Friday, December 7, 2012

"Beyond the Cliff," UCLA Anderson Forecast, December 2012

As of this writing, the U.S. economy is hurtling towards the fiscal cliff. In short hand, the fiscal cliff is a colloquial expression describing the expiration of previously enacted tax cuts combined with some automatic spending cuts totaling about $600 billion (about 4% of the economy) that are scheduled to take effect in January 2013. Congress and President Obama will resolve it one way or another. Its resolution will be characterized as good, bad or ugly largely depending on the world view of the observer.

Just to remind you, the major elements of the fiscal cliff include automatic spending cuts next year of $78 billion, the elimination of $40 billion in emergency unemployment compensation benefits, and tax increases totaling more than $400 billion from an end to the:
• 1. Payroll Tax Cut - $126 Billion
• 2. 2001/2003 Tax Cut (Upper Income) – $56 billion
• 3. 2001/2003 Tax Cut (Middle/Low Income) - $136 billion
• 4. Alternative Minimum Tax Fix - $103 billion

Because we don’t know what the final resolution will be we are assuming for forecasting purposes, despite the current furor, a "benign" compromise where spending is reduced and taxes are increased in a phased in manner over the next few years. From the point of view of the near-term economic environment modest growth continues, but an agreement on the cliff will be far from a solution to the long-term fiscal deficits facing the U.S. economy.

If Congress and the President fail to compromise, then, according to the Congressional Budget Office, the economy will fall back into recession with unemployment rate returning to 9% late next year. In general we agree with that assessment. In this report we look beyond the cliff.

Even assuming a benign resolution to the fiscal cliff and after taking into account the recent upward revision to the third quarter GDP data, the near-term outlook for the U.S. economy continues to be characterized by modest growth. Specifically, we are forecasting that real GDP will increase at an annual rate of only 0.7% in the current quarter and sub-2% growth in 2013s first half. (See Figure 1)

Thereafter, we can visualize growth accelerating to a run rate in excess of 3% in 2014. In this environment the unemployment rate will remain close to 8% in 2013, but decline to 7.2% by the end of 2014. (See Figure 2) Although this reduction in unemployment appears modest, we are forecasting job growth on
the order of 160,000 a month in 2013 and 200,000 a month in 2014. (See Figure 3) Not great, but a small improvement from recent years.

Why will growth be so tepid even after a fiscal cliff deal?

Deal or no deal the U.S. economy is being buffeted by economic weakness abroad. Europe and Japan are in recession and Brazil, China, and India are slowing. Simply put, the export growth engine is stalling; more on that later.

Furthermore, Hurricane Sandy has severely disrupted the economy of the Mid-Atlantic States thereby reducing output over the near-term. To be sure, measured GDP next year will be boosted later
Figure 3 Payroll Employment, 2005Q1 -2014Q4
Figure 1 Real GDP Growth, 2005Q1 -2014Q4F

Figure 2 Unemployment Rate, 2005Q1 – 2014Q4F

by rebuilding efforts, but make no mistake, wealth destruction is hardly an economic positive. Finally, the tax increases and spending cuts coming out of any fiscal deal will weigh on economic activity. It remains to be seen that a deal will engender sufficient euphoria to boost the economic outlook as so many commentators are currently arguing.

Fiscal Imbalances Remain

The most important thing to understand about the fiscal cliff and the long-term deficit negotiations accompanying it is that both parties have much higher priorities than deficit reduction. If President Obama really cared about the deficit he would never have created the new healthcare entitlement or alternatively he would delay its implementation a few years and use the revenue to reduce the deficit. Similarly, there was nary a tax increase in the Ryan Budget passed by the House Republicans. To emphasize the point neither President Obama nor Speaker John Boehner endorsed the bipartisan Simpson-Bowles Commission recommendations. Any serious attempt to reign in the deficit requires both tax increases on more than just the high income earners and more than modest entitlement reductions, especially in Medicare and Medicaid programs. As a result, we continue to forecast high deficits over the next decade. (See Figure 4)

The current impasse involving the fiscal cliff and the on-going structural deficit of the United States has not gone unnoticed by the global credit markets. Forget the Standard & Poor’s down grade last year, look at the credit default swap market. In early November, it was cheaper to insure against default corporate credits such as Chevron, Google, Johnson & Johnson and Wal-Mart than the United States of America.
1 Simply put, high-quality corporates have become the new sovereigns.

Furthermore, the current deficit is understated as result of the extraordinary aggressive monetary policies of the Federal Reserve. A zero interest rate policy does wonders for the interest expense line on the federal budget. In essence, the Federal Reserve has enabled the high deficit policies implicitly endorsed by both political parties. In defense, the Fed has argued were it not for their policies the deficit would be much higher because the economy would have been much weaker.
Figure 4 Federal Surplus/Defecit,
FY 2000 - FY 2022
Figure 5 Federal Funds Rate vs. Yield on 10-Year U.S. Treasury Bonds, 2005Q1 - 2012Q4F

Nevertheless, we anticipate that the current zero interest rate policy will continue until late 2014. (See Figure 5) In contrast, we note that the Fed has signaled that the current policy will continue until mid-2015. We base our view on the premise that the bond market will begin to sense more inflationary pressures in the economy in 2014 than the Fed now contemplates.

Front End Strength Offset by Back End Weakness

In contrast to the typical business cycle, the recent recovery has been characterized by strength in the back end of the economy, business investment and exports, and weakness in the front end, consumer spending and housing. Now with the recovery more than three years old, the business side of the economy and exports are weakening and housing is gaining strength. In fact ,the late arrival of the traditionally early pickup in the housing market has become the leading source of strength.

Led by gains in multi-family construction housing starts are expected to increase from 612,000 units in 2011 to 768,000 units this year. Further increases to 991,000 units and 1.34 million units are anticipated in 2013 and 2014, respectively. (See Figure 6) Indeed, by the end of 2014 housing starts are expected to run at an annual rate of 1.45 million units. We do not believe our forecast for housing starts to be aggressive because from 1990 – 2007 housing starts averaged about 1.5 million units a year.

After expanding at an 11% clip, the growth rate in real investment in equipment and software will decline to 6.8% this year and is projected to slow again to 5.6% in 2013. (See Figure 7) Essentially, the early cycle rebound in equipment and software spending represented a rebound from the freezing up of capital spending by businesses in response to the credit crisis of 2008. Similarly, business investment in structures, which never really recovered from the recession, appears to be stalling out with essentially zero growth expected for 2013. (See Figure 8) What’s happening here is a temporary reduction in natural gas drilling
Figure 6 Housing Starts, 2005 – 2014F, Annual Data
Figure 7 Real Investment in Equipment and Software, 2005 – 2014F, Annual Data


in response to falling prices and the completion of several major utility projects. By 2014 this sector will be growing briskly as the construction of office buildings and shopping centers rebounds and natural gas drilling responds to an improved pricing environment.

Over the longer run, energy development has the potential to transform the U.S. economy. For example, the International Energy Agency believes that the U.S. will become the world’s largest oil producer, surpassing Saudi Arabia, by 2020.
2 Furthermore natural gas production is surging as the U.S. is forecast to surpass Russia as the world’s leading producer by 2015. So much so that natural gas boilers now account for 31% of U.S. electricity production compared to 24% a year ago.

Much of the increased production is the result of hydraulic fracturing, a process involving the use of a mixture of highly pressurized water with sand and chemicals that has the ability to unlock hydrocarbon reserves in hitherto inaccessible shale formations. This new technology has triggered an energy boom in Pennsylvania and Ohio and it has transformed North Dakota into a leading energy producing state. In fact, the Bakkan Shale in North Dakota appears to have the equivalent oil reserves of two Prudhoe Bays (Alaska’s largest field).

The oil and gas boom is fueling an industrial revival in the Midwest and the Gulf Coast as low cost feed stocks have made the U.S. the low cost producer in a host of petro-chemicals and fertilizer. New plants have been announced in Pennsylvania, Louisiana and Texas. Moreover, the once nearly dead steel town of Youngstown, Ohio is being revived with the manufacture of steel pipe and drilling equipment.

To be sure the boom is not without its critics. Hydraulic fracturing is water intensive and there are several pollution-related questions involving the chemicals used in the process. A major test will come in California where the vast Monterey/Santos Shale (Kern and Los Angeles Counties) is just beginning to be opened for development. A critical question will be the attitude of the state and federal regulators towards this activity. Although much of the energy-related spending will occur beyond our forecast horizon, it
Figure 9 Real Exports, 2005 – 2014F, Annual Data
Figure 8 Real Investment in Business Structures, 2005 – 2014F, Annual Data


does offer the prospect of a better economic environment later in the decade. It is ironic that the Obama Administration came to power in 2009 on a platform of alternative energy and that it is now presiding over a major boom in conventional hydrocarbon production.

Meantime, while we await the energy boom that is to come, real exports are decidedly slowing. After increasing at an 11.1% annual rate in 2010, growth slowed to 6.7% in 2011 and will only be 3.3% this year. (See Figure 9) Simply put, it is very hard to grow exports with Europe and Japan in recession and much of the rest of the world in a slowdown. Recall that for several years we have believed that the U.S. growth engine would be exports. That engine is now sputtering, but with rising domestic energy production, at least import growth is slowing even faster than exports.

Inflation: Cold Now, Simmering Later

Although inflation certainly is not a problem today, with gradual but accelerating economic growth and the lagged effect of the extraordinary monetary ease of the Fed, it could very well become an issue in late 2014. Put bluntly, the Fed wants a temporary increase in inflation to lower real interest rates. It believes such a policy will speed up the recovery. With the Federal Funds rate set at zero the only way it can lower real interest rates is by increasing the inflation rate. Because capacity utilization remains low and unemployment and under-employment remains high, it is likely that inflation will stay low in 2013, but we surmise that inflationary pressures will build far quicker than the Fed now thinks and that inflation will be running above their target 2% rate in 2014. (See Figure 10) One source of the inflation will come from rising apartment rents (already happening) and the interaction of higher rents and housing prices on the owners’ equivalent rent calculation in the various price indices.


Looking beyond the fiscal cliff debate, we forecast that the economy will be growing at less than a 2% annual rate through mid-year 2013. Thereafter we expect growth to pick up and to exceed 3% for most of 2014 with housing activity leading the way. In this environment unemployment will stay close to the current 7.9% rate in 2013, but gradually decline to 7.2% by the end of 2014. Towards the end of the forecast period we expect that inflation will be running above the Fed’s 2% target that will bring to an end the zero interest rate policy that has been with us since late 2008.
Endnotes 1. See Goodman Lawrence, "Better Borrowers than Uncle Sam," Center for Financial Stability, November 13, 2012.
2. See Faucon, Benoit and Keith Johnson, "U.S. Redraws World Oil Map," The Wall Street Journal, November 13, 2012, p.1

Monday, November 19, 2012

My Appearance on CNBC, November 19, 2012

See the url below:

Wednesday, November 7, 2012

My Latest USNews blog, "The Outlines of a Post-Election Tax Deal", November 7, 2012

For the full article see the URL below:

The Republicans Have to Learn How to Count

Last night's re-election win for President Barack Obama was a lesson in arithmetic that the Republican Party had better learn if it is ever to be successful in future presidential elections. Simply put the Republicans can't appear downright hostile to the fast growing Latino population that now accounts for 10% of the vote. When a party loses the Latino vote by 40 points, it is obvious it will lose New Mexico, Colorado, Virginia, Nevada and likely Florida. Knock knock, is anybody home. Time to support immigration reform.

Furthermore the Republicans can't appear hostile to the life style choices of millions of young single women and gay Americans. The party certainly can be pro-life, but does it make sense to support state required vaginal probes and sanctify the fetuses that are the result of rape? The two wacko Senate candidates in Missouri and Indiana nationalized the "rape issue" to the benefit of the Democrats.

It would also help if the party emulated the Obama campaign's effective use of "big data" to identify potential voters and to get them to the polls. Thus learning how to count is essential and doing it better certainly won't hurt.

Monday, November 5, 2012

My Letter to Comcast CEO Brian Roberts on MSNBC

I wrote this letter a month ago and have yet to receive a reply. As a long shot, maybe making it public will get a response.

Mr. Brian L. Roberts
Chairman and CEO
Comcast Corporation
One Comcast Center
Philadelphia, PA 19103-2838

 October 1, 2012

Dear Mr. Roberts:

I am writing you as a fiduciary for my wife and daughter who collectively own XXX(original has exact number of shares) shares of Comcast “A” stock. There is a cancer growing on our NBC News franchise and that cancer is MSNBC. By becoming the house organ of the American Left and the mouthpiece for President Obama’s reelection campaign MSNBC is destroying the credibility of NBC News. To be sure if MSNBC were completely separate from NBC News, it would be possible to maintain the hard earned credibility of NBC News. Unfortunately that is not the case.

 Although “Morning Joe” remains a credible outlet for NBC News personalities, it cannot be said for the rest of MSNBC’s programming. I weep when I see the formerly credible Andrea Mitchel get sucked into the partisanship of MSNBC. The same can be said about Tom Brokaw, a newscaster I have watched since he was doing local news in Los Angeles. Moreover our news super-stars, Brian Williams and David Gregory, lose all credibility when they do election coverage with the likes of Rachel Maddow, Ed Schultz and the formerly reasonable Chris Matthews.

 While I agree there is a real cable audience for a Left perspective on the news, I do not believe there is a mass audience for it. Remember NBC News is in the mass audience business and herein lies my worry. The more NBC News mingles with MSNBC it loses credibility with less partisan viewers and those viewers, in my opinion, will find their news elsewhere. Thus whatever is gained with cost-synergies between NBC and MSNBC, more will be lost on the revenue side as ratings drop.

Mr. Roberts, I don’t think I am a right wing crank. The issues I am raising speak to the credibility of the news business. Maybe it was lost a long time ago, but it will make running our democracy far more difficult. Furthermore if NBC and MSNBC continue on their current paths, the profitability of Comcast will be eroded. Speaking for my family, NBC/MSNBC’s share has declined over the past year.

 Yours truly,

David Shulman

Saturday, October 6, 2012

A Note on the Publc Education Employment Revisions in the September Unemployment Report

A very exciting title, but this stuff is important. Buried in yesterday's employment report for September 2012 was a positive 97,000 job revision for public employment in education in August. What happened? Simply put several school districts, including the 40,000 teacher strong Los Angeles Unified School District, started school early this year. So instead of having the jobs reported in September, they were pick up in the revision for August. Thus there was no hiring surge over the summe. Moreover private sector jobs were revised down by 5,000 for July and August. All this means is that yesterday's job report was over-hyped. To be sure it was good news that the unemployment rate dropped to 7.8%, but don't be surprised if it returns to 8% next month.

Saturday, September 22, 2012

"The Muddle Through Economy". UCLA Anderson Forecast, September 2012


The economy continues to muddle through at a very sluggish pace as it has since the nadir of the Great Recession in mid-2009. In general real GDP growth has been in a 1-3% channel and it is now operating at the lower end of the range. Specifically, we are forecasting real GDP growth of 1.3% in the current quarter and 1.5% in the fourth quarter. (See Figure 1) Nevertheless, as we get into 2013, growth will ratchet up to above 2% and 2014 could very well put the run rate of GDP growth in excess of 3% as economic activity is buoyed by strength in residential and nonresidential construction and a rebound in export growth.

Tepid GDP growth, combined with a structural adjustment in the economy, has caused employment gains to be modest. (See Figure 2) As a result, the unemployment rate has stayed above 8% for three and a half years. (See Figure 3) With several quarters of 1-2% growth ahead of us we do not expect the unemployment rate to dip below 8% on a quarterly basis until the first quarter of 2014. Simply put, job growth on the order of 160,000 a month in 2013 will not be sufficient to make any real dent in the unemployment rate. However, as job growth accelerates to 200,000 a month in 2014 the unemployment rate will begin to meaningfully improve.
Figure 2 Unemployment Rate, 2005Q1 – 2014Q4F
Figure 1 Real GDP Growth, 2005Q1 -2014Q4F


The economy is being held back by a still over-leveraged consumer and that is working to dampen consumption, a slowdown in corporate investment spending, a softer export environment and a pall of policy uncertainty with respect to fiscal policy and regulation.

Aside from working off the hangover caused by the debt binge of 2003-07, consumers are being plagued by a decline in real household income. Although the economy can and did grow in the face of stagnant median income in the 2000s, weakness in median income is certainly no help. According to Sentier Research, a new economics consultancy founded by two former Bureau of the Census senior staffers, real median household income has declined by 5% since early 2008 and is still 2% below where it was when the economy bottomed in June 2009. (See Figures 4 and 5)
Figure 3 Payroll Employment, 2005Q1 -2012Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 4 Real Median Household Income Indexed (thin line) and Unemployment Rate (thin line), 2000 – June 2012
Source: Sentier Research

Business Investment Slowdown

After rising at a very robust 11% rate in 2011, we project that investment in equipment and software growth will slow to 8.1% and 6.4% in 2012 and 2013 respectively. (See Figure 6) To a great degree, the strong growth in investment represented a catch up from the 16.4% collapse in 2009. Similarly, we expect minimal growth next year for investment in business structures as factory, mining (gas drilling) and utility construction started in 2011 is completed later this year and early in 2013. A rebound in these sectors, as well as a ramp up in commercial construction, will cause investment in structures as a whole to grow by 7% in 2014. (See Figure 7) Furthermore, the rapid growth in exports witnessed in 2010 and 2011 is ebbing as Europe is mired in recession and growth in China, Brazil and India slows. (See Figure 8)
Figure 5 Real Consumer Spending,
2005 – 2014F, Annual Data
Figure 6 Real Investment in Equipment Software, 2005 – 2014F, Annual Data


Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 7 Real Investment in Business Structures, 2005 – 2014F, Annual Data

Sources: U.S. Department of Commerce and UCLA Anderson Forecast


Housing Rebound

As we noted last quarter, the one bright spot in the economy is the long-awaited rebound in housing construction. Led by multi-family construction, housing starts are ramping up from 612,000 units in 2011 to 763,000 units this year and just under one million units in 2013. By 2014, we anticipate that housing starts will be in excess of 1.3 million units. (See Figure 9) The growth in housing will account for about a full percentage point in GDP growth by 2014. The strength in housing is being underpinned by gradually rising home prices, record low mortgage rates, improved household formations and modest employment growth.

All Out Monetary and Fiscal Policy

The sluggish growth of the past few years has occurred against a backdrop of extremely stimulative monetary and fiscal policies. Since 2008 the Federal Reserve has had its "pedal to the metal" by engendering an unprecedented explosion in its balance sheet which has more than tripled in size. (See Figure 10) Initially the Fed engaged in a largely conventional monetary policy by lowering its target for the Federal Funds rate from 5 ¼% to essentially zero where it has stood since late 2008. (See Figure 11)

With the policy rate stuck at the "zero bound," the Fed engaged in a large scale asset purchase program known as quantitative easing and made a commitment to maintain its zero interest rate policy through 2014. Fed Chairman Ben Bernanke noted in his recent Jackson Hole remarks that there is academic support for the notion that the Fed’s non-traditional policies lowered the yield on 10-year U.S. Treasury bonds by 80-120 basis points; hardly trivial.


Thus far, the extraordinary monetary policy has not ignited inflation nor an increase in inflationary expectations. Put simply, despite a commodity scare that has accompanied the second round of quantitative easing in late 2010, inflation has been quiescent. (See Figure 12) Nevertheless, if we are correct about acceleration in economic growth in 2014, we won’t be surprised to see inflation rising above their 2% inflation target.
Figure 8 Real Exports, 2005 – 2014F,
Annual Data, Percent Change

Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 9 Housing Starts, 2005 – 2014F, Annual Data

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 10 Federal Reserve Bank Credit, 1991 – Aug 2012, Weekly Data, In $ Billions.
Source: Federal Reserve Bank of St. Louis
Figure 12 Price Deflator for Personal Consumption Expenditures, 2005Q1-2014Q4F
Figure 11 Federal Funds Rate vs. 10-year U.S. Treasury Bonds, 2005Q1 -2014Q4

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Sources: Federal Reserve Board and UCLA Anderson Forecast

Similarly, fiscal policy has been highly stimulative with the cumulative federal deficit of the past four years amounting to $5.1 trillion. (See Figure 13) As a result, U.S. debt held by the public has risen from 36% of GDP in 2007 to 73% of GDP in 2012. However, with that level of deficit spending now being viewed as unsustainable, federal government purchases are actually contracting. (See Figure 14)

Remember, in the GDP accounts the bulk of Federal spending is accounted for as transfer payments, which mostly enter into the GDP stream as consumer and state and local government spending. This is important, because as sluggish as it has been, consumer spending has been supported by increases in unemployment compensation, disability payments and other income support programs.

Nevertheless if you spoke to most economists in late 2008 and you told them that the Fed would embark on a four year zero interest rate policy and more than triple the size of its balance sheet and that the federal government would run $5 trillion of deficits over the next four years; they would have predicted a major boom with inflationary consequences. Donald Kohn, the former Vice-Chairman of the Fed and long-time Fed staffer asked the question at Jackson Hole, "Why is it that we’ve had such incredibly accommodative monetary policy for so long and we’ve had so little growth?"


Strong growth has obviously not occurred and two constrasting hypotheses would argue that we were truly headed for Great Depression 2.0 and the policy prevented a disaster or that economic policy as we know it is not as effective as we thought. Perhaps more likely the truth involves a combination of the two alternative hypotheses. We have no answers to this question here and now, but this will be the topic of more than a few Ph.D. dissertations over the next few years. Counter-factual history is hard to do.

Falling Off the Fiscal Cliff?

At midnight December 31, 2012 the tax cuts enacted in 2001, 2003 and 2009 expire, and that includes not only the tax rate schedule, but also the
Figure 14 Real Federal Purchases, 2005 – 2014

Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Figure 13 Federal Surplus/Deficit,
FY 2000 – FY 2022

Sources: Office of Management and Budget and UCLA Anderson Forecast


so-called alternative minimum tax patch and the two percentage point reduction in social security taxes.
5 In addition, about $55 billion of spending will be sequestered and emergency unemployment benefits will expire. All told, about $600 billion in tax hikes and spending cuts are scheduled to take effect. The Congressional Budget Office predicts that if all these eventualities occur, the deficit would be cut almost in half, but the United States would be pushed into recession with real GDP declining by 0.3% in 2013 and the unemployment rate rising to 9%.

The astute reader would have noticed that in Figure 13 above we have the federal deficit gradually coming down. There is no cliff. Why? In the triumph of hope over experience we are assuming that there will be a post-election compromise that will allow for a phase-in of tax increases and spending reductions. This will be especially difficult to do after what will likely be the most vitriolic election in years.

Furthermore, private sector activity is bound to be influenced as individuals and businesses handicap the likely outcome to all of the tax and spending changes on the table. Remember in the fourth quarter of 1992 activity was pulled forward to avoid the likely tax increases that were to come in the new Clinton Administration with a concomitant slowdown in the first half of 1993.

Nevertheless, fiscal discipline is sorely needed. Despite all of the campaign rhetoric that we have already heard and soon will hear, entitlement programs are going to be cut and taxes are going to be raised. A policy of spending roughly $3 for every $2 taken in is hardly sustainable. Indeed with the current debt load equal to GDP and with the debt held by the public equal to 73% of GDP we are rapidly approaching the danger zone identified by Rogoff and Reinhart in their cross country comparisons of historical debt crises.

The economy continues to muddle through in a 1-3% growth environment that will keep the unemployment rate painfully high. Although not contracting, consumer spending, exports and business investment will remain sluggish. In addition, federal purchases weighed down by a high debt load are contracting. The one bright spot is the beginning of the long awaited rebound in housing. The big near-term risk comes in the form of the fiscal cliff where a too rapid fiscal consolidation could very well trigger a recession in early 2013.
Endnotes 1. See Shulman, David, "The Uncertain Economy," UCLA Anderson Forecast, September 2010.
2. See Shulman, David, "Rebuilding the Housing Economy," UCLA Anderson Forecast, March 2012
3. See Bernanke, Ben S., "Monetary Policy since the Onset of the Crisis," Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 31, 2012
4. See Hilsenrath, Jon, "Bernanke Faces Skepticism Over Policy," The Wall Street Journal Online, September 2, 2012
5. See, "An Update to the Budget and Economic Outlook: Fiscal Years 2012-2022," Congressional Budget Office, August 2012

6. For an updated version of Rogoff and Reinhart see, Reinhart, Carmen. M., Reinhart, Vincent R., and Rogoff, Kenneth S., "Public Debt Overhangs: Advanced Economy Episodes since 1800," Journal of Economic Perspectives, Summer 2012, pp. 69-86.

Saturday, August 11, 2012

The Ryan Choice

Mitt Romney's choice of House Budget Chairman Paul Ryan as his running mate is a strong governing choice, but it represents very risky political choice. By this choice Romney has decided to play on President Obama's playing field by making this presidential election a choice on the future direction of the country, instead of a referendum on the sad state of the economy. You can bet on it, that the airwaves will be be filled with Obama ads showing Romney and Ryan throwing granny off the medicare cliff, while a few fat cats are toasting their tax cuts with glasses of champagne.

Nevertheless Paul Ryan is a strong campaigner and he, more than any of the other VP hopefuls, can articulate the case that the United States is on a fiscally unsustainable path.  This election will be about big things, not small bore stuff. No matter what President Obama says, he knows and most senior Democrats know, medicare, medicaid and social security have to be reformed. Simply put, the postwar entitlement state has run out of gas and the Democratic leadership continues to lie to the American people about it. The Republicans lie when they say the fiscal problems of the the United States can be solved without any tax increases. As an aside the big loser from today's announcement is Vice President Joe Biden. He will have his work cut out for him when he meets Ryan in their debate.

In terms of governing, should the Romney-Ryan team win in November they will be able to hit the ground running with respect to the budget. This would be an enormous advantage given the fiscal situation our Nation faces. Furthermore, as a complete outsider, it looks to me that Romney and Ryan really get along; they are both highly focused numbers people.

Monday, June 25, 2012

"Rebuilding the Housing Economy," UCLA Anderson Forecast, June 2012

After an agonizing six year decline where nearly $7 trillion of wealth was destroyed, the housing economy is now in the process of rebuilding. With average home prices declining by one-third, it has been a searing experience for most homeowners who never believed that housing prices would ever fall. (See Figure 1) As a result, with existing homeowners being foreclosed upon and potential homeowners either unable to meet more stringent purchase requirements or fearful of continued price declines, the homeownership rate declined from a peak of 69% in 2004 to 66% in 2011 and is forecast to drop to 65% by the end of this year. (See Figure 2)
Figure 1 Case-Shiller Home Price Index, 2000 – March 2012, Monthly Data, 2000 = 1.0. Source: Federal Reserve Bank of St. Louis and Standard & Poor's 

Nevertheless, there are many indicators offering evidence that the housing market has bottomed and a recovery is underway. Despite a regulatory logjam in the process, foreclosures appear to have peaked. (See Figure 3) Concomitantly, existing home sales are now on the rise. After peaking at 7.1 million home sales in 2005, the series declined to 4.1 million units in 2008 and is expected to exceed 5.0 million units in 2013. To be sure, about one-third of existing home sales are accounted for by either foreclosures or "short sales," yet, the steady rise in activity is indicative of recovery. (See Figure 4)

The recovery is underpinned by a gradually improving labor market, a rebound in household formations and record low mortgage rates, now below 4%. (See Figures 5, 6, and 7) For example, household formations averaged 1.33 million a year between 2000 -2007 and then collapsed to 327,000 in 2009. By last year household formations recovered to 1,072,000 and we forecast a robust 1.7 million run rate in 2013- 14.
Figure 2 Homeownership Rate, 1990 -2012E, Yearend Data, Percent
Source: U.S. Bureau of the Census and UCLA Anderson Forecast
Figure 3 Loans in Foreclosure and Past Due Mortgages, 2005Q1 – 2012Q1, Percent
Source: Mortgage Bankers Association and The Wall Street Journal
 Simply put there are too many young adults living in their parent’s homes, an untenable situation for all of the parties involved.

Nonetheless the recovery will continue to be gradual and uneven. Though improving, the job market remains far from healthy and higher down payment and credit score requirements are working against the stimulative effects of low interest rates. New to this cycle is the impact of exploding student loan debt that will keep potential buyers out of the housing market for years to come. (See Figure 8)
Figure 4 Existing Home Sales, 2000 – 2014E
Figure 6 Household Formations, 2000 – 2014E

Source: Bureau of the Census and UCLA Anderson Forecast

Source: National Association of Realtors and UCLA Anderson Forecast
Figure 5 Payroll Employment, 2000Q1 -2014Q4E
Figure 7 30-Year Fixed Mortgage Rate, 2000Q1 – 2014Q4E

Source: Federal Reserve Board and UCLA Anderson Forecast

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

At one trillion dollars, student loan debt now rivals credit card debt. And because student loan debt is not extinguishable in bankruptcy, it will impair the ability of younger people to buy homes in the years to come.

After peaking at nearly 2.1 million units in 2005, housing starts plummeted 73% by 2009 to 554,000 units. (See Figure 9) After remaining at roughly that level in 2010 and 2011, housing starts are expected to reach 755,000 units this year and exceed one million units in 2013. Although this looks like a steep recovery, at one million units housing activity would have only recovered from depression levels to recession levels. Remember that from 1991 – 2010 housing starts averaged 1.42 million units a year. As we noted earlier, household formations on the order of 1.6 million a year can easily support this long-run average.

The real drama taking place is in multi-family housing. We are now in the midst of a boom in multi-family construction, especially in rental apartments. Like housing starts in general, multi-family starts collapsed from its peak in 2005 of 354,000 units to a nadir of 112,000 units in 2009. Since then starts will have more than doubled to the 260,000 units forecast in 2012. (See Figure 10) We would not be surprised to see multi-family starts exceed 400,000 units in 2014.
Figure 8 Student Loan Debt, 2000Q1 -2011Q4
Figure 9 Housing Starts, 1991- 2014E, Annual Data

Source: U.S. Department of Commerce and UCLA Anderson Forecast

Source: Federal Reserve and The Wall Street Journal

Figure 10 Multi-Family Housing Starts, 1991 – 2014E

Source: U.S. Department of Commerce and UCLA Anderson Forecast
After all, the flip side of a falling homeownership rate is a rising rate of home renting.

The coming boom in multi-family starts is underpinned by a very low vacancy rate (below 5%), rising rents and a flood of institutional money coming into the sector. (See Figure 11) Although not reflected in the consumer price index where the rent regulated cities of New York and Los Angeles are over-weighted, rents on renewals are now rising at 4% and many of the publicly traded real estate investment trusts are reporting year-over-year rent increases on the order of 5% to 7%.

With 10-year U.S. Treasury yields below 2%, institutional investors are seeking out higher yielding alternatives and they are finding rental apartments to be increasingly attractive. Although going in, cash returns in the more active markets are at historical lows, around 4%-5%, rising rents offer the prospect of higher future income and capital appreciation. With a buying frenzy underway, investors can and do come up with very aggressive assumptions about future rents to justify new construction.

Of course this boom in multi-family construction will have within it the seeds of its own destruc-
Figure 11 Apartment Vacancy Rate, 2005Q1 – 2012Q1, Percent
Source: REIS Reports and Calculated Risk

tion. As rents rise, consumers will shift out of rental into ownership units. The American Dream of homeownership may be comatose, but it is not dead and the wakeup call will come in the form of higher rents.

As a result by 2014, supply will begin to outpace demand. New physical supply will be augmented by the renting of existing single-family homes by a growing number of investor groups. Although much of that supply is on the urban fringe, many observers forget that sub-prime lending financed and refinanced homes in central core areas. As rents increase those areas will become ripe for gentrification and become competitive with traditional rental housing.

When outlining our thesis to several real estate investors we heard a common objection which loosely stated is, "sure the money is there, but you’ll never get the zoning." Our counter to that argument is that the planning and zoning world has changed. Instead of discouraging density, governmental planners are now encouraging it. As examples we point to the passing of California’s SB 375 which more strictly links transportation with land use planning and the "transit village" concept now being employed in New Jersey. Yes, there will still be neighborhood fights, but there will be far fewer supply constraints than heretofore.

Thursday, April 12, 2012

My latest blog in US News, "What Obama's, Ryan's Tax Plans are Really About"

For the full article see the URL below:

Friday, March 30, 2012

"Curb Your Enthusiasm," UCLA Anderson Forecast, March 2012

With the economy creating 227,000 and 284,000
net new payroll jobs in February and January, respectively,
the employment situation is clearly improving.
Although that pace of job growth will not be sustainable
over the near-term, total employment is finally
climbing out of the gaping hole that was caused by
the recession of 2007-09. (See Figure 1) Concomitantly,
the unemployment rate improved from 9.0% in
October to 8.3% in February, but we expect it to fall
only modestly going forward as new entrants into the
long depressed labor force begin to seek work. (See
Figure 2)

We have argued elsewhere that the recent
improvement in the labor market and the consumer
economy has been, in part, driven by exceptionally
mild winter weather.2 In fact this past winter was the
fourth warmest on record with January and February
temperatures running between five and six degrees
warmer than last year.
Why is this important?

The seasonal adjustment factors used by government
statisticians take into account weather-related
impacts on the economy. Examples include slower
construction activity and plant closings caused by inclement
weather, as well as weaker retail sales caused
by the inability of consumers to brave sub-freezing
weather and snow to go out and shop. The Bureau
of Labor Statistics reported an unusually low number
of workers being kept from their jobs due to inclem-

Figure 1 Payroll Employment, 2005Q1-2014Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 2 Unemployment Rate, 2005Q1 – 2014Q4

Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

ent weather in February. Thus, with this winter being
almost balmy in the normally frigid Northeast and
Midwest, economic activity soared and the data was
put into overdrive by the normal seasonal factors that
are looking for depressed conditions.
Furthermore, the warmer temperatures -- along
with plummeting natural gas prices -- slashed home
heating bills on the order of 20%-40%, offsetting the
rise in gasoline prices. Thus, we suspect that once the
weather and the seasonal adjustment factors normalize
in March and April, the economic data won’t look
so ebullient.

Indeed, without the benefit of lower heating
costs, higher gasoline prices will begin to bite into
consumer spending. With oil prices staying over $100
a barrel and the global Brent price another $15-$20
higher, it seems highly likely that gasoline prices will
soon average over $4 a gallon. (See Figure 4) Of
course, over the near-term, oil prices will continue to
reflect political tensions caused by the Iranian nuclear

Unfortunately, the stronger employment data
are not appearing to translate into stronger overall
GDP growth. Indeed, it can be argued that part of the
recent gains in employment are in response to prior
growth, not expectations for future growth. After
growing at 3% in the fourth quarter, we are forecasting
real GDP growth to slow to around a 2% annual
rate for most of 2012, with the point estimate for the
first quarter at 2.0%. Growth is expected to improve
from that level in both 2013 and 2014. (See Figure 3)
Figure 4 West Texas Intermediate Oil,
2005Q1 - 2014Q4

Sources: Investors' Business Daily and UCLA Anderson Forecast
Figure 3 Real GDP Growth, 2005Q1 – 2014Q4

Source: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 5 Real Equipment and Software Spending,
2005Q1 - 2014Q4

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Why is this happening?
Although the so-called “front end” consumer
portion of the economy seems to be doing better, the
“back end” business part of the economy is weakening.
Simply put, both investment and exports, which
led the economy earlier in the recovery, are now
slowing. (See Figures 5 and 6)

Europe in Recession

Europe is in recession. Euro-area real GDP declined
in the fourth quarter and is forecast to decline
by 0.5% this year. The recent Greek debt default/restructuring
highlighted the fiscal imbalances afflicting
Europe. Behind Greece, though not as troubled, stand
Portugal, Spain and Ireland. In response to the crisis,
the European Central Bank (ECB) embarked on a
massive quantitative easing program called the Long
Term Refinancing Operation (LTRO). In short, the
LTRO offers the European banks three year money at
very low rates. As a consequence, the ECB’s balance
sheet exploded. (See Figure 7)

With Europe accounting for roughly 20% of
U.S. and China exports, it is not surprising to see a
slowdown in this sector. As China and Asia slow as
well, U.S. exports weaken in those markets. Nevertheless,
the real risk coming out of Europe is not a
modest recession, but another financial crisis arising
out of the continent’s long-running imbalances. The
French presidential elections on April 22nd, might
renew the crisis if the less Eurocentric Francois Hollande,
who is now leading in the polls, defeats the
incumbent Nicolas Sarkozy.

Figure 6 Real Exports, 2005Q1 - 2014Q4

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 7 ECB Balance Sheet, 1999 - 2012, In Millions of Euros


The Fed and Housing

Like its ECB counterpart, the Fed continues to
flood the banking system with liquidity with a near
promise to keep interest rates at roughly zero through
mid-2014. Our sense is that the zero rate policy will
end somewhat sooner, in late 2013. (See Figure 8)
In addition, the Fed is undertaking an “operation
twist” designed to lower long-term rates and that
has allowed 30-year fixed rate mortgage interest
rates to plum depths to 4% and below. The low rate
policy will be enabled by less than 2% year-over-year
increases in the deflator for personal consumption
expenditures, the Fed’s preferred inflation gauge. (See
Figure 9)

To be sure, housing prices as measured by the
Case-Shiller Index recently dropped to a new cyclical
low, but our sense is that 2012 will represent the
low point in the housing price cycle. (See Figure 10)
Why? Employment is up, interest rates are very low,
incomes are gradually rising and the long-stalled
foreclosure logjam is breaking. Yes, credit standards
remain tight, but as the economy heals more buyers
will come into the market. Prodding them will
be rapid increases in apartment rents that are already

Figure 8 Federal Funds Rate vs. 10-Year U.S.
Treasury Bonds, 2005Q1 - 2014Q4

Sources: Federal Reserve Board and UCLA Anderson Forecast

Figure 9 Personal Consumption Expenditures
Deflator, 2005Q1 - 2014Q4

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 10 Case-Shiller House Price Index, 1988 - 2012

Source: Standard and Poor's

Figure 11 Housing Starts, 2005Q1 - 2014Q4

Sources: U.S. Department of Commerce and UCLA Anderson Forecast

occurring. In more than a few markets, rents are up
between 5%-10% and in practically all markets real
rents are rising.

As a result, multi-family housing starts have
more than doubled off the bottom and single-family
starts are beginning to rebound as well. We estimate
that total housing starts this year will rise to 741,000
units up from 611,000 last year and will approach one
million units in 2013. (See Figure 11)

The Fiscal Train Wreck

Fiscal policy is inexorably headed for two train
wrecks, one in the short-run and the other in the longrun.
The short-run largely involves taxes. All of the
Bush era tax cuts expire at the end of the year along
with the payroll tax cut of the past two years. Should
all of the tax cuts expire at once along with some
mandatory spending cuts, the U.S. would be faced
with a $400 billion fiscal contraction, the biggest
since the end of World War II.

This looming uncertainty will hardly be a tonic
for economic activity in the second half of this year.
Just to note for modeling purposes, we are assuming
that a gradual phase out of most, but not all, of the tax
cuts will be approved after the election. And yes, this
is a heroic assumption.

The other train wreck is the long-run deterioration
in the fiscal condition of the United States. Even
with a heroic compromise, the U.S. faces mega-deficits
as far as the eye can see. (See Figure 12) Unless
the long-term entitlement programs of social security,
Medicare, Medicaid and perhaps “Obamacare” are
brought under control, there really isn’t any solution
to the long-term deficit. In our long-term outlook we
assume that the U.S. will muddle through. We caution,
however, sometimes the world isn’t so kind.

Figure 12 Federal Surplus/Deficit, FY2000 –FY2022

Sources: Office of Management and Budget


Although the employment outlook has decidedly improved, the growth outlook remains sluggish with 2% GDP growth likely for much of this year. The recent data has been favored by an unusually warm winter that brought forward economic activity that would normally have occurred in the spring.Thus, the weather effect along with higher gas prices and weak exports temper our enthusiasm for the balance of the year. Morevoer the looming expiration of all of the Bush era tax cuts and the payroll tax cut will elevate economic uncertainty in the second half of the year.