As the year draws to a close, Capital Spectator will have limited posting. We will resume our regular schedule on Monday, January 4.
In the meantime, we wish all our readers the best. Thank you for your continued support. If we can make it through 2008/2009, we can tackle anything. Here’s to a strong 2010!
Last month, we expressed our doubts about the effectiveness of nearly a trillion dollars in government spending aimed at healthcare reform to address the budget deficit. A month later, our concerns persist.
As always, the intricacies of substantial legislation reveal their complexities, and recent reports suggest that the prevailing economic logic may not hold up under scrutiny. Specifically, James Pethokoukis at Reuters has highlighted how double counting of Medicare tax increases may skew perceptions of the deficit reductions attributed to healthcare reform. The Congressional Budget Office has joined the debate regarding spending practices. As they state in their analysis:
To ascribe the entire amount of [hospital insurance] trust fund savings to both enhancing government capacity to fund future Medicare benefits and financing additional spending outside of Medicare effectively double-counts a significant portion of those savings, thereby overstating the governmental fiscal improvement.
It appears lawmakers are navigating budget projections with a degree of flexibility that raises eyebrows. While we acknowledge the potential for savings amid this healthcare overhaul, we remain skeptical.
“Is there no way,” said I, “to escape Charybdis while keeping Scylla at bay when she tries to harm my men?”
Homer’s Odyssey
There’s room for debate regarding whether the recent positive figures on consumer spending and personal income for November are influenced by the holiday season’s characteristic spending spree. There’s also room to discuss the downward revision of third-quarter GDP and its implications for the pace of recovery. Furthermore, the noteworthy increase in November sales of existing homes raises questions about the impact of the expired first-time buyer’s tax credit. We can also reflect on various theories regarding the role of government stimulus in averting an economic catastrophe. Nevertheless, the upward trend in recovery for America remains intact.
The challenge is determining its sustainability. While unforeseen negative factors could emerge in the following weeks and months, the U.S. recovery seems to have momentum. The real question is how stable that momentum will be. A broader view of economic indicators—particularly spending and income—reveals a clear upward trajectory, as illustrated in our chart below.
There are still plenty of concerns on the horizon, primarily focused on how 2010’s growth unfolds. Yes, an expansion seems to be forming, but it remains uncertain whether it will adequately address forthcoming challenges.
“I believe we’ll be ‘driving sideways’ in both the California economy and the U.S. economy,” states economist Barry Eichengreen of UC Berkeley today. Economists like Brian Bethune from IHS Global Insight predict a modest U.S. economic growth of 2.0% to 2.5% in the coming year, characterizing it as a “half-speed recovery.”
The 2000s have been the worst decade for U.S. stocks in two centuries, according to a report from yesterday’s Wall Street Journal. In contrast, the Global Market Index—a passively weighted blend of all major asset classes—performed somewhat better, serving as a benchmark for our sister publication, The Beta Investment Report.
As 2009 and the decade near their conclusion, the outcomes are becoming clearer. With just two weeks remaining in the year, we can start to analyze annual and decade-long performances. Based on results through November, here are the 10-year annualized total returns for major asset classes and the GMI: 
U.S. stocks ranked last, returning a meager 0.1% on an annualized basis over the past decade. In stark contrast, emerging market bonds emerged as the top performer with an impressive 11.5% annualized total return. The Global Market Index recorded a return of 4.2% over the same period.
Concerns for the economy in 2010 are numerous, with one of the foremost being the state of bank lending, which appears to be declining.
According to a report from the Federal Reserve, commercial and industrial loans from U.S. banks fell in November to $1.36 trillion, representing the lowest level since September 2007 reports. Although the significant economic shock of the past two years explains this decline, it raises troubling questions. 
While the Federal Reserve can increase the money supply as much as it likes, an absence of lending to businesses could hinder the recovery process. Financial institutions are eager to take advantage of the central bank’s monetary support but are focusing primarily on strengthening their balance sheets, leading to a decrease in lending.
While the Fed has not laid out a concrete exit strategy, they are subtly preparing for the day when the central bank may dial back its liquidity support. Although today’s FOMC statement confirmed that the federal funds target rate remains at a historic low of 0 to 0.25%, there was also an effort to temper expectations for endless stimulus measures.
“In light of ongoing improvements in the functioning of financial markets,” the Fed indicated this afternoon, “the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010…” This marks a significant step forward.
This is part of a continuum. Ben Bernanke, the Fed chair and occasional op-ed contributor, previously noted in a Wall Street Journal article that an exit strategy does indeed exist. Furthermore, he emphasized that the Federal Reserve possesses both the resources and determination to tighten monetary policy when necessary.
The Fed has consistently informed us that its quantitative easing measures would eventually dissipate. However, today marks a notable shift towards establishing clear timelines for these changes. The various measures of monetary support were not all implemented simultaneously, and thus their termination will not occur in unison, but they will finish nonetheless.
Although future announcements concerning these changes may not be as transparent, a reckoning awaits, regardless of how gradual or sudden it may be.
If you’re seeking an optimistic view of the economy, Alan Blinder is the one to consult.
Today’s consumer price update presents a less alarming picture compared to yesterday’s producer price report for November. While wholesale inflation increased for both overall and core measures (excluding food and energy), this morning’s Consumer Price Index (CPI) results show a mixed bag. Although headline CPI rose by 0.4% in November—the highest since June—core CPI remained unchanged, seasonally adjusted. This balanced data supports the notion that the Fed is unlikely to raise interest rates at today’s FOMC meeting, should they require additional justification to maintain a dovish stance.
“Inflation is not currently a concern and should not be one anytime soon,” Brian Bethune, chief economist at IHS Global Insight, told Bloomberg before the CPI update. He added that “deflation risks have significantly decreased.” In essence, we can continue to celebrate… but with caution.
Even if the CPI report had painted a bleak picture, Fed Chairman Ben Bernanke would likely refrain from raising interest rates today, especially given that he has just been named Time magazine’s Person of the Year—as “the most powerful nerd on the planet.”
Time is of the essence regarding the policy of maintaining high liquidity without succumbing to inflationary pressures. Today’s producer price report for November reveals potential shifts.
Wholesale prices rose by 1.8% last month, according to the Bureau of Labor Statistics report. While this increase is among the highest seen in recent years, much of it can be attributed to rising energy costs. Assuming energy prices stabilize, one might downplay the headline PPI number for November.
However, the core PPI, which excludes the volatile food and energy sectors, recorded a significant increase of 0.5%—the highest monthly change in over a year as shown in our chart below.
Is this simply statistical noise, or are we witnessing a resurgence in pricing pressures as the financial crisis of 2008 recedes further into the past? Additional insights will come with tomorrow’s consumer price report.
Consumer spending remains steadfast, even in the face of household debt and the repercussions from the recession. This morning’s retail sales report for November serves as a reminder that America is a consumer-driven economy, and habits die hard.
According to the Census Bureau’s report, U.S. retail and food services sales increased by 1.3% on a seasonally adjusted basis in November. A monthly increase beyond 1% is noteworthy and alleviates fears regarding a potential double-dip recession. Even when auto sales, known for their volatility, are excluded, retail sales still grew by 1.2%. Moreover, this growth was broad-based, with only a few sectors showing declines.
