Thursday, October 23, 2014

Claims collapse

On a four-week moving average basis, weekly initial claims for unemployment in April 2000 were a few thousand lower than they were last week (top chart), but compared to the size of the workforce, they have never been lower than they were last week (second chart). 

The only potentially disturbing thing about this is that recessions tend to follow lows in unemployment claims. Maybe, if things can't get much better, they are likely to get worse? I think that's a premature concern, if not an meaningless concern. Low levels of firings don't cause recessions. Low levels of firings usually happen when the economy is humming along and inflation is increasing. That—rising inflation and strong growth—is what prompts the Fed to tighten monetary policy, and tighter policy inevitably results in the economy sliding into a recession a year or so later. The current recovery stands in sharp contrast: it's the weakest on record, the Fed has never been more accommodative, and the Fed is probably years away from tightening policy by enough to strangle the economy.

Plus, one of the reasons this is a weak recovery is that the pace of hiring has been relatively tepid. If this were a normal economy we might have as many as 10 million additional jobs by now. Businesses have yet to become euphoric and over-build and over-hire. Businesses instead have been very cautious this time around, keeping their operations lean and mean and their bottom lines strong. This increases the odds that the current recovery still has years of life left. Recessions usually follow periods of over-confidence; confidence today is still relatively low, and caution is still prevalent.

With firings at very low levels, it's not surprising to see that the number of persons collecting unemployment insurance hasn't been as low as it is today for the past 14 years. In less than a year the number has dropped by more than half, from 4.65 million at the end of last year to only 2 million last week. From the all-time peak of 2010, almost 10 million people have dropped off the unemployment claims rolls in just five years.

Those are dramatic changes, especially in an era which transfer payments (unemployment insurance, welfare, food stamps, disability, medicare, social security, etc.) have risen to a new all-time nominal high ($2.5 trillion)) and a new all-time high relative to total federal spending (72%). Never have so few received government assistance for losing their job, and never have so many received so much for not working.

It's not just the weakest recovery, it's the craziest.

Wednesday, October 22, 2014

Robust construction and CRE conditions

Surely this news is not widely appreciated:

According to the American Institute of Architects (AIA), their September billings index "shows robust conditions ahead for [the] construction industry." The billings index, shown in the chart above, is registering new highs for the current business cycle. Furthermore, "the recently resurgent Institutional sector is leading to broader growth for the entire construction industry.”

According to the CoStar Group, "demand [for commercial property] continues to outstrip supply across major property types, resulting in tighter vacancy rates and continued investor interest in commercial real estate." Furthermore, "price gains in [their] equal-weighted U.S. Composite Index, which is influenced more by smaller non-core deals, accelerated to an annual rate of 13.6% in August 2014." And, "rising occupancies have bolstered net operating income across a number of markets."

The outlook for the construction and commercial real estate (CRE) sectors of the economy hasn't been this strong for many years.

This lends support to my belief that the U.S. economy is doing better than most people realize or expected. That's been the case for this entire business cycle. That's why the equity market has been moving higher even though this has been the weakest recovery in history.

Tuesday, October 21, 2014

How China could explain the decline in gold

In January, 2013, I wrote a post titled "Developments in China explain the end of gold's rise." I speculated that China's spectacular growth over the previous two decades, which included a monster accumulation of foreign exchange reserves and a significant appreciation of the yuan, could have been the driver for the the incredible rise in gold prices. I then noted the slowing in China's accumulation of forex reserves, the slowing in Chinese economic growth, and the beginnings of stabilization of its currency, and asserted that "the boom in gold is over." Shortly thereafter gold suffered a significant decline which I followed up on in a post in April, 2013: "Gold is relinking to commodities."

Here's the short version of how the link between China and gold works: the outstanding stock of gold doesn't change very fast, growing only about 3% a year. But the spectacular growth of the Chinese economy beginning in the mid-1990s created legions of newly prosperous Chinese whose demand for gold pushed gold prices to stratospheric levels. China's economic boom attracted trillions of foreign investment capital, which China's central bank was forced to purchase in order to avoid a dramatic appreciation of the yuan, and to provide solid collateral backing to the soaring money supply needed to accommodate China's spectacular growth. China's explosive growth and new-found riches were what fueled the rise in gold prices. But in recent years the bloom is off the rose.

I think these same dynamics are still in play. Chinese economic growth has definitely slowed, China's forex reserves only increased by 6% in the year ending September, the yuan is unchanged over the past year, and gold prices are down by one-third from their 2011 peak. Here are some updated charts to illustrate what's going on.

China's economy is no longer booming, but 7% growth still ranks as very impressive. China's economy is not collapsing, it's maturing. Even 7% growth is unsustainable for long periods. We ought to expect further slowing in the years to come.

The growth in China's foreign exchange reserves was exponential for many years, but now it's slowed to a trickle. Capital inflows (money wanting to invest in the China boom) have slowed, while outflows (money looking for diversification overseas and money to pay for China's growing appetite for foreign goods and services) have picked up, and the two are coming into balance. That means the BoC doesn't have to buy up capital inflows to keep the currency from appreciating. The yuan is likely to be much more stable going forward.

As it is, the real value of the yuan has appreciated by an astounding 83% in the past 20 years, despite the valiant attempts by the BoC to prevent excessive appreciation. Slower growth and more balanced capital flows mean there is no more need for currency appreciation.

A strong currency and a strong economy have enabled China to enjoy a low rate of inflation for the past 15 years or so. Happily, inflation in the U.S. and China has converged. China's economy has accommodated to its strong currency, and capital flows are coming into balance. On a PPP basis, there is very little pressure for the yuan to keep appreciating.

The spectacular rise in China's forex reserves paralleled the outsized growth of its economy and mirrored the equally spectacular rise in the price of gold. Lots of newly rich Chinese (and Indians, for that matter) were eager to acquire gold for the first time, but that demand appears now to be largely sated.

Gold is still trading well above its long-term average in real terms (I calculated that the average price of gold over the past century in today's dollars is about $650/oz.), so without the onslaught of newly rich Asian buyers its price is coming back down to more closely track those of other commodity prices.

I continue to believe that the downside risks to owning gold are much greater than the upside risks, even though I worry that central banks may inadvertently spark a round of higher inflation in the years to come (as I explained in yesterday's post). If I had to reconcile those two views, I would say that today's elevated real price of gold has effectively priced in a lot of higher inflation in the future.