Friday, October 14, 2011

Retail sales and supply-side economics

Today's release of September retail sales data may be old news by now, and retail sales aren't what drives economic growth, but they sure don't paint a picture of an economy on the cusp of recession. Indeed, the strength of retail sales—which are up 8% in the past year and have now surpassed their 2008 high by 4.5%—is impressive given that 7 million fewer people are working today than at the pre-recession peak. Yes, with 5% fewer people working, we are collectively spending almost 5% more. That is a testament to the worker productivity that has occurred in the past 3 years, and the degree to which businesses have become leaner and meaner and more profitable. Government transfer payments may be helping out, of course, but most of the big "stimulus" money is now water under the bridge, with little or no lasting effect on jobs or permanent incomes, which are the main determinants of spending. A good portion of this growth in sales has got to be due a genuine improvement in economy, even though we are still way below where we should be.

As a supply-sider, I consider retail sales to be a reflection of the underlying growth fundamentals of an economy, not the principal driver of that growth. Too many people these days are insisting that what we suffer from is a lack of aggregate demand, but that gets things backward. Supply-siders understand that it's not about how demand creates more jobs—it's how more and better jobs are what create demand. If there's a chicken and egg argument here, it's that supply comes first (supply being the result of investment and work creating jobs and output) and demand follows. Or to paraphrase the great French economist Say: "supply creates its own demand."

The reason Obama's "stimulus" plans haven't worked is that in grand (and mistaken) Keynesian tradition, they have focused on stimulating demand, not on stimulating supply. As the late Jude Wanniski used to say, "we can't spend out way to prosperity." Prosperity comes only from more work, smarter work, more and better computers, more entrepreneurs, more efficient companies, and more risk-taking. Redistributing income from the rich to the poor, in the belief that the poor are more likely to spend it than the rich, and thus more likely to "stimulate" the economy, is just plain nonsensical. If anything good has come out of pouring $1 trillion of "stimulus" money down the drain, I would hope it will be understood as a failed experiment in Keynesian economics.

The continued strength in retail sales also shows that consumers in aggregate can spend more even as they deleverage. In the chart above, note that households' debt burdens (consumer and mortgage debt payments as a % of disposable income) have declined dramatically since just before the recent recession, by about 20%. This is the biggest effective deleveraging of the household sector on record. In a sense, you could say that, based on this chart, the consumer debt bubble has burst, and we are back to levels that in the past have served to launch significant economic recoveries (e.g., 1983, 1995). Of course, some portion of this deleveraging is the result of massive defaults on mortgage debt, but it still shows that debt can be cut back dramatically without causing an economy to shrink.

For more on how debt works (how more debt doesn't create money or new demand, and therefore less debt doesn't destroy money or demand), see my July post titled "Debt musings and misconceptions." This has great relevance not only to how the U.S. economy has survived a massive deleveraging largely intact, but also to how it is not inevitable that the Eurozone must implode just because the Greeks have little choice but to default on their debt. Debt does not create demand, nor does it create growth (it can facilitate growth, but not create it out of thin air), and wiping out debt therefore does not necessarily wipe out demand. The money that the PIIGS borrowed and squandered is gone: the Eurozone economy has already paid the price of its bad investment decisions and bad spending decisions. Wiping the debt slate clean, which must happen at some point, could well prove to be the catalyst for stronger growth in the future, not the death knell of the global economy.

Finally, today's retail sales number is one more in a growing list of statistics that have thrown buckets of cold water on the notion that the U.S. economy is sick and about to slip into another recession. The bond market, which only two weeks ago was priced to the expectation that the entire global economy was going down the drain, has only just begun to wake up to the fact that pessimism has gotten way out of line with reality.


elegantstroke said...

/* Debt is an agreement between two parties to exchange cash now with a reversal of that exchange, plus interest, in the future.*/

How come banks issue debt beyond their available reserves? You're telling that the banks lend out money that they already have. How can this be true when the bank leverage ratios both in US and Europe are extremely high (30:1 to 50:1)? Are you saying Fractional Reserve Banking is not what's happening when banks lend? Would appreciate your response on this.

/* Debt payments by a borrower are not equivalent to flushing money down the toilet.*/

If we assume that FRB is true and banks create credit out of thin air (more than their reserve ability to lend), then when the borrower pays off the debt - the credit created is actually destroyed. Is this also not true?

Too much borrowing beyond one's means to service the debt leads to a transitory enjoyment of the borrowing benefits, but eventually all debt needs to be repaid, written down or devalued away. Your claim that the 'damage' of too much borrowing is already done is dubious. Damage comes after borrowing, not during the borrowing phase!

Take Greece for example. Too much borrowing has allowed the people to retire early and they've enjoyed the benefits of it. Now the youth has to suffer because of the debt burden.

elegantstroke said...

/* Too many people these days are insisting that what we suffer from is a lack of aggregate demand, but that gets things backward. */

Keynesians are wrong and supply-siders are also wrong because both focus on just one side of the economic cycle (demand or supply respectively).

An economy is a cycle with producers producing products that consumers need and consumers consuming the said produced products. Both sides are *equally* important for the cycle to function in a stable manner. Too much supply or too much demand created due to artificial tinkering of interest rates is the fundamental problem.

Lowering interest rates has allowed people to borrow more than what they can, it has also allowed house prices to rise to ridiculous levels, lead to a lot of construction job boom which wouldn't have been there otherwise.

Distorting the economic cycle is the fundamental problem. Markets always try to self-correct after these distortions and these self-corrections can be very severe. The pain can be alleviated if the positive distortion that lead to the boom is compensated in the opposite direction.

Of course no distortion is probably the best option long term, but given the present nature of distorted global markets -- it is probably impractical to remove all distortions rapidly.

brodero said...

One item people neglect to realize
is there is an underground economy
the size of 7 to 10% of our GDP that shows itself in retail sales
from time to time....Breaking Bad??

Anonymous said...
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Anonymous said...

I've been doing a bit of research on ECRI's recession predictions the past couple days. Their list of predictions since 1990 is here:
ECRI Track Record

There are 2 things I'm looking at: GDP growth, and initial jobless claims.

Typically, they predict a recession 1-3 quarters before we get actual negative GDP readings. So, we could get positive GDP readings in Q3, Q4 and even Q1 next year, and their prediction could still be intact.

Initial jobless claims are a different story.
-- At the time of their February 1990 prediction, initial jobless claims had already been rising for about a year, and were continuing to slope upward.
-- At the time of their September 2000 prediction, initial jobless claims had bottomed out in April and were then sloping upwards at the time of their prediction.
-- At the time of their Nov-Dec 2007 prediction, initial claims had begun a faint upward slope since about the middle of the year.

This time, while jobless claims have, in fact, risen above their April lows, they ceased rising, plateaued and are now showing preliminary signs of falling back down again (maybe). The key here is the trend: The previous two times there was a definite, gradual upward trend. This time there were a couple of sudden shocks (Japanese earthquake and TS Irene and Elliot) which created a plateau, not a slope. If we don't see initial claims start to regularly hit the 430-450K range by the end of the year, whatever recession we may or may not get next year seems likely to be extremely weak.

Anonymous said...

"The key here is the trend: The previous two times there was a definite, gradual upward trend."

Oops, I meant the previous *three* times.

Scott Grannis said...

elegantstroke: the vast majority of debt comes from the private sector. The amount of money created by bank lending (made possible by our fractional reserve system) is minimal. The basic supply of money (M2) in circulation has grown about 6% per year over long periods, or about the same as the growth of nominal GDP. Total debt outstanding has grown by far more. The expansion of debt relative to GDP is made possible this way: I lend some money to A, A lends some money to B, and B lends some money to C, etc. Lots of lending and borrowing, but very little money creation.

Lending is an alternative to spending; the lender forgoes spending in favor of letting the borrower spend the money. When the borrower spends the money on non-productive things, then his future cash flow is insufficient to repay the lender. This is what has happened in Greece. The money has been wasted, and we see the results in very slow GDP growth.

elegantstroke said...

Scott -

Thanks for your reply. I think it would be a similar story in the US as well.

Please consider this newsletter from David Rosenberg:

In it he shows the graph of household debt to asset ratio and debt to income ratio (using Fed's data). Historically these ratios have been 13 and 70 (pre-bubble averages) but now they stand at an astounding 19 and 120. How does this correlate with what you are showing (debt as a % of disposable income)?

It depends on how you look at the data to determine what's the reality.

Scott Grannis said...

Rosenberg is a raging bear, so I think he has cherry-picked the data in his favor. Comparing debt to assets and debt to income is mixing apples and oranges. Debt is not an asset, it represents negative cash flow. And the rate on the debt is what determines the amount of negative cash flow. It's one thing to owe $100 when interest rates are 10%, and quite another when rates are 3%, for example.

I've used the Fed's chart because that compares apples to apples: the month cost of servicing debt compared to monthly after-tax (disposable) income. That compares flows to flows, and that is the only valid comparison.

Bill said...


Any idea why ECRI's leading indicators keep tanking week after week despite the good data? Can it be that we will have negative growth in Q1 or Q2 in 2012?

William said...

Scott - What would your first chart of Retail Sales look like on an inflation adjusted basis? Would that be too difficult to produce?

William said...

Bill said....Any idea why ECRI's leading indicators keep tanking week after week..."

I read recently that the ECRI is 90% correlated with the S&P 500 level although they have many other factors in their index.

Scott Grannis said...

Re ECRI: I don't follow ECRI, so I don't know why their indicators are so dismal. It doesn't jibe with what I pay attention to.

Scott Grannis said...

Real retail sales show the same pattern, obviously, but the current level is about 2.5% below the 2007 high.

Chris McFarland said...

Interesting stats. Part of me wonders what amount of the sales totals are paid for by folks who are either are no longer saving or who are living rent free in defaulted but non-foreclosed homes. I seem to recall that the savings rate has declined a bit recently. I've never seen what I feel is a good estimate for the total "freed" cash from folks living rent-free but I imagine it is substantial. However, my guess is that, as long as income does not continue to fall, the retail sales figures are still pretty good despite some helpful tailwinds.

Benjamin Cole said...

Good post--but if you lived in Japan in the early 1990s, would you have said, "Well, interest rates can't stay this low."

If we are are copying Japan's macro-economic policies--and we are--will we copy their results too?

Interest rates have been low in Japan for 20 years, and they don't look like they are going higher, despite heavy federal fiscal outlays in Japan.

If monkey-see-monkey-do, then do not be surprised to the see the Flag of the Rising Sun over the Fed.