This article is a guest contribution by John P. Hussman, Ph.D., Hussman Funds
Breaking News: Philly Fed Survey at 5.1, Showing that Growth Is Firming at a Slower Pace
This was an item that appeared on CNBC MobileWeb on Thursday. Read that headline again. Growth is firming. At a slower pace. Talk about "spin." You can't make this stuff up.
Important metrics of economic activity are slowing rapidly. Notably, the ECRI weekly leading index slipped last week to a growth rate of -9.8%. While the index itself was reported as unchanged, this was because of a downward revision to the prior week's reading to 120.6 from the originally reported 121.5. The previous week's WLI growth rate was revised to -9.1% from the originally reported -8.3% rate. Meanwhile, the Philadelphia Fed Survey dropped to 5.1 from 8.0 in June, while the Empire State Manufacturing Index slipped to 5.1 from 20.1. The Conference Board reported that spending plans for autos, homes, and major appliances within the next six months all dropped sharply. These figures are now at or below the worst levels of the recent economic downturn, and are two standard deviations below their respective norms - something you don't observe during economic expansions.
As I've frequently noted, the first year of post-war economic recoveries are invariably paced by strong growth in credit-sensitive spending such as housing, autos, appliances and capital goods. While government programs such as Cash-for-Clunkers and the first-time homebuyers' credit did bring forward a great deal of demand to produce short spikes in activity, we continue to observe a failure of the private economy to pick up where government spending now trails off.
There was a bit of good news last week in that new claims for unemployment (seasonally adjusted) dropped by 29,000 to 429,000. Still, much of this decline can be attributed to the fact that several manufacturers, including General Motors, skipped their usual summer layoffs. While the seasonal adjustment factors are smaller for the weekly claims data than they are for the monthly employment data (see Notes on a Difficult Employment Outlook - February 22, 2010), it's clear that last week's figure benefited from a downward seasonal adjustment factor applied to data that did not require it. As usual, the 4-week moving average, at 455,250, is more informative. Incrementing the latest week's data by about 20,000 to reflect the excessive seasonal factor would imply a 4-week average of roughly 460,000, fairly consistent with the other data we're observing. Given the likelihood of heavy job cuts at the state and local levels in the next few quarters, these figures are at odds with the notion that the economy is in a durable recovery.
Economic Policy Notes
The U.S. economy continues to face the predictable effects of credit obligations that quite simply exceed the cash flows available to service them, coupled with the predictable shift away from the consumption patterns that produced these obligations. The misguided response of our policy makers has been to defend bondholders at all costs, using public funds to make sure that lenders get 100 cents on the dollar, plus interest, while at the same time desperately trying to prod consumers back to their former patterns of overconsumption. These policies are designed to preserve exactly the reckless and unsustainable behavior that caused the recent downturn. They are likely to fail because the strategy is absurd. The ultimate outcome, which will be forced upon us eventually if we do not pursue it deliberately, will be the eventual restructuring of debt obligations and a gradual shift in the profile of U.S. economic activity toward greater saving - either to finance exploding government deficits, or preferably, to finance an expansion in productive investment, research and development, and capital accumulation.
From my perspective, bolder approaches are required. Debt that cannot be serviced should be restructured, rather than socializing the losses of reckless private decision-making. We will inevitably have a large "stimulus" package, but it will be essential to craft it in a way that emphasizes incentives to create and accumulate productive capital, both private and public.
On the tax side, we also have options. There are far more possibilities than simply preserving or discarding the Bush tax cuts. Frankly, I was never a fan of those cuts, which added more variation, not less, in tax rates across various forms of income. Ideally, efficient tax systems should feature flat rates and very broad bases. You define income in a very wide manner, and you tax it all at the same rate. You introduce a progressive tax structure by creating large exclusions from taxes at low income levels, so that people at lower income scales pay no tax at all. In my view, the same thing should be done with Social Security - drop the rate substantially, but include all income - wage and non-wage. Three-quarters of Americans pay more in payroll taxes than in income taxes. By reducing the wedge between the hourly amount earned by employees and the hourly cost paid by employers, this strategy would create immediate incentives for employment. Moreover, it would raise more revenue because at present, even Warren Buffett only pays Social Security taxes on the first $106,800 of income. Combining a flatter income tax with a flatter and broader payroll tax would stimulate growth, employment, and greater economic efficiency without compromising total revenues.
