The first revision of the third quarter real GDP numbers were actually stronger than the preliminary estimates, coming in at 2.6% growth for the quarter after first being announced at 2.0% annualized growth. Looking inside the numbers reveals that personal consumption expenditures led the growth along with export expansion growing more competitively relative to import growth (imports still grew faster despite reductions in the value of U.S. currency). Residential investment continues to lag, but fixed investment grew strongly and inventory investment did too. This now makes five consecutive quarters of growth despite the unemployment rate continuing to remain stable at just under 10%.
The bailout train appears to have stopped, or at least taken a break over the last few months, which is a good thing. However, the FED will soon begin its $600 billion quantitative easing (which the markets have already started to assimilate). The outlook for this expansionary move is not clear, but understand that it will be flexible, i.e., the FED will not engage in all or even part of it if the economic recovery proceeds effectively without it, and the exit strategy is in place to alleviate inflation if it appears forthcoming. At his classroom appearance here in Jacksonville last month, chairman Bernanke released publicly for the first time that we are aware of, his exit strategy relative to bank reserves. He intends to extract liquidity from the system when necessary by increasing the interest payments to banks for their reserves held at the FED. Presently this interest rate is 0.25%, but Bernanke perceives raising that to whatever is necessary to motivate the banks to lend less if the economy is overheating. To our knowledge, this is the first time such an approach is possible given that interest payments on reserves has not been available previously. This strikes us as a legitimate approach to maintaining the desired level of liquidity. If you want a good laugh about quantitative easing see Quantitative Easing Explained.
It is our opinion that the recently concluded recession lasted so long (seven quarters) and that its after effects in terms of slow growth and persistent high unemployment arose, because the policy initiatives employed by both the fiscal side of government and the FED were less than appropriate for the causes and consequences of the downturn. The “Great Recession” was initiated by the escalation of oil prices that began in January of 2007. The growth in oil futures prices in particular, motivated investors to migrate away from other investments in financial markets, real assets, and particularly real estate, which exposed the faulty lending practices in the mortgage industry and precipitated the crash. It is not coincidental that the crash occurred in October 2008, just three months after the peak in oil prices at $147.29 per barrel. This was a supply-side driven recession (like, it can be argued successfully, the previous five recessions going back to 1973-74) and the government continues to employ demand side policy initiatives to solve a supply side recession. We contend that tax cuts to businesses, encouragements of particularly small businesses, and restructuring of regulation to reduce the costs of doing business are the best approaches to solving supply side weakness.
Finally, we suggest here in writing for the first time a possible solution to the residential housing and commercial real estate gluts. It is definitively radical, and likely to be controversial, but ultimately will assist the real estate markets to promote price growth and stimulate additional investments in real estate. The White House wants to invest public funds into “make work” projects along the lines of the New Deal. We recommend that such projects focus on eminent domain and real estate. Many of the inner city areas of this country are blighted with substandard housing that breeds crime and poverty. Alternatively, there is a massive amount of foreclosed yet superior housing available elsewhere in most communities. We recommend that each state government employ eminent domain to acquire large quantities of the blighted properties and destroy large blocks of real estate in these depressed communities. In so doing, the present residents of these properties would compete with the funds provided to them to relocate to foreclosed properties elsewhere in the community, purchased with down payments from the eminent domain compensation from the government. Renters in these depressed areas could continue to rent the foreclosed properties in the other neighborhoods from the same landlords. Perhaps you are wondering where the money would come from to replace the expenditures by government, particularly since state and local governments are struggling to find funds to produce standard services they routinely provide presently. In the short term, the funds would come in the form of loans from the federal government. These loans would be repaid from the real estate markets. Once the blighted neighborhoods are destroyed, and the foreclosed properties are repopulated, real estate values should increase based on basic supply and demand. The state and local governments will own land in the city ripe for development to fuel the agglomeration movement that was underway when this recession began, which they could sell to developers to repay the federal loans. We believe that this program would work just as well for commercial real estate as residential neighborhoods. Although this program would be novel, and generating coincident outcomes will be difficult, it would reinvigorate not just real estate demand with less excess supply, but also provide increased employment in real estate and construction to alleviate the massive unemployment from these industries.
The U.S. economy is at a crossroads relative to the ultimate strength of the recovery from the Great Recession. This year’s Christmas season will provide considerable insight into how the recovery proceeds. If consumers spend freely during the holiday season it will promote businesses to expand investment and perceive that capital expenditures and increased hiring will be advantageous for the upcoming year and beyond. If consumers do not spend, we face the potential to fall into the malaise that has gripped Japan for two decades.
Austrian economists can lament mal investment and promote savings to enhance investment all that they want, but the glut of loanable funds worldwide is far in excess of current demand for those funds, leading to excess liquidity and surplus labor. Young people entering the labor force for the first time are struggling to compete with those without jobs yet considerable more experience. Social safety nets like unemployment insurance and health care for all provide disincentives for these potentially innovative young workers to avoid working to their maximum value. We risk repeating the legacy of European economies with their large safety nets and persistent double digit unemployment, particularly amongst the young and inexperienced. How the U.S. economy recovers from this recession could generate a major structural shift in how Americans will be employed in the future and the general productivity of our economy for the next several decades.
Since many of the data change for at least one month after we first report them, we have decided to wait until at least the middle of the following quarter to report each quarter’s implications. Since the local CPI is the most significant variable that we analyze, we will start with it.
The local CPI has continued its downward movement since the beginning of the year. Seven of the last nine months have generated declines in the CPI, implying deflation. Prices in the Jacksonville MSA through October 2010 were up only by a 0.20% annualized rate and only because the increases in January, May, and August were substantial. Food prices have remained quite stable, with some products like bread and milk at levels not seen since the middle of the decade. Automobile prices have bounced back and forth as dealers try to ride the markets to infer consumer preferences for used versus new vehicles. Gasoline prices have bounced as well, ending the current analysis period up, but then dropping just in the last week. Residential real estate prices and sales fell during the third quarter, but less so for single family housing versus condos.
The outlook for the fourth quarter of 2010 appears to be more deflation. Despite moderate increases in consumer expenditures and a six point jump in consumer confidence in October, the outlook for price increases is weak given the deep discounting that retailers are using to attract customers into the stores and onto the web. It appears that businesses facing higher costs for raw materials and semi-finished goods are attempting to be selective and strategic regarding price increases. Recently, evidence has arisen of what some would construe as price gouging due to holiday periods or high demand events (e.g., localize increases in gasoline or food around venues for sporting events, or high travel seasons) in an attempt to extract higher revenues from specific sales without raising prices in general. While coupons and special offers are always available, their prevalence in the current holiday season is unprecedented.
The aggregate unemployment rate in Jacksonville spiked in August despite adjustments for seasonality, rising to 11.77%. However, the rates fell in September and October, yet remained above 11% while the national number remained at the 9.6% level. The local labor market has revealed very little improvement and we continue to be concerned that a structural shift has taken place towards greater unemployment as firms have discovered greater productivity of labor and the ability to bolster profits without additional employees. LEIP only seasonally adjusts the unemployment rate (we do not calculate it), but doing so provides valuable short term insight into the changes from month to month. For example, the unadjusted unemployment rate for October fell to 10.9%, but because unemployment generally tends to fall in October due to the beginning of the escalation in employment for the holiday season, after adjustment the 11% barrier is still below us.
The outlook for the fourth quarter of 2010 is hopefully going to continue the trend downward in unemployment, but the key will continue to be the growth of jobs versus the growth of the labor force. In October we saw an exodus of workers from the labor force while the number of unemployed also fell. Since unemployment is a ratio of workers unemployed to the workforce, the decline in the unemployed dominated and the ratio fell. However, where did those approximately 5,000 workers previously in the workforce go? If they left town then the numbers of potential workers diminished perhaps for a long time. If they remain in the Jacksonville area, but are no longer looking for work, then they have joined the ranks of the discouraged workers, a potentially long term group that does not contribute to local production but yet extracts public resources. A sizable decline in unemployment rates will require considerable increases in employment by particularly small businesses, but unfortunately, that movement still seems several quarters if not years off.
The LEIP leading indicator was up moderately overall in the third quarter of 2010, although September revealed a strong increase associated with declining new applications for unemployment insurance (a trend that was reversed in October). Consumer confidence was up strongly in October (six points), but building permits are now averaging below 250 per month, down from over 2,000 per month in 2006. Local stocks continue to be well behind the DOW as a whole. Interestingly, interest rate spreads for local financial institutions continue to be strong. Consumers need to regain their confidence and find their debit cards over the upcoming Christmas season to reverse our perspective and the fate of the local economy.
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