearings in May of 2002.

The overvaluation of the dollar is one of the most serious economic problems – perhaps the single most serious economic problem -- now facing manufacturing in this country. It is decimating U.S. manufactured goods exports, artificially stimulating imports, and putting hundreds of thousands of American workers out of work. It is leading to plant closures and to the offshore movement of production away from the United States, with harmful long-term consequences for future U.S. economic leadership.

This is a matter to be taken seriously not only because of the cost in terms of jobs that have been lost, but also because manufactured goods comprise over 85 percent of all U.S. goods exports – and two-thirds of all exports of goods and services. America’s ability to pay its international bills depends on America’s manufacturing industry.

Cui bono? Who benefited from this policy? Well, in the short term, Americans benefited via low inflation, low interest rates, and a rise in activity in the service sector of the economy. However, others also benefited. Money center banks such as Goldman Sachs and JP Morgan, with outstanding loans to Asia and Latin America would have suffered large financial losses if their dollar denominated loans were paid back in cheaper dollars by the debtors.

In the long term, the ongoing structural imbalances in world trade have left the US a major international debtor facing a Depression. Unlike previous Depressions, however, it has also left the US economy with the ghost of its previous manufacturing sector. All the stimulus plans emanating from the Obama economic team, headed by one of the architects of the destructive strong dollar policy, Lawrence Summers, and his alumnus, Geithner, will fail because there is no productive sector of the economy left to absorb the stimulus and provide employment.

Since no one in the Obama economic administration seems aware of the problem, it is unlikely that we will address the basic issues of how to increase manufacturing production in the US until such time as the international destruction of the dollar forces the US to look inwards for the production of goods and services previously imported via credit rather than trade of goods and services.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Synch or Sink?

The Earth circles the Sun, Spring turns to Summer, and just like in 1930, hope Springs eternal. I thought I would update the usual comparison of the peaks in stock prices in 1929 and 2007 as shown by the DJIA. No offense to the bond market traders, who trade multiples of value compared to equity traders, but we are linguistically programmed to associate the economy with equity prices, and not bond prices.

You don't have to be a rocket scientist market technician to figure out that there is something not quite right with the current rally in stock prices which seems to be coming to an end. I have drawn lines from the intermediate peaks to troughs at each major juncture in both time series. You can see that the beginning of the end of the Great Depression, the slope, graphically represented by the dashed or solid lines, flattened out. This is when most folks who were going to sell had done so, and a few timid but well rewarded investors were beginning to buy up shares at 10-20% of their previous maximal values.

The thick dashed line shows the last downward bump of our Current Unpleasantness. The solid thick line shows the last downward draft of The Big Correction prior to some recovery. It is a lot milder and more prolonged, which are signs that the "bottom" may have been reached.



I think one of the reasons we often see multi-decadal cycles in these kinds of time series is that people who have lived through the economic disasters tend to remember them and change their buying and selling habits for the rest of their lives. Since most of the wise folks who made it through the last Great Depression have now gone on to their just rewards, this leaves a few generations removed in time to relearn the lesson. As the Preacher said:

What has been is what will be,
and what has been done is what will be done,
and there is nothing new under the sun.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.

Your Assets Are Safe With US. Really!

I think the US Treasury has hit a new low with this Reuter's report from Geithner's recent visit to China.

China is the biggest foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion in Treasuries as of March, but some analysts believe China's total U.S. dollar-denominated investments could be twice as high.

"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.

For more fun with business cycles and financial time series, visit econocasts.com and my public chart list at stockcharts.com.