Will the US economy bounce?

There is a wealth of debate surrounding the US economy at the moment. The basic tenets of the debate can be summarised as bulls arguing that the current slowdown is the result of high oil prices whacking consumers and the Japanese tsunami whacking production. Bears are arguing there is a structural problem that these shocks have revealed.

Let’s first examine the bull case. They argue that both the high oil prices and Japanese effects will pass soon. And there is evidence for a crimping of consumption, form Money Game:

Our analysis shows that over the past 18 years, the impact has been somewhat larger—closer to $1.4 billion for every once cent increase. Based on the above relationships, the run-up in energy prices through May lopped between $90 to $150 billion (annualized) off of consumer spending in H1.

Also, 5% or so of US exports go to Japan (under half a % of GDP). And there have been additional impacts from the shut down of some car production following supply chain disruptions.

However, neither of these (especially the latter) is enough to explain the slowdown. The US economy managed to power through higher oil prices in 2007 and 2008. Moreover, the dreadful BLS jobs report form Friday showed a broad-based hiring slowdown.

Whilst oil and Japan are weights, there is clearly something else going on. Which is where we turn to the bear case and Tim Duy:

It is beginning to look like the economy is circling the drain.  To be sure, I hate to make too much of one report, but the May employment report comes at the end of a series of bad reports stretching back to nearly the beginning of the year.  There looked to be solid hope the recovery was on a better track as 2010 drew to a close, and that momentum appeared to carry through into January.  But then we hit a wall.

What wall?  Theories abound.  Temporary weather and tsnumai induced disruptions for one, but we should be trying to look through such short term events.  The crisis in Europe, although to be honest I don’t think this is having much of an impact on the decision making of the average US citizen or firm.  I tend to think the rise in commodity prices, particularly oil, was the primary culprit, as consumer spending faltered and businesses struggle to pass increasing costs onto consumers.  But what it really comes down to is that we have only had one good quarter in this recovery, and that simply was not enough to provide sufficient resilience to the sheer number of shocks the economy has weathered this year.

That’s right, the underlying economy is weak and shocks simply snuff out any virtuous cycle of spending leading investment and job growth leading spending. Or vice versa.

But we still haven’t got to the source of the weakness. For that, let’s look at a great post today by Barry Ritholz:

Now, what’s most troubling is that among the reasons income is going nowhere is the simple fact that American workers are getting less of the spoils, as clearly evidenced by their “labor share.”  We can determine fairly easily what share of the fruits of our labor are coming back to us in wages, salaries, and benefits, as we see here:

Per the BLS (third article, Chart 5 reproduced below):

Labor share is the portion of output that employers spend on labor costs (wages, salaries, and benefits) valued in each year’s prices. Nonlabor share—the remaining portion of output—includes returns to capital, such as profits, net interest, depreciation, and indirect taxes. [Emphasis mine for later reference.]

When labor share is constant or rising, workers benefit from economic growth. When labor share falls, the compensation–productivity gap widens.

Labor share averaged 64.3 percent from 1947 to 2000. Labor share has declined over the past decade, falling to its lowest point in the third quarter of 2010, 57.8 percent. The change in labor share from one period to the next has become a major factor contributing to the compensation–productivity gap in the nonfarm business sector.

So, how are Americans doing?  Here’s the history of the series (PRS85006173 — Nonfarm Business: Labor Share):

…So, where’s the nonlabor share of the equation showing up (see reference above)?  How about, in large part, on the balance sheets of nonfarm nonfinancial corporations — in their liquid assets:

And those are the nonfinancial companies that weren’t showered with government largesse and arguably made their money the old-fashioned way:  They (presumably) earned it (unlike the banksters).

…I consider myself an ardent capitalist.  But what we’ve got now isn’t capitalism — it’s some warped perversion of capitalism that is leading us to a very troubling place.  As long as Congress continues to play Jerry Mahoney to corporate America’s Paul Winchell, color me decidedly dour on the outlook.  The parasite has almost killed its host.

This is what Sell on News has been pointing to for the past week. The accumulation of debt by households has hidden a transformation of the US economy from industrial powerhouse to corporate host. Now that its corporations have shifted production elsewhere, the debt remains but the jobs have gone. Profits are terrific but unsustainable because there is no scope for a virtuous economic cycle at home unless labour gets its share of national profits for demand growth.

The US still needs to find a new, external source of demand. Sooner or later, QE3 is coming.

Houses and Holes
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  1. Corporations get an ever increasing share of GDP, and employees get an ever decreasing share of GDP. What could possibly be wrong with that? That’s just capitalism running efficiently in country where labour force “rigidities” are not a problem.

    • Similar if less extreme forces are at work here. Although the labour pendulum has swung back in the past few years (arguably a bit too far), our production and especially income is going to become increasingly reliant upon on a small a VERY powerful group of miners that will, of course, perennially seek to increase their share of profits over labour. Households are already weighed down with debt having covered for the loss of other corporates sending production elsewhere. And many of the old income sources are being deflated to make way for the new. An RSPT of some sort is absolutely vital to prevent a similar trajectory for us as the US…

      • The political might of the miners was clearly demonstrated during the anti-RSPT campaign. I don’t care what your opinion of the resources sector, I don’t think its healthy for our democracy for one industry to become all powerful. That’s why its so important to get the message out there, that’s its high interest rates, the strong currency, and ultimately the resources boom, that’s the cause of the current pain in mainstream Australia. It sure as hell isn’t the carbon tax, which if I’m not mistaken, doesn’t even exist yet.

        Once the voters twig that the miners are getting fabulously wealthy while they are hit with high interest rates, falling house prices and a weak domestic economy, I think you’ll find a mining tax will become a far more acceptable politically.

        • You missed the banks ..

          What about the coffee shops?

          Look then at the platform companies that have managed to overcome the burden of Oz labour…

          And whilst we are at it let us again introduce a 95% tax on the wealthy. Damn them, how dare they!

          • Bleh. The usual drivel.

            I’m not advocating a tax on the wealthy or even higher corporate tax rates.

            The mining boom is qualitatively different. Its a one-off bonanza profiting from resources that belong to all Australians, and its imposing restraint on the rest of the economy.

            I don’t care if Gina and Twiggy get fabulously wealthy. Good on ’em. I do care when their activities directly affect my livelihood through higher interest rates and a higher exchange rate.

          • Sorry Lorax, what theory is the mining tax based on?

            No usual drivel just a serious question and shows how ignorant all and sundry are.

            As a different take on the matter, not ALL mining companies make profits, not ALL mines are productive mines so how the ‘ell can one quantify the return?

            What are you in favour of, the poorest mine paying no tax, yet all the other more productive mines paying tax?

            Is not this a trap in that ALL of the productive mines are mined first?

            Regretfully Lorax you are waging a war and through lack of understanding of the Marxist ideals that are inter-played throughout our political system. One day someone might wake up but by then it will be too late ..

            Same as the Carbon Tax ..

            Hello South Africa, South America and Canada …

        • Get over it.

          All this anti-mining rhetoric is getting really boring.

          The RSPT was an incompetent piece of drafting, effectively nothing more than a blatant tax grab by a desperate government needing to replenish its middle-class welfare coffers in order to buy votes at the next election. It was undemocratic, unannounced and unfair – changing the rules of engagement with legally operating taxpaying businesses overnight. It threatened not only the profits of the bigger miners but the very viability of the smaller ones. Getting a big project off the ground is a momentous effort – and should be supported by the Australian government – not jeopardised. So what if a few individuals become wealthy in the process – the greater benefit to the Australian economy is of more importance.

          Selling widgets is not going to save us. So get real, comprehend our natural comparative advantage – RESOURCES – and get on with it.

          Stop complaining. Please.

          • The point is the RSPT is constantly referred to – it was fatally flawed and deserved its fate. A pity the same didn’t apply to the political careers of all the perpetrators.

            Profits are reasonable, at the moment. It is a cyclical industry. Profits will not always be as substantial. If indeed an equitable method can be developed to secure a greater proportion of the these businesses profits (something that applies to no other other businesses in the country – that is what the royalty system is for) it would be essential that these revenues are isolated to a SWF for generational benefit. Truth is, with the current government, any additional revenues raised would be spent on frivolous feelgood projects with no generational benefit. Without a SWF I’d rather the miners get it.

          • I don’t want to tax mining out of existence. I want to tax it when it takes an unreasonable share of profits whilst the rest of the economy pays a high price.

            When prices fall, I don’t want to tax them any more than anyone else. Saul Eslake’s idea of a sliding tax bracket is super!

            As you know, I believe that without mining, we’re Ireland…

          • I too thought Saul Eslake’s proposal had some merit. It was modest enough to be acceptable, potentially.

            The waters get murky when talking of ‘unreasonable share of profit’ – what is the barometer of reasonable?

            It remains that these are legally operating businesses paying the legally requisite levels of tax – to redefine their taxpaying responsibilities in a fair manner, when such additional tax-paying responsibilities apply to no other sector is open to debate.

            We have a constitution which allocates mineral rights to the states and as such only the states can apply royalties. Royalties have a degree of fairness in the sense that they are applied with some relation to the amount of mineral extracted. After all, it is the loss of resource that is being compensated for – that is permanent, profits are not. Perhaps a tax loosely based on the system of royalties is an even better way to go (of course not called that!) – decreased tax revenues in times of boom but ongoing revenue calculated on volume as compensation calculated for the long term loss of the resource?

            The issue of the rest of the economy suffering – well the resources companies do not determine that – talk to Treasury, RBA and the government!

        • Mind you, Lorax…

          ..IRs are only really going to go up if we’re looking at net CPI positive inflation above that of the RBA’s “control” band.

          Now, if we assume that housing is definitely on its last major leg down (ie. Phase 4 of a Bubble, whether that be slow or fast), and Housing Decline >> Mining Boom, then having a “large” CPI above that of 3% is highly unlikely.

          What’s more, if people keep saving how they are, then there a lot of money being “taken out” of the system in the short to medium term – reducing both the amount of money flowing, and it’s velocity. That’s very disinflationary, IMHO.

          So, with disinflationary and deflationary headwinds blowing on so much of the economy right now, I really can’t see inflation getting too much higher.

          That is, not without AUD “printing” of various kinds.

          There’s just so much deflationary headwind (though I will concede that “need” items, such as fuel and food, are likely inflate faster than “want” items will deflate).

          My 22222 cents!

    • Vertrauensmann

      Naïve. Consider the consequences of a society bound by such an ideal. You think the worker will be satisfied living under such conditions?
      I, for one, am thankful I am able participate in a society with a degree of “rigidity” within it’s labour laws.

      • Understood…but it is still inflationary in the sense that i provides a high floor on what deflation can achieve (ie. in correcting misallocation of capital/value)…

        A difficult one…

  2. Nice post. You beat me to it on the share of labor thing – was planning something on this! But will probably still do something in the coming week. Lots to talk about…

  3. This ‘Labor share of productivity’ concept is a smokescreen.

    The reason there is no recovery is because of the Fed and insane monetary policy.

  4. In the 1920’s our own Prime Minister Stanley Melbourne Bruce ordered troops to open fire on striking coal miners – all part of his wonderful efforts to keep wages down and save the economy. The belief back then was that lower wages increased corporate profits and higher stock dividends – the crash of ’29 only accelerated the drive to cut wages. We all know how that panned out…

  5. I personally think the US will be unrecognisable in 10 years. Why?

    1.Even if their income taxes were raised to 100% – there is still no way the US government can cover its liabilities. Its foreign policy of war alone is a 1 trillion dollar drain on the economy.

    2. Consumers are tapped out and consumer spending is on the slide, which accounts for over 60% of economic growth.

    3.The US relies on importing 2/3 of its oil and is vulnerable to supply shocks from the Middle East.

    4.It effectively has a fascist corporatist government looting its economy.

    Here’s an interesting article from Forbes. ‘The Next Financial Crisis Will Be Hellish and It’s On Its Way’


    • I pretty much agree with everything you have stated.

      They are currently defaulting by debasing their currency and paying back their creditors in inflated currency.

      They may actually default in the more traditional way in the future. It’s not like anyone in the international community is going to demand to be paid back “or else.” If the USA defaults it’s creditors have no recourse….they should reallly start thinking about that.

      • I know it’s a commonly used term these days, but what do you mean by currency “debasement”? Sure, QE is bad for the dollar. But the dollar has been falling for a decade now. Look at a chart — the trend started well before the recent crisis.

        This is not default in any normal sense of the word. Anybody who buys a sovereign bond knows that it comes with currency risk.

  6. in short, no the American economy will not bounce. And further more we have very similar demographics and economic attachments.

  7. Bill Mitchell repeatedly makes similar observations about the labour share of GDP here.

    Sooner or later, QE3 is coming.

    So how exactly does QE address any of the issues raised in the article?

    Q. Hasn’t the labour share of GDP declined (collapsed) during 2 years of QE?

    A. You betcha.

    • Doesn’t, but does at least have the merit of inflating the rest of the world as devalues the currency…that will boost demand for AMerican goods and help rebuild their industrial base.

      • Well you have a bit over 2 years of QE data to test that theory. How is that working out for you?

        And as noted, the article raises issues w.r.t the american economy and the biggest negative change in those factors occured during QE yet you end by saying more QE is coming. For whatever reason you seem to have taken a set position w.r.t. to more QE when the only data that exists shows that metrics raised in the article got substantially worse during QE.

  8. Will the US economy bounce? Long term I’m optimistic it will, but a lot of ground to cover before that.

    Personally, I think the structural issues are too big at the moment, and like I said yesterday if they cut spending things would get better, but it’s not going to happen in five years, and might take twenty. They can move towards a balanced budget, and hope over long period of time inflation will devalue the debt. It’s still nearly a USD 15 Trillion mountain to pay down, or as I think, re-structure, and the R word means the D word (default on some part of it). China is diversifying is paper foreign surplus away from the US and more towards the EU.

    This is a bit off topic, but relevant:
    [ http://www.telegraph.co.uk/finance/economics/8560503/European-Central-Bank-risks-being-wiped-out-by-bail-outs.html ] who would invest in the EU if the ECB could be wiped out by a 4.23% fall in asset value? If you look at how quickly Greece spent the first bail out this next one won’t last long. In this next deal Greece looses it assets; what a great deal [subject for a blog here]. The reason I added this as the US will likely get hit but an EU financial discontinuity. There is a reasonable chunk of US Treasuries held by Europe if you include the UK. Food for thought.

    This is all sizing up for a crisis bigger than GFC V1. The FED earlier this year changed it’s accounting rules so it can’t go broke, so that in itself is another warning sign.

    Russell Napier is telling clients to sell US equities due to the failure of QE2, and he presents a compelling case for that advice. [ http://www.docstoc.com/docs/79789745/Napier-QE2-Failure ].

    Take QE2 away and we’re going to get a wild ride IMO. The ASX follows the US mostly so I expect the same effects here.

  9. Hitting the nail right on the head IMO.

    The link between US corporate health and the US publics wellbeing has been vastly weakened over the last 10 years. I lived there for much of that period, working for a big US company, and saw these trends developing. Outsourcing and efficiency has hit hard. At the same time, medical costs have kept accelerating. The motivation for US companies to keep hiring people, and keep paying more to those they have, has drastically reduced. At the same time, huge amount of manufacturing has left the US. Finally, US companies derive far more of their revenue from overseas than was the case even 10 yeara ago.

    Companies have also learned how to cope with ever-fewer employees, and even sitting on cash reserves now are loathe to increase their headcounts.

    The corporate sector will NOT lead the US out of this recession IMO. They better come up with some new ideas or face a Japan scenario.

  10. “This is what Sell on News has been pointing to for the past week. The accumulation of debt by households has hidden a transformation of the US economy from industrial powerhouse to corporate host. Now that its corporations have shifted production elsewhere, the debt remains but the jobs have gone.”

    This is what I have been saying too! We abandon our manufacturing capabilities at great risk to our long term prosperity. Services will not fill the gap left- this is idealogical nonsense spouted by globalisation’s promoters. Developed economies are effectively experiencing the sting in globalisation’s tail – the proverbial duel edged sword. Rapid financial and industrial globalisation works well in prosperous times and is totally reliant on access to unlimited credit – credit needed to feed the beast. When economic conditions deteriorate this beast cannot be sustained in a healthy nor long term way.

    Developed economies have long abandoned their ability to ‘make things’ having succumbed to the globaliser’s myth that all that industrial stuff can be done cheaper in a foreign locale and we reap the rewards in terms of cheap consumer items – financed by the culture of easy credit. When the credit tap is reduced to a trickle, and consumer can no longer do what they do best, jobs in retail and services disappear – and there is nowhere for people to go. Not even the old standby – industrial work – we sent that overseas years ago. Jobs disappear, permanently. They don’t morph into services – services are reliant on a solid industrial base and a degree of economic prosperity.

    For the US to bounce back, there is going to have to be a reckoning with the realities of globalisation and the role of the corporation. Corporate responsibility, not only to shareholders but all ordinary citizens. There will need be a massive re-investment in US manufacturing capabilities together with political and popular media encouragement of corporations developing new facilities on home turf. A ‘Bring the Jobs Back Home’ type campaign. And a recognition that the services sector can only function effectively as part of a healthy multi-tiered economy.

    This will require a rethink of the key aspects of corporate and financial system s and the even an acceptance that a slight reduction in profits of these institutions is to be welcomed if necessary to rejuvenate a once great economy – for the benefit of all. End the tyranny of the stockmarket in terms of companies forever seeking greater share price at whatever cost – in fact, long term to their own possible destruction.

    We need a more moderate and humane vision for the future of globalisation.

    • Developed economies have long abandoned their ability to ‘make things’ …

      Well Japan and Germany are examples of developed countries with a strong manufacturing sector but apart from that generalization I agree with you points. Short of public floggings of economists who promote failed theories and frakk up countries I don’t see this changing.

      • Fair point. I think I’m focusing on the Australian adoption of the US model – of course even then a generalisation! You’re right – it’s the economic model that promotes this thinking that requires debunking. Interesting to note that the two countries that had to rebuild their economies post WW2 opted for the industrial model as a solid base.

  11. 3d1k, I would agree. Trouble is, neither party seems willing to sign onto this message, for all kinds of reasons.