Tag Archives: economic recovery

The Economic Recovery continues

Recovery has turned out to be far from predictable since the recession, however it is proving to be one of the longest. The National Bureau of Economic Research (NBER) judges that the US economy began expanding again in June 2009- about 58 months ago. This means that this current stretch is bound to surpass the average for post-WWII recoveries.

Although the economy is recovering, this has been one of the slowest recoveries we’ve seen. The 6.7% unemployment rate is the highest that we’ve seen compared to recent expansions. Also, GDP has grown only 1.8% a year on average since the recession, which is about half the growth of the previous three expansions.

What are potential reasons for such slow growth? Big surprise- the Republicans are blaming the Democrats and the Democrats are blaming the Republicans. Republicans argue that Obama and other Democrats in congress are slowing growth with tax increases and regulations such as the Affordable Care Act, which they argue has supposedly drawn businesses away from investing and hiring. Democrats blame the Republicans for “withholding support for stimulus spending at precisely the moment the economy needs a boost and for brinkmanship during fiscal battles”. On a more optimistic note, chief US economist at JP Morgan Michael Feroli proposed that slow growth may just imply that the economy isn’t completely out of fuel. Essentially, he believes that this is a signal that the expansion still has room to grow.

Other economists posit that the weak growth is due to the continuing effects of the recent financial crisis. After recessions, it is always hard for both banks and consumers to get back to stable financial conditions. Another hypothesis says that the sluggish economy is due to ‘secular stagnation’- “The theory claims that the labor force and productivity, growing more slowly than in the past, along with reduced consumption and increased savings, prevent the economy from returning to prior growth levels”. This was the same fear of economists in the 1930s after the Great Depression.

Although unemployment is high, job creation is below optimum, and economic growth is below average- business profits are still continuing to climb. In terms of future growth in the economy, it is definitely a good sign that consumers are still spending and supporting businesses. I feel that there is definitely still room for the current recovery to expand. A key indicator that this article failed to mention is that business investment has recently been increasing. The fact that businesses are increasing investments and capital levels means that banks are now more willing to lend. It also signals a 2-way street between businesses and consumers that both are more confident that each will do their part to benefit the other.

Condition of the Housing Market

The United States housing market has certainly been something to keep an eye on recently. Rising prices on homes have been extremely beneficial for many including homeowners, banks, and those building new homes. However, prices have risen so much that as much as it has been helpful, it has been almost as detrimental; at least to a particular partition of the economy. First-time buyers now look at the potential opportunity to purchase their own house as a very daunting task. It is something that is not nearly as affordable anymore. That being said, while the increase in home prices generally seems like a great thing for the economy, the fact that the rise has been so extreme may actually slow down the recovery overall, with a large group of potential (entry-level) buyers being completely priced out of the housing market. This will not be good for the future condition of the economy.

The following graph from The Wall Street Journal is a good illustration of this idea.

EI-CG290_OUTLOO_G_20140309150005

With many young people finding it hard to afford to buy a home, new-home building has turned more to apartments as opposed to single-family houses. Certainly for the real-estate companies making this call it is the right decision, and they can take advantage of these unfortunate circumstances borne by people in their twenties and lower thirties who need a place to call home. The portion of new homes being constructed as apartments for rent as opposed to single-family homes has reached the highest level since the mid-1970s. It is as high as 30.8% currently, and looks to be on the rise.

The move toward apartment construction reflects the convergence of several trends. Mortgage credit is still tight. Also, Americans have seen muted wage gains, and others have high student-debt loads, forcing people who otherwise would have bought homes to rent instead.

What I take away from this turn to the building of rental apartments as opposed to more single-family homes is not good for the economy. First of all, as Moody’s Analytics estimates, only two jobs are created for each new multi-family unit compared to four jobs for a single-family home. That is, approximately half as many new jobs are going to be created (for the amount of multi-family units being built instead of single-family homes) because of the current conditions of the housing market. Anyone can see that it is much more beneficial for the jobs market to build single-family homes to buy and own as opposed to multi-family homes to rent. However, one positive that comes out of this, as Chris Foley, a principal at Polaris Pacific, a sales and marketing firm specializing in new condominium sales on the West Coast says, is that “Over time you’re going to see these units get converted from rental to condo.” The quicker this process occurs, the better for the economy.

Something else to consider regarding the housing market is how it will affect this generation of young prospective home-owners that cannot afford to buy single-family homes at this point in time and are essentially being forced to rent for the time being. As Malkiel discusses in A Random Walk Down Wall Street, “Renting Leads to Flabby Investment Muscles” (page 325). Being a homeowner has many benefits compared to renting, which really only hurts you as an investor. First of all, the returns on homes have been very plentiful over the long-run. While there are short-run periods when this does not hold true (such as 2007 and 2008), over the long-run it is certainly better to own a home than to rent. The main reason is that there are a few tax advantages when it comes to buying as opposed to renting. As Malkiel lays out, “interest payments on your mortgage and property taxes–are deductible”, and “realized gains in the value of your house up to substantial amounts are tax-exempt” (page 326). Further, owning a home is a surefire way to make yourself start saving, and is even good for your emotional wellbeing.

So, the fact that potential first-time homebuyers are being forced into renting is not beneficial for them currently or for their future selves since they are not as likely to begin saving as early on in their lives. Thus, the current condition of the housing market, while extremely beneficial for some people, has impressed some very unfortunate circumstances upon at least one (significant) group of people and will likely slow down the housing market’s recovery as well as the country’s economic recovery overall.

Two Faces of Recent and Future Consumer Spending

Consumer expenditure makes up about two thirds of the gross domestic product in the United States each year. With this in mind, it’s fairly obvious that the state of the economy is essentially in sync with consumer spending, for better or for worse. This can be a very good thing when consumers have lots of money to spend as the economy would be in great shape. In the final quarter of 2013, GDP grew by 3.2% (seasonally-adjusted rate) while consumer spending grew at a rate of 3.3%, clearly a large driver of the fourth quarter growth. The second half of 2013 actually saw the strongest growth since 2003, when the economy was flourishing. Recently, there has been a rise in consumer confidence, people are spending more, and in order to meet this increased demand, suppliers have been ramping up production. Evidently, this is good for the condition of the economy.

On the other side of the coin lies the possibility that consumer spending is going to take a hit and slow down due to slow income growth this year. If people are not making an increased amount of money, how can we expect them (us) to continue to spend more and more money?

The income figures “raise a degree of caution for the near-term outlook because some pullback in spending growth seems likely,” said Scott Brown, chief economist at financial firm Raymond James & Associates Inc. “We came into the year priced for a strong recovery, and now it looks like it might stumble a bit.”

This is certainly a cause for concern about the economy and its continued recovery. As slow and weak as it has been, the recent increase in consumer spending has been reason for optimism looking forward; but now we might take a step backward. 

That being said, the likelihood that slow income growth will stifle consumer spending is not set in stone. The increase in consumer spending towards the end of 2013 came with flat incomes in the month of December. Also, even if incomes do not grow in the near future, people can always save just a little bit less or hold off on repaying debt for the time being in order to sustain their higher amounts of spending. “The personal saving rate fell to 3.9% in December from 4.3% in November.” So clearly there are things that we (the consumers, or at least some consumers) can do, and have already started to do, in order to continue spending. It is extremely important to the continued recovery of our economy that consumers keep on spending at increased levels, and while this may not be easy to do, it can certainly be done. It will be interesting to see the growth levels of the economy and consumer spending several months from now. Hopefully any slow income growth that the country faces will not be the be-all and end-all to sustained growth in consumer expenditures going forward.

(Revised) Rising Inequality Explains the Weak Recovery, Not Vice Versa

In this article, I will not passionately try to convince you of the post title. Instead, I will make points on how John B. Taylor’s argument on the topic fails under more scrutiny. In his article in the Wall Street Journal, titled “The Weak Recovery Explains Rising Inequality, Not Vice Versa”, John B. Taylor makes following use of data to make his point that today’s inequality isn’t a cause of the type of recovery we are witnessing. First, he explains what the people who he is arguing against say: the slow recovery has been a result of growing inequality. He writes down their argument as follows:

“The key causal factor of the middle-out view is that a wider income distribution slows economic growth by lowering consumption demand. Saving rates rise and consumption falls if the share of income shifts toward the top, according to middle-out reasoning, because people with higher incomes tend to save more than those with lower incomes.”

And then he goes on to counteract this view by data he collected and put some make up on. He gives what his data shows:

“The data for the recovery since mid-2009 do not support this view. The 5.4% overall savings rate during this recovery is not high compared with the 8.4% average since 1960. It is relatively low compared to past recoveries, such as the 9.3% savings rate during a comparable period during the recovery in the early 1980s.”

In my curiosity, I was able to look at the data he worked on. It is data on personal saving ratio-the ratio of personal saving to disposable personal income. The following graph shows what the saving rate has been.
PSAVERT_Max_630_378John Taylor is correct on that the saving rate has been averaging 5.4% since the end of the latest recession. However, when he tried to compare this rate to the 8.4% average rate since the 1960, he makes wrong comparison. Due to the general downward trend of this rate over the last decades, he shouldn’t compare this 5.4% average rate of saving during the recovery to the all time average saving rate. But if we compare the 5.4% average rate during the recovery with the average saving rate between the end of 2001 and the start of the recession, which is 3.9%, we can see that the saving rate today is higher than its pre-recession level. Therefore, we have just disproved his claim by using the same argument he tried to use. In other words, with data on how the income inequality has grown, we have further see that the saving rate also increased after the recession.

10economix-sub-wealth-blog480Hence, we are able to claim that the increase in inequality indeed increased the saving rate; therefore, the total consumption demand has declined, which is exactly what the people he argued against said.

One could argue that increased personal saving rate isn’t caused by the increasing inequality . It is possible that because people might be willing to save more than what it was saving before the crisis to use their saving when another crisis comes during the recovery and uncertainty. Therefore, one could say inequality isn’t playing a much role in hindering a recovery today.

However, this surge in the saving rate after any given recession has been witnessed only twice, once after 2001 and again after 2007-2009 recessions.  The prior recoveries experienced the saving rate which was actually lower than its level before the crises. If we look at the average saving rate between November 1970 and November 1973, it was 12.8% which is higher than the saving rate after the recession, between April 1975 to December 1979, which is 10.8%. The same decrease in the saving rate was seen also during the early 1980’s recovery. We can see this trend of decrease in the saving rate following any recession in the above graph except for the last two recoveries. In last two recoveries, the saving rate surged and stayed at the higher level than it was before the recessions.

In my very first blog post, I compared the income inequality during the pre-recession periods for the Great Depression and the Great Recession and argued the recovery the economy is going through now is unhealthy one. One could agree with John Taylor on that the weak recovery is causing the widening inequality and the first problem policymakers should tackle is to boost the recovery by any means. However, the increasing inequality could be the heart of the problem, and the policymakers should prioritize equality to change the speed of the recovery. But how the inequality must be tackled should be devoted to a number of blog posts itself. I believe recent discussions and steps toward solving the inequality is a way to fasten the recovery.

Rising Inequality Explains the Weak Recovery, Not Vice Versa

In this article, I will not passionately try to convince you of the post title. Instead, I will make points on how John B. Taylor’s argument on the topic fails under more scrutiny. In his article in the Wall Street Journal, titled “The Weak Recovery Explains Rising Inequality, Not Vice Versa”, John B. Taylor makes following use of data to make his point that today’s inequality isn’t a cause of the type of recovery we are witnessing. First, he explains what the people who he is arguing against say: the slow recovery has been a result of growing inequality. He writes down their argument as follows:

“The key causal factor of the middle-out view is that a wider income distribution slows economic growth by lowering consumption demand. Saving rates rise and consumption falls if the share of income shifts toward the top, according to middle-out reasoning, because people with higher incomes tend to save more than those with lower incomes.”

And then he goes on to counteract this view by data he collected and put some make up on. He gives what his data shows:

“The data for the recovery since mid-2009 do not support this view. The 5.4% overall savings rate during this recovery is not high compared with the 8.4% average since 1960. It is relatively low compared to past recoveries, such as the 9.3% savings rate during a comparable period during the recovery in the early 1980s.”

In my curiosity, I was able to look at the data he worked on. It is data on personal saving ratio-the ratio of personal saving to disposable personal income. The following graph shows what the saving rate has been.
PSAVERT_Max_630_378 John Taylor is correct on that the saving rate has been averaging 5.4% since the end of the latest recession. However, when he tried to compare this rate to the 8.4% average rate since the 1960, he makes wrong comparison. Due to the general downward trend of this rate over the last decades, he shouldn’t compare this 5.4% average rate of saving during the recovery to the all time average saving rate. But if we compare the 5.4% average rate during the recovery with the average saving rate between the end of 2001 and the start of the recession, which is 3.9%, we can see that the saving rate today is higher than its pre-recession level. Therefore, we have just disproved his claim by using the same argument he tried to use. In other words, with data on how the income inequality has grown, we have further see that the saving rate also increased after the recession.

10economix-sub-wealth-blog480Hence, we are able to claim that the increase in inequality indeed increased the saving rate; therefore, the total consumption demand has declined, which is exactly what the people he argued against said.

One could argue that  because people might be willing to save more than what it was saving before the crisis to use their saving when another crisis comes during the recovery and uncertainty, the higher saving rate doesn’t say that inequality is hindering the recovery. But this surge in the saving rate after a recession has been witnessed only twice, after 2001 and 2007-2009 recessions. Prior recoveries experienced the saving rate which was actually lower than its level before the crises. If we look at the average saving rate between November 1970 and November 1973, it was 12.8% which is higher than the saving rate after the recession, between April 1975 to December 1979, which is 10.8%. The same decrease in the saving rate was seen also during the early 1980’s recovery. We can see this trend of decrease in the saving rate following the recession in the above graph except during the latest two recoveries.

In my very first blog post, I compared the income inequality during the pre-recession periods for the Great Depression and the Great Recession and argued the recovery the economy is going through is unhealthy one. One could agree with John Taylor on that the weak recovery is causing the widening inequality and the first problem policymakers should tackle is to boost the recovery by any means. However, the increasing inequality could be the heart of the problem, and the policymakers should prioritize equality to change the speed of the recovery.

Increasing Bond Prices in the Wake of a Perceived Economic Recovery

With a burgeoning American stock market and the Fed’s announcement to start cutting back its bond-purchasing program, the field was set for bond prices to drop in the beginning of 2014. It seemed likely that investors, seeking higher returns, would shift their investments from bonds to equities. As a recent article in The Economist points out, however, this is not the case so far this year. Bond markets are actually doing surprisingly well.

Instead of rising since the end of 2013, yields on benchmark ten-year bonds, which are inversely related to prices, have fallen in America and Europe (see chart). Yields on US Treasuries have slipped from 3.01% to 2.88%; on British gilts from 3.03% to 2.86%; and on German bunds from 1.94% to 1.83%.

So far the story is pretty straightforward: yields on bonds are falling, causing bond prices to increase. Before we go any further I want to pause and ask a couple of questions in order to focus our analysis. (1) Why are bond prices and interest rates inversely related? (2) How are inflation, bond prices, and interest rates related? (3) Given we understand the answers to the previous two questions, why are bond prices rising in the wake of an apparent economic recovery? Shouldn’t demand for bonds fall as investors shift their money to the stock market?

(1) Why are bond prices and interest rates inversely related?

We answered this question in class today, but for the sake of clarity and my own learning I’ll summarize it again here. Purchasing a bond allows you to receive a stream of future cash payments from the borrower in the form interest payments (aka coupon payments) and the eventual repayment of the principal when the bond matures. Ignoring inflation expectations and credit risk, the bond price is calculated by summing the present value of each of these coupon payments plus the present value of the bond at maturity. To find the present value of each of these payments, their future value is discounted (aka divided) by the yield (aka the interest rate of the bond). Thus it is clear why a bond’s price and its corresponding interest rate are inversely related: as the interest rate rises, each coupon payment is discounted (aka divided) by a larger amount, causing the total bond price to decrease.

(2) How are inflation, interest rates, and bond prices related?

This is an important question that I don’t think we covered as much in class. I’m sure most people taking this class know the answer already, but it’s nice to get a quick refresher. Simply put, bonds hate inflation. High inflation and high-expected inflation cause future coupon payments to lose value. As a consequence, lenders demand higher yields (aka interest rates rise) and the price of the bond falls. This explanation, however, is a bit too simple. Inflation expectations affect short-term and long-term interest rates differently, so bonds with different terms to maturity will be affected differently. These effects are summarized quite nicely in a concept/graphic called the yield curve.

(3) Why are bond prices rising in the wake of an apparent economic recovery?

This question doesn’t have as much of a straightforward answer as the other two, but the main two reasons I’d like to discuss are low inflation expectations and poor job figures. As I’ve discussed in previous blog posts inflation rates across the developed economies have remained low and show no signs of rapid growth:

In America the price index targeted by the Fed (which aims at 2% inflation) has been rising by less than 1%. In Britain consumer-price figures published on January 14th showed inflation hitting the Bank of England’s 2% target, after four years above it. The fillip to bond markets from low inflation is stronger still in the euro zone, where consumer prices rose by just 0.8% in the year to December and core inflation (stripping out volatile items like energy and food) fell to a record low of 0.7%.

These low inflation figures cause long-term interest rates to fall, which, in turn, cause bond prices to rise.

Another reason is the underwhelming jobs figures that were released on January 10th:

Economists had expected employers to add around 200,000 jobs in December; the actual number was a lowly 74,000.

Poor jobs figures may be a sign that the economic recovery is not as strong as investors thought, causing some investors to hesitate in investing in the stock market and buy up bonds instead.