The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

14 July 2007

Incredible shrinking deficit (cont.) + Retail sales growth quite modest

The following commentary is by Scott Grannis, Chief Economist at Western Asset Management.
-- David M Gordon / The Deipnosophist
Incredible shrinking deficit (cont.)

[President] Bush needs a better PR person, because the budget numbers are way better than the projections released yesterday in the Administration's midsession budget review. The review predicts the current fiscal year deficit will fall to $205 billion by September, but as of June 30 it had already fallen to $120 billion, a mere 0.9% of GDP! If recent trends continue, the deficit could reach zero within a year. Maybe they want keep the good news for later in the election cycle, or maybe they are just making some extremely conservative assumptions for the next three months. Whatever the case, it's one more example of how optimism is in short supply these days.

The good news is that federal tax revenues continue to flood in at a pace that is substantially faster than the growth of the economy, as they have since tax rates were cut three years ago. Jobs may be growing at a meager pace, but incomes, corporate profits, and capital gains remain strong across the board. There's even more good news: despite Bush's reputation as a spendthrift unable to wield his veto pen, government spending has grown at the same pace as the economy for the past four years, despite the ongoing Iraq war expenditures. And believe it or not, spending grew by only 2.7% in the 12 months ended June!

till more good news came out today as we learned that U.S. exports of goods and services in May continued to grow at the double-digit pace which has prevailed since late 2003, driven by a robust global economy and a weaker dollar. Import growth, not surprisingly, has slowed over the past year due to the weaker economy. Housing is still the principal drag on growth, but net exports have now become a key source of strength.

Returning to the jobs market, it's comforting that the 4-week moving average of weekly claims for unemployment is the same today as it was almost two years ago. The housing market is still in trouble, but life goes on. Supply-side logic says that falling home prices and a drying up of mortgage equity withdrawal (MEW) aren't really the economy killers that they are made out to be. MEW may enable some households to finance extra spending, but the money has to come from someone else's pocket, so it doesn't really represent any addition to the size of the economy. Even if falling home prices caused MEW to go to zero, the economy could still grow as long as jobs didn't start to disappear. (If spending could make the economy grow, we could spend our way to prosperity, as Art Laffer wryly notes.) In the end, the economy only grows if we work more. Claims, tax revenues and corporate profits tell us that more and more people are working productively, and that's what really counts.

Retail sales growth quite modest

Retail sales have not been very strong for the past year, and June was no exception. The year over year growth in inflation-adjusted retail sales is about as weak as it has been for a long time. Does this point toward a recession? Not necessarily.

So many things were different the last time that retail sales slumped (2000-2001) that it's hard to know where to begin. Back then the Fed was very tight, the dollar was rising, inflation was falling, gold and commodity prices were collapsing, spreads were on the moon, corporate profits had been declining for several years, and weekly unemployment claims were high and rising. All those developments reflected stress in the system, if not an outright liquidity shortage. Today there are few signs of stress or liquidity shortages. The Fed is not tight, the dollar is at the very low end of its historical range, inflation has been trending slowly up for the past 4 years, gold and commodity prices are rising, spreads are generally well-behaved (though I would note that 10-yr swap spreads at 65 bps do reflect some degree of stress, likely related to subprime mortgage and MBS-related hedging), corporate profits are at record-high levels, and unemployment claims are low and stable. About the only thing that's ominous today is the housing market, since it is clearly weak now, while back then it was going gangbusters.

It's just my opinion, but I think the overall picture is not very grim, and I'm encouraged by the ongoing strength in the global economy. It's hard to see a recession coming, but it's equally hard to see a boom. The thing I worry most about is the Democrats' relentless urge to raise taxes on the most productive sectors of the economy. Isn't there anyone in the Republican ranks who can point out that the deficit has all but disappeared and the last thing the economy needs at this point is higher taxes?


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