The Importance of Savings

The chart above shows the U.S. savings rate, which has been clocking in between 5%-6% for almost two years. This is an incredibly importance development for a variety of reasons.

1.) First, it indicates that people are not spending all of their earnings at once, but instead are putting some money aside for a "rainy day."

2.) It provides fuel for consumption. One of the big questions being asked right now is how can the U.S. consumer be purchasing more goods right now? The answer is he's been setting aside a lot more money

3.) Increased savings also helps to keep interest rates low. Increased savings leads to a larger pool of money for financial intermediaries to lend, which lowers interest rates.

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Krugman on Commodities

From the NY Times:

So the case for a speculative component is a lot stronger this time around. But — and this is important — the speculation is not being driven by financialization, by all those index fund investors going long. Cotton hoarding seems to be taking place at the level of individual Chinese farmers and factories, with no indication that they’re being influenced by the futures market. And iron ore hasn’t been available for futures-market speculation: the first futures markets there came into existence just a few days ago.

For at least some commodities, then, we’re seeing a real demand boom, which may be getting reinforcement from speculative hoarding, but with this speculation taking old-fashioned forms rather than involving Wall Street.

Now, what about food prices?

Not much evidence of hoarding, as far as I can tell. So this is straightforward supply and demand. Demand may be up to some extent because of that emerging-market boom. But if you look at the FAO reports it becomes clear that the key thing for cereals prices is that production is down in advanced countries, largely owing to terrible weather. And yes, it’s likely that climate change has played a role.

This is what we've been saying all along.

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U.S. Is the World's Largest Manufacturer

From the AP:

Yet America remains by far the No. 1 manufacturing country. It out-produces No. 2 China by more than 40 percent. U.S. manufacturers cranked out nearly $1.7 trillion in goods in 2009, according to the United Nations.

The story of American factories essentially boils down to this: They've managed to make more goods with fewer workers.

The United States has lost nearly 8 million factory jobs since manufacturing employment peaked at 19.6 million in mid-1979. U.S. manufacturers have placed near the top of world rankings in productivity gains over the past three decades.

That higher productivity has meant a leaner manufacturing force that's capitalized on efficiency.

"You can add more capability, but it doesn't mean you necessarily have to hire hundreds of people," says James Vitak, a spokesman for specialty chemical maker Ashland Inc.

This is a very important point to make. The internet is full of chatter about how the U.S. is always falling behind in manufacturing. Yet, we're still the world's largest manufacturer. As we've pointed out here on several occasions, the issue is productivity: the U.S. manufacturing is in fact incredibly efficient.

Here's the chart from the article:

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Yesterday's Markets

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Let The Good Times Role!

As David Cameron sheds tears today for the average British householder, who will face a "difficult and tough" year ahead, it is reassuring to know that the banking sector is booming again.

The Telegraph reports that four HSBC, Barclays, Lloyds and Standard Chartered will announce combined profits of £24.2BN (a rise of over 10% compared with the £21.5BN they reported last year).

To some extent these profits (and associated bonuses) will be recouped by taxes. However, the key to the banks' "reassimilation" into "polite" society will be whether they show that they are willing to lend more to businesses and homebuyers than they have been doing of late.

Seemingly, as discussions between George Osborne and the banks over lending levels (aka project "Merlin") have become deadlocked, it may be a while before banks (by their actions) are "reassimilated".

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Weekly Indicators: Good bye Recovery Edition

- by New Deal democrat

The big news this week was 4th Quarter GDP, which was +3.2% unadjusted, and up 2.6% in real terms, and up 2.9% for all of 2010 in real, inflation-adjusted terms. This means that all those people who say we aren't in a Recovery are now correct - but only in a backhanded sense. Since real GDP is now higher than it was at any time before the recession, we are no longer in a "recovery," but in an economic "expansion" instead. As an aside, I frequently read on some blogs that we shouldn't pay attention to GDP because it doesn't have anything to do with Main Street America. I disagree, for one simple reason. If you know the YoY% change in real GDP, and subtract 2%, that will give you a good idea what the YoY % change in employment will be in the next 3-6 months. As of today that gives a forecast of +.9% YoY employment in the next 3-6 months. Indeed, pending next week's BLS revisions, as of now for all of 2010 employment was up +.87%. That suggests that we will get employment gains about equal to working-age population growth on average for the next few months.

Meanwhile, consumer expectations for January rose to their highest level in over 6 months. This is one of the smaller components of the LEI. New home sales were also higher, while house prices continued to decline (enough so that yours truly is looking into a bargain). Durable goods orders unexpectedly fell.

Here is this week's high frequency data:

The BLS reported initial jobless claims of 454,000. This, needless to say, is bad news. My best guess is that we are looking at the result of renewed state and municipal layoffs. For now, the trend to under 400,00 claims is definitely halted. Maybe somebody in Versailles should think about creating some jobs.....

The Mortgage Bankers' Association reported a net decrease of -12.9% in seasonally adjusted mortgage applications last week. This number has declined substantially over the last 6 weeks, and is at its lowest point since October. Refinancing decreased 12.0%, and is at its lowest point in a year. Increasing mortgage rates are killing this index (which may be a substantial part of ECRI's leading indicator index).

Gas at the pump went up 1 more cent again to $3.11 a gallon, while Oil went down to as low as about $86 a barrel. Gasoline usage is perhaps beginning to be affected by prices, as it was up less than 0.2% on a weekly basis from last year's levels.

The American Staffing Association Index increased 1% to 89 for the week ending January 16. This was 13% above a year ago, but about 5% below 2007 levels. Seasonality is no longer an issue. This is the closest so far the index has come to pre-recession levels.

Railfax showed seasonal improvement as would be expected. Total rail shipments, however, were only 1.8% higher in the week ending January 22 than during the same week the year before. Shipments of waste and scrap metal and auto shipments were both at last year's levels. In general rail traffic is still improving YoY, but the rate of that improvement has been decreasing for months. It is possible that there is still some seasonality at play, but if the YoY comparisons remain week for a couple more weeks, then the slowdown cannot be dismissed.

The ICSC reported that same store sales for the week ending January 22 decreased -1.2% w/o/w, but increased 2.7% YoY. Shoppertrak reported that sales rose 3.7% YoY for the week ending January 22, and were up 4,7% from the week before.

Weekly BAA commercial bond rates rose to 6.12%. This was similar to the +.06% increase in the yields of 10 year treasuries.

A reminder that on a trial basis I am using Matt Trivisonno's +1.07% adjustment to withholding data this year vs. last year, due to the recent payroll tax political deal. So adjusting, the Daily Treasury Statement showed adjusted receipts in the first 16 reporting days of January of $134.1 B vs. $123.5 B a year ago, for a gain of $10.6 B or almost +9% YoY. Over the last 20 reporting days, this year shows $158.6 B collected vs. $144.4 B one year ago, or an adjusted gain of $14.2 B or +9.8%YoY.

While I'm gone, if you want to do something really nice, go over to Frank Chow's blog and congratulate him on his engagement!

Have a nice weekend!

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Real GDP Up 3.2%

From the BEA:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.2 percent in the fourth quarter of 2010,(that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.6 percent.

The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4). The "second" estimate for the fourth quarter, based on more complete data, will be released on February 25, 2011.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, and nonresidential fixed investment that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.

The acceleration in real GDP in the fourth quarter primarily reflected a sharp downturn in imports, an acceleration in PCE, and an upturn in residential fixed investment that were partly offset by downturns in private inventory investment and in federal government spending and a deceleration in nonresidential fixed investment.

I'll be digging into the report over the weekend and will post on it extensively next week. However, here are some initial thoughts.

1.) I've seen in several internet posts that the consumer is dead or that nothing can happen until the consumer returns. Let's just say that statement is not based on a realistic appraisal or analysis of available data. The consumer is back. PCEs accounted for 95% of the top line growth number. Durable goods purchases increased 21.6% (motor vehicle and parts purchases accounted for 28% of growth) ; nondurable goods purchases increased 5%.

2.) Investment in equipment and software -- a strong driver of the previous few quarters growth -- increased 5.8%. While this is still a good rate of increase, it is below the previous quarters far more torrid pace. The change in private non-farm inventories subtracted from growth last quarter (as this growth in private inventories over the last year was somehow illegitimate growth according to some pundits, I'm sure this drop will be treated with a rousing chorus from the same parts).

3.) Imports decreased 13.6%. Don't expect this to repeat. Exports increased 8.5%, the sixth straight quarter of increases, while exports of goods increased 10%.

Overall, this is a good report. While I'm sure we'll see the litany of internet economists tell us this report somehow indicates the sky is falling or that we are of course doomed to the pit of fire, the reality (as in data based analysis) indicates this is the 6th straight quarter of economic growth, which is usually associated with an expansion rather than a recession.

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Yesterday's Market

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Alex P. Keaton is President

- by New Deal democrat

I'm going to take a little foray out of this blog's typical comfort zone, to take the opportunity today to sum up my core opinion of Barack Obama. To put it simply, with the exception of skin color, the conservative hero of TV's "Family Ties," Alex P. Keaton (Michael J. Fox's character), is President.

This note has been long-in-coming, but is provoked by two notes I just read. First, Paul Rosenberg at Open Left says:

Obama has accomodated himself, and worked tirelessly to redifine liberalism or progressivism in terms of a neo-liberal vision that is, at bottom, aimed at implementing conservative policies in a more technocratically competent manner, with a "human face" that makes it far more palatable to those whose rights and interests are being continually eroded.

Second, Armando a/k/a Big Tent Democrat at Talk Left says:

8 percent unemployment would require 1.5% drop in the current unemployment rate. The Obama Administration has decided that it has to sell something along those lines as a success - a crisis averted. Politically, I can understand why. It is hard for someone to argue that 4 years of their Administration failed to alleviate a crisis.

But activists do not work for Obama or his political fortunes. The fact is that America is in crisis - an economic crisis, a jobs crisis and an income inequality crisis. And if you care about creating space for policies to address these crises, in many ways, your interests now diverge from those of President Obama, who wants to win reelection and has decided that pretending the crisis is over is the way to do that.

Barack Obama was born in 1961. He is a nearly exact contemporary of Alex Keaton's. He has said (I've been unable to track down a link to the quote) in response to the Great Recession, that New Deal style solutions from the 1930's won't work in 21st century America. In fact, it is clear to me that, just as Herbert Hoover was hamstrung by the dominant economic ideology of his day, so Barack Obama is a true believer in neoliberal economics. He is unable to consider that anything other than a lightly regulated casino - er, free market - is the correct and natural solution to any problem.

But don't take my word for it: Back in 2008 one of the "Family Ties" writers wrote a NY Times editorial about who Alex Keaton would support for president, and here's what he said:

Alex P. Keaton’s political idols, Richard Nixon and Ronald Reagan, have each gone off to their deserved places in history....

[T]o properly represent Alex and his political point of view I, as well as the rest of the “Family Ties” writers, did a great deal of research on this subject....

Alex Keaton was a true conservative Republican. He was for limited government. He was strongly against government involvement in the personal lives of its citizens. He was competent and capable — the ultimate over-achiever. But, above all Alex Keaton was a firm believer in the power of ideas. He believed in the competitive marketplace of intellectual discourse, where the best ideas win .... Alex was smart. Real smart. And, proud of it....

So what about Barack Obama? I honestly don’t know. I think Alex is an independent now, and as deeply engaged in politics as ever. He would be intrigued by Obama — impressed with his eloquence and intelligence. He would be unhappy with his plan to tax the wealthy at a higher rate, but keenly aware that eight years of neglect and corruption and no-bid contracts have to somehow be overturned. And, I think Obama’s slogan is very similar to Alex’s own personal mantra: “Of Course I Can.”

Of course, as it turns out, Barack Obama didn't choose to tax the wealthy at a higher rate, either.

Barack Obama and Alex P. Keaton are black and white mirror images: both have the same self-regard and the same neoliberal core ideology - and the same high regard for Ronald Reagan. To understand Barack Obama, you simply need to understand this: the truth is, Alex P. Keaton has become President.

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Inflation Increasing ... Except in the U.S

From the WSJ:

With the risks of a double-dip recession apparently receding in most parts of the world, another economic challenge is emerging: inflation.

Rising prices for food, energy and other commodities are reducing the disposable incomes of poor people across the planet, providing a trigger for street protests in North Africa and posing a deep conundrum for policy makers world-wide.

.....

In the euro zone, rising prices could lead the European Central Bank to increase interest rates, intensifying pressures on weak economies such as Greece and Ireland that use the common currency. On Wednesday, new data showed the prices of German imports rose at their fastest clip for two decades.

Simon Johnson, a professor at Massachusetts Institute of Technology and a former chief economist at the International Monetary Fund, said the only major country where commodity-price inflation isn't an important concern is the U.S., because imported food accounts for a tiny proportion of U.S. consumer spending.

This is something we've been looking at for some time. As the FT noted today, the current situation directly mirrors the 2008 price spikes: crop failures led to export restrictions which led to food riots which led to government policies such as price caps. However, it is very important to note that this problem is as much based on supply/demand issues as it is on the cheap dollar. In other words, the causes and therefore the solutions will be complicated. Here are some thoughts.

1.) A regular commenter suggested that the only people who can participate in the futures markets are those who can physically deliver the commodity, thereby returning the futures markets to their origins as a hedge against crop price fluctuations. While I see his point, I think this would be too restrictive. I do think something has to be done to balance the speculator/hedger dynamic, but am unsure what the final solution would look like.

2.) Move to some type of currency basket to price commodities rather than the dollar. I don't think this should go so far as to create a world currency, but I do think the reliance on the dollar as the primary store of value in the commodity markets is outdated.

3.) Last years crop failure in Russia was the result of extreme weather conditions in Russia: the entire country was literally on fire. The cause was probably due to global warming. In other words, we need to deal realistically with climate change -- like acknowledging that when a 1000 square mile area of China can't be viewed from space because of pollution in the air, or when the average life expectancy of a traffic cop in Beijing is under 50 because of complications from air pollution a problem just might exist.

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What the Fed Sees, Beige Book Redux and Possible Potholes

From the latest Fed statement:

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.

Last week I went over the latest Beige Book and added detail from various economic reports. The above paragraph sums up the overall situation pretty well, although I would add the following points.

1.) Consumer spending is actually stronger than reported. PCEs have regained the levels seen at the height of the last expansion. Purchases of non-durable and durable goods have moved past previous highs. Anyone who is arguing the consumer hasn't returned isn't looking at the data.

2.) Manufacturing has also rebounded and is doing well. The drop we saw as the result of the EU situation (and to a lesser extent the BP crisis) has ended.

3.) Services are also picking up, although the overall tone is more muted. We're seeing a pick-up in orders, but there is still a sense that the pick-up won't be permanent.

We have the following weak points moving forward.

1.) Housing is still a basket case and will be for some time. The inventory of existing homes on the market is still very large which will probably keep prices depressed for the foreseeable future.

2.) Oil prices. While prices have recently fallen, we're only a few dollars shy of $90/bbl which is a psychologically important level. True, OPEC has recently announced it will increase production, but they only control 40% of the world's oil supply. And, we're in a cheap dollar environment.

3.) Employment. The current economic cycle is actually similar to the last two recoveries where employment growth was delayed at least a year after the end of the recession. In addition, it's important to remember that the last time we saw unemployment at these levels (the 1980s) it took an entire decade to hit full employment.

4.) China is experiencing higher than desired inflation, leading many to conclude they will start to take more aggressive interest rate action, thereby slowing their economy. Brazil is in the same boat as is India. In other words, the BRIC economies who have driven the recovery will probably start trying to slow their growth to prevent overheating.

5.) U.S. Congress. My God, but this institution continues to lower the bar regarding the definition of stupid. During my lifetime, I have seen the quality of Congressional representative continually decline to the current level of "lobotomy required to serve." God knows what kind of idiotic ideas they've got up their sleeve, but rest assured it will continue to redefine the word "incompetent." As such, Congressional action could conceivably screw up the recovery through some hair-brained scheme.

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Yesterday's Market

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Soros Warns About Cuts

George Soros has issued a warning at the Davos financial summit that Britain's austerity programme may push the country into recession again.

Whilst it should not be forgotten that Soros made money out of betting against the UK in 1992, when the UK was pursuing the folly of the exchange rate mechanism, he may well have a point.

Cutting public expenditure, and hoping that the private sector will take up the slack will only work if there is room to significantly loosen monetary policy.

Interest rates are near zero, there is no further room to loosen monetary policy. Additionally, banks are steadfastly refusing to lend money at rates even vaguely comparable to the Bank of England rate.

It seems that Osborne's austerity programme was a leap in the dark, based on hope that the brief surge in the economy last summer was sustainable.

Plan B, as and when Osborne creates one, will doubtless have to be unveiled before this coming summer.

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The Cost of Traffic

From the Texas Tribune:

Think repairing the state’s roads and highways is costly? Try not repairing them. That's the message from transportation advocacy groups, which say poor road conditions are costing Texas drivers $22.6 billion per year in car damage, fuel costs and traffic accidents. But as Mose Buchele of KUT News reports, before any of those problems can be addressed, we should all prepare for a bumpy ride.

But, it's not like bad roads cost us anything or that there are no viable infrastructure projects....

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Now He Talks About Investment....

From last nights SOTU:

The third step in winning the future is rebuilding America. To attract new businesses to our shores, we need the fastest, most reliable ways to move people, goods, and information – from high-speed rail to high-speed internet.

Our infrastructure used to be the best – but our lead has slipped. South Korean homes now have greater internet access than we do. Countries in Europe and Russia invest more in their roads and railways than we do. China is building faster trains and newer airports. Meanwhile, when our own engineers graded our nation’s infrastructure, they gave us a “D.”

We have to do better. America is the nation that built the transcontinental railroad, brought electricity to rural communities, and constructed the interstate highway system. The jobs created by these projects didn’t just come from laying down tracks or pavement. They came from businesses that opened near a town’s new train station or the new off-ramp.

Over the last two years, we have begun rebuilding for the 21st century, a project that has meant thousands of good jobs for the hard-hit construction industry. Tonight, I’m proposing that we redouble these efforts.

We will put more Americans to work repairing crumbling roads and bridges. We will make sure this is fully paid for, attract private investment, and pick projects based on what’s best for the economy, not politicians.

Within 25 years, our goal is to give 80% of Americans access to high-speed rail, which could allow you go places in half the time it takes to travel by car. For some trips, it will be faster than flying – without the pat-down. As we speak, routes in California and the Midwest are already underway.

Within the next five years, we will make it possible for business to deploy the next generation of high-speed wireless coverage to 98% of all Americans. This isn’t just about a faster internet and fewer dropped calls. It’s about connecting every part of America to the digital age. It’s about a rural community in Iowa or Alabama where farmers and small business owners will be able to sell their products all over the world. It’s about a firefighter who can download the design of a burning building onto a handheld device; a student who can take classes with a digital textbook; or a patient who can have face-to-face video chats with her doctor.

All these investments – in innovation, education, and infrastructure – will make America a better place to do business and create jobs. But to help our companies compete, we also have to knock down barriers that stand in the way of their success.

I highlighted the underlying arguments for infrastructure investment in an article posted here. I called the argument a no brainer -- which regrettably leaves out Washington. Here's the short version: our infrastructure is in poor shape and there are a ton of people in the construction industry out of work. Let's solve two problems at the same time and invest in the country.

Of course, there is no way this will get through the current Congress, but anyway ...

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Are Housing Prices Bottoming?

From Bloomberg:

U.S. home prices have reached a bottom and may be set to rise in the first half as buyers take advantage of increased affordability, said Karl Case, the economist who co-founded the S&P/Case-Shiller home price index.

“Prices have gone flat, bouncing around at what I think is essentially a bottom,” Case, a retired professor of economics at Wellesley College, said in a radio interview today on “Bloomberg Surveillance.” “We’re really going to have to wait to see what the spring market brings.”

The S&P/Case-Shiller index of home values in 20 cities fell 1.6 percent in November from a year earlier, the biggest 12- month decrease since December 2009, the group said today in New York. The Federal Housing Finance Agency, which measures sales financed with mortgages backed by Fannie Mae and Freddie Mac, said separately that prices slid 4.3 percent from November 2009.

An abundance of inexpensive homes and an expanding economy will support housing demand as it enters the so-called spring selling season when the bulk of transactions typically occur, said Case, who created the price index with Yale University Economics Professor Robert Shiller. The National Association of Realtors’ affordability index, a gauge of median income against home prices, reached an all-time high of 184.5 in November.

Shiller presents an interesting argument, although I disagree with his conclusion. Most economists do as well, according to a story in the Financial Times, which notes this is the fifth consecutive month with a drop in home prices. I recently looked at the Beige Book's real estate section and came to this conclusion:

Overall, housing is still a basket case. However, the incredibly low level of inventory gives home sales the opportunity to pick-up quickly and boost the economy should demand pick-up in a sharp way.

The short version is new home inventory is very low, but the existing number of homes is still high. To a certain extent, existing homes are a substitute new homes, but only at the lower end of the price spectrum. In essence, there is still a ton of inventory for the market to clear and that does not bode well for prices in the short or intermediate term.

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Dark Days Coming

Yesterday's lousy "growth" figures (a fall of 0.5% in GDP) have heralded further bad news. Minutes from January's MPC meeting show that two members voted for an increase in rates, they must be mad.

The mood of gloom surrounding the economy was further depressed by a speech made last night by Mervyn King (Governor of the Bank of England), in which he said that wages will have to fall and that we are facing the worst economic conditions for 90 years.

I wonder if George Osborne has actually factored all of this into his economic plans?

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Yesterday's Market

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More on Commodity Prices

From Bloomberg:

Cotton futures soared to a record on speculation that global supplies will fail to keep pace with rising demand in China, the world’s largest user.

Chinese imports surged 86 percent in 2010 as economic growth lifted demand from textile mills and adverse weather hurt the domestic crop. The country’s purchases may increase before next month’s Lunar New Year holidays, said Han Sung Min, a broker at Korea Exchange Bank Futures Co. On Jan. 12, the U.S. government cut its global-production outlook. Prices have more than doubled in the past year.

“Cotton was supported by China’s import data and speculation that the country will buy more” as the holidays approach, Seoul-based Han said.

From Bloomberg:

Wheat fell for the first day in six in Chicago on speculation that a rally to a five-month high will reduce demand from investors. Corn and soybeans also dropped.

Wheat gained 8 percent in the past five sessions on speculation adverse weather in South America, China and the U.S. curbed production. Hedge-fund managers and other large speculators pared their net-long position in Chicago wheat futures by 1 percent in the week ended Jan. 18, according to U.S. Commodity Futures Trading Commission data.

“Everybody is aware of the weather situations going on right now,” said Connor Noonan, an analyst with Castlestone Management in London. “Everybody has priced in the floods in Australia, and now we have flooding in South America. All of that combined, people are taking a little off the table.”

From Agrimoney:

The world faces another year of substantial wheat deficit in 2011-12, amid what is likely to be the "most intense battle for acres in history", Commonwealth Bank of Australia warned.

World wheat production, which is expected to fall 17m tonnes below consumption in the current season, will chalk up a second successive shortfall, reducing inventories to their lowest for four years.

Indeed, it will take until 2012-13 for the world to return to a, modest, surplus in wheat output, CBA said, pitching itself at the gloomier end of the round of forecasters releasing initial estimates for the coming season.

CBA forecast the 2011-12 deficit at 15m tonnes, noting that prospects for winter crops in the US and China had been curtailed by drought, while the likelihood of a rise in further seedings was being curbed by the clamour for nearly all crops for extra area to rebuild production and depleted supplies.

Notice that all the articles point to supply and demand issues: China increased its cotton imports 86% in a single year. That's a huge increase, and one that is large enough to drain world supplies. The wheat market is also suffering from supply issues. Also note that with increasing living standards, diets change, and hence people typically demand more food. In short, there are plenty of fundamental reasons for the increase in commodity prices, most of which are the result of increasing living standards.

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The Washington Lobotomy Factory Moves in High Gear

From the WSJ:

House Majority Leader Eric Cantor said he didn't support allowing states to seek bankruptcy protection and ruled out any federal bailouts of state governments.

"There will not be a federal bailout of the states," he said at a news conference Monday.

Rep. Cantor, (R., Va.), is the latest Washington official to take a dim view of further fiscal aid to state governments.

On Jan. 7, Federal Reserve Chairman Ben Bernanke ruled out a central-bank bailout of state and local governments straining under municipal debt burdens, saying the Fed had limited legal authority to help and little will to use that authority.

Mr. Cantor, the number-two House Republican, said states had the tools to deal with their fiscal challenges, including renegotiating agreements with public-sector unions, so there was no reason for federal involvement in their fiscal problems.

Great. So states that need help aren't going to get it. What a great way to sabotage an economy that is mending. I have another idea: let's not raise the debt ceiling and see what happens in world bond markets -- oh, they're already considering that move.

Here's the deal: like it or not, government spending is part of the economy and government employees perform useful tasks that help us all be more productive. For example, do you like that street you drove in on? I know I do --it helps me get to appointments. And how about that employee you just hired who can read and write? Pretty convenient, isn't it? Or how about the fact that no one broke into your house last night because the police were around to stop them? Kind of a nice feeling, isn't it? I have an idea -- let's start to gut those services, because we really don't need them. The result is called anarchy, a politically unwise decision to make.

Also -- have you noticed that no one is talking about tax increases? It's always spending that has to be cut. At this point, I return to what is becoming a central theme: the U.S. costs money to run -- and it's not going to run itself. If you benefit from that (and we all do, so it's a moot question) deal with the fact that you pay for what you get.

Cantor's statement is shortsighted, myopic and downright stupid and uninformed. Period.

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Yesterday's Market

The IWMs -- which have led the market higher -- are clearly now in a correction and will probably lead the SPYs and QQQQs lower. The IEFs are still consolidating and the dollar is moving lower.

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Economy Shrinks 0.5%

The Office for National Statistics (ONS) has released figures for Q4 2010 that show that the UK economy contracted by 0.5% in this period. "Experts" had been predicting a rise of 0.5%.

Needless to say, the weather is being blamed for some of this fall.

However, cold snap or not (even allowing for the fact that the ONS invariably has to revise its figures), it is clear that any rush to raise rates (as being mooted by some "experts") would be folly indeed when the economy is so very clearly "fragile".

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Commodity Prices Spiking -- Is Speculation to Blame?

Consider these two stories:

First we have this:

French President Nicolas Sarkozy said regulation of commodity markets will be a priority as he leads the Group of 20 nations this year, and inaction may cause food rioting in the world’s poorest countries.

Some commodity markets lack safeguards to limit price spikes and “price manipulation,” Sarkozy said at a press briefing in Paris today. France’s head of state said he asked Russian President Dmitry Medvedev to help study the role of derivatives in commodity-price swings.

“If we do nothing, we risk having food riots in the poorest countries and also an unfavorable impact on global growth,” Sarkozy said. “We want regulation of the financial markets for commodities.”

Some type of regulation for price swings would not be unheard of. In fact, we already see it in various commodity markets. However, it's also important to realize that regulation is not the sole issue:

Wheat futures climbed to the highest since August as importers stepped up purchases while adverse weather cut global output. Rice headed for the longest rally since late October.

The U.S. Department of Agriculture said on Jan. 21 that exporters sold 1.054 million metric tons of wheat in the week ended Jan. 13, seven times more than a week earlier and the most since August. Tunisia bought 100,000 tons of durum, Reuters said, citing European traders. Qatar, Bangladesh, Morocco and Iraq have issued tenders to buy rice or wheat since Jan. 19.

“Some governments are concerned about food riots, so they’re walking into the rice and wheat markets and just buying it,” said Darrell Holaday, the president of Advanced Market Concepts in Manhattan, Kansas. “We’ve had enough production problems in different spots around the world that it’s caused some problems.”

Wheat crops were hammered by the poor conditions last year in Russia. Global warming will change crop growth patterns. And with China, India and other emerging countries coming on line and growing, demand increases are to be expected. So there are legitimate demand based issues involved as well.

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Expect More Economic Growth

Last week, we saw a string of solid economic reports come out that indicate more economic growth ahead. Perhaps most importantly was the index of leading economic indicators, that increased 1%. From the press release:

The Conference Board Leading Economic Index® (LEI) for the U.S. increased 1.0 percent in December to 112.4 (2004 = 100), following a 1.1 percent increase in November, and a 0.4 percent increase in October.



.....

Says Ataman Ozyildirim, economist at The Conference Board: “While the LEI points to an economic expansion that is gaining further traction, its components still suggest the expansion path may be uneven. December’s gain was led by housing permits, the interest rate spread, initial claims for unemployment insurance and consumer expectations. The large increases in December and November show that, after a brief pause in the second quarter of 2010, the LEI is resuming the upward trend that began in March 2009.”

Says Ken Goldstein, economist at The Conference Board: “The four-month rise suggests the economy now has some wind in its sails; however, it still faces some strong headwinds in the medium-term. Overall economic activity is likely to continue to gain momentum in 2011.”

What's particularly impressive about this increase is there are two numbers responsible for 50% of the LEI: average hours of manufacturing (which account for 27% of the number) and M2 (which accounts for 32% of the number). However, neither of these numbers contributed to the increase in the LEIs. Instead, the increase was the result of building permits and the interest rate spread.

The Empire State Manufacturing Survey also printed some good numbers;

The Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved in January. The general business conditions index rose 2 points to 11.9. The new orders index moved up 10 points to 12.4, and the shipments index surged 18 points to 25.4. After a sharp decline last month, the inventories index rose above zero. Employment indexes also climbed into positive territory. Both the prices paid and prices received indexes rose, pointing to an acceleration in both input prices and selling prices. Future indexes conveyed a high level of optimism, with the future general business conditions index advancing to a level not seen since early 2010, while future price indexes climbed to multiyear highs.

This number dropped in the summer law year, probably in relation to the EU situation. However, it has bounced back for the last few months, indicating the problems from the EU situation are probably subsiding.

The Philly Fed also showed improvement:

The survey's broadest measure of manufacturing conditions, the diffusion index of current activity, edged down slightly from a revised reading of 20.8 in December to 19.3 in January.* The index has been positive for four consecutive months, following a two-month dip into negative territory (see Chart). The demand for manufactured goods is showing continued improvement this month: The new orders index increased 13 points this month, the fourth consecutive monthly increase. The shipments index also improved, increasing 8 points.

Firms' responses continue to suggest that labor market conditions are improving.The current employment index increased 13 points, and for the fifth consecutive month, the percentage of firms reporting an increase in employment (25 percent) is higher than the percentage reporting a decline (7 percent). Twice as many firms reported a longer workweek (22 percent) than reported a shorter one (11 percent).

.......

Price increases for inputs as well as firms' own manufactured goods are more widespread this month. Fifty-four percent of the firms reported higher prices for inputs, compared with 52 percent in the previous month. The prices paid index, which increased 6 points in January, has increased 42 points over the past four months. On balance, firms also reported a rise in prices for their own manufactured goods: More firms reported increases in prices (26 percent) than reported decreases (9 percent), and the prices received index increased 8 points, its second consecutive positive reading.

Let's take a look at the chart of both data points:





The chart above shows the dip both indexes experienced in the summer and early fall of last year and the subsequent rebound.



Going forward there are two issues for the manufacturing area: price increases as we see commodity prices continue to move higher and a possible slowdown, this time caused by China as their central bank tries to slow down their economy. I should add that a Chinese slowdown -- if bona fide -- should exert downward pressure on commodity prices.



Finally, we saw continued improvement in the labor picture:

First-time applications for jobless benefits fell by 37,000 last week to 404,000, mostly reversing a sharp spike earlier this month, according to Labor Department data.

Yet the latest drop doesn’t reflect a sudden improvement in hiring trends: Labor officials attributed the prior spike in claims to a backlog that built up over the holidays. State unemployment offices were open fewer hours and poor winter weather deterred some people from filing applications right away. As the backlog was processed claims were expected to recede/

The previous week saw a large spike in claims, which were supposedly caused by an administrative backlog. Now we know that story was pretty much true, as the backlog appears to be clearing out.

The bottom line is last week's data was solid and points to continued expansion.

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Irish Woes

Ireland stands on the brink of political and economic chaos, and will drag the Euro down with it.

The resignation from the government of the Green Party, over the resignation of Brian Cowen as leader of Fianna Fail (but not as Prime Minister), means that the government will have to bring forward the date of the general election (originally planned for March 11.

However, the finance bill (scheduled to be debated this Friday) has yet to be passed. The bailout agreed with the IMF/EU is contingent on that bill passing. In the event that it does not pass, the bailout deal will unravel and the Euro will be under renewed pressure as Ireland teeters on the brink of being forced to leave the Eurozone.

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Yesterday's Market

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Weekly Indicators: The depths of Winter edition

- by New Deal democrat

Meteorologically speaking, we are at the coldest point of the winter. From now on, we can begin to look forward to spring.

Economically speaking, housing has been stuck in the depths of winter for two years, and that was the spotlight of the monthly data this week. Housing starts declined more than expected to 529,000, but were still above 2009 lows. Permits, however, surged 91,000 to 635,000. Existing home sales increased for the 3rd time in 4 months, from 4.12 million annualized in August to 5.28 million last month. Months of supply was cut to just over 8 months (we'd want to see under 7 months for several months in a row to begin looking for a possible bottom in prices). Billings by architects rose to the highest level in several years, signalling that commercial real estate may also be close to bottoming. Housing permits are one of the 10 leading indicators and helped that gauge of future activity rise 1.0 for December - just about cementing good growth for this quarter.

So, let's start this week's high frequency data with the housing component:

The Mortgage Bankers' Association reported a net decrease of -1.9% in seasonally adjusted mortgage applications. This number has declined over the last 5 weeks, giving back about 1/3 of its uptrend since bottoming in July, and is down -11.0% YoY . Refinancing increased 7.7%, and is actually up YoY, but in real terms remains near low levels equal to many bottoms in the last 5 years.

The BLS reported initial jobless claims of 404,000. The 4 week moving average declined to 412,000. Last week I noted that "the first full week in January is typically by far the highest number for NON-seasonally adjusted claims all year. Thus the seasonal adjustment is major, and it is easy - and common - for this adjustment to be 'off.'" :This week certainly seemed to confirm that. The downtrend in initial claims is intact, and the real question is whether it stalls at just above 400,000 or moves down into the 300,000. We'll know by the end of February.

Gas at the pump went up 1 more cent to $3.10 a gallon last week, while Oil went below the $90 a barrel mark to $89.55 Thursday night. Gasoline usage was up about 2% from last year's levels.

The American Staffing Association Index increased 7.7% to 88 for the week ending January 9, entirely for seasonal reasons. This was 13% above a year ago, but about 5% below 2007 levels. Seasonal factors probably finally ended with this week.

Railfax generally remained steady in all components last week, and also steady in its comparative improvement over last year. Shipments of waste and scrap metal and auto shipments were slightly better than last year's levels. We are at the low seasonal point for rail traffic, which should start to increase next week.

The ICSC reported that same store sales for the week ending January 15 decreased -0.1% w/o/w, but increased a paltry 1.4% YoY. Shoppertrak reported that sales rose 3.3% YoY for the week ending January 15, but were down almost 13% from the week before, suggesting that shoppers took a breather in early January after a strong holiday season.

Weekly BAA commercial bond rates gave back -.02%, to 6.07%. This was less than the -.04% decrease in the yields of 10 year treasuries.

A reminder that on a trial basis I am using Matt Trivisonno's +1.07% adjustment to withholding data this year vs. last year, due to the recent payroll tax political deal. So adjusting, the Daily Treasury Statement showed adjusted receipts in the first 12 reporting days of January of $99.0 B vs. $96.5 B a year ago, for a gain of $2.5 B. Over the last 20 reporting days, this year shows $159.9 B collected vs. $160.5 B one year ago, or an adjusted loss of -0.8 B. Either we have suddenly had a slowdown (i.e., still ahead of last year's levels, but just barely), or Matt Trivisonno's adjustment is too conservative. We should have a better handle on this after a full month.

Finally, a real change in the last couple of weeks: M1 was down -0.5% for the week, up +0.2% month over month, and up +7.5% YoY, meaning "Real M1" was up 6.1%. M2 was up +0.1% for the week, +0.1% month over month - and now, the big change - up +3.9% YoY, meaning "Real M2" was up +2.5%. Real M2 has now, for the first time, joined Real M1 out of the "red zone." There has never been a recession with positive Real M1, or Real M2 at 2.5% or above.

Bottom line: we have an economy that is trying to gain momentum, and is being restrained by the choke collar of Oil.

P.S. One final note: For a great chuckle to start off your weekend, where the DK Pied Piper of Doom gets completely pwn'd, read this exchange!

Have a nice weekend!

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Will Oil Prices Derail the Recovery?

From This Week in Petroleum

In late December, the average national retail price of regular grade gasoline rose above $3 per gallon for the first time since October 2008. However, when gasoline sold for $3 per gallon in October 2008, gasoline prices were in the midst of a sharp decline that saw prices fall from a peak of $4.11 per gallon in July 2008 before bottoming-out at $1.61 per gallon in December 2008. Since then, prices have been on an upward trend.

.....

Crude oil prices have risen to over $90 per barrel fueled by world petroleum demand growth, particularly in non-Organization for Economic Cooperation and Development Asian countries such as China and India, and other factors. As highlighted in the Energy Information Administration's (EIA) most recent Short Term Energy Outlook (STEO) and last week’s This Week In Petroleum, EIA expects continuing tightening of world oil markets over the next two years, keeping upward pressure on crude oil prices.

Also consider the following graph from the same report:



The price of gas is a key price that consumers see everyday. Escalation beyond psychologically important levels (like $3.00/gallon) gives consumers cues regarding the economy. Remember that the spike to over $4.00/gallon occurred before the last recession.

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Yesterday's Market

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More Budget Stupidity

The Financial Times -- which has one of the most ridicules copyright policies of any newspaper -- has a story today about the city of Vallejo California. They had to declare bankruptcy, so now there are almost no city services to speak of. Potholes are everywhere and the police are horribly understaffed. The paper goes on to note that this is the future for more than a handful of U.S. cities.

But here is the rub: it's all the unions fault for demanding outlandish benefits packages. Never mind that all the parties to the contract sat down at the same table at some point and negotiated a contract in good faith, and never mind the fact that contract terms and conditions and enforcement are a bedrock principal of the legal system. In addition, never mind that collective bargaining equalizes the negotiating process, making any contract negotiated through collective bargaining that must more viable from a contract theory perspective. Also note that despite the love of law and order and always siding with cops and firefighters because they do gods work and they are so brave, now we see politicians running for the doors.

Here's the real answer, ladies and gentleman: if you want a nice country, you have to pay for it. That's the bottom line. A country the size of the U.S. requires an expansive infrastructure. We need solid roads, schools, court houses and the like to operate. These things are not free. Yesterday I noted that my home state of Texas is cutting school spending to the bone -- again. This will hurt our competitiveness in 20 years -- long after the idiots and yahoos who made the cuts are out of office. But that is long-term thinking (actually that is thinking in general regardless of the time frame over which we are projecting the intellectual results) which is beyond the pale for most of our culture.

The reality is the U.S. is an expensive country to run, plain and simple. If you want a nice country, you have to pay for it.

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Beige Book, Part 4: Real Estate

From the Beige Book:

Activity in residential real estate and new home construction remained slow across all Districts. A majority of the Districts, including Boston, New York, Cleveland, Atlanta, Chicago, Minneapolis, Dallas, and San Francisco characterized local housing markets as weak and sluggish with little change from the previous reporting period. Kansas City noted further weakening, while Richmond received reports of both flat activity and further declines. The St. Louis District saw additional declines in existing home sales, but also cited increased new home construction permits. All Districts attributed slumping activity to concerns about the pace of economic recovery, especially in employment, while the Philadelphia, Atlanta, and Chicago Districts mentioned difficulty obtaining credit as another constraint on demand. High levels of existing home inventories continued to damp the pace of new home construction in most Districts reporting on construction, although Boston, Richmond, Dallas, and San Francisco mentioned pick-ups in multifamily construction within their Districts. Home prices generally declined or held steady in the New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, Kansas City, Minneapolis, and San Francisco Districts; the New York, Atlanta, Chicago, and San Francisco Districts mentioned distressed properties placing downward pressure on prices. Boston reported rising median home prices across most states in the District, but contacts attributed those increases to relatively higher sales of more expensive properties rather than a general upward movement in home prices. Outlooks for residential real estate in the coming year were mixed, with contacts in most Districts described as expecting continued weak conditions.

Commercial real estate markets displayed mixed results across the Districts again this reporting period, as leasing markets exhibited increasing signs of recovery and nonresidential construction remained weak. Leasing activity increased modestly in the Richmond, Chicago, Minneapolis, and Kansas City Districts and showed tentative improvement in the Dallas District. Vacancy rates, while quite high across the country, fell marginally in the Kansas City District and in New York City's office market. Leasing market fundamentals held roughly steady in the Boston, Philadelphia, and San Francisco Districts. Commercial construction activity was described as very limited across most Districts, with the bulk of new activity coming from projects related to healthcare, public infrastructure, and multifamily housing. Contacts in most Districts expected modest improvements in commercial leasing in 2011, although the outlook for construction was mixed and some Districts noted rising costs as a concern.

Time is a bit short right now, so I'm going to skip to the data, courtesy of Calculated Risk.


The existing home sales chart shows the distortions caused by the home buyer tax credit, along with a large fall off when sales expired. Sales have been rising, but they are still at low levels.


The months of supply at the existing sales pace is still very high by historical standards, as is



The existing home sales inventory.


New home sales are near the lowest level seen in the last 40 years.


Total inventory, however, is also very lean right now


but the market clearing pace is still high.

Overall, housing is still a basket case. However, the incredibly low level of inventory gives home sales the opportunity to pick-up quickly and boost the economy should demand pick-up in a sharp way.

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