blaming the banks

People are still pissed at the banks for screwing us all over and this anger is horribly misplaced. It's like blaming the bartender for your hangover, and it's disturbing to think we may be learning the wrong lessons from this whole economic debacle. Consider the chart below, which shows that in the decade leading up to the Great Recession, the average person's debt grew at a rate roughly twice as fast as their income:

It's pretty easy to see the connection between this debt run-up and the economic collapse, but did the banks force us to borrow beyond our means? Did the bartender force us to chug down those extra shots? Many states have laws that restrict bartenders from serving obviously drunk people, and likewise our financial system used to have reasonably effective safeguards against these kinds of excesses. But they were dismantled by anti-regulatory zealots in the 1980s, 1990s, and 2000s. Who kept voting these people into power?

Similarly, there is a widespread misunderstanding about why we bailed out the banks. Some people smell a conspiracy but this overlooks the simple truth that we did it to save ourselves. If the local nuclear power plant started overheating beyond the control of its managers, it would be a no-brainer to send in public safety resources to prevent a meltdown that could ruin the surrounding communities. It was a similar concern that motivated the bailout of the banks. Our financial power system is as potent as our electrical power system and should be regulated accordingly.

But while re-regulating the financial system deals with the proximate cause of imprudent banking practices, it misses entirely the ultimate cause of out of control consumer debt. Why were people borrowing so far beyond what they could afford? As I argue in my Jan. 4 post ("Dirty Money"), I believe it was due in part to the Reagan and Bush II tax cuts that disproportionately favored the wealthiest and increased income inequality. In his timely, if tragically under-appreciated,  2007 book "Falling Behind: How Inequality Harms the Middle Class", the great economist Bob Frank argues that a good deal of consumer spending is positional - that is, much of it is aimed at gaining a competitive advantage in the great Darwinian game that is life on earth. For example, only half of our children can have an above-average education, so a scenario where the wealthiest bid up homes in the best school districts forces everyone else to spend more so as not to fall behind.

Sure, bankers behaved badly, but any worse than the rest of us who backed this ideology with our political support? Besides, the bankers' behavior was entirely predictable - the fact that many of the regulations we dismantled were themselves antidotes to the Great Depression puts such moves squarely into the "fool me twice, shame on me" category. Bottom line: to scapegoat Wall Street is to deny our own culpability and the fact that the GOP is still peddling these so thoroughly discredited ideas and the magical thinking they require only highlights the importance of getting our facts straight. We've already paid a heavy price for our schooling, so let's make sure we learn the right lessons: progressive taxes and responsible regulation are cornerstones of our prosperity.

How much should we be worried about rising gasoline prices?

That the recovery has taken root is now a well-established story in the mainstream media, so I was going to move on to other subjects but the recent coverage of rising gasoline prices and its economic and political implications seemed to be nearing a hysterical pitch, so I thought I should look into it.

Simply put, there is no relationship between oil prices and economic growth. (Statistics nerds will appreciate that my regression analysis of quarterly changes in real GDP against oil prices from January, 1947 - January, 2012 showed a correlation of 0.08, R-squared 0.006, and a standard error almost exactly the same as GDP's standard deviation. Further, I was unable to find any 10-year period in that span that featured a discernible connection between the two.) This is due in part to the fact that the energy industry is a major contributor to our economy. Beyond that, and perhaps contrary to conventional wisdom, it could be argued at this point rising energy prices are beneficial to our aggregate economic growth because we are once again net exporters of petroleum products. And in the short run it's not hard to imagine that steeply rising gas prices would accelerate the process of people catching up on automobile purchases they had deferred during the downturn.

So what's the big deal? The issue the pundits are wringing their hands over (and just about anyone who's had to buy a tank of unleaded gas understands) is that higher oil prices can divert consumer spending away from the things people really value (e.g., food, shelter, entertainment). But how much? To get an idea, it's helpful to look at energy spending's place in our collective household budgets and how that's changed over time:

A couple of observations:

1. There is a distinct long-run downtrend of energy's role in our budgets. This is consistent with the notion that over time we've become more efficient energy consumers.

2. The two big deviations from the trendline relate to the two most significant periods of oil price volatility: roughly 1974-1986 and 1999-now. The 1974-1986 period pretty much follows the same contour as oil prices, indicating that the oil price changes didn't affect our energy consumption as much as it crowded out spending on other things. This is the kind of painful displacement that political pundits think could derail Obama's prospects.

But a closer look at what's been going on since 1999 reveals a different story:

The period begins at 4%, the lowest level on record, peaks at 7% in 2008 (when oil spiked to almost $140/barrel) and ends at about 5.5%, just above the 5.25% average for the period. While the line broadly tracks oil prices, the slope tends to be much more gradual. This is very different from what we saw during the oil price shock of the 1970's.

Consumers' budgets are clearly less sensitive to oil price swings than they used to be, and there several reasons, including our diversification of energy sources (natural gas recently became the #1 home heating fuel) and efficiency improvements to our transportation. But perhaps most significant is the simple fact that we don't drive as much as we used to:

This chart shows per capita miles driven in the US since 1970. It's easy to see that we've driven fewer miles on average since the 2004 peak, but it's also noteworthy that the rate of growth prior to then was declining, too. In the 1970s and 1980s, per capita driving was growing at a 2.4% average annual rate, but the rate shrank to less than half that in the 1990s and up until the 2004 peak (1.15%). I could only guess as to why, but it's reasonable to imagine that it's at least partially due to the proliferation of the internet - there is so much stuff we do online that our parents used to have to leave the house to do (banking, shopping, working, etc.).

All of this is just to say that fears that a spike in gas prices will sink either our economy or Obama's prospects are way overblown. There is no evidence that higher energy prices actually damage our economy, and while no driver likes to see higher gas prices, it's not as big a deal as it used to be.

Income update

I mentioned in my last post that it would be worthwhile to look out for the March 1 report on personal income earned in January. Below is an update of the chart from my last post, where the focus is on personal income associated with business payrolls (as opposed to personal income from government sources or investment earnings). There are 2 noteworthy developments:

     1. The Bureau of Economic Analysis revised upward their #'s for 3rd & 4th quarter 2011.

     2. January's gains were roughly on par with December's.

Taken together, this should make us more confident in the sustainability of our economic recovery. Steady gains to personal income earned from private payrolls is the healthiest enabler of growth in consumer spending, and consumer spending is what ultimately drives our economy.    

Does the recovery have legs? Part 2: The income strikes back

I think the single most important indicator to predict our near-term economic growth is personal income growth. This follows from my previous posts, where I suggest that consumer spending is the key to our recovery, and it's no great insight to suggest that for spending to grow, income must grow. This is particularly true in an environment like ours, where consumers are generally over-indebted and therefore are less likely to use debt to increase spending.

This chart shows growth in compensation people receive from private businesses. This is strictly private wages - that is, I've excluded things like the income of government employees, investment earnings, income from social security and other government programs, and indirect compensation like employer pension contributions. The idea is to specifically focus on the personal income most sensitive to our growth trajectory: the payrolls of businesses.

The story this tells is something of a mixed bag. We are not seeing consistent growth over each of the last few months, and what growth there has been is lower than the gains we saw Jan-Feb 2011 or even Mar-May 2010, for that matter. On the other hand, the last 4-5 months overall look better than the 4-5 before them. So, the jury is still out here, which makes it all the more important that we follow this closely over the next few months. The report on January's performance comes out March 1, and we should be looking to see if private compensation grew more or less rapidly than it did in December.

My guess - and it's only a guess - is that the report will show that January's wage growth was good, and I'm basing that on the chart below, which shows that the number of people submitting claims for unemployment insurance has dropped more in the last 8 weeks than in the previous 8 months.

It would stand to reason that if private payrolls are expanding, unemployment compensation claims would decline. However, there are other factors that drive these numbers - for example, maybe people stopped filing claims simply because they exhausted their eligibility - so it's just a speculation, but I'm optimistic.

Does the recovery have legs? Part 1: housing on the rebound

It's only been a few months since I became confident enough in our recovery's strength to start blogging about it and it's still tenuous enough to bear close monitoring. But what exactly should we be watching for? One of the great challenges in evaluating economic situations in general is that reality is fluid and it's often hard to distinguish between cause and effect (e.g., are higher wages pushing inflation up or is inflation forcing employers to pay more?). In this and other posts I am going to provide my take.

It's widely understood that the housing market's recovery is key to the sustainability of the broader recovery, and a bird's eye view suggests things are rebounding:



What this chart shows is that in each of the last 3 quarters residential investment has positively contributed to our economic growth, even after adjusting for inflation. And while the contributions were relatively modest as compared to individual quarters in 2009 and 2010, I like to think the consistency of 3 consecutive upticks is meaningful in its own right. I would caution that this simplistic analysis may be missing important considerations, like that a flood of foreclosures on the heels of the recent bank settlement could swamp the market with inventory and depress investment in new construction. Still, after what we've been through it is helpful to see any sign that activity in the most troubled sector of our economy is trending in the right direction.